Questions tagged [modern-portfolio-theory]

A theoretical framework for analyzing investment portfolios based on their expected return and risk.

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1answer
82 views

Kelly Criterion for Multiple Simultaneous Correlated Bets

I am looking for an equation for the optimal fractional bet sizing for N number of simultaneous correlated bets. I am looking specifically for an equation for binary bets, but an equation for bets ...
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1answer
73 views

Why additivity assumption holds in CAPM and factor models? (Screenshot of a textbook included) [closed]

All the excerpts are from the book investment, written by Bodie. At the bottom of this post, I attached pages of the the book that show a related part of my question. Question 1. Why the variance of ...
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93 views

Criticism against mean-variance analysis

Are there any good review papers or books about the criticism against mean-variance analysis?
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396 views

How to derive this mathematical equation from the perspective of the mean-variance portfolio optimization?

Question I found a simplified inequation to decide whether the new asset A should be added to my current portfolio B. If the following inequation is satisfied, the new asset A should be added to my ...
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54 views

MPT pitfalls and solutions

I am a master student in finance and I am looking for a (literature) review paper (or book) about the pitfalls of MPT and the potential solutions. Specifically, I am interested in the sensitivity of ...
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2answers
365 views

Best books on portfolio construction?

I am a master of finance student and although I understand the basics and the theory of portfolio construction I am still struggling when it comes to the practical side of things, i.e. building a real-...
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37 views

Factor Models vs. Risk-Adjusted Performance Measures

I am building a study focusing on portfolio returns relative to a number of portfolios constructed using various ESG screening techniques. My intention is to measure and compare the performance of '...
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1answer
78 views

Carhart 4-Factor Model intercept interpretation

I've been following studies such as Kempf & Osthoff (2007) and Statman & Glushkov (2009) in building a methodology measuring ESG portfolio performance centred around the Carhart 4-Factor Model....
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64 views

Portofolio selection by aggregating online expert advice

My question is about the following 2020 article : Universal portfolio selection strategy by aggregating online expert advice. I am at the moment trying to understand the underlying logic of the ...
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57 views

Consensus expected excess return from Active Portfolio Management

In the book Active Portfolio Management, when discussing components of expected return (page 92 in edition 2), the authors mention that the consensus expected excess return $\beta_n\mu_B$ is the ...
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1answer
121 views

Optimal portfolio with only n assets (with n less than total assets)

Given a time series of a set of N assets (let's say 100), how can I find the optimal portfolio, with the constraint that only n<N assets (let's say 10) can be in the portfolio? With 'optimal ...
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36 views

CAPM derivation - active portfolio management

In the book Active Portfolio Management by Grinold and Kahn, the author presents the derivation of CAPM. I am rather confused by the notation of $\beta$ in this derivation and hope to seek some help. ...
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1answer
111 views

Active portfolio management - characteristic portfolios derivation

In the book Active Portfolio Management by Grinold and Kahn, on page 30, when it derives the characteristic portfolio $h_a$ for some characteristic vector $a$, the problem is set up as $$\min h^TVh$$ ...
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Problem from Stochastic Portfolio Theory Textbook

I'm trying to do the following problem from Robert Fernholz's textbook Stochastic Portfolio Theory: The assumptions mentioned are: and my attempt is as follows: I have no idea how to deduce that ...
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Interaction between raw position signals and portfolio optimisation methodologies [closed]

I'm trying to get my head around how the various aspects of constructing a final position generally interact and wonder whether anyone could expand on my (tentative) understanding currently. As I see ...
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1answer
36 views

How to deal with securities that has short historical data when performing mean-variance portfolio analysis?

I am trying calculate expected return and risk (stdev) based on historical data using Mean Variance Analysis framework. Let's say the portfolio has 10 stocks, 9 of them have more than 10 years history ...
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72 views

Strange efficient frontier, when I try to calculate BTC & ETH ratios using MPT(Modern Portfolio Theory) [closed]

The 10k Monte-carlo simulations all fall on the same line, instead of a proper scatter plot.. Not sure what I'm doing incorrect. It all works fine, if I include Monero in the mix. Any pointers ? I'm ...
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22 views

How to prove that the return criteria for adding an investment A to an existing portfolio can be represented using Sharpe Ratio Approach

How can I prove that the return criteria for adding an investment A to an existing portfolio can be represented as the below inequality using the Sharpe Ratio Approach for risk adjusted returns as ...
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1answer
104 views

annualized vs annual returns

For the purposes of MPT, to compute return of an asset, one typically uses the daily log return of the assets and then anualizes it and the same goes for stddev ...
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1answer
57 views

Sub-portfolio correlation

I am trying to reduce correlation matrices into sub portfolios. For example, I have a covariance matrix $\Sigma$ and weight-vector $w$ of two line items which I blend together into a sub-portfolio $\...
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78 views

Python: Parametric Portfolio optimization with data from Kenneth French

I am fairly new to Python and struggling right now. I am trying to build the parametric portfolio policies by Brandt (2009) with the data of the Fama French Factors by Kenneth French, which is taken ...
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1answer
88 views

Equivalence of Standard Deviation and Variance as a risk measure - WRONG?

In Modern Portfolio Theory, I often see that people seem to view Standard Deviation and Variance as equivalent. Example from Markowitz himself: "Thus far I have used the standard deviation ...
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1answer
95 views

RIsk-retun of 2-asset portfolio with perfect negative correlation

Risk-retun of 2-asset portfolio with perfect negative correlation $(\rho=-1)$ is a straight line with slope of $\frac{|\mu_2 - \mu_1|}{\sigma_2+\sigma_1}$ since $\sigma_P=|\omega_1\sigma_1 -\omega_2\...
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98 views

global minimum variance portfolio vs all-bond portfolio

I'm leaning portfilio theory and have got some questions. global minimum variance portfolio is defined as the leftmost point on the efficient frontier which suggest it is a all-bond portfolio if risk ...
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1answer
83 views

Optimal Portfolios with Skewed and Heavy-Tailed Distributions

I am learning about portfolio theory and been using Markowitz. I wondered, however, if I can use distributional and asymmetric information of the returns to solve the problem. For instance, I have a ...
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1answer
60 views

Should a stock with high return autocorrelation be weighted more heavily in a portfolio?

Some say the presence of autocorrelation (aka serial correlation) in a stock's financial return time series helps with forecasting its next-day movements, unlike a stock that has low serial ...
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2answers
181 views

Portfolio rebalancing to optimal weights including transaction costs and without cash component

Consider a portfolio with 4 assets (A, B, C, D) with prices, quantities, current weights, and target weights as follows: I want to rebalance the portfolio from the current weights to the target ...
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1answer
66 views

Portfolio variance $<=$ weighted average of individual variances [closed]

In portfolio theory, I often (with some justifications but the message is the same) come across the following statement: "The most important quality of portfolio variance is that its value is a ...
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1answer
85 views

Why is a smaller portfolio norm better?

If the norm of the portfolio weight vector, $\frac{1}{p}\sum_{i=1}^n |w_i|^p$ for $p=1,2$, of portfolio A is 0.6, and the norm of portfolio B is 0.4, then portfolio B is considered more attractive ...
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79 views

Prove norm $\frac{1}{p}\sum_{i=1}^n |w_i|^p$ of min-variance portfolio $\leq$ max-Sharpe portfolio

The minimum-variance portfolio weight vector is $$\boldsymbol{w}_{MV} = \frac{\boldsymbol{\Sigma}^{-1} \boldsymbol{1} }{\boldsymbol{1}' \boldsymbol{\Sigma}^{-1} \boldsymbol{1}}$$ whereas the maximum ...
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1answer
199 views

For portfolio variance, why doesn't $Var(X w) = w^\top \Sigma w$? [closed]

From multivariate asset returns $X$, we can calculate the sample covariance matrix $\Sigma$. The definition of (any) portfolio variance is $w^\top \Sigma w$, where $w$ are portfolio weights. If $X w$ ...
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59 views

Do you need multi-period ahead covariance forecast, in order to construct portfolios with weekly/monthly rebalancing?

Suppose I want to rebalance my portfolio each week. Do I then need weekly covariance forecasts, from some multivariate volatility model to do this? Ie. Insert the weekly covariance forecast $\Sigma_{t+...
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31 views

Higher risk = high reward?

Some theory (in my understanding) suggests that price is the expectation of future cash flows discounted by expected return: $$p_t=\frac{\mathbb{E}^m_t[c_{t+1}+p_{t+1}]}{1+\mathbb{E}_t^m[r_t]}$$ where ...
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1answer
79 views

Criteria for excluding an Asset Class from a Strategic Asset Allocation

While historically the return, volatility and correlation characteristics justified the inclusion of Sovereign Bonds (US Treasuries, European Central Bank Debt, etc) in Strategic Asset Allocation ...
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1answer
105 views

Maximum skewness portfolio solution derived from its Lagrangean formulation

$$\arg \min_w \quad w^\top \Sigma w$$ \begin{align}\text{s.t.} \quad \mathbf{1}^\top w = 1 \end{align} is the optimization problem for the minimum-variance portfolio weights, whose analytical solution,...
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109 views

Why isn't the asset with minimum variance given a 100% portfolio weight? [closed]

The maximum expected return portfolio is the one that assigns a 100% weight to the asset with the highest expected return amongst all assets under consideration. Shouldn't then the asset with the ...
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240 views

How to compare mean-variance-skewness-kurtosis portfolios obtained by expected utility maximization?

Suppose I have some portfolios which are the result of maximizing the expected utility of different approximations of a utility function, how do you test these portfolio's out-of-sample and how do you ...
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1answer
71 views

Correlation between mean-variance efficient portfolios

If the covariance solution between the returns series of the minimum-variance portfolio ($A$) and any other portfolio along the efficient frontier ($B$) is $$Cov_{A, B} = \frac{1}{\mathbf{1}^T\mathbf{\...
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59 views

Maximum expected return portfolio: Lagrangean derivation of closed-form analytical solution

\begin{align} \arg \min_w \enspace & -w^\top \mu \\ \mathrm{s.t.} \enspace & 1_N^\top w = 1 \\ & w_i \geq 0 \enspace \forall i=1,\dots, N \end{align} is the optimization problem for ...
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1answer
203 views

Mathematical proof that the covariance between two portfolios is $w_A^\top\Sigma w_B$

How to prove in a line-by-line derivation that the covariance between two mean-variance efficient portfolios is equal to $$w_A^\top\Sigma w_B$$ where $w_i$ is a unique portfolio weight vector, and $\...
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1answer
113 views

Efficient frontier portfolio's analytical solution for a given expected return $r$

$$\begin{equation} \boldsymbol{w}(r) = \frac{r\mathbf\Sigma^{-1} \boldsymbol{\mu}}{\boldsymbol{\mu}^{\top} \mathbf{\Sigma}^{-1}\boldsymbol{\mu}} \end{equation} $$ is the closed-form analytical ...
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Is the feasible set of portfolios an epigraph?

In mathematics, the epigraph of a function is the set of points lying on or above its graph, in this case a convex function: The efficient frontier from mean-variance portfolio analysis encloses an ...
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1answer
183 views

Does mean variance optimization work in real life? If so, why are defined benefit pension funds so underfunded?

I understand the theoretical underpinnings of mean variance optimization and modern portfolio theory. But does the application of modern portfolio theory work in real life? If so, why are all the ...
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336 views

Contribution of an asset's variance to portfolio variance

How can an asset's variance, $\sigma_i^2$, be shown to contribute to portfolio variance, $\sigma_p^2$? I was thinking of taking the derivative (first order conditions $\frac{\partial L_{\sigma_p^2}(w,\...
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48 views

Mathematical proof of out-of-sample disappointment in portfolio performance being a function of a portfolio's variance

The minimum-variance portfolio is considered more optimal than the maximum Sharpe ratio (tangency) portfolio on the grounds that its in-sample performance is less likely to disappoint out-of-sample. ...
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1answer
335 views

Derivation of mean-variance portfolio weights as closed-form analytical solution from Lagrangean equations

I am trying to find a closed form solution for the constrained MVO problem below. $\max_w w'\mu - \frac{\lambda}{2}w'\Sigma w $ s.t. $w'$1 = 1 The Lagrange for the objective is $L(w, \gamma) = w'\mu ...
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825 views

Closed-form analytical solution for the variance of the minimum-variance portfolio?

The portfolio weights vector of the minimum-variance portfolio has a closed-form analytical solution, $$\boldsymbol{w} = \frac{\boldsymbol{\Sigma}^{-1} \boldsymbol{1} }{\boldsymbol{1}^\top \boldsymbol{...
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54 views

Should the sharpe ratio always change with number of assets?

I am trying to understand if the Sharpe ratio of a portfolio change if we increase or decrease the number of assets in the portfolio. It would be helpful if you could provide an explanation with ...
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82 views

Can Merton's continuous-time portfolio model be reformulated without a utility function?

Under the standard Merton optimization problem the agent maximizes expected utility $$J(\pi,c) =\mathbb{E}\Big[\int_0^TU(c_tX_t) dt + U(X_T)\Big],$$ where the dynamics of wealth of the agent satisfy $...
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68 views

Maximum return portfolio using linear programming with quadratic constraints

In the maximum return portfolio problem formulation above, is $A=\mu^\top \Sigma^{-1} \mu$? What is $b$ equal to, and is the second constraint required? An inequality constraint for target portfolio ...

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