An Empirical Study of Modern Portfolio Optimization
Sammanfattning: Mean variance optimization has shortcomings making the strategy far from optimal from an investor’s perspective. The purpose of the study is to conduct an empirical investigation as to how modern methods of portfolio optimization address the shortcomings associated with mean variance optimization. Equal risk contribution, the Most diversified portfolioand a modification of the Minimum variance portfolio are considered as alternatives to the mean variance model. Portfolio optimization models introduced are explained in detail and solved using the optimization algorithms Cyclical coordinate descent and Alternating direction method of multipliers. Through implementation and backtesting using a diverse set of indices representing various asset classes, the study shows that the mean variance model suffers from high turnover and sensitivity to input parameters in comparison to the modern alternatives. The sophisticated asset allocation models equal risk contribution and the most diversified portfolio do not rely on expected return as an input parameter, which is seen as an advantage, and are not affected to the same extent by the shortcomings associated with mean variance optimization. The paper concludes by discussing the findings critically and suggesting ideas for further research.
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