Bayes-Stein Estimation for Portfolio Analysis

Philippe Jorion

Journal of Financial and Quantitative Analysis, 1986, vol. 21, issue 3, 279-292

Abstract: In portfolio analysis, uncertainty about parameter values leads to suboptimal portfolio choices. The resulting loss in the investor's utility is a function of the particular estimator chosen for expected returns. So, this is a problem of simultaneous estimation of normal means under a well-specified loss function. In this situation, as Stein has shown, the classical sample mean is inadmissible. This paper presents a simple empirical Bayes estimator that should outperform the sample mean in the context of a portfolio. Simulation analysis shows that these Bayes-Stein estimators provide significant gains in portfolio selection problems.

Date: 1986
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