Time-varying minimum variance portfolio

Qingliang (Michael) Fan, Ruike Wu, Yanrong Yang and Wei Zhong

Journal of Econometrics, 2024, vol. 239, issue 2

Abstract: This paper proposes a new time-varying minimum variance portfolio (TV-MVP) in a large investment universe of assets. Our method extends the existing literature on minimum variance portfolios by allowing for time-varying factor loadings, which facilitates the capture of the dynamics of the covariance structure of asset returns (and hence, the optimal investment strategy in a dynamic setting). We also use a shrinkage estimation method based on a quasi-likelihood function to regularize the residual covariances further. We establish the desired theoretical properties of proposed time-varying covariance and the optimal portfolio estimators under a more realistic heavy-tailed distribution. Specifically, we provide consistency of the optimal Sharpe ratio of the TV-MVP and the sharp risk consistency. Moreover, we offer a test of constant covariance structure and show the asymptotic distribution of the test statistic. Simulation and empirical studies suggest that the performance of the proposed TV-MVP is superior, in terms of estimation accuracy and out-of-sample Sharpe ratio, compared with that of other popular contemporary methods.

Keywords: Minimum variance portfolio; Dynamic covariance; Large portfolio; Shrinkage estimation; Sharp risk consistency; Flexible rebalancing (search for similar items in EconPapers)
JEL-codes: C38 C55 C58 G11 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:239:y:2024:i:2:s0304407622001646

DOI: 10.1016/j.jeconom.2022.08.007

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