Characteristic-based mean-variance portfolio choice

Erik Hjalmarsson and Petar Manchev

Journal of Banking & Finance, 2012, vol. 36, issue 5, 1392-1401

Abstract: We study empirical mean-variance optimization when the portfolio weights are restricted to be direct functions of underlying stock characteristics such as value and momentum. The closed-form solution to the portfolio weights estimator shows that the portfolio problem in this case reduces to a mean-variance analysis of assets with returns given by single-characteristic strategies (e.g., momentum or value). In an empirical application to international stock return indexes, we show that the direct approach to estimating portfolio weights clearly beats a naive regression-based approach that models the conditional mean. However, a portfolio based on equal weights of the single-characteristic strategies performs about as well, and sometimes better, than the direct estimation approach, highlighting again the difficulties in beating the equal-weighted case in mean-variance analysis. The empirical results also highlight the potential for ‘stock-picking’ in international indexes using characteristics such as value and momentum with the characteristic-based portfolios obtaining Sharpe ratios approximately three times larger than the world market.

Keywords: Mean-variance analysis; Momentum strategies; Portfolio choice; Stock characteristics; Value strategies (search for similar items in EconPapers)
JEL-codes: C22 C23 G11 G15 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Working Paper: Characteristic-based mean-variance portfolio choice (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:5:p:1392-1401

DOI: 10.1016/j.jbankfin.2011.12.002

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