Universal Portfolio Shrinkage

Bryan T. Kelly, Semyon Malamud, Mohammad Pourmohammadi and Fabio Trojani

No 32004, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce a nonlinear covariance shrinkage method for building optimal portfolios. Our universal portfolio shrinkage approximator (UPSA) is given in closed-form, is cheap to implement, and improves upon existing shrinkage methods. Rather than uniformly penalizing all principal components of returns or discarding low-variance ones, UPSA instead reweights components to explicitly optimize expected out-of-sample portfolio performance. In empirical applications using a large cross-section of anomaly factors, it delivers robust improvements over alternative shrinkage methods in the literature.

JEL-codes: C1 C14 C53 C55 C58 G10 G11 G14 G17 (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-mac
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