Ridge Regularization or Weight Constraints? Portfolio Optimization in a Small Frontier Market

Silvija Vlah Jerić (), Margareta Gardijan Kedžo () and Zrinka Lovretin Golubić ()
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Silvija Vlah Jerić: Faculty of Economics & Business, University of Zagreb
Margareta Gardijan Kedžo: Faculty of Economics & Business, University of Zagreb
Zrinka Lovretin Golubić: Faculty of Economics & Business, University of Zagreb

No 2603, EFZG Working Papers Series from Faculty of Economics and Business, University of Zagreb

Abstract: This paper examines whether ridge regularization improves portfolio performance in the Croatian equity market and whether it adds value when individual portfolio weights are already capped. We compare long-only global minimum variance (GMV) and minimum conditional value-at-risk (CVaR) portfolios using CROBEX constituent returns from 2004 onward, covering 43 index revisions and six estimation and holding-window schemes. The regularization parameter is selected adaptively using information from previous holding periods. Performance is assessed against corresponding unregularized portfolios, an equally weighted portfolio, and the CROBEX index. We also examine turnover, transaction costs, and crisis performance. Under the baseline 30% maximum-weight constraint, adaptive ridge regularization does not produce a statistically significant improvement in Sharpe ratios over the corresponding unregularized portfolios. For CVaR portfolios, the weight constraint accounts for a substantial part of the observed Sharpe-ratio improvement, while the additional benefit of ridge regularization is limited and varies across specifications. Both mechanisms have only small effects on GMV performance. Although selected CVaR specifications outperform CROBEX in cumulative returns, GMV generally provides better realized downside protection. These results suggest that ridge regularization and maximum-weight constraints are partly substitutable in this small frontier market.

Keywords: portfolio optimization; ridge regularization; maximum-weight constraints; conditional value-at-risk; global minimum variance; frontier markets; CROBEX (search for similar items in EconPapers)
JEL-codes: C58 C61 G11 (search for similar items in EconPapers)
Pages: 14
Date: 2026-09-15
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