A unified model for regularized and robust portfolio optimization

Lukas Plachel

Journal of Economic Dynamics and Control, 2019, vol. 109, issue C

Abstract: Mean-variance optimization severely suffers from model- and estimation errors. Two commonly isolated but complementary concepts to overcome the corresponding limitations are problem regularization and robustification. I introduce a joint method for covariance regularization and robust optimization which exploits this complementarity and I show that both the regularization- as well as the robust optimization part can be achieved through systematic manipulations of the correlation matrix’ eigenvalues. An application of the method to equity markets reveals similarly attractive behavior as pure covariance regularization during normal times and improved performance if a jump in systematic risk occurs. Furthermore, the model constitutes a framework for the logically consistent incorporation of systematic risk expectations into the portfolio selection problem and thereby complements similar models for individual return expectations, such as the Black and Litterman model.

Keywords: Covariance regularization; Robust optimization; Portfolio selection (search for similar items in EconPapers)
JEL-codes: C13 C53 C61 G01 G11 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188919301769
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:109:y:2019:i:c:s0165188919301769

DOI: 10.1016/j.jedc.2019.103779

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().