 Portfolio optimization with estimation errors—A robust linear regression approachYilin Du, Wenfeng He and Xiaoling Mei Journal of Empirical Finance, 2025, vol. 82, issue C Abstract: Covariance and precision matrices of asset returns are unknown in practice and must be estimated in minimum variance portfolio optimizations. Although a variety of estimators have been proposed that give better out-of-sample performance than the sample covariance matrix, they nevertheless contain estimation error of the type that is most likely to disrupt the optimizer. In this study, we propose a robust optimization framework to tackle the estimation error issue. Rather than the sample covariance matrix, as is the case with the existing approaches, our framework focuses on the row sums of estimates of the precision matrix, which can greatly minimize the number of unknown parameters. A robust linear regression framework is developed to tackle the estimate error by first rewriting the portfolio optimization as a least-squares regression model. Furthermore, our results on both simulated and empirical data reveal that the suggested robust portfolios are more stable and perform better out-of-sample than existing estimators in general. Keywords: Minimum variance portfolio; Parameter uncertainty; Precision matrix; Robust least squares (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:82:y:2025:i:c:s0927539825000416 DOI: 10.1016/j.jempfin.2025.101619 Access Statistics for this article Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff More articles in Journal of Empirical Finance from Elsevier |
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