K-fold cross validation performance comparisons of six naive portfolio selection rules: how naive can you be and still have successful out-of-sample portfolio performance?

M. Ryan Haley ()
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M. Ryan Haley: University of Wisconsin Oshkosh

Annals of Finance, 2017, vol. 13, issue 3, No 5, 353 pages

Abstract: Abstract Recent research reports that optimal portfolio selection models often perform worse than equal-weight naive diversification in out-of-sample testing. This paper extends this line of inquiry by comparing the out-of-sample performance of the equal-weight naive strategy to the out-of-sample performance of five alternative naive strategies, each of which derives from a simple heuristic that does not require any optimization. Out-of-sample portfolio performance is assessed by mean, standard deviation, skewness, and Sharpe ratio; k-fold cross validation is used as the out-of-sample testing mechanism. The results indicate that the proposed naive heuristic rules exhibit strong out-of-sample performance, in most cases superior to the equal-weight naive strategy. These findings are consequential for at least two reasons: first, if these simple heuristic-based rules outperform the equal-weight naive strategy, then by transitivity they can outperform the mean–variance- and shortfall-optimal portfolio rules that have been shown in the literature to be inferior to the equal-weight naive rule, which further emphasizes the out-of-sample fragility of “optimal” methods; and second, among naive diversification strategies, some appear more robust in out-of-sample testing than others, hence the proposed methods may be useful when forming mixed portfolio selection models wherein a naive strategy is combined with an optimal strategy to improve performance.

Keywords: Naive diversification; Optimal diversification; Cross validation; Portfolio choice; G02; G10; G11; G17 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s10436-017-0301-4

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