Portfolio Optimization Using Forward-Looking Information

Alexander Kempf, Olaf Korn and Sven Saßning

Review of Finance, 2015, vol. 19, issue 1, 467-490

Abstract: We develop a new family of estimators of the covariance matrix that relies solely on forward-looking information. It uses only current prices of plain-vanilla options. In an out-of-sample study, we show that a minimum variance strategy based on these fully-implied estimators outperforms several benchmark strategies, including various strategies based on historical estimates, index investing, and 1/N investing. The outperformance originates in crisis periods when information flow and information asymmetry are high. Although the historical benchmark strategies improve when more recent data are used, they never outperform fully-implied strategies. Thus, our results suggest that investors are better off relying on forward-looking information.

Date: 2015
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Citations: View citations in EconPapers (19)

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