Tangent portfolio weights without explicitly specified expected returns

Paskalis Glabadanidis ()
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Paskalis Glabadanidis: Business School, Accounting and Finance, University of Adelaide

Journal of Asset Management, 2014, vol. 15, issue 3, No 2, 177-190

Abstract: Abstract In this article, I propose an extension of the Treynor–Black model to a case where the investor is not fully invested in the stock market at the outset and there is no need to explicitly specify securities’ expected returns. I derive explicit tangent portfolio weights based on a factor model of securities’ expected returns. The computational burden of the model is linear in the number of securities in the portfolio and does not involve any matrix inversion. I present an empirical application using the market model of Sharpe, the three-factor model of Fama and French and the four-factor model of Carhart with up to 30 industry portfolios between 1963 and 2012 and up to 1000 US stocks starting in 1992 until 2012. The portfolios perform well out-of-sample relative to the entire US value-weighted stock market portfolio with dividends reinvested from the Center for Research in Security Prices. The proposed framework can be extended in a straightforward way to time-varying factor models with multiple state variables affecting securities’ expected returns and factor loadings.

Keywords: tangent portfolio weights; factor models of expected returns; market model; Fama and French three-factor model; Carhart four-factor model; out-of-sample realized active return (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (3)

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DOI: 10.1057/jam.2014.22

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