Portfolio turnover when IC is time-varying

Zhuanxin Ding (), R. Douglas Martin () and Chaojun Yang ()
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Zhuanxin Ding: Analytic Investors
R. Douglas Martin: University of Washington
Chaojun Yang: Shanghai Jiao-Tong University

Journal of Asset Management, 2020, vol. 21, issue 7, No 5, 609-622

Abstract: Abstract We develop new formulas for the turnover and leverage of mean–variance optimal long–short market neutral portfolios, where active weights are obtained using a factor model conditional mean forecast and a conditional forecast error covariance matrix that reflects strategy risk. We show that for eight commonly used quantitative factors, the turnovers and leverages derived using our long–short formulas are quite close to what the practitioners actually implement. We further carry out extensive simulations for long-only active portfolios and develop a highly accurate empirical formula that relates long-only turnover to long–short turnover, a transfer coefficient, portfolio target tracking error, strategy risk and a benchmark choice coefficient. Our result shows that when the proper risk model is used in factor investing, the optimal portfolio’s turnover and leverage are well within reasonable practically implementable ranges even if no additional constraints are imposed.

Keywords: Turnover; Leverage; Factor model; Conditional mean forecast; Conditional forecast error covariance matrix; Transfer coefficient (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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DOI: 10.1057/s41260-019-00145-1

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