A generalized pivotal quantity approach to portfolio selection

Philip L.H. Yu, T Mathew and Yuanyuan Zhu

Journal of Applied Statistics, 2017, vol. 44, issue 8, 1402-1420

Abstract: The major problem of mean–variance portfolio optimization is parameter uncertainty. Many methods have been proposed to tackle this problem, including shrinkage methods, resampling techniques, and imposing constraints on the portfolio weights, etc. This paper suggests a new estimation method for mean–variance portfolio weights based on the concept of generalized pivotal quantity (GPQ) in the case when asset returns are multivariate normally distributed and serially independent. Both point and interval estimations of the portfolio weights are considered. Comparing with Markowitz's mean–variance model, resampling and shrinkage methods, we find that the proposed GPQ method typically yields the smallest mean-squared error for the point estimate of the portfolio weights and obtains a satisfactory coverage rate for their simultaneous confidence intervals. Finally, we apply the proposed methodology to address a portfolio rebalancing problem.

Date: 2017
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DOI: 10.1080/02664763.2016.1214241

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