Covariance complexity and rates of return on assets

Leonard C. MacLean, Michael E. Foster and William T. Ziemba

Chapter 26 in Handbook of the Fundamentals of Financial Decision Making:In 2 Parts, 2013, pp 445-465 from World Scientific Publishing Co. Pte. Ltd.

Abstract: This paper considers the estimation of the expected rate of return on a set of risky assets. The approach to estimation focuses on the covariance matrix for the returns. The structure in the covariance matrix determines shared information which is useful in estimating the mean return for each asset. An empirical Bayes estimator is developed using the covariance structure of the returns distribution. The estimator is an improvement on the maximum likelihood and Bayes-Stein estimators in terms of mean squared error. The effect of reduced estimation error on accumulated wealth is analyzed for the portfolio choice model with constant relative risk aversion utility.

Keywords: Financial Decision Making; Asset Pricing; Prospect Theory; Utility Theory; Risk Aversion; Static Portfolio Theory; Stochastic Dominance; Dynamic Modeling; Dynamic Portfolio Theory; Tactical Asset Allocation; Kelly Strategy; Capital Growth (search for similar items in EconPapers)
Date: 2013
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