Universal Portfolio Shrinkage

Bryan T. Kelly, Semyon Malamud, Mohammad Pourmohammadi and Fabio Trojani

No 32004, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce a novel shrinkage methodology for building optimal portfolios in environments of high complexity, where the number of assets is comparable to or larger than the number of observations. Our universal portfolio shrinkage approximator (UPSA) is given in closed form, is easy to implement, and improves upon existing shrinkage methods. It exhibits an explicit two-fund separation, complementing the Markowitz portfolio with an optimal complexity correction. UPSA does not annihilate the low-variance principal components (PCs) of returns; instead, it optimally reweighs them and produces a stochastic discount factor that substantially improves on its feasible PC-sparse counterparts.

JEL-codes: C1 C14 C53 C55 C58 G10 G11 G14 G17 (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-mac
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