On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model

Louis K.C. Chan, Jason Karceski and Josef Lakonishok

No 7039, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We evaluate the performance of different models for the covariance structure of stock returns, focusing on their use for optimal portfolio selection. Comparisons are based on forecasts of future covariances as well as the out-of-sample volatility of optimized portfolios from each model. A few factors capture the general covariance structure but adding more factors does not improve forecast power. Portfolio optimization helps for risk control, but the different covariance models yield similar results. Using a tracking error volatility criterion, larger differences appear, with particularly favorable results for a heuristic approach based on matching the benchmark's attributes.

JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 1999-03
New Economics Papers: this item is included in nep-ets and nep-fin
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (214)

Published as The Review of Financial Studies (Winter 1999).

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