Research Article

Reducing estimation risk in optimal portfolio selection when short sales are allowed

  1. Gordon J. Alexander1,*,
  2. Alexandre M. Baptista2,
  3. Shu Yan3

Article first published online: 17 NOV 2008

DOI: 10.1002/mde.1451

Issue

Managerial and Decision Economics

Managerial and Decision Economics

Volume 30, Issue 5, pages 281–305, July 2009

Additional Information

How to Cite

Alexander, G. J., Baptista, A. M. and Yan, S. (2009), Reducing estimation risk in optimal portfolio selection when short sales are allowed. Managerial and Decision Economics, 30: 281–305. doi: 10.1002/mde.1451

Author Information

  1. 1

    University of Minnesota, Minneapolis, MN, USA

  2. 2

    The George Washington University, Washington, DC, USA

  3. 3

    University of South Carolina, Columbia, SC, USA

*Carlson School of Management, Department of Finance, University of Minnesota, 321-19th Avenue South, Minneapolis, MN 55455, USA

Publication History

  1. Issue published online: 17 JUN 2009
  2. Article first published online: 17 NOV 2008

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Abstract

The issue of estimation risk is of particular interest to the decision-making processes of portfolio managers who use long–short investment strategies. Accordingly, our paper explores the question of whether a VaR constraint reduces estimation risk when short sales are allowed. We find that such a constraint notably decreases errors in estimates of the expected return, standard deviation, and VaR of optimal portfolios. Furthermore, optimal portfolios in the presence of the constraint are substantially closer to the ‘true’ efficient frontier than those in its absence. Finally, we provide VaR bounds and confidence levels for the constraint that lead to the best out-of-sample performance. Copyright © 2008 John Wiley & Sons, Ltd.

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