We are grateful for comments and suggestions by Björn Hansson, Mark Kritzman, Paolo Porchia, Indranarain Ramlall, Jim Steeley, Szymon Wlazlowski and one anonymous referee, as well as conference presentation attendants at the Financial Management Association European Meeting 2007 (IESE Barcelona), the European Financial Management Association Annual Meeting 2007 (WU Wien) and Money, Macroeconomics and Finance (MMF) 2007 (Birmingham University), and seminar attendants at Lund University Economics Department. The usual disclaimer applies. Correspondence to the first author, e-mail firstname.lastname@example.org.
MEAN–VARIANCE VERSUS FULL-SCALE OPTIMIZATION: BROAD EVIDENCE FOR THE UK
Article first published online: 21 NOV 2008
© 2008 The Authors. Journal compilation © 2008 Blackwell Publishing Ltd and The University of Manchester
The Manchester School
Volume 76, Issue Supplement s1, pages 134–156, September 2008
How to Cite
HAGSTRÖMER, B., ANDERSON, R. G., BINNER, J. M., ELGER, T. and NILSSON, B. (2008), MEAN–VARIANCE VERSUS FULL-SCALE OPTIMIZATION: BROAD EVIDENCE FOR THE UK. The Manchester School, 76: 134–156. doi: 10.1111/j.1467-9957.2008.01084.x
- Issue published online: 21 NOV 2008
- Article first published online: 21 NOV 2008
Portfolio choice by full-scale optimization applies the empirical return distribution to a parameterized utility function, and the maximum is found through numerical optimization. Using a portfolio choice setting of three UK equity indices we identify several utility functions featuring loss aversion and prospect theory, under which full-scale optimization is a substantially better approach than the mean–variance approach. As the equity indices have return distributions with small deviations from normality, the findings indicate much broader usefulness of full-scale optimization than has earlier been shown. The results hold in- and out-of-sample, and the performance improvements are given in terms of utility as well as certainty equivalents.