Transcription of Optimal Versus Naive Diversification: How Inefficient is the ...
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Optimal Versus Naive Diversification: How Inefficient is the ...
Optimal Versus Naive Diversification:How Inefficient is the 1/NPortfolio Strategy?Victor DeMiguelLondon Business SchoolLorenzo GarlappiUniversity of Texas at AustinRaman UppalLondon Business School and CEPRWe evaluate the out-of-sample performance of the sample-based mean-variance model, andits extensions designed to reduce estimation error, relative to the Naive 1/Nportfolio. Of the14 models we evaluate across seven empirical datasets, none is consistently better than the1/Nrule in terms of Sharpe ratio, certainty-equivalent return, or turnover, which indicatesthat, out of sample, the gain from Optimal diversification is more than offset by estimationerror.
portfolio rules that impose shortselling constraints (Frost and Savarino, 1988; Chopra, 1993; Jagannathan and Ma, 2003).5 Our objective in this paper is to understand the conditions under which mean-variance optimal portfolio models can be expected to perform well even in the presence of estimation risk. To do this, we evaluate the out-of-sample
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