Robust portfolio construction controlling the alpha-weight angle

Estimation risk is widely seen to have a significant impact on mean-variance portfolios and is one of the major reasons the standard Markowitz theory has been criticized in practice. While several attempts to incorporate estimation risk has been considered in the past, the approach by of Golts and Jones (2009) represents an innovative approach to incorporate estimation risk in the sample estimates of the input returns and covariance matrix. In this project we discuss the theory introduced by Golts and Jones (2009) which looks at the direction and the magnitude of the vector of optimal weight and investigates them separately, with focus on the former. We demystify the theory of the authors with focus on both mathematical reasoning and practical application. We show that the distortions of the mean-variance optimization process can be quantified by considering the angle between the vector of expected returns and the vector of optimized portfolio positions. Golts and Jones (2009) call this the alpha-weight angle. We show how to control this angle by employing robust optimization techniques, which we also explore as a main focus in this project. We apply this theory to the South African market and show that we can indeed obtain portfolios with lower risk statistics especially so in times of economic crisis.

Grantor dc:publisher.institution

Division of Actuarial Science

Year dc:date.issued

2013

Author dc:creator

• Bailey, Geraldine

Advisor dc:contributor.advisor

• Bradfield, Dave

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/11427/5812

OAI identifier oai:identifier

oai:open.uct.ac.za:11427/5812