Risk reduction and mean-variance analysis: an empirical investigation

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Abstract

I examine the performance of global minimum variance (GMV) and minimum tracking error variance (TEV) portfolios in UK stock returns using different models of the covariance matrix. I find that both GMV and TEV portfolios deliver portfolio risk reduction benefits in terms of significantly lower volatility and tracking error volatility relative to passive benchmarks for every model of the covariance matrix used. However, the GMV (TEV) portfolios do not provide significantly superior Sharpe (1966) (adjusted Sharpe) performance relative to passive benchmarks except for the restricted GMV portfolios. I find that a number of alternative covariance matrix models can improve the performance of the restricted TEV portfolio formed using the sample covariance matrix but not the restricted GMV portfolio. I also find that simpler covariance matrix models perform as well as the more sophisticated models
Original languageEnglish
Pages (from-to)951-971
Number of pages21
JournalJournal of Business Finance and Accounting
Volume36
Issue number7-8
DOIs
Publication statusPublished - Oct 2009

Keywords

  • covariance matrix
  • shrinkage methods
  • mean-variance analysis

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