Parameter Estimation Techniques, Optimization Frequency, and Portfolio Return Enhancement

Abstract

Modern portfolio theory dictates that the lower the pairwise correlation between securities, the greater the potential for efficiency enhancement from ex ante optimization. When securities exhibit a high degree of pairwise correlation, ex ante optimization should provide less potential for efficiency enhancement. It is an empirical issue as to whether ex ante return estimation and optimization techniques can provide strict return enhancement in risk–return space. Strict return enhancement, without the use of leverage, may be possible if ex ante portfolio parameter estimation techniques allow securities with higher realized returns to carry greater weights in the ex ante optimal portfolio than in the benchmark portfolio. The authors of this article examine how various ex ante portfolio parameter estimation techniques and optimization/holding–period frequency intervals can enhance managed portfolio returns. Overall, the results suggest that it is possible to consistently achieve enhanced returns at much the same level of return per unit of risk as the benchmark portfolio.