Constraint Attribution

Abstract

Constraints are now an integral part of the portfolio construction process.With constraints comes the challenge of understanding how they cause the optimal portfolio to deviate from a trade-off dictated by the forecasts of risk and return. Stubbs and Vandenbussche describe the theory and application of a technique that is able to quantify the impact of individual constraints in several different ways, including decomposing the difference between the optimal constrained and unconstrained portfolios as well as the difference between alphas and implied alphas as described in earlier work by Grinold and others. The authors also introduce a new technique that applies these decompositions on an ex post basis, thus providing an understanding of how constraints actually impact realized risk and return.

TOPICS: Portfolio construction, quantitative methods, security analysis and valuation