Journal of the Korean Operations Research and Management Science Society (한국경영과학회지)

The Korean Operations Research and Management Science Society (한국경영과학회)
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Application of Tracking Signal to the Markowitz Portfolio Selection Model to Improve Stock Selection Ability by Overcoming Estimation Error

추적 신호를 적용한 마코위츠 포트폴리오 선정 모형의 종목 선정 능력 향상에 관한 연구

  • 김영현 (연세대학교 경영대학 경영학과) ;
  • 김홍선 (연세대학교 경영대학 경영학과) ;
  • 김성문 (연세대학교 경영대학 경영학과)
  • Received : 2015.12.18
  • Accepted : 2016.01.12
  • Published : 2016.08.31
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Abstract

The Markowitz portfolio selection model uses estimators to deduce input parameters. However, the estimation errors of input parameters negatively influence the performance of portfolios. Therefore, this model cannot be reliably applied to real-world investments. To overcome this problem, we suggest an algorithm that can exclude stocks with large estimation error from the portfolio by applying a tracking signal to the Markowitz portfolio selection model. By calculating the tracking signal of each stock, we can monitor whether unexpected departures occur on the outcomes of the forecasts on rate of returns. Thereafter, unreliable stocks are removed. By using this approach, portfolios can comprise relatively reliable stocks that have comparatively small estimation errors. To evaluate the performance of the proposed approach, a 10-year investment experiment was conducted using historical stock returns data from 6 different stock markets around the world. Performance was assessed and compared by the Markowitz portfolio selection model with additional constraints and other benchmarks such as minimum variance portfolio and the index of each stock market. Results showed that a portfolio using the proposed approach exhibited a better Sharpe ratio and rate of return than other benchmarks.

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