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http://dx.doi.org/10.7737/JKORMS.2014.39.4.137

Covariance Estimation and the Effect on the Performance of the Optimal Portfolio  

Lee, Soonhee (College of Business, KAIST)
Publication Information
Journal of the Korean Operations Research and Management Science Society / v.39, no.4, 2014 , pp. 137-152 More about this Journal
Abstract
In this paper, I suggest several techniques to estimate covariance matrix and compare the performance of the global minimum variance portfolio (GMVP) in terms of out of sample mean standard deviation and return. As a result, the return differences among the GMVPs are insignificant. The mean standard deviation of the GMVP using historical covariance is sensitive to the estimation window and the number of assets in the portfolio. Among the model covariance, the GMVP using constant systematic risk ratio model or using short sale restriction shows the best performance. The performance difference between the GMVPs using historical covariance and model covariance becomes insignificant as the historical covariance is estimated with longer estimation window. Lastly, the implied volatilities from ELW prices do not lead to superior performance to the historical variance.
Keywords
Global Minimum Variance Portfolio; Covariance Estimation; Historical Covariance; Implied Volatility; Correlation;
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