Optimized Portfolios vs. the Naive-Diversification Strategy

Master's thesis Business Administration BE501 - University of Agder 2019Thenoveltyof my thesisisto add to the academic debate introducedby DeMiguel, Garlappi, and Uppal (2009) anattemptto answer the question whetheroptimized portfolio strategies consistently outperform the naïve-diversification strategy. Earlier academic studiesthat have tried to defend the optimized portfolios strategies against the naïve-diversification strategyareKritzman, Page & Turkington (2010) and C.Kirby and B. Ostdiek (2010).But there are also some weaknesses by these studies that the datasets provided by Kenneth French and the performance is measured by means of the Sharpe Ratio. The study by Zakamulin (2017) aims to provide a cautionary note regardingthe use of Kenneth French datasets in portfolio optimization,without controlling whether the superior performance appears due to better mean-variance efficiency or due to exposures to established factor premiums. Also,almostalldatasets in the Kenneth French online data librarycontains the low volatility anomaly. In this thesis I want to do aresearch and find out the answer of the thesisby using 16datasets provided by Kenneth French (2018),to find out if the optimized portfolio strategies can consistently outperform the naïve-diversification strategy. Optimized strategies aresimulated over a periodfromJanuary1963 to December2018. The performanceismeasured by means of Sharpe ratioand Alpha, the Capital Asset Pricing Model and the Fama-French 3-factor model. I will focus especially on the Fama-French 3-factor. Additionally to the naïve-benchmarkstrategy, this thesis coversa study of 4 optimized strategies. The results show that the optimized portfolio strategies cannot outperformthe naïve-diversification, either can the naïve-diversification beat the optimizedportfolio strategies. By the 95% significance we cannot reject the hypothesis and the hypothesis will be equallike the paper of DeMiguelet al (2009).But withthat choosing a specific optimization portfolio strategy does not guarantee a poorly performance than the Naïve-diversification strategy when the set of portfolios are chosen arbitrarily

On the Construction of Common Size, Value and Momentum Factors in International Stock Markets: A Guide with Applications

Demand is growing for a better understanding of how assets are priced in countries outside of the U.S. While financial data are available for many firms world-wide, it is important to have a reliable and replicable method of constructing high-quality systematic risk factors from these data. This paper first documents that appropriately screened data from Thomson Reuters Datastream and Thomson Reuters Worldscope can be used to replicate closely not only U.S. market returns and the corresponding momentum risk factor (as existing work has suggested), but also the widely-used U.S. size and value risk factors. We then build novel pan-European and country-specific momentum, size, and value risk factors. By comparing our pan-European market returns and risk factors with their counterparts in the U.S., we find that they are astonishingly highly correlated. The factors we compute are made available to other researchers.Risk factors; value, size, momentum, international equity markets, asset pricing anomalies

Price Ratios and the Cross-section of Common Stock Returns on Bucharest Stock Exchange: Empirical Evidence

This paper tests the relationship between above market returns and beta, size, leverage, book-to-market equity and earning-price ratios for the Bucharest Stock Exchange common stocks. Results from cross-sectional regressions document that both book-to-market equity and earning-price ratios are important risk factors on the Romanian stock market, while, contrary to the CAPM, the relationship between stock returns and beta is insignificant, even when beta is the only explanatory variable. In addition, a portfolio selection model based on the two factors whose explanatory power on stock returns has been previously attested seems to perform well on out-ofsample data.cross-sectional regressions, risk factors, portfolio selection, Bucharest Stock Exchange

Do High ROE Stocks Outperform the Market with Persistence: An Empirical Analysis, 2009 - 2014

Academic studies by Eugene Fama and Kenneth French as well as Robert Novy Marx identify profitability as one of the factors determining the variation in excess returns in the cross section of stock returns. Using return on equity (ROE) as my measure of profitability and the S&P 500 as my universe of stocks, I examine the impact of ROE on S&P 500 stock performance for the period 2009 - 2014. I test the following hypotheses with respect to ROE: (1) Portfolios of firms with high ROE\u27s (40% or higher) outperform the market with persistence i.e. over long periods of time, (2) Growth firms with high ROE\u27s outperform value firms with high ROE\u27s, (3) Portfolios of high ROE firms outperform portfolios of low ROE firms.https://ecommons.udayton.edu/stander_posters/1715/thumbnail.jp

Long-Run Cash-Flow and Discount-Rate Risks in the Cross-Section of US Returns

This paper decomposes the overall market (CAPM) risk into parts re.ecting uncertainty related to the long-run dynamics of portfolio-speci.c and market cash .ows and discount rates. We decompose market betas into four sub-betas (as- sociated with assets.and market.s cash .ows and discount rates) and we employ a discrete time version of the I-CAPM to derive a four-beta model. The model performs well in pricing average returns on single- and double-sorted portfolios ac- cording to size, book-to-market, dividend-price ratios and past risk, by producing high estimates for the explained cross-sectional variation in average returns and economically and statistically acceptable estimates for the coe¢ cient of relative risk aversion.CAPM, cash-.ow risk,discount-rate risk, VAR-GARCH,BEKK, asset pricing

The Really Long-Run Performance of Initial Public Offerings: The Pre-NASDAQ Evidence

Financial economists in recent years have closely examined and intensely debated the performance of initial public offerings using data after the formation of NASDAQ. The paper seeks to shed light on this controversy by undertaking a large, out-of-sample study: we examine the performance for up to five years after listing of nearly 3,661 initial public offerings in the United States from 1935 to 1972. The sample displays some evidence of underperformance when event-time buy-and-hold abnormal returns are used. The underperformance disappears, however, when cumulative abnormal returns are utilized. A calendar-time analysis also shows that over the entire sample period i.e., from 1935 to 1976 IPOs return as much as the market. Finally, the intercepts in CAPM and Fama-French three-factor regressions are insignificantly different from zero suggesting no abnormal performance.

Time Varying Sensitivities on a GRID architecture

We estimate time varying risk sensitivities on a wide range of stocks' portfolios of the US market. We empirically test, on a 1926-2004 Monthly CRSP database, a classic one factor model augmented with a time varying specification of betas. Using a Kalman filter based on a genetic algorithm, we show that the model is able to explain a large part of the variability of stock returns. Furthermore we run a Risk Management application on a GRID computing architecture. By estimating a parametric Value at Risk, we show how GRID computing offers an opportunity to enhance the solution of computational demanding problems with decentralized data retrieval.

Land of Addicts? An Empirical Investigation of Habit-Based Asset Pricing Behavior

This paper studies the ability of a general class of habit-based asset pricing models to match the conditional moment restrictions implied by asset pricing theory. We treat the functional form of the habit as unknown, and to estimate it along with the rest of the model's finite dimensional parameters. Using quarterly data on consumption growth, assets returns and instruments, our empirical results indicate that the estimated habit function is nonlinear, the habit formation is better described as internal rather than external, and the estimated time-preference parameter and the power utility parameter are sensible. In addition, the estimated habit function generates a positive stochastic discount factor (SDF) proxy and performs well in explaining cross-sectional stock return data . We find that an internal habit SDF proxy can explain a cross-section of size and book-market sorted portfolio equity returns better than (i) the Fama and French (1993) three-factor model, (ii) Lettau and Ludvigson (2001) scaled consumption CAPM model, (iii) an external habit SDF proxy, (iv) the classic CAPM, and (v) the classic consumption CAPM.