How Much Should Portfolios Shrink?

Han, C.

doi:10.1111/fima.12282

How Much Should Portfolios Shrink?

Han, C.

Authors

C. Han

Abstract

This paper develops a portfolio model that penalizes the deviation from a reference portfolio. The proposed model renders a robust portfolio that performs superior under parameter uncertainty. Penalizing the deviation also improves the performance of existing shrinkage portfolio models that are sub‐optimal due to model parameter uncertainty. The equal‐weight portfolio turns out to be a better reference portfolio than the currently holding portfolio even in the presence of transaction costs. A data‐driven method for determining the degree of penalization is offered. Comprehensive simulation and empirical studies suggest that the proposed model significantly outperforms various existing models.

Citation

Han, C. (2020). How Much Should Portfolios Shrink?. Financial Management, 49(3), 707-740. https://doi.org/10.1111/fima.12282

Journal Article Type	Article
Acceptance Date	Jun 18, 2019
Online Publication Date	Aug 1, 2019
Publication Date	Sep 3, 2020
Deposit Date	Jun 26, 2019
Publicly Available Date	Aug 1, 2020
Journal	Financial Management
Print ISSN	0046-3892
Publisher	Wiley
Peer Reviewed	Peer Reviewed
Volume	49
Issue	3
Pages	707-740
DOI	https://doi.org/10.1111/fima.12282
Public URL	https://durham-repository.worktribe.com/output/1327911

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Copyright Statement
This is the accepted version of the following article: Han,C. (2020). How Much Should Portfolios Shrink? Financial Management 49(3): 707-740 which has been published in final form at [https://doi.org/10.1111/fima.12282. This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.