estimation methods in portfolio selection and the effectiveness of short sales restrictions uk evidence forecasting the mean returns vector and the covariance matrix is a key feature in implementing portfolio theory the performance of the bayes stein method for forecasting these parameters for use in the markowitz model with and without short sales was compared with that of seven other estimation methods and three alternative portfolio selection techniques this paper represents the first large scale empirical investigation of the usefulness of the bayes stein approach using historical data this data was drawn from the london stock exchange in contrast to earlier studies the relative performance of bayes stein was mixed while it produced reasonable estimates of the mean returns vector there were superior methods e g overall mean for estimating the covariance matrix when short sales were permitted when short sales were prohibited actual portfolio performance was clearly improved although there was little to choose between the various estimation methods

optimal portfolio of foreign currencies with borrowing and lending until the late sixties most american corporations held their liquid assets in the form of cash short term government notes and other highly liquid marketable securities since the early seventies more and more firms have begun to hold their current assets in foreign currencies beyond what would be required to conduct normal foreign operations in the last few years companies have accumulated and retained much more cash than they held in the past in order to understand the magnitude of this issue realize that at the end of 1977 cash and short term securities held by international business machines amounted to 5 4 billion by exxon 4 2 billion and ford and general motors held well above 3 billion obviously with this cash pile up most companies devote much attention to cash management even a slight improvement in the management of these assets means a substantial profit and firms have responded with highly trained staff in particular people familiar with the international money market and the investment opportunities available the change in attitude toward cash management may be summarized by the following quotation from a senior adviser to the j henry schroder bank and trust company companies are no longer looking at a bank balance they re looking at a

money bonds and foreign exchange in the theory of finance capital markets provide securities which allow the ownership of productive assets to be allocated among investors according to their willingness to bear risk in exchange for return and independently of their tastes for the productive services provided by the assets this paper uses the theory of finance to study the role of money as a productive asset and the transformation of money into a portfolio asset true to its purpose the capital market provides securities nominal bonds that allow an allocation of the current services of the money supply according to its current productivity and without regard for its future purchasing power risk and an allocation of the future purchasing power risk of the money supply according to the willingness of investors to bear this risk in exchange for return and without regard for investor needs for the future transactions services of money in open

bayes stein estimation for portfolio analysis in portfolio analysis uncertainty about parameter values leads to suboptimal portfolio choices the resulting loss in the investor s utility is a function of the particular estimator chosen for expected returns so this is a problem of simultaneous estimation of normal means under a well specified loss function in this situation as stein has shown the clas sical sample mean is inadmissible this paper presents a simple empirical bayes estimator that should outperform the sample mean in the context of a portfolio simulation analysis shows that these bayes stein estimators provide significant gains in portfolio selection problems

disagreement portfolio optimization and excess volatility disagreement a key factor inducing trading has been receiving ever increasing attention in recent years most research has focused on disagreement about the expected returns several authors have shown that if the average belief coincides with the true expected return in the portfolio context prices are unaffected by disagreement in this paper we study the pricing effects of disagreement about return variances we show that i disagreement about variances has systematic and significant pricing effects more disagreement leads to higher prices and ii prices are very sensitive to the degree of disagreement even if the average belief about the variance is constant tiny fluctuations in the disagreement about the variance lead to substantial price fluctuations this second result may offer an explanation for the excess volatility puzzle when small changes in the degree of disagreement occur they induce relatively large price changes yet the changes in disagreement may be hard to directly detect empirically leading to apparent excess volatility

portfolio selection an alternative approach this paper provides a solution to the portfolio diversification problem based on finding optimal weights that will result in maximizing the risk adjusted return of the underlying portfolio subject to the budget constraint contrary to the standard approach that aims at finding the required weights based on minimizing the variance of the portfolio subject to the budget constraint a mathematical proof is given for the suggested solution an application is provided to the portfolio diversification opportunity between all the share market indexes of the two largest economies in the world the results show that the portfolio created by our suggested approach leads to almost one percent increase in the risk adjusted return compared to the portfolio created by the standard method

performance of portfolios optimized with estimation error we explain the poor out of sample performance of mean variance optimized portfolios developing theoretical bias adjustments for estimation risk by asymptotically expanding future returns of portfolios formed with estimated weights we provide closed form non bayesian adjustments of classical estimates of portfolio mean and standard deviation the adjustments significantly reduce bias in international equity portfolios increase economic gains and are robust to sample size and to nonnormality dominant terms grow linearly with the number of assets and decline inversely with the number of past time periods under suitable conditions sharpe ratio maximizing tangency portfolios become more diversified using these approximation methods it may be possible to assess before investing the effect of statistical estimation error on portfolio performance

cvar models with selective hedging for international asset allocation abstract we develop an integrated simulation and optimization framework for multicurrency asset allocation problems the simulation applies principal component analysis to generate scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates we then develop and implement models that optimize the conditional value at risk cvar metric the scenario based optimization models encompass alternative hedging strategies including selective hedging that incorporates currency hedging decisions within the portfolio selection problem thus the selective hedging model determines jointly the portfolio composition and the level of currency hedging for each market via forward exchanges we examine empirically the benefits of international diversification and the impact of hedging policies on risk return profiles of portfolios we assess the effectiveness of the scenario generation procedure and the stability of the model s results by means of out of sample simulations we also compare the performance of the cvar model against that of a model that employs the mean absolute deviation mad risk measure we investigate empirically the ex post performance of the models on international portfolios of stock and bond indices using historical market data selective hedging proves to be the superior hedging strategy that improves the risk return profile of portfolios regardless of the risk measurement metric although in static tests the mad and cvar models often select portfolios that trace practically indistinguishable ex ante risk return efficient frontiers in successive applications over several consecutive time periods the cvar model attains superior ex post results in terms of both higher returns and lower volatility

right to choose in oral auctions abstract oral right to choose auctions raise higher revenue when buyers are risk averse when standard sequential and right to choose auctions allocate the objects in the same fashion this means that sellers prefer the latter

60 years of portfolio optimization practical challenges and current trends abstract the concepts of portfolio optimization and diversification have been instrumental in the development and understanding of financial markets and financial decision making in light of the 60 year anniversary of harry markowitz s paper portfolio selection we review some of the approaches developed to address the challenges encountered when using portfolio optimization in practice including the inclusion of transaction costs portfolio management constraints and the sensitivity to the estimates of expected returns and covariances in addition we selectively highlight some of the new trends and developments in the area such as diversification methods risk parity portfolios the mixing of different sources of alpha and practical multi period portfolio optimization

the benefits from international diversification for nordic investors abstract in this paper we investigate the magnitude of the benefits from international diversification from the nordic point of view special attention is paid to whether potentially increased co movement of stock markets together with more volatile nordic currencies have resulted in decreased benefits from international diversification towards the end of the 1980s moreover the paper presents evidence on the benefits from international diversification for a currency which has recently started its free float the finnish markka fim we find significant increases in stock market co movement both unhedged ex ante strategies as well as strategies hedged for exchange rate risk are investigated revealing substantial benefits from international diversification for the nordic countries however we obtain mixed results concerning the question of the optimality of hedging

confidence in the familiar an international perspective one striking feature of intemrnational portfolio investment is the extent to which equity portfolios are concentrated in the domestic equity market of the investor the home bias puzzle i examine the role of investors perception of foreign investment risk on their portfolio choices the expected retumrns and risk of foreign investment are specified through an asset pricing model with the home portfolio being the benchmark asset pastor s 2000 domestic capm the model serves as a reference point around which investors can center their prior beliefs i focus on investors prior beliefs that are consistent with the literature on confidence in the familiar foreign equities in terms of both expected returns and risk being viewed less favorably than domestic equities these prior beliefs are then combined with the data on g7 equities and the revised beliefs are used to obtain the global optimal asset allocation to hold predominantly domestic equities each g7 investor has to believe that the risk of foreign investment is several times higher than the actual risk the home bias is more of a puzzle for a u s investor during the 1970s specifying investors prior beliefs around the world capm does not help resolve the puzzle

bayesian and capm estimators of the means implications for portfolio selection abstract this paper compares active investment policies under three alternative models for estimating expected stock returns the historical sample mean a shrinkage or bayesian estimator and a capm based estimator the out of sample performance of actively managed u s industry portfolios is analyzed for these three estimators over the period 1931 to 1987 it is found that the classical method based on historical means and covariances leads to the worst forecasts and out of sample performance and is generally outperformed by shrinkage estimators an active portfolio with expected returns based on the capm produced the best results among all actively managed portfolios this strategy as we show closely matches a simple buy and hold the market rule

efficient portfolios when housing needs change over the life cycle abstract we address the issue of the efficiency of household portfolios in the presence of housing risk we treat housing stock as an asset and rents as a stochastic liability stream over the life cycle households can be short or long in their net housing position efficient financial portfolios are the sum of a standard markowitz portfolio and a housing risk hedge term that multiplies net housing wealth our empirical results show that net housing plays a key role in determining which household portfolios are inefficient the largest proportion of inefficient portfolios obtains among those with positive net housing who should invest more in stocks

trader types and volatility of emission allowance prices evidence from eu ets phase i abstract this paper studies the relation between the trading activity of market participants and the volatility of the european emission allowance price during phase i of the european union emission trading system eu ets we focus on the contrasting roles of different trader types we find evidence of a positive and significant trading activity volatility relation which appears to be stronger when accounting for trader type the positive relation can be mainly attributed to energy providers in contrast industrial companies seem to have traded more frequently when volatility levels were lower finally the non liable players represented by financial intermediaries appear to have acted as a flexible counterparty trading more with the energy sector when volatility was higher and more with the industrial firms when volatility was lower we discuss possible explanations for these contrasted positions understanding the trading activity volatility link is relevant for evaluating the efficiency of the eu ets although the relation is generally positive many players remained often inactive and traded mostly when volatility levels were lower policies targeting the engagement of less active players could lead to a smoother incorporation of information into prices and to an increase in market efficiency

risk reduction by diversification in the nordic stock markets empirical examination of the ex post potential gains of risk reduction through international portfolio diversification started with grubel 1968 levy and sarnat 1970 solnik 1974 and lessard 1974 in their survey of international finance adler and dumas 1983 p 938 summed up the results the potential for international diversification to reduce risk seems unquestionable in the wake of increasing liberalization for international portfolio investment more recent contributions include jorion 1985 1989 grauer and hakansson 1987 and levy and lerman 1988 the results of the pioneers have been corroborated by contemporary research and according to jorion 1989 p 54 international diversification extolled by grubel as early as 1968 seems to have delivered on its promises despite the long tradition of studies in international portfolio diversification there has been no such work regarding the nordic markets this paper fills the gap through an analysis of potential gains from international diversification for different nordic investors danish finnish norwegian and swedish if they invest in all the nordic equity markets until the beginning of the 1980s nordic investors particularly in finland and sweden faced legal restrictions on investment abroad see nordiska radet 1987 adler and dumas 1983 have pointed out that such restrictions would lead to partially or fully segmented markets and hietala 1989 has shown the existence of premiums in the finnish stock market in our study we do not make any direct test of whether the nordic equity markets have been segmented or integrated but our results might provide some indirect evidence the nordic countries are generally viewed as fairly homogeneous from a social political and economic point of view while international diversifi

international portfolio diversification with estimation risk international portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign securities this proposition however relies on the assumption that the required inputs to the classical mean variance analysis are known with certainty typically expected returns variances and covariances are simply replaced by their ex post sample values and the optimal portfolio is derived without mentioning the uncertainty inherent in these parameter values but the rational investor should take this uncertainty into account when forming expectations and probably will consider estimators that are less subject to estimation error than the classical sample mean this paper investigates alternative estimators of expected returns and their implications for the alleged gains from diversification an important observation is the crucial influence that errors in estimating expected returns have on portfolio analysis a closer examiprevious studies of international portfolio diversification have relied on ex post meanvariance analysis without considering the problem of estimation risk typically past averages are substituted for expected returns and no allowance is made for the uncertainty inherent in these parameter values first i demonstrate the shortcomings of such an approach and second i investigate another method of estimating expected returns initially proposed by stein by shrinking the sample averages toward a common mean i find that the out of sample performance of the optimal portfolio is substantially increased one of the implications of this method is that the classical conclusions vastly overestimate the possible gains in average returns instead benefits from diversification are more likely to accrue from a reduction in risk this paper draws on part of my dissertation at the university of chicago i am grateful to arnold zellner michael mussa george constantinides and especially john bilson for useful discussions and comments numerous improvements were also suggested by the referee this research received the generous financial support of the college interuniversitaire d etudes doctorales dans les sciences du management

a general equilibrium model of international portfolio choice we investigate in a two country general equilibrium model whether a bias in consumption towards domestic goods will necessarily lead to a preference for domestic securities we develop a model where investors are constrained to consume only from their domestic capital stock and where it is costly to transfer capital across countries in this model investors less risk averse than an investor with log utility bias their portfolios towards domestic assets investors more risk averse than log however prefer foreign assets thus this model suggests that it is unlikely that the portfolios observed empirically can be explained by the high proportion of domestic goods in total consumption we investigate in a two country general equilbrium model whether a bias in consumption toward domestic goods will necessarily lead to a preference for domestic assets in an investor s optimal portfolio we constrain investors to consume only from their domestic capital stock and introduce a proportional cost for transferring goods from one country this cost gives rise to endogenous deviations from the law of one price lop thus the home and foreign investors do not hold identical portfolios we show that an investor s optimal portfolio is biased towards domestic equity only if she is less risk averse than an investor with log utility investors with relative risk aversion greater than one exhibit a preference for the foreign asset this is because the exchange rate derived endogenously is negatively correlated with the return on the foreign asset and therefore the translated return on the foreign stock is less risky than that on the domestic stock thus the results of this model suggest that it is unlikely that the preference for domestic assets that is observed empirically can be explained by the high proportion of domestic goods in total consumption there exists a considerable body of literature documenting the gains from international diversification grubel 1968 was the first to propose that international diversification allows investors to attain lower return variances than those achievable by diversifying domestically this proposition relies on the correlation between stock indices across countries being significantly less

gains from international diversification 1968 85 returns on portfolios of stocks and bonds this paper applies the multi period investment model to a universe of international securities on the basis of the simple probability assessment approach our principal findings are 1 the gains from including non u s asset categories in the universe were remarkably large in some cases statistically significant especially for the highly risk averse strategies 2 the gains from removing the no leverage constraint were more substantial than they were in the absence of non u s securities and 3 there is strong evidence of market segmentation in that the optimal levels of investment in u s securities were mostly zero in the presence of the non u s asset categories