Econ 424/Amath 540

Statistical Analysis of Ecient Portfolios

Eric Zivot
August 7, 2012
The CER Model and Ecient Portfolios
Let 1
it
denote the return on asset i in month t and assume that 1
it
follows
CER model:
1
it
iio .(j
i
, o
2
i
),
i = 1, . . . , . (assets)
t = 1, . . . , T (months)
cc(1
it
, 1
)t
) = o
i)
We estimate the CER model parameters using sample statistics giving
j
i
, o
2
i
, o
i)
Remember, the estimates j
i
, o
2
i
are o
i)
are random variables and are subject
to error
Key result: Sharpe ratios and ecient portfolios are functions of j
i
, o
2
i
, o
i)
;
they are random variables and are subject to error
Statistical Properties of Ecient portfolios
Inputs to portfolio theory are estimates from CER model j and

Sharpe ratios and ecient portfolios are functions of j and

.
The estimated Sharpe ratio is
d
S1
i
=
j
i
v
)
o
i
No easy formula for S1(
d
S1
i
)
The estimated global minimum variance portfolio is
m =

1
1
1
0

1
1
m is estimated with error because we estimate using

.
No easy analytic formulas for the standard errors of the elements of m =
( n
1
, . . . , n
a
)
0
; i.e. no easy formula for S1( n
i
)
In addition, the expected return and standard deviation of 1
j, n
= m
0
R
have additional sources of error due to the error in m. That is,
j
j, n
= m
0
j
o
j, n
= ( m
0

m)
12
No easy analytic formulas for SE( j
j, n
) and SE( o
j, n
)
Bootstrapping Ecient Portfolios
The bootstrap can be used to evaluate the sampling uncertainty of Sharpe
ratios and ecient portfolios.
Portfolio statistics to boostrap:
Portfolio weights
Portfolio expected returns and standard deviations
The CER Model and Ecient Portfolios
Result: We have seen evidence that the parameters of the CER model for
various assets are not constant over time:
Rolling estimates of j, o, and o
i)
show variation over time
Implication: Since estimates of j, o, and o
i)
are inputs to ecient portfolio
calculations, then time variation in j, o, and o
i)
imply time variation in ecient
portfolios
Rolling Ecient Portfolios
Idea: Using rolling estimates of j and compute rolling ecient portfolios
global minimum variance portfolio
ecient portfolio for target return
tangency portfolio
ecient frontier
Look at time variation in resulting portfolio weights
Rolling Global Minimum Variance Portfolio
Idea: compute estimates of portfolio weights m over rolling windows of length
a < T :
min
m(a)
m
t
(a)
0

t
(a)m
t
(a) s.t. m
t
(a)
0
1 = 1
t = a, . . . , T

t
(a) = rolling estimate of in month t
If

a
(a)

a+1
(a)

T
(a)
then
m
a
(a) m
a+1
(a) m
T
(a)
Rolling Ecient Portfolios
Idea: compute estimates of portfolio weights x over rolling windows of length
a < T for t = a, . . . , T :
min
x(a)
x
t
(a)
0

t
(a)x
t
(a)
s.t. x
t
(a)
0
1 = 1, x
t
(a)
0
j
t
(a) = j
target
j
j
t
(a) = rolling estimate of j in month t

t
(a) = rolling estimate of in month t
If
j
a
(a) j
a+1
(a) j
T
(a)

a
(a)

a+1
(a)

T
(a)
then
x
a
(a) x
a+1
(a) x
T
(a)