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Working Paper 2007-016D

"Mean-Variance vs. Full-Scale Optimization: Broad Evidence for the UK"
by Björn Hagströmer, Richard G. Anderson, Jane M. Binner, Thomas Elger, and Birger Nilsson

Portfolio choice by full-scale optimization applies the empirical return distribution to a parameterized utility function, and the maximum is found through numerical optimization. Using a portfolio choice setting of three UK equity indices we identify several utility functions featuring loss aversion and prospect theory, under which full-scale optimization is a substantially better approach than the mean-variance approach. As the equity indices have return distributions with small deviations from normality, the findings indicate much broader usefulness of full-scale optimization than has earlier been shown. The results hold in and out of sample, and the performance improvements are given in terms of utility as well as certainty equivalents.

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Category > Finance
Author > Richard G. Anderson
Research Papers and Publications: JEL Code > G11