Analytic solution to variance optimization with no short positions

DOI10.1088/1742-5468/AA9684MaRDI QIDQ3302932zbMATH OpenOpenAlexFDO

Authors Imre Kondor, Gábor Papp, Fabio Caccioli

Publication date 11 August 2020

Published in Journal of Statistical Mechanics: Theory and Experiment (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1612.07067

Mathematics Subject Classification ID

Applications of mathematical programming (90C90) Portfolio theory (91G10)

Abstract: A large portfolio of independent returns is optimized under the variance risk measure with a ban on short positions. The no-short selling constraint acts as an asymmetric $el{l}_1$ regularizer, setting some of the portfolio weights to zero and keeping the out of sample estimator for the variance bounded, avoiding the divergence present in the non-regularized case. However, the susceptibility, i.e. the sensitivity of the optimal portfolio weights to changes in the returns, diverges at a critical value $r=2$. This means that a ban on short positions does not prevent the phase transition in the optimization problem, it merely shifts the critical point from its non-regularized value of $r=1$ to $2$. At $r=2$ the out of sample estimator for the portfolio variance stays finite and the estimated in-sample variance vanishes. We have performed numerical simulations to support the analytic results and found perfect agreement for $N/T<2$. Numerical experiments on finite size samples of symmetrically distributed returns show that above this critical point the probability of finding solutions with zero in-sample variance increases rapidly with increasing $N$, becoming one in the large $N$ limit. However, these are not legitimate solutions of the optimization problem, as they are infinitely sensitive to any change in the input parameters, in particular they will wildly fluctuate from sample to sample. We also calculate the distribution of the optimal weights over the random samples and show that the regularizer preferentially removes the assets with large variances, in accord with one's natural expectation.

Recommendations

• Analytic approach to variance optimization under an \(\mathcal{l}_1\) constraint
• Replica approach to mean-variance portfolio optimization
• Mean--variance efficient portfolios with many assets: 50\% short
• The large-sample distribution of the maximum Sharpe ratio with and without short sales
• Multiple Optimal Solutions in the Portfolio Selection Model with Short-Selling

Cites work

• A generalized approach to portfolio optimization: improving performance by constraining portfolio norms
• A well-conditioned estimator for large-dimensional covariance matrices
• Distributional properties of portfolio weights
• Dominating estimators for minimum-variance portfolios
• Eigenvectors of some large sample covariance matrix ensembles
• scientific article; zbMATH DE number 1273988 (Why is no real title available?)
• scientific article; zbMATH DE number 845714 (Why is no real title available?)
• Instability of portfolio optimization under coherent risk measures
• Introduction to Modern Portfolio optimization with NUOPT and S-PLUS
• Jackknife Estimator for Tracking Error Variance of Optimal Portfolios
• Linear statistical inference for global and local minimum variance portfolios
• Liquidity risk and instabilities in portfolio optimization
• Living on the edge: phase transitions in convex programs with random data
• Minimal investment risk of a portfolio optimization problem with budget and investment concentration constraints
• Nonlinear shrinkage estimation of large-dimensional covariance matrices
• Observed universality of phase transitions in high-dimensional geometry, with implications for modern data analysis and signal processing
• On the feasibility of portfolio optimization under expected shortfall
• Portfolio optimization under expected shortfall: contour maps of estimation error
• Replica approach to mean-variance portfolio optimization
• Risk minimization through portfolio replication
• Sparse and stable Markowitz portfolios
• Stable signal recovery from incomplete and inaccurate measurements
• Statistics for high-dimensional data. Methods, theory and applications.
• Theory of Financial Risk and Derivative Pricing

Cited in

(6)

• On non-negative solutions to large systems of random linear equations
• Replica approach to mean-variance portfolio optimization
• Mean--variance efficient portfolios with many assets: 50\% short
• Macroscopic relationship in primal-dual portfolio optimization problem
• A new spin on optimal portfolios and ecological equilibria
• Analytic approach to variance optimization under an \(\mathcal{l}_1\) constraint

Describes a project that uses

Uses Software

• ElemStatLearn

This page was built for publication: Analytic solution to variance optimization with no short positions

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q3302932)