Bayesian mean-variance analysis: optimal portfolio selection under parameter uncertainty

DOI10.1080/14697688.2020.1748214zbMATH Open1466.91277arXiv1803.03573OpenAlexW3024688460MaRDI QIDQ4991069FDOQ4991069

Authors: David Bauder, Taras Bodnar, Nestor Parolya, Wolfgang Schmid 

Publication date: 2 June 2021

Published in: Quantitative Finance (Search for Journal in Brave)

Abstract: The paper solves the problem of optimal portfolio choice when the parameters of the asset returns distribution, like the mean vector and the covariance matrix are unknown and have to be estimated by using historical data of the asset returns. The new approach employs the Bayesian posterior predictive distribution which is the distribution of the future realization of the asset returns given the observable sample. The parameters of the posterior predictive distributions are functions of the observed data values and, consequently, the solution of the optimization problem is expressed in terms of data only and does not depend on unknown quantities. In contrast, the optimization problem of the traditional approach is based on unknown quantities which are estimated in the second step leading to a suboptimal solution. We also derive a very useful stochastic representation of the posterior predictive distribution whose application leads not only to the solution of the considered optimization problem, but provides the posterior predictive distribution of the optimal portfolio return used to construct a prediction interval. A Bayesian efficient frontier, a set of optimal portfolios obtained by employing the posterior predictive distribution, is constructed as well. Theoretically and using real data we show that the Bayesian efficient frontier outperforms the sample efficient frontier, a common estimator of the set of optimal portfolios known to be overoptimistic.

Full work available at URL: https://arxiv.org/abs/1803.03573

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zbMATH Keywords

optimal portfolioparameter uncertaintyefficient frontierstochastic representationposterior predictive distributionBlack-Litterman model

Mathematics Subject Classification ID

Applications of statistics to actuarial sciences and financial mathematics (62P05) Portfolio theory (91G10) Optimal stochastic control (93E20)

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Cited In (26)

• Optimal investment in ambiguous financial markets with learning
• Bayesian inference for the tangent portfolio
• Bayesian portfolio optimization for electricity generation planning
• Bayesian learning for the Markowitz portfolio selection problem
• Portfolio Choice and Estimation Risk. A Comparison of Bayesian to Heuristic Approaches
• BAYESIAN INTERPRETATION OF CONTINUOUS-TIME UNIVERSAL PORTFOLIOS(Special Issue on Theory, Methodology and Applications in Financial Engneering)
• An improvement of the parameter certainty equivalence method in portfolio selection
• Title not available (Why is that?)
• An application of a minimax Bayes rule and shrinkage estimators to the portfolio selection problem under the Bayesian approach
• Bayesian filtering for multi-period mean-variance portfolio selection
• Portfolio selection based on Bayesian theory
• Bayesian estimation of the efficient frontier
• Mean-variance portfolios using Bayesian vector-autoregressive forcasts
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• Bayesian portfolio selection with multi-variate random variance models
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• Bayesian Estimation and Optimization for Learning Sequential Regularized Portfolios
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• Bayesian adaptive portfolio optimization
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Uses Software

• BayesDA

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