Normative Portfolio Theory
Forthcoming International Review of Financial Analysis
Posted: 12 Sep 2014 Last revised: 9 Jul 2017
Date Written: August 1, 2015
Abstract
In this paper, we correct the adverse impact of estimation risk on both portfolio weights and performance with two new equity allocation methods we implement with estimation-free and estimated ex-ante returns. Portfolios with estimation-free ex-ante returns and systematic-to-unsystematic risk weights have statistically higher Sharpe ratios than both similar portfolios with estimated ex-ante returns and 1/N’th portfolios. Optimal portfolio methods with well-behaved weights guide investors in a way not hitherto possible (normative portfolio theory).
Keywords: Equity Allocation, Estimation Risk, Ex Ante Returns, Sharpe Ratio
JEL Classification: G14, G15
Suggested Citation: Suggested Citation