We introduce a novel shrinkage methodology for building optimal portfolios in environments of high complexity, where the number of assets is comparable to or larger than the number of observations. Our universal portfolio shrinkage approximator (UPSA) is given in closed form, is easy to implement, and improves upon existing shrinkage methods. It exhibits an explicit two-fund separation, complementing the Markowitz portfolio with an optimal complexity correction. UPSA does not annihilate the low-variance principal components (PCs) of returns; instead, it optimally reweighs them and produces a stochastic discount factor that substantially improves on its feasible PC-sparse counterparts.
Authors
Bryan T. Kelly, Semyon Malamud, Mohammad Pourmohammadi, Fabio Trojani
- Acknowledgements & Disclosure
- The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Bryan T. Kelly I have received consulting income from AQR Capital Management exceeding $10,000 over the past three years. AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.
- DOI
- https://doi.org/10.3386/w32004
- Published in
- United States of America
