TY - JOUR
T1 - Estimation error in mean returns and the mean-variance efficient frontier
AU - Simaan, Majeed
AU - Simaan, Yusif
AU - Tang, Yi
N1 - Publisher Copyright:
© 2017 Elsevier Inc.
PY - 2018/7
Y1 - 2018/7
N2 - In this paper, we build estimation error in mean returns into the mean-variance (MV) portfolio theory under the assumption that returns on individual assets follow a joint normal distribution. We derive the conditional sampling distribution of the MV portfolio along with its mean and risk return when the sample covariance matrix is equal to the population covariance matrix. We use the mean squared error (MSE) to characterize the effects of estimation error in mean returns on the joint sampling distributions and examine how such error affects the risk-return tradeoff of the MV portfolios. We show that the negative effects of error in mean returns on the joint sampling distributions increase with the decision maker's risk tolerance and the number of assets in a portfolio, but decrease with the sample size.
AB - In this paper, we build estimation error in mean returns into the mean-variance (MV) portfolio theory under the assumption that returns on individual assets follow a joint normal distribution. We derive the conditional sampling distribution of the MV portfolio along with its mean and risk return when the sample covariance matrix is equal to the population covariance matrix. We use the mean squared error (MSE) to characterize the effects of estimation error in mean returns on the joint sampling distributions and examine how such error affects the risk-return tradeoff of the MV portfolios. We show that the negative effects of error in mean returns on the joint sampling distributions increase with the decision maker's risk tolerance and the number of assets in a portfolio, but decrease with the sample size.
KW - Estimation error
KW - Investment
KW - Multivariate analysis
KW - Portfolio theory
UR - http://www.scopus.com/inward/record.url?scp=85033701098&partnerID=8YFLogxK
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U2 - 10.1016/j.iref.2017.10.019
DO - 10.1016/j.iref.2017.10.019
M3 - Article
AN - SCOPUS:85033701098
SN - 1059-0560
VL - 56
SP - 109
EP - 124
JO - International Review of Economics and Finance
JF - International Review of Economics and Finance
ER -