Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?
@article{DeMiguel2009OptimalVN,
title={Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?},
author={Victor DeMiguel and Lorenzo Garlappi and Raman Uppal},
journal={Review of Financial Studies},
year={2009},
volume={22},
pages={1915-1953}
}We evaluate the out-of-sample performance of the sample-based mean-variance model, and its extensions designed to reduce estimation error, relative to the naive 1-N portfolio. Of the 14 models we evaluate across seven empirical datasets, none is consistently better than the 1-N rule in terms of Sharpe ratio, certainty-equivalent return, or turnover, which indicates that, out of sample, the gain from optimal diversification is more than offset by estimation error. Based on parameters calibrated…
Tables from this paper
table 1 
table 2 
table 3 
table 4 
table 5 
table 6 
table 7 
table 8 
table 9 
table 10 
table 11 
table 12 
table 13 
table 14 
table 15 
table 16 
table 17 
table 18 
table 19 
table 20 
table 21 
table 22 
table 23 
table 24 
table 25 
table 26 
table 27 
table 28 
table 29 
table 30 
table 31 
table 32 
table 33 
table 34 
table 35 
table 36 
table 37 
table 38 
table 39 
table 40 
table 41 
table 42 
table 43 
table 44 
table 45 
table 46 
table 47 
table 48 
table 49 
table 50 
table 51 
table 52 
table 53 
table 54 
table 55 
table 56
2,701 Citations
An Updated Review of (Sub-)Optimal Diversification Models
- Economics
- 2018
In the past decade many researchers have proposed new optimal portfolio selection strategies to show that sophisticated diversification can outperform the na\"ive 1/N strategy in out-of-sample…
How good is the out-of-sample performance of optimized portfolios : an empirical comparison of optimal versus naive diversification
- Economics
- 2014
Preceding research is inconclusive on the empirical performance of optimized portfolios. In this thesis I evaluate the out-of-sample performance of a minimum-variance portfolio, a meanvariance…
Approximating the numéraire portfolio by naive diversification
- Economics
- 2010
Estimation theory has shown, owing to the limited estimation window available for real asset data, that the sample-based Markowitz mean-variance approach produces unreliable weights that fluctuate…
Optimal Granularity for Portfolio Choice
- EconomicsJournal of Empirical Finance
- 2019
Many optimization-based portfolio rules fail to beat the simple 1/N rule out-of-sample because of parameter uncertainty. In this paper we suggest a grouping strategy in which we first form groups of…
Optimizing the Performance of Sample Mean-Variance Efficient Portfolios
- Economics
- 2012
We propose a comprehensive empirical strategy for optimizing the out-of-sample performance of sample mean-variance efficient portfolios. After constructing a sample objective function that accounts…
Does Greater Diversification Really Improve Performance in Portfolio Selection?
- Economics
- 2014
One of the fundamental principles in portfolio selection models is minimization of risk through diversification of the investment. This seems to require that in a given working universe, or market,…
The Jury is Still Out On the Performance of Naive Diversification (1/N rule)
- Computer ScienceSSRN Electronic Journal
- 2020
It is demonstrated that risk-based diversification - which rely solely on the variance-covariance matrix - strongly outperform the 1/N naive rule in terms of Sharpe ratio, certainty equivalent returns and turnover and that machine learning and clustering techniques can be used to enhance the benefits from diversification when using risk- based allocation rules.
Being Naive about Naive Diversification: Can Investment Theory be Consistently Useful
- Economics
- 2008
The modern portfolio theory pioneered by Markowitz (1952) is widely used in practice and taught in MBA texts. DeMiguel, Garlappi and Uppal (2007), however, show that, due to estimation errors,…
An optimal combination of risk-return and naive hedging
- Economics
- 2015
Taking an approach contrary to the mean-variance portfolio, recent studies have appealed to an older wisdom, ”the naive rule provides the best solution,” to improve out-of-sample performance in…
Shortfall minimization and the Naive (1/N) portfolio: an out-of-sample comparison
- Economics
- 2016
ABSTRACT Naive portfolio selection, wherein an investor allocates an equal portion of their wealth to the field of candidate assets, is a simple ad-hoc way to create a portfolio. Naive portfolio…
References
SHOWING 1-10 OF 69 REFERENCES
Parametric Portfolio Policies: Exploiting Characteristics in the Cross Section of Equity Returns
- Economics
- 2004
This work proposes a novel approach to optimizing portfolios with large numbers of assets by model directly the portfolio weight in each asset as a function of the asset’s characteristics, and presents an empirical implementation for the universe of all stocks in the CRSP-Compustat dataset.
Optimal Portfolio Choice with Parameter Uncertainty
- EconomicsJournal of Financial and Quantitative Analysis
- 2007
Abstract In this paper, we analytically derive the expected loss function associated with using sample means and the covariance matrix of returns to estimate the optimal portfolio. Our analytical…
International Portfolio Diversification with Estimation Risk
- Economics
- 1985
International portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign…
On the Sensitivity of Mean-Variance-Efficient Portfolios to Changes in Asset Means: Some Analytical and Computational Results
- Economics
- 1991
This paper investigates the sensitivity of mean-variance(MV)-efficient portfolios to changes in the means of individual assets. When only a budget constraint is imposed on the investment problem, the…
When Will Mean-Variance Efficient Portfolios Be Well Diversified?
- Economics
- 1992
The authors characterize the conditions under which efficient portfolios put small weights on individual assets. These conditions bound mean returns with measures of average absolute covariability…
An Empirical Bayes Approach to Efficient Portfolio Selection
- Economics, Computer ScienceJournal of Financial and Quantitative Analysis
- 1986
This empirical Bayes method is shown to select portfolios whose performance is superior to that achieved, given the assumption of a noninformative prior or by using classical sample estimates.
Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps
- Economics
- 2002
Mean-variance efficient portfolios constructed using sample moments often involve taking extreme long and short positions. Hence practitioners often impose portfolio weight constraints when…
Portfolio Resampling: Review and Critique
- Economics
- 2002
A well-understood fact of asset allocation is that the traditional portfolio optimization algorithm is too powerful for the quality of the inputs. Recently, a new concept called “resampled…
Portfolio Selection with Parameter and Model Uncertainty: A Multi-Prior Approach
- Economics
- 2004
In this paper, we show how an investor can incorporate uncertainty about expected returns when choosing a mean-variance optimal portfolio. In contrast to the Bayesian approach to estimation error,…