Risk Reduction in Style Rotation

We investigate the potential improvement in the implementation of style rotation strategies by techniques addressing estimation errors.

Author(s):

Rodrigo Dupleich

Vice President, Equities Quantitative Analysis - Europe,Citi Global Markets

Daniel Giamouridis

Assistant Professor, Department of Accounting and Finance,Athens University of Economics and Business, and Research,EDHEC Risk and Asset Management Research Centre

Chris Montagu

Director, Head of Global Quantitative Research - Europe,Citi Investment Research

We select two approaches that have recently stood out in the statistics and econometric literature and have been applied to portfolio construction literature. One builds on regularization methods which address estimation error by focusing on the weights of the constructed portfolios. And a second method that uses pooled forecasts obtained across different observation windows. Thus it focuses on minimizing estimation error in the moments of the return distribution that may arise due to structural breaks. We conclude that overall there are benefits from departing from naïve approaches which can be as significant as an improvement in the information ratio of about 54%, i.e., from 0.65 (naïve) to about 1 (dynamic).

Type: Working paper
Date: le 21/10/2010
Research Cluster : Finance

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