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- W1512933403 abstract "Mean-variance efficient portfolios constructed using sample moments often involve taking extreme long and short positions. Hence practitioners often impose portfolio weight constraints when constructing efficient portfolios. Green and Hollifield (1992) argue that the presence of a single dominant factor in the covariance matrix of returns is why we observe extreme positive and negative weights. If this were the case then imposing the weight constraint should hurt whereas the empirical evidence is often to the contrary. We reconcile this apparent contradiction. We show that constraining portfolio weights to be nonnegative is equivalent to using the sample co-variance matrix after reducing its large elements and then form the optimal portfolio without any restrictions on portfolio weights. This shrinkage helps reduce the risk in estimated optimal portfolios even when they have negative weights in the population. Surprisingly, we also find that once the non-negativity constraint is imposed, minimum variance and minimum tracking error portfolios constructed using the sample covariance matrix perform as well as those constructed using covariance matrices estimated using factor models and shrinkage estimators." @default.
- W1512933403 created "2016-06-24" @default.
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- W1512933403 date "2001-01-01" @default.
- W1512933403 modified "2023-09-23" @default.
- W1512933403 title "Risk Reduction in Large Portfolios: A Role for Portfolio Weight Constraints" @default.
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- W1512933403 doi "https://doi.org/10.2139/ssrn.293579" @default.
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