Publication: An empirical study on effect of estimation risk on portfolio risk.
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Issued Date
2007
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eng
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Mahidol University
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Thammasart University
Bibliographic Citation
Journal of Business Administration. Vol.30, No.116 (Oct.-Dec. 2007), 57-80
Suggested Citation
Sarayut Nathapan An empirical study on effect of estimation risk on portfolio risk.. Journal of Business Administration. Vol.30, No.116 (Oct.-Dec. 2007), 57-80. Retrieved from: https://repository.li.mahidol.ac.th/handle/123456789/9892
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Title
An empirical study on effect of estimation risk on portfolio risk.
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Abstract
This study explores effect of estimation risk on an admissible efficient set and
an optimal portfolio based on a Bayesian framework assuming diffuse prior and
informative conjugate prior distribution functions. Based on the U.S. sectorial
index, the result indicated that, when estimation risk is taken into account, the
admissible efficient set is not changed. Therefore, three conclusions can be
drawn. First, true portfolio returns can be represented by weighted average
sample returns given that samples are drawn from high frequency data with a
long average period. However, historical sample average is not an efficient
estimator for true parameters. Second, portfolio risk or variance, when
estimation risk is built into a decision, is affected by a scale factor. Therefore, a
Bayesian admissible efficient set will always lies to the right of the traditional
admissible efficient set due to higher risk from estimation. Third, portfolio
decisions based on a traditional approach, ignoring estimation risk, would lead
to a suboptimal portfolio due to utility loss caused by underestimation of risk.
Empirical results show that annualized Bayesian portfolio risk is larger than that
of a traditional portfolio by approximately 40 to 80 basis points for a weekly
index return interval and approximately 100 to 220 basis points for a monthly
index return interval. Moreover, the annualized average excess portfolio return
from Bayes-Stein shrinkage portfolio is higher than those of traditional, passive,
and naïve portfolio by 36, 384, and 144 basis points, respectively.