Menu simplification for portfolio selection under short-sales constraints |
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Authors: | Farid AitSahlia Thomas Doellman Sabuhi Sardarli |
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Institution: | 1. Eugene Brigham Department of Finance and Real Estate, Warrington College of Business, University of Florida, Gainesville, Florida, USA;2. Department of Finance, John Cook School of Business, Saint Louis University, St. Louis, Missouri, USA;3. Department of Finance, College of Business Administration, Kansas State University, Manhattan, Kansas, USA |
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Abstract: | We introduce a risk-reduction-based procedure to identify a subset of funds with a resulting opportunity set that is at least as good as the original menu when short-sales are imposed. Relying on Wald tests for mean-variance spanning, we show that the better results for the subset can be explained by a higher concentration of covariance entries between its assets, ultimately leading to smaller Frobenius norms of the associated matrices. With data on US-defined contribution plans, where participants have limited financial literacy, tend to be overwhelmed and prefer to make decisions among fewer choices, we obtain a 75% average reduction. |
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Keywords: | asset allocation defined contribution plans mean-variance spanning short sales Wald test |
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