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Being Naive About Naive Diversification: Can Investment Theory Be Consistently Useful?, Jun Tu, Guofu Zhou
Being Naive About Naive Diversification: Can Investment Theory Be Consistently Useful?, Jun Tu, Guofu Zhou
Research Collection Lee Kong Chian School Of Business
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, existing theory-based portfolio strategies are not as good as we once thought, and the estimation window needed for them to beat the naive $1/N$ strategy (that invests equally across N risky assets) is 'around 3000 months for a portfolio with 25 assets and about 6000 months for a portfolio with 50 assets.' In this paper, we modify the modern portfolio theory to account for estimation errors, so that the theory …