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1. Introduction
The mean-variance analysis of Markowitz (1952) is
currently important for both practitioners and researchers
in finance (cf. Litterman 2003). The theory provides an
easy access to the problem of optimal portfolio selection.
It is recommended that an investor invests in the portfolio
with the smallest risk for a given level of the expected
return. All optimal portfolios in the mean-variance space
lie on the parabola, which is called the efficient frontier
(cf. Merton 1972, Bodnar and Schmid 2008a).
However, by implementing the theory in a situation of
practical interest, the investor faces a number of
difficulties. The practical pitfalls of the mean-variance
analysis are mainly related to the extreme weights that
often arise when the sample efficient portfolio is
constructed (see, e.g. Merton (1980), Best and Grauer
(1991), Chopra and Ziemba (1993) among others). For
the first time, this phenomenon was studied by Merton
(1980), who argued that the estimates of the variances and
the covariances of the asset returns are more accurate
than the estimates of the means. Best and Grauer (1991)
showed that the sample efficient portfolio is extremely
sensitive to changes in the asset means, while Chopra and
Ziemba (1993) concluded for a real data set that errors
*Email: bodnar@euv-frankfurt-o.de
Quantitative Finance
ISSN 14697688 print/ISSN 14697696 online 2009 Taylor & Francis
http://www.informaworld.com
DOI: 10.1080/14697680802446748
364
T. Bodnar
subject to
w0 1 1 ,
1 1
:
10 1 1
n
1 X
0
Xt XX
t X
n 1 t1
^ GMV
w
^ 1 1
D
:
^ 1 1
10 D
^ 1 1
LD
,
^ 1 1
10 D
^
D~ 1
and w^~ GMV
7
^ 1
10 D~ 1
P
~
with X
m
t1 Xnt =m.
~ L;p L~
Let w
w. We consider the general linear hypothesis given by
H0 : w~ L;p wL;p 0 against
H1 : w~ L;p wL;p 6 0:
8
365
Let a
1
c X
a ib i xi
:
ab i0
c i
i!
10
p
~ 0 1=2 wL;p w~ L;p and
10 D~ 1 1LRL
B
10 D~ 1 1 ~ 0 1=2
~ 0 1=2 :
LRL0 LRL
LRL
10 D1 1
a
2
x2 x1
nkp1
1
2
x2
Mi x1 , x2
exp x2 =2 p dx1 dx2
detBx1 Ix2
fTp x
366
T. Bodnar
i1
X
Cji1 Mj x1 , x2 gi1j ,
j0
n k 2
p
10 D1 1
2
p
f1,mk x
p n k 1
l0 Rl
2
mk1=2
Z 1
0 1
1D 1
1 0
r w^ l;1 2
l Rl
1
nk2=2
0 1
1D 1
1 0
r wl;1 2
l Rl
0
Bn k 1 n k 1 1
x
B
,
, ;
2 F1 B
@
2
2
2 nkx
1
10 D1 1
2
r w^ l;1 C
l0 Rl
C
C
10 D1 1
2 A
r w^ l;1
1 0
l Rl
n k 2 p
Z
b 1
2
p
f1,mk x
1 b y a2 nk2=2
nk1
1
2
nk1 nk1
2 mk1=2
,
,
1 y
F
2 1
2
2
1
x
y2
;
,
2 n k x 1 y2
p p
~ and b 10 D1 1=
where a wl;1 w~ l;1 10 D~ 1 1= l0 Rl
0 ~ 1
0
0~
follows
from the
l Rl=1 D 1=l Rl. The last pequality
p
~ .
transformation y r w~ l;1 10 D~ 1 1= l0 Rl
i1
and
11
1i
^ 1
with D~ ^~
ij . Moreover, it provides a test for the
hypothesis that, e.g. all weights are equal to the
corresponding previously defined values. Consequently,
it can be used as a tool for detecting changes in the
GMVP. It permits a decision whether the portfolio should
be adjusted or not.
The results of Theorem 3.1b can be applied to construct
a 1 confidence interval for the difference w~ L;p wL;p ,
as well. It consists of all r that satisfies
0
m k 0 ^~ 1 ^
^~ 0 1
1 D 1 w~ L;p w^ L;p r LRL
p
w^~ L;p w^ L;p r F~Tp ;1 ,
12
where F~Tp ;1 stands for the 1 quantile of the
distribution of Tp with the density given in Theorem
3.1b. Equation (12) is the equation of an ellipsoid in Rp.
When the point (0, . . . , 0)0 belongs to (12) the null
hypothesis cannot be rejected. Otherwise H1 is accepted,
i.e. the holding GMVP has to be reconstructed.
Next, we consider the power function of the suggested
test. Because the distribution of Tp depends on a large
number of parameters, the discussion is given for a partial
case of the testing problem (8) with one linear restriction.
Based on Remark 2, the power function is obtained.
It depends on k, D, and L l0 only via the quantities
a and b, i.e.
Z F~T ;1
1
13
fT1 xdx ,
GT1 ; a, b 1
0
0.8
0.6
Power 0.4
0.2
0
11
2
1.5
1
0.5
0
a
0.5
0.5
1
367
1
0.75
Power 0.5
0.25
2
1.5
0
1
1
0.5
0
a
0.5
0.5
1
4. Empirical study
In order to obtain a better understanding for the results
presented in section 3, we consider an example with real
data in this section. We use weekly returns of seven
stocks, which are included in the Dow Jones index.
The considered assets in the study are the stocks of
American Express (ATX), Boeing Co. (BA), General
Motors Corp. (GM), IBM, Coca-Cola Co. (KO),
Microsoft Corp. (MSFT), and Walt Disney Co. (DIS).
The data are taken for the period from January 1995 to
December 2006. Based on the data from January 1995 to
December 1995, a global minimum variance portfolio is
determined. The rest of the data from January 1996 to
December 2006 are grouped on a yearly basis. They are
used for testing purposes.
Our aim is to detect changes in the composition of the
GMVP in two successive sub-periods. The results are
presented in table 1. It holds that k 7 and n m 52. For
each year, the estimated weights of the GMVP portfolio
and the corresponding estimators for the standard
deviation of each weight (in parentheses) are calculated.
The calculation is based on the distributional results for
the estimated GMVP weights given in section 2.
In order to test structural changes in the GMVP
weights, the test statistic of section 3 is applied.
The values of the test statistic are given in the ninth
column of table 1. Based on the results of Theorem 1b,
we obtain the p-values of the test that are given in the
Table 1. In the table the estimated GMVP weights and the test statistic Tp of section 3 are presented. We use weekly returns of
seven stocks included in the Dow Jones index for the period from January 1995 to December 2006. The weights sum to one.
The standard deviations of the estimated GMVP weights are given in parentheses. The p-values of the test are calculated using
the results of Theorem 3.1b. In the last column, the p-values of the test on the GMVP weights (see Bodnar and Schmid 2008b)
are given. Here, the test statistic from section 3 is applied by considering the estimated weights of the holding portfolio to be
known. In parentheses, the values of p and p~ are calculated with the actual GMVP weights used in the expression of the
corresponding test statistic.
Year
wATX
wBA
wGM
wIBM
wKO
wMSFT
wDIS
1995
0.09612
(0.0739)
0.06727
(0.1499)
0.05432
(0.1148)
0.26125
(0.1332)
0.00998
(0.0973)
0.03107
(0.1031)
0.01246
(0.1136)
0.07036
(0.1121)
0.04509
(0.1397)
0.36784
(0.1808)
0.04535
(0.1139)
0.24299
(0.1385)
0.16085
(0.0732)
0.20123
(0.1144)
0.28493
(0.0874)
0.08984
(0.0805)
0.32839
(0.0737)
0.08851
(0.0811)
0.03442
(0.0827)
0.20047
(0.0828)
0.13275
(0.1145)
0.06669
(0.0917)
0.04481
(0.1105)
0.05297
(0.0800)
0.12498
(0.0628)
0.32565
(0.0986)
0.19063
(0.0995)
0.20817
(0.1228)
0.09960
(0.1137)
0.27136
(0.0782)
0.18014
(0.1367)
0.09139
(0.1215)
0.07478
(0.1195)
0.03065
(0.1138)
0.01027
(0.0430)
0.05464
(0.0390)
0.07896
(0.0710)
0.05310
(0.0959)
0.09847
(0.0841)
0.32261
(0.1153)
0.19756
(0.0651)
0.08740
(0.0866)
0.00639
(0.1430)
0.17724
(0.1076)
0.48593
(0.1599)
0.20705
(0.1463)
0.01246
(0.0904)
0.12642
(0.1491)
0.32513
(0.0687)
0.14955
(0.1207)
0.11665
(0.1107)
0.38503
(0.1253)
0.10443
(0.0975)
0.30541
(0.0746)
0.66652
(0.0982)
0.47277
(0.0964)
0.51984
(0.1217)
0.28297
(0.0871)
0.56043
(0.1838)
0.42502
(0.1439)
0.07523
(0.0494)
0.09537
(0.1181)
0.01878
(0.0973)
0.18908
(0.1080)
0.13334
(0.0728)
0.11520
(0.0616)
0.19302
(0.1259)
0.14035
(0.1220)
0.14615
(0.1543)
0.22767
(0.1229)
0.21696
(0.1118)
0.06028
(0.0862)
0.13874
(0.0835)
0.10782
(0.1265)
0.46953
(0.1368)
0.06651
(0.1037)
0.14665
(0.0823)
0.10105
(0.0823)
0.01359
(0.1407)
0.01187
(0.1058)
0.02207
(0.1107)
0.01180
(0.0767)
0.13026
(0.0913)
0.14696
(0.1071)
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
p~
1.0572
0.8023
(0.8023)
0.4646
(0.1519)
0.0214
(0.2091)
0.0669
(0.2638)
0.3170
(0.8212)
0.1533
(0.0688)
0.3594
(0.8065)
0.8386
(0.4623)
0.0344
(0.2604)
0.3735
(0.3111)
0.6915
(0.1181)
0.4021
(0.4021)
0.0799
(0.0052)
0.0001
(0.0001)
0.0008
(0.0008)
0.0298
(0.0298)
0.0053
(0.0053)
0.0409
(0.0409)
0.4692
(0.4692)
0.0002
(0.0013)
0.0451
(0.0451)
0.2489
(0.2489)
2.0388
6.2524
4.7132
2.6043
3.6056
2.4234
0.9505
5.6046
2.3670
1.3661
368
T. Bodnar
5. Conclusion
In this paper we derive an exact test for detecting
structural changes in the weights of the GMVP.
The exact density of the test statistic is derived assuming
the asset returns to be independent and multivariate
normally distributed. It is shown that the density function
of the test statistic is independent of the parameters of the
asset returns k and D under the null hypothesis of no
change. As a result, the p-value of the test does not
depend on k and D, as well. It constitutes an advantage of
the suggested approach.
We implement the derived test in a practical relevant
situation by considering the weekly returns of seven
stocks included in the Dow Jones index. The obtained
results are compared with a situation where the weights of
the holding portfolio are assumed to be known. The test
on the GMVP weights of Bodnar and Schmid (2008b) is
applied. The p-values are calculated for both tests using
the numerical integration in Mathematica. Ignoring the
sample errors of the estimated weights of the holding
portfolio leads to a more frequent reconstruction of the
GMVP. It occurs another five times out of 11 for the 5%
level of significance if the GMVP weights of two
successive periods are compared.
Acknowledgement
The author would like to thank the referees for their
thoughtful and constructive suggestions that led to
a considerable improvement of this paper.
References
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13518470802423478.
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minimum variance portfolio in an elliptical model. Metrika,
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655671.
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Let us consider
y0 yx1 y a0 B1 y ax2 y0 yx1 y0 B1 yx2
Proof
(a) From Theorem 2 of Bodnar and Schmid (2008b)
and the independency of (X1, . . . , Xn) and
(Xn1, . . . , Xnm), it follows that the density of Tp
^ L;p r is
given w
~ mkp=2
fTp j w^ L;p r x fp,mk x1 Qr
1
1
m
k
p
m
k
p
1
X
2
2
i
i
1
i0
i! p
2 i
!i
~
pxQr
,
~
m k px1 Qr
369
~ 10 D~ 1 1r w~ L;p 0 LRL
~ 0 1 r w~ L;p . Let
where Qr
(a)i (a i)/(a) and Qr 10 D1 1r wL;p 0 LRL0 1
r wL;p . From (6) we get
Z
fTp x fTp jw^ L;p r xjrfw^ L;p r dr
r
nkp1
10 D1 1p=2
2
fp,mk x
n k 1 p
p=2
detLRL0
2
1
1
m
k
p
m
k
p
1
X
2
2
i
i
1
i0
i! p
2 i
i
px
I1 i ,
m k px
where
Z
a,
x2 x1
where the last equality follows from the matrix inversion
lemma, i.e. (A1 CG1D0 )1 A AC(A D0 GC)1
D0 A. Hence,
q
nm2k2p1
~ 0
i
detLRL
2
2
I1 i 0 1 p=2 mkp nkp1
1 D~ 1
i
2
Z 1 Z 1 mkp2i 2
1
x1 2
expx1 =2
0
0
!, ! nkp1
I 1
1
0 B
exp a
a
2 x2 2
x2 x1
2p=2
expx2 =2 p Mi x1 ; x2 dx1 dx2
detIx1 B1 x2
where
Mi(x1, x2) E((y0 y)i)
with
y N p(x2(Ix1
1
1 1
B x2) B a, (Ix1 B1x2)1). All combined, we
obtain the statement of Theorem 3.1a.
(b) We get B I, a 0, and Mi(x1, x2) E((y0 y)i) with
y N p(0, (x1 x2)1I). It yields
Mi x1 , x2 x1 x2 i Ex1 x2 y0 yi
i 1
i
p :
2 x1 x2
2 i
~ mkp2i=2
~ i 1 Qr
Qr
I1 i
r
1 Qrnkp1=2 dr:
p
~ 0 1=2
Making the transformation q
y 10 D~ 1 1LRL
0
1
~ 1p=2 and
~ 0 =1 D
r w~ L;p with the Jacobian detLRL
R
b1
applying the equality Ab 1=2b b 0 expAx=2dx,
b 40, it yields
q
~ 0
detLRL
2nm2k2p1=2i
I1 i 0 1 p=2
mkp
nkp1
1 D~ 1
i
2
2
Z 1 Z 1 mkp2i
Z
nkp1
1
1
x1 2
exp x1 =2x2 2
y0 yi
y
10 D~ 1 1 ~ 0 1=2
~ 0 1=2 :
LRL0 LRL
LRL
10 D1 1
A1
x2
nm2kp1
1
2
x2
nm2kp1
2
2
1 t
2
n m 2k p 1
:
2
370
T. Bodnar
Hence,
nm2kp1
n m 2k p 1
i 1
2
p 2
Ki 2
2
2
Z1 i
nm2k2p2i1
mkp2i
2
t 2 1 1 t
dt
0
nm2kp1
n m 2k p 1
i 1
2
p 2
2
2 i
2
mkp
i nkp1
2
2
:
nm2k2p1
i
2
Substitution of Ki yields
nkp1
n m 2k p 1
2
2
fT x fp,mk x
nk1
n m 2k 2p 1
2
2
1
1
i
m k p
m k p
1
X
2
px=2
i 2
i
:
1
m k px
i0
i!
n m 2k 2p 1
2
i