Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation

By Richard O. Michaud

Book Overview

In spite of theoretical benefits, Markowitz mean-variance (MV) optimized portfolios often fail to meet practical investment goals of marketability, usability, and performance, prompting many investors to seek simpler alternatives. Financial experts Richard and Robert Michaud demonstrate that the limitations of MV optimization are not the result of conceptual flaws in Markowitz theory but unrealistic representation of investment information. What is missing is a realistic treatment of estimation error in the optimization and rebalancing process.

The text provides a non-technical review of classical Markowitz optimization and traditional objections. The authors demonstrate that in practice the single most important limitation of MV optimization is oversensitivity to estimation error. Portfolio optimization requires a modern statistical perspective. Efficient Asset Management, Second Edition uses Monte Carlo resampling to address information uncertainty and define Resampled Efficiency (RE) technology. RE optimized portfolios represent a new definition of portfolio optimality that is more investment intuitive, robust, and provably investment effective. RE rebalancing provides the first rigorous portfolio trading, monitoring, and asset importance rules, avoiding widespread ad hoc methods in current practice.

The Second Edition resolves several open issues and misunderstandings that have emerged since the original edition. The new edition includes new proofs of effectiveness, substantial revisions of statistical estimation, extensive discussion of long-short optimization, and new tools for dealing with estimation error in applications and enhancing computational efficiency. RE optimization is shown to be a Bayesian-based generalization and enhancement of Markowitz's solution. RE technology corrects many current practices that may adversely impact the investment value of trillions of dollars under current asset management. RE optimization technology may also be useful in other financial optimizations and more generally in multivariate estimation contexts of information uncertainty with Bayesian linear constraints.

Michaud and Michaud's new book includes numerous additional proposals to enhance investment value including Stein and Bayesian methods for improved input estimation, the use of portfolio priors, and an economic perspective for asset-liability optimization. Applications include investment policy, asset allocation, and equity portfolio optimization. A simple global asset allocation problem illustrates portfolio optimization techniques. A final chapter includes practical advice for avoiding simple portfolio design errors.

With its important implications for investment practice, Efficient Asset Management 's highly intuitive yet rigorous approach to defining optimal portfolios will appeal to investment management executives, consultants, brokers, and anyone seeking to stay abreast of current investment technology. Through practical examples and illustrations, Michaud and Michaud update the practice of optimization for modern investment management.

• Format: Hardcover
• Language: English
• ISBN: 0195331915
• ISBN13: 9780195331912
• Release Date: March 2008
• Publisher: Oxford University Press
• Length: 144 Pages
• Weight: 0.94 lbs.
• Dimensions: 0.6" x 6.4" x 9.3"

Customer Reviews

Important information when considering Markowitz optimization

Michaud's resampling methodology is quite rigorous, although the patentability of application of econometric concepts that are over 40 years old to a theory advanced by Markowitz in 1952 should be seriously questioned by any rational reader. The applicability of resampling and improvements to the inputs to estimation are clear, and should be strongly considered by anyone in the asset management industry. The book glosses over other approaches to optimization that are not based on Markowitz, all but ignoring the huge body of literature that has been built up around other optimization approaches. Except for this shortfall, this is an excellent book, and shoulds be a part of your library on quantitative asset management.

Required Reading for Sophisticated Investors

This is an excellent book for the readers with solid quant skills. This is not a course in investing for poets. So be honest with yourself about your capabilities and needs.

Raises important questions

Michaud raises several important issues that one is sure to encounter in portfolio optimization. Michaud exposes the fallibility of mean-variance optimization and suggests several techniques to obtain more reliable results. His conclusions merit consideration. Props for increasing the breadth of statistical scope of efficient asset management. Michaud is also a fluid writer. My largest complaint is that the majority of his work utilizes sign-constrained (long-only) optimization. If you manage, advise or consult on portfolio management and you utilize optimization techniques or have considered them, you should become knowledgeable with the contents of this book.

Raises important questions

Michaud raises several important issues that one is sure to encounter in portfolio optimization. Michaud exposes the fallibility of mean-variance optimization and suggests several techniques to obtain more reliable results. His conclusions merit consideration. Props for increasing the breadth of statistical scope of efficient asset management. Michaud is also a fluid writer. My largest complaint is that the majority of his work utilizes sign-constrained (long-only) optimization. If you manage, advise or consult on portfolio management and you utilize optimization techniques or have considered them, you should become knowledgeable with the contents of this book...

all you ever wanted to know...

This short, simple book offers a synthesis of research about the uses and practical problems associated with Markowitz optimization procedures. It will give you a good opportunity to see in a few interesting hours what can go wrong in implementing MV optimization and what to do to improve the process. Things that are relatively obscure, but have a direct practical relevance, such as considering the efficient frontier as having a variance, and offering some pointers on where to get arcane Stein-like estimators for the variances and covariances (Ledoit estimators). There is no math entrance barrier (almost no equations), so this book will be of benefit to users of MV optimization who want to understand the issues deeper and not just press on a button and assume that the weights they get make sense. It is to be noticed that this is not the book for those interested in quadratic programming algorithms per se, as the focus is more from a user point of view. Also notice there are no new results in the book and that sometimes I wished some discussions were more detailed - but they may be too detailed for some other readers as well. In brief an honest book, not too dumb and not too hard. An interesting and useful reading for all users of MV optimization. Also, a perfect book to complement an undergrad education in finance. NOTE: Although the presentation, printing and binding is similar to the infamous NYSE "technical" books or Wiley trader's advantage series, this is actually a good vulgarization book written by somebody having an academic training. No chaos, technical analysis or other arbitrary opinions are to be found here. In case you'd be scared by the look of it...