Modern Portfolio Theory Is Still Relevant Today
- By Sam van de Schootbrugge
- 5 min read
Summary
- A Review of Financial Studies paper examines the pitfalls of mean-variance portfolio optimisation.
- It confirms a well-known result – historical sample moments are suboptimal proxies for true means and variances, and that optimisation methods estimating these past values have poor forecasting performance.
- Instead, the authors propose a new approach, coined the ‘Galton’ strategy, which uses out-of-sample forecasting errors to correct for changing relationships between past values and ex-post realisations.
- The Galton approach places fewer restrictions on past data and so avoids suffering from some of the well-documented concerns in Modern Portfolio Theory.
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