Journal of Banking & Finance Vol. 34 No. 9 2010
Active portfolio management with benchmarking: A frontier based on alpha
Abstract
Active portfolio management often involves the objective of selecting a portfolio with minimum tracking error variance (TEV) for some expected gain in return over a benchmark. However, Roll (1992) shows that such portfolios are generally suboptimal because they do not belong to the mean-variance frontier and are thus overly risky. Our paper proposes an appealing method to lessen this suboptimality that involves the objective of selecting a portfolio from the set of portfolios that have minimum TEV for various levels of ex-ante alpha, which we refer to as the alpha-TEV frontier. Since practitioners commonly use ex-post alpha to assess the performance of managers, the use of this frontier aligns the objectives of managers with how their performance is evaluated. Furthermore, sensible choices of ex-ante alpha lead to the selection of portfolios that are less risky (in variance terms) than the portfolios that active managers would otherwise select.
- DOI
- 10.1016/j.jbankfin.2010.02.005
- Volume
- 34
- Issue
- 9
- Pages
- 2185-2197
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref