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Minimising operational risk in portfolio allocation decisions
Models play an important role in strategic asset allocation (SAA). Overdependence on the stability of models, however, can reduce the utility of the results for practitioners. Professionals face the problem of choosing an SAA model that matches their goals, and must bear the operational risk of making the wrong choice (the model risk). The present paper sets out to assist in this challenge by evaluating several methodologies for estimating efficient portfolios, according to the perspective of a global long-term investor. It also presents the resampling adjusted technique (RATE) approach to incorporate estimation risk into mean-variance portfolio selection, based on the portfolio resampling technique. The results support the use of the Michaud resampling methodology followed by the RATE, as they offer better results in terms of financial efficiency, allocation stability and diversification. The evaluation of the different models uses several international asset classes for the period between June 1998 and July 2006. The findings are very useful for practitioners who can benefit from a fairly simple and robust asset allocation methodology.
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José Luiz Barros Fernandes is a professor at the Universidade Católica de Brasília and holds a PhD in business administration and quantitative methods from the Universidad Carlos III de Madrid. He is currently working as Advisor of the Executive Office for Integrated Risk Management at the Central Bank of Brazil. His main academic interests are related to investor behaviour and strategic asset allocation.
José Renato Haas Ornelas holds a PhD in business administration and management from Bocconi University, Italy. He is currently working as Advisor of the Executive Office for Integrated Risk Management at the Central Bank of Brazil. His research topics include risk management, performance measurement, asset allocation, option pricing and behavioural finance.
CitationFernandes, José Luiz Barros and Ornelas, José Renato Haas (2009, September 1). Minimising operational risk in portfolio allocation decisions. In the Journal of Risk Management in Financial Institutions, Volume 2, Issue 4.