Active portfolio management with benchmarking: A frontier based on alpha
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.
Year of publication: |
2010
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Authors: | Alexander, Gordon J. ; Baptista, Alexandre M. |
Published in: |
Journal of Banking & Finance. - Elsevier, ISSN 0378-4266. - Vol. 34.2010, 9, p. 2185-2197
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Publisher: |
Elsevier |
Keywords: | Active portfolio management Benchmarking Alpha Tracking error Risk management |
Saved in:
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