Chapter 15. Employing Portfolio Selection Models in Practice


Senior Economist, Bank for International Settlements, Basel, Switzerland

Abstract: Decisions regarding the asset composition to hold have a profound influence on the investment returns of a portfolio over longer time horizons. Balancing the risk-return trade-off that leads to a strategic benchmark choice against which the portfolio is managed is traditionally supported by quantitative decision-support tools. Furthermore, active managers often deviate temporarily from the strategic benchmark by taking tactical positions to enhance returns. Moreover, portfolio managers with fiduciary responsibilities have to ensure that risk exposures taken across different mandates reflect consistent investment views commensurate with the investment management guidelines. In these circumstances too, quantitative asset allocation models have played an increasingly import role to support the investment decisions. This chapter reviews different asset allocation models with a view to help practitioners understand their strengths and weakness while trying to employ them in real world situations.

Keywords: mean-variance optimization, Black-Litterman model, expected shortfall, equilibrium excess returns, asset allocation, pension fund, liability modeling, service cost

An important investment decision individual and institutional investors make is the choice of the asset composition to hold over a certain investment horizon. ...

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