Jay's Asset Allocation Blog

Blog about my off-hours work on the problem of Asset Allocation including but not limited to Portfolio Optimization algorithms, algorithms and approaches for improved estimation of Asset Allocation inputs and other potentially related items.

Saturday, June 12, 2010

New paper on Black-Litterman tau parameter

Finally got this paper put together enough to post for some feedback.

The crux of the paper is either to use tau properly or just drop it altogether, but no sense messing around with tau when you don't even need to. Most authors would do better to drop tau from their model and use what I call the Alternative Reference Model. I think Atillio Meucci uses the same name for it, we have some agreement that it is a different animal and can be clearly defined.

I expect to make a small set of edits/updates to this paper over the next week and then get it posted up on ssrn with my other paper on Black-Litterman. Mean while the big paper will also be shortly getting some edits. I've had many people tell me over the past year or areas which are not clear, mistakes or ways to simplify the paper and I am going to start making those edits. Also came upon some interesting new metrics during the research for the tau paper. I'll leave that for another time when I get the edits made to the paper.

Friday, June 4, 2010

William Sharpe's Adaptive Asset Allocation

Just read William Sharpe's article in the latest FAJ and it seems like an interesting idea, Adaptive Asset Allocation or the concept of adapting a static asset allocation to the current market conditions based on the conditions in place when the allocation policy was determined. It frees the investor from having to rebalance as the market moves, though it seems like the literature has a lot to say about the value of rebalancing. Sharpe calls that a contrarian strategy, buying losers and selling winners and that certainly seems correct. He makes some good arguments that it cannot be an equilibrium strategy, if everybody tried to sell the latest winners or buy the loser it the market wouldn't clear. There needs to be a mix of momentum investors in order to keep the market liquid. Being an equilibrium type this argument is appealing to me on some level.

Didn't see any historical results in the paper, so I guess that has been left up to somebody else to run the analysis and see how the Adaptive Asset Allocation process works over time in order to really judge it.

I am still digesting MarkKritzman's article in the March/April FAJ which told us about the 1/N fallacy. He did lots of historical analysis and showed several portfolios beating the market portfolio and I expect that they made use of rebalancing, but he didn't spend a lot of time on simple 60/40 type portfolios.