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Efficient Frontier Redux
Old 07-14-2005, 01:04 PM   #1
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Efficient Frontier Redux

OAP has this nasty habit of deleting his threads, so I thought I'd repost this gem of a link somebody here posted in his thread.

Gummy's lucid explanation of the efficient frontier, complete with some relatively recent correlation data:

http://gummy-stuff.org/correlation.htm
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Re: Efficient Frontier Redux
Old 07-14-2005, 01:28 PM   #2
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Re: Efficient Frontier Redux

I wondered what the hell happened to my post! I was interested in seeing what his response might be to suggesting he needed to do a little reading befor pestering Bernstein.
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Re: Efficient Frontier Redux
Old 07-14-2005, 01:46 PM   #3
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Re: Efficient Frontier Redux

might also check out William Goetzmann's

An Introduction to Investment Theory

- Alec
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:20 PM   #4
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Re: Efficient Frontier Redux

That thread had gone way off track and what I really want is "where do you find the correlation data". Nobody so far knows how to find it.

As far a pestering Bernstein, he has a website with an email address. How can a question like "Mr. Berstein, I've just finished reading The Four Pillars and was wondering where to access correlation data on the web.?" be considered pestering.

I doubt that qualifies as pestering and the emails were several days apart.
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:23 PM   #5
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Re: Efficient Frontier Redux

Uh-huh.
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:27 PM   #6
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Re: Efficient Frontier Redux

Wab, thanks a lot for that link. *Perfect. *And as you can see from the article my questioning of correlation is not unfounded.

Still reading it but it's very interesting.
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:38 PM   #7
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Re: Efficient Frontier Redux

Has anyone seen any data on how correlation between asset classes has changed over time. It seems that most correlation data looks at the last 70-80 years. If we took a time machine back to 1960 and analyzed the correlation of asset classes, what would those correlations be (assuming we don't have any knowledge of the assets' performance data 1960-current)? What type of assets would we put in our four pillars portfolio?
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:45 PM   #8
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Re: Efficient Frontier Redux

Quote:
Originally Posted by justin
Has anyone seen any data on how correlation between asset classes has changed over time.* It seems that most correlation data looks at the last 70-80 years.* If we took a time machine back to 1960 and analyzed the correlation of asset classes, what would those correlations be (assuming we don't have any knowledge of the assets' performance data 1960-current)?* What type of assets would we put in our four pillars portfolio?*
I've seen it in finance textbooks. Yes, the correlations change over time.

You have identified the biggest hole in efficient frontier stuff. Correlations and volatilities change all the time. Getting an "optimal" portfolio is an exercise in self delusion.

Having said that, the basic thrust of the research is still of use. If I know that two asset classes are correlated less than 1, it makes sense to include at least some of both of them in my portfolio. How much of each? Well, either you get a mean-variance optimizer to give you a mathematically correct (but practically useless) answer to the fourth decomal point, or you wing it with a rough approximation. Will it be perfect? Of course not. Will it be better than having just one asset class? Almost certainly.
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:53 PM   #9
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Re: Efficient Frontier Redux

Quote:
Originally Posted by OldAgePensioner
Wab, thanks a lot for that link. *Perfect.
Well, I just reposted a link somebody else had posted in the thread you deleted.* *I consider wanton thread deletion to be pretty rude.* *I can only speak for myself, but I bet many of the people who posted in the thread didn't just post for you to read.* *They probably thought their post would contain information that would be useful or entertaining to other readers (or, like me, they simply post to read their own words).* * Please consider that before you delete another thread that you happened to start.
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Re: Efficient Frontier Redux
Old 07-14-2005, 03:59 PM   #10
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Re: Efficient Frontier Redux

Let's all play nice. OAP, I think we are trying to tell you that we consider thread deletion to be rude. 'Sup to you what to take from that.

I also wasn't trying too hard to pull your tail, so no offense intended.
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Re: Efficient Frontier Redux
Old 07-14-2005, 04:07 PM   #11
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Re: Efficient Frontier Redux

Wab,
gotcha.
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Re: Efficient Frontier Redux
Old 07-15-2005, 08:08 AM   #12
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Re: Efficient Frontier Redux

Bylo has some historical correlation data [doesn't go back pre 1970] for Canadians and Americans. If you want further back than that you'll probably have to go to SBBI.

An example of how correlations change over time is Careful with Asset Class Correlations

I think it is Chapter 9 of Roger Gibson's Asset Allocation: Balancing Financial Risk that discusses problems with optimization when assumptions [rates or return, asset correlations, etc] change [with examples]. I found it at my local library.

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Re: Efficient Frontier Redux
Old 07-15-2005, 11:55 AM   #13
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Re: Efficient Frontier Redux

Great links, Alec. I wonder if anyone has statistically shown what the best "size" of correlation is useful. In my equation below, X. Something like:

10. Re-Check Correlations for the past trailing X years.
20. Reallocate based on these correlations (either every X years or how ever often you choose to rebalance)
30 goto 10

Of course, historical data isnt an accurate measure of yadda yadda. But still.... It would be interesting to see it backtested none-the-less.
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Re: Efficient Frontier Redux
Old 07-15-2005, 11:59 AM   #14
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Re: Efficient Frontier Redux

raddr has done quite a bit of correlation study; anyone post over there?
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Re: Efficient Frontier Redux
Old 07-15-2005, 03:39 PM   #15
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Re: Efficient Frontier Redux

For those of you wishing to do the whole portfolio optimization technique, will it be worth the effort? Maybe not*

How Inefficient are Simple Asset-Allocation Strategies?

Quote:
Abstract:* * *
In this paper, we wish to evaluate the performance of simple asset-allocation strategies such as allocating 1/N to each of the N assets available. To do this, we compare the out-of-sample performance of such simple allocation rules to about ten models of optimal asset-allocation (including both static and dynamic models) for ten data sets. We find that the simple assetallocation rule of 1/N is not very inefficient. In fact, it performs quite well out-of-sample: it typically has a higher Sharpe ratio, a higher certainty equivalent value, and a lower turnover than the policies from the optimal asset allocation. The intuition for the good performance of the 1/N policy is that the loss from naive rather than optimal diversification is smaller than the loss arising from having to optimize using moments that have been estimated with error. Simulations show that the performance of policies from optimizing models relative to the 1/N rule improves with the length of the estimation window (which reduces estimation error) and also with N (which increases the gains from optimal diversification). But, even with an estimation window of 50 years, the difference in the performance of the 1/N policy and the policies from models of optimal asset allocation is not statistically significant.
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