A mean-variance portfolio optimization based on firm characteristics and its performance evaluation

Abstract

A flexible and financially sensible methodology that takes quantifiable firm’s characteristics into account when constructing a portfolio inspired by Brandt et al. (2009) and Hjalmarsson and Manchev (2010) is described. The method imposes the weights to be a linear function of characteristics for investor that maximizes return and penalizes for amount of volatility and solves the optimization model with a statistical method suggested by Britten-Jones (1999). It is designed in a way to be dollar-and beta-neutral.

In order to exploit the information of some of the return-predictive factors with the described method, we form various single- and combined-factor strategies on a portfolio of 76 stocks out of FTSE100 in the period of January 2000 to October 2011 both in-sample and 60-rolling window out-of-sample. The results show that the designed strategies based on abnormal return, Jenson’s alpha and bootstrapped Sharpe-ratio lead to better performance in most of the designed strategies. Holding-based and expectation-based evaluation methods also support our results.