A1609
Title: Sparse spanning portfolios and under-diversification with second-order stochastic dominance
Authors: Stelios Arvanitis - RC-AUEB (Greece) [presenting]
Olivier Scaillet - University of Geneva and Swiss Finance Institute (Switzerland)
Nikolas Topaloglou - Athens University of Economics and Business Research Center (Greece)
Abstract: The purpose is to develop and implement methods for determining whether relaxing sparsity constraints on portfolios improves the investment opportunity set for risk-averse investors. A new estimation procedure is formulated for sparse second-order stochastic spanning based on a greedy algorithm and linear programming. The asymptotic optimal recovery of the sparse solution is shown whether spanning holds or not. From large equity datasets, the expected utility loss due to possible under-diversification is estimated, and it is found that there is no benefit from expanding a sparse opportunity set beyond 30 assets. The optimal sparse portfolio invests in 10 industry sectors with a larger weighting on the small size, high book-to-market, and momentum stocks from the S\&P 500 index. It cuts tail risk when compared to a sparse mean-variance portfolio. On a rolling-window basis, the number of assets shrinks to 10 assets in crisis periods.
