ABSTRACT
In this chapter, the authors apply different portfolio performance measures to evaluate and compare portfolio allocation strategies. It introduces a direct way to estimate optimal portfolio weights for large-scale cross-sectional applications. More precisely, the approach of Brandt et al. proposes to parametrize the optimal portfolio weights as a function of stock characteristics instead of estimating the stock's expected return, variance, and covariances with other stocks. The allocation strategy is straightforward because the number of parameters to estimate is small. Intuitively, the portfolio strategy is a form of active portfolio management relative to a performance benchmark. Deviations from the benchmark portfolio are derived from the individual stock characteristics. The value-weighted portfolio delivers an annualized return of more than 6 percent and clearly outperforms the tilted portfolio, irrespective of whether they evaluate expected utility, the Sharpe ratio, or the CAPM alpha.
