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Constructing 130/30-portfolios with the Omega ratio

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Abstract

We construct portfolios with an alternative selection criterion, the Omega function, which can be expressed as the ratio of two partial moments of a portfolio's return distribution. The main purpose of the article is to investigate the empirical performance of the selected portfolios, especially the effects of allowing short positions. Many studies on portfolio optimisation assume that short sales are not allowed. This is despite the fact that theoretically, short positions can improve the risk-return characteristics of a portfolio, and practically, institutional investors can and do sell stocks short. We investigate whether removing the non-negativity constraint really improves out-of-sample portfolio performance under realistic assumptions, that is when optimal weights need to be estimated from the data and different transaction costs apply to long and short positions.

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Notes

  1. Another reason for the public and political attention is, of course, the market turmoil since the summer of 2008.

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Acknowledgements

The authors gratefully acknowledge financial support from the EU Commission through MRTN-CT-2006-034270 COMISEF; they would like to thank DynaGest S.A., Geneva, for providing the data for this study, and Evis Këllezi for discussions and comments. The article was presented under the title ‘Implementing Realistic Long/Short Portfolios: Optimisation Methods and Out-of-Sample Performance’ at the 14th International Conference on Computing in Economics and Finance at the Sorbonne, Paris, 26–28 June 2008. An older version, ‘Constructing Long/Short Portfolios with the Omega Ratio’, with more emphasis on optimisation issues is available from the Swiss Finance Institute's Research Paper Series at SSRN.

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  1. Department of Econometrics, University of Geneva and Swiss Finance Institute, Boulevard du Pont-d’ Arve 40, Geneva, 1211, Switzerland

    Manfred Gilli

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  1. Manfred Gilli
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  2. Enrico Schumann
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  3. Giacomo di Tollo
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  4. Gerda Cabej
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Correspondence to Manfred Gilli.

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Gilli, M., Schumann, E., di Tollo, G. et al. Constructing 130/30-portfolios with the Omega ratio. J Asset Manag 12, 94–108 (2011). https://doi.org/10.1057/jam.2010.25

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  • DOI: https://doi.org/10.1057/jam.2010.25

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