Working Paper
Uncertainty-Aware Portfolios
Abstract: This paper studies mean-variance portfolio choice when expected returns are estimated with heterogeneous uncertainty across assets. I model forecast uncertainty through asset-specific uncertainty radii and show that the resulting robust portfolio problem is equivalent to mean-variance optimization with an asset-specific l1 penalty. With short selling allowed, heterogeneous radii act as selective shrinkage of portfolio weights. Under long-only constraints, however, they also change portfolio composition by altering which assets clear the endogenous funding threshold. This generates two economic channels through which heterogeneous calibration can outperform a homogeneous benchmark: an active-set reallocation channel, through which capital shifts toward assets with more precise signals, and a covariance amplification channel, through which the gains from reallocation are larger when cross-asset correlation is high. I also derive finite-sample bounds linking calibration error in estimated radii to economic loss. Monte Carlo simulations and an illustrative application are consistent with these predictions.
Presentation: UMD Finance Brownbag Seminar
Work in Progress
Generated Regressors and Inference Fragility in Two-Pass Asset Pricing