Constraint Effect on Minimum Tracking Error Volatility: A Global Asset Approach

Abstract

This paper studies the out of sample tracking error of minimum variance portfolios of global assets, equities and bonds. The methodology follows the one presented by Jagannathan and Ma (2003) regarding the risk reduction in US stock portfolios using weight constraints. The sample covariance matrix is used. Optimal minimum tracking error and minimum variance portfolios are derived using upper/lower and no restrictions. We show results assuming different revision frequencies and transaction costs assumed. The data used are monthly indices of stocks, bonds, gold oil and spreads from 1996 until 2013. Differences in relative risk, due to restrictions or rebalancing frequency, vary from 2 bps to 18 bps.