Universal Portfolio Shrinkage
We introduce a nonlinear covariance shrinkage method for building optimal portfolios. Our universal portfolio shrinkage approximator (UPSA) is given in closed form, is cheap to implement, and improves upon existing shrinkage methods. Rather than annihilating low-variance principal components of returns, UPSA instead reweights components to explicitly optimize expected out-of-sample portfolio performance. We demonstrate robust empirical improvements over alternative shrinkage methods in the literature.
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