Extreme Events – Specimen Question
A.6.1(a) – Answer/Hints
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Q. To what extent should you
exclude such observations when developing a robust portfolio construction
algorithm?
If the observations really are errors then they should be
excluded from the underlying return series. In this respect ‘robust’ portfolio
construction is not really like ‘robust’ regression in which we (usually) give
reduced (but not nil) weight to outliers. Instead, with robust portfolio
construction we should clean the dataset as far as possible, and include
outliers if they really are valid data points but exclude them if they are not.
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