Markowitz Allocation–fixed Income Securities

Abstract

The Markowitz allocation model has not been properly tested with individual corporate bonds. Several authors have argued theoretically that the expectations necessary for the model cannot be formed from ex post time series data because the distribution of bond returns is not stationary. A methodology under which corporate bonds can be included in tests of the Markowitz model is presented in this study. Five sets of naive expectations are used, and as the distribution problem is removed from the data, the risk-adjusted performance of the Markowitz model becomes potentially very useful.

Corporate Bonds, Term Structure Expectations and Optimal Portfolios: The Canadian Experience

“…Each bond return in a time series has a different maturity and therefore an average of these is economically meaningless. Barnes (1985) found that expectations formed using the ex post time series returns of individual bonds did not result in portfolios that did as well as an equal allocation strategy. Furthermore, better performance was noted when future returns were used to improve the estimate of the current distributions.…”