(This Is The Main One) Norm-Constrained-Minimum-Variance-Portfolios-With-Short-Selling - 2023 - Springer-Science-and-Business-Media-Deutschland-GmbH

Computational Management Science (2023) 20:6
https://doi.org/10.1007/s10287-023-00438-2
ORIGINAL PAPER
Norm constrained minimum variance portfolios

with short selling
Vrinda Dhingra1 · Shiv Kumar Gupta1 · Amita Sharma2
Received: 11 April 2022 / Accepted: 27 December 2022

© The Author(s), under exclusive licence to Springer-Verlag GmbH Germany, part of Springer Nature 2023
Abstract
Short selling is a wealth-building trading procedure which, when included in the
portfolio construction, not only helps increase the return on investment but also
reduces the investor’s overall exposure to the market risk. In this study, we incor-
porate it in the minimum variance model by analyzing several constraints that aptly
consider the different practical settings of a short sale transaction. We propose to
utilize the short-rebate gain by maximizing this additional interest due to short sales
in the objective function. In constraints, we impose the bounds on 1- and 2-norm
that respectively generate sparse and diversified portfolios. Along with the norm
constraints, we also bound the budget constraint to homogenize the allocations in
long and short and avoid the dominance of one strategy over the other. We present
empirical results highlighting the effect of the specific choice of constraints and,
thereafter, conduct a comparative analysis of our proposed models vis-a-vis several
related models from literature across eight global data sets using the rolling window
scheme. We observe that our proposed models outperform the others in terms of
several performance measures. In particular, the 1-norm constrained model gener-
ates statistically significant portfolios as compared to other related models in terms
of variance and Sharpe ratio. Additionally, the threshold parameter of the 1-norm
constraint provides the flexibility to tune the short sale budget, proving more favora-
ble for a short sale scenario.
Keywords Minimum variance portfolio model · Norm constraints · Short selling ·

Short-rebate · Risk-free interest rate · Budget constraint
* Shiv Kumar Gupta

s.gupta@ma.iitr.ac.in
Vrinda Dhingra
vdmath.iitr@gmail.com
Amita Sharma
amita.sharma@nsut.ac.in
1
Department of Mathematics, Indian Institute of Technology, Roorkee, Uttarakhand 247667,
India
2
Department of Mathematics, Netaji Subhas University of Technology, New Delhi 110078, India
13
Vol.:(0123456789)
6 Page 2 of 35 V. Dhingra et al.
1 Introduction
One of the essential features of an efficient stock market is to reflect the com-
posite viewpoint of all competing interests. To admit only the view focusing on
higher stock prices provides a one-sided perspective of the market while compil-
ing an open expression for both the long and short positions furnishes a two-
sided market view that better reflects prevailing conditions of the price structure.
Incorporating short selling in portfolio optimization models is a natural way to
account for both price structures in the portfolio selection procedure (Chang and
Young 2019; Jiang et al. 2018; Khodamoradi et al. 2021; Najafi and Ghasemi
2013). The rationale behind short selling is that, even though it is highly specula-
tive, its inclusion in the portfolio construction not only helps increase the return
on investment but also reduces the investor’s exposure to overall market risk. A
relevant question, thus, is how to incorporate short selling in portfolio modeling
to assist practical investment decisions.
In practice, several institutional procedures are laid out for short selling. For
instance, Regulation T, created by the Federal Reserve Board in the U.S. man-
dates that the short seller must have 150% of the total value of the short sale
position held in the margin account at the time of initiating the short sale. That is
100% of the short sale proceeds, which is the sum of money that the short seller
earns from selling the shorted (borrowed) stocks, and an additional 50% as an ini-
tial margin requirement. The short sale proceeds are posted as collateral with the
broker or the stock lender. These proceeds can further be invested in cash instru-
ments such as treasury bills and thus earn interest. The lender receives a portion
of this interest as a lending fee, and the short seller reaps the balance interest as
a “short rebate". Under specific arrangements, the margin deposit also earns a
risk-neutral return to the short seller. The short seller thus earns a risk-free return,
either from the proceeds, the margin, or both.
In literature, several models and procedures have been designed to incorpo-
rate short selling. Lintner (1965) was among the first few to include the notion of
short selling by combining institutional procedures in the portfolio framework.
The author modeled with the assumption that the proceeds are held as collateral,
and the short seller is required to deposit an equal amount in the margin, both of
which earn a risk-free interest. However, this assumption considers only one of
the many possible scenarios under a short sale transaction. To accommodate the
need for versatile features, Kwan (1995) proposed a ranking procedure to first
identify stocks in long/short positions and thereafter employed a single index
model of the Sharpe ratio to obtain the optimal portfolios. In Kwan (1997), the
author further extended his previous model (Kwan 1995) by considering both the
normative and market equilibrium aspects. Zhang et al. (2004) studied the impact
of different interest rates of borrowing and lending in the mean-variance portfolio
framework.
Among many approaches to generate stable long-short portfolios is the inclu-
sion of cardinality and size constraints (Gao and Li 2013; Khodamoradi and
Salahi 2022; Khodamoradi et al. 2021; Kobayashi et al. 2021; Le Thi and Moeini
13
Norm constrained minimum variance portfolios with short… Page 3 of 35 6
2014) in the model. While these constraints help to generate long-short portfolios
with lower turnover, they, however, suffer from two issues. Firstly, these models
fall into the class of NP-hard optimization problems, and secondly, the involve-
ment of several parameters, like the size or the cardinality bounds which are sub-
jective and there is no formal procedure to determine their ideal values. How-
ever, the significance of the cardinality-constrained model has motivated many
researchers to investigate several algorithms to overcome the computational diffi-
culty (Kobayashi et al. 2021; Le Thi and Moeini 2014), while the choice of these
bounds still remains arbitrary. An alternate option to overcome these limitations
while preserving the diversification advantages is the introduction of norm con-
straints. Lately, many studies have explored norm-constrained portfolios as they
provide a trade-off between volatility and diversification of assets (see,Behr et al.
2013; Coqueret 2014; Dai and Wen 2018; Fan et al. 2012; Gotoh and Takeda
2011; Husmann et al. 2022; Takeda et al. 2013).
DeMiguel et al. (2009) presented a general framework wherein they constrained
the norm of the portfolio weights by a threshold parameter in the minimum variance
portfolio model. It is widely known that the errors from the estimation of the mean
vector significantly impact portfolio weights more than those from the estimation of
covariances.1 Due to the same reason, recent advancements capitalize on the mini-
mum variance portfolio model that depends only on the estimates of covariances and
is less prone to estimation error (see, Clarke et al. 2010; Coqueret 2014; DeMiguel
et al. 2009; Husmann et al. 2022; Xidonas et al. 2017; Yang et al. 2015). Another
relevant factor used by researchers to model short selling is the risk-neutral interest
rate or the short-rebate that the short seller earns, either from margin deposits or
proceeds or from both (see, Birge and Zhang 1999; Jacobs et al. 2005; Khodamoradi
et al. 2020, 2021; Kwan 1995).
This paper aims to analyze various constraints that aptly consider different prac-
tical scenarios of short selling in the minimum variance portfolio framework. We
propose to utilize the 1- and 2-norm constraints to comprehend the impact of diver-
sification on short selling as these constraints, respectively generate sparse and
diversified portfolios. In addition to variance, we maximize the short-rebate in the
objective of the minimum variance model, which is the additional interest the short
seller earns from proceeds, margin deposits, or both. To have a fair allocation in
long and short, we suggest replacing the usual equality budget constraint with a
bounded budget constraint.
To investigate the proposed models empirically, we first carry out in-sample and
out-of-sample analyses highlighting the relevance of the specific choice of budget
constraint and the impact of risk-free interest rate (or short-rebate term). The pro-
posed models are then compared and analyzed with several related existing mod-
els in the literature; namely, the traditional minimum variance model, 1-norm and
2-norm constrained portfolio models (DeMiguel et al. 2009) cardinality constrained
mean-variance model with short selling and risk-neutral interest rate (Khodamoradi
1
For evidence of the poor performance of mean-variance model based on sample estimates of the mean
vector and covariance matrix, see Merton (1980), Best and Grauer (1991), Chopra and Ziemba (1993),
Jagannathan and Ma (2003) and Kondor et al. (2007).
13
et al. 2021) and the equally weighted 1/N portfolio. The analysis is carried over
a period of 10 years from April 2010 to March 2020, across eight global market
indices, viz., SENSEX (India), CSI 100 (China), DAX 100 (Germany), NASDAQ
100 (USA), CNX 100 (India), FTSE 100 (UK), NIKKEI 225 (Japan) and S &P
500 (USA). The performance is analyzed on several financial performance indi-
ces, including the mean return, risk measures: variance and downside deviation,
and ratios: Sharpe, Sortino, and the turnover ratio. Apart from this, we also carry
out statistical tests for variances and Sharpe ratios (Ledoit and Wolf 2008, 2011) to
measure the significance of the proposed models in comparison to the existing ones.
The empirical analysis results in the following observations: (i) the bounds on
budget constraint along with norm constraints yield a balanced allocation in long
and short positions, resulting in a better risk-return profile quantified through the
higher values of Sharpe and Sortino ratios; (ii) the proposed models perform bet-
ter than the norm constrained models, two variants of the cardinality constrained
models, and the 1/N portfolios in terms of risk measures as well as the Sharpe and
Sortino ratios suggesting the importance of the right choice of constraints and the
short-rebate term in the long-short selection; (iii) the traditional minimum vari-
ance model, which was found to suffer from the highest turnover ratio due to the
unjustified extreme allocation in long and short positions, has been improved by
the proposed models, especially the 1-norm constrained model; (iv) In particular,
the 1-norm constrained model generates statistically significant portfolios than the
related models in terms of variance and Sharpe ratio, proving more favourable for
short selling.
The rest of the paper is organized as follows. Section 2 highlights the motivation
and contributions of the paper. Section 3 describes the notation and the related mod-
els from the literature. Section 4 presents the proposed models. Section 5 explains
the methodology for performing the empirical investigation. Section 6 lays out the
empirical justification of the proposed models. Section 7 details the in-sample and
out-of-sample comparative analyses of the proposed models with related models.
Section 8 concludes the paper.
2 Motivation and contributions
The main motivation for this work stems from the need to provide a simple yet
effective portfolio model incorporating the salient features of short selling. The tra-
ditional models that incorporate short selling are based on the assumption that an
investor can sell short without any limit and use the short sale proceeds to buy assets
long. This is a convenient mathematical assumption to model; however, it is not
practically viable. Actual constraints that illustrate long-short portfolios vary with
time, broker, and client. Thus, to model short selling in practice, we consider norm
constraints along with a bounded budget constraint in the portfolio selection process.
The advantages of employing norm constraints are twofold; firstly, they are
computationally advantageous over cardinality constraints as they result in a
13
convex optimization problem. Secondly, these constraints yield portfolios with

better out-of-sample performance in the presence of estimation error due to
variance.
The contributions of this paper are multi-fold:
• We analyze 1- and 2-norm constraints along with a bounded budget constraint

(bounding between 0 and 1) that aptly incorporates different practical scenarios
of short selling in the minimum variance portfolio framework.
• We use short-rebate in the objective function of the model that helps allocate
the short sale budget wisely. Plus, the bounded budget constraint, along with the
norm constraints, plays a crucial role in avoiding the dominance of long over
short and short over long.
• Among the norm constraints, the 1-norm is of specific importance with respect to
short selling as the threshold for 1-norm constraint (𝜁1) along with the bounded
budget constraint helps in restricting the short sale budget to 𝜁1 ∕2. This gives an
investor the flexibility to choose and tune the bound according to the availability
of short sale assets and his risk appetite, thereby avoiding the use of short sale
proceeds.
• We conduct an extensive numerical investigation to inspect the benefit of the
bounded budget constraint in the proposed model. The portfolios generated using
the non-negativity of the budget constraint exhibits better out-of-sample perfor-
mance than the portfolios without this constraint in terms of Sharpe and Sortino
ratios for almost all data sets.
• The comparison analysis carried out with several related models from the litera-
ture provides valuable insights into the models: (i) the proposed models allocate
funds with equal proportions in long and short, thereby reducing overall risk;
(ii) while the model with 2-norm constraint provides mixed results, the model
with 1-norm constraint produces statistically significant results, superior in
terms of variance and Sharpe ratio; (iii) the proposed model with 1-norm further
overcomes the limitation of traditional models of using short sale proceeds by
restricting the short sale budget, thus proving to be an ideal choice for a short
sale scenario.
3 Notation and related portfolio models
To make the paper self-reliant, we begin by tracing out the related models from the
literature that motivated the formulation of the proposed models.
Let N be the total number of assets available for investment with
w = (w1 , w2 , … , wN )T being the portfolio weights vector where wi denotes the
proportion of investment in asset i, i = 1, … , N . Let Rw denote a discrete random
∑
variable representing the return of a portfolio w. Then, E(Rw ) = Ni=1 𝜇i wi and
∑ ∑
wT Σw = i=1 j=1 wi wj 𝜎ij are respectively the expected return and variance of the
N N
13
portfolio w, where 𝜇i is the mean return of the i-th asset and 𝜎ij is the covariance
between the i-th and j-th assets.
3.1 Minimum variance portfolios
The minimum variance portfolio (MV) with short selling is the solution of the fol-
lowing quadratic optimization problem:
N N
∑ ∑
(MV) min wi wj 𝜎ij
i=1 j=1
N
∑
s.t. wi = 1.
i=1
∑
The constraint Ni=1 wi = 1 ensures that the portfolio weights sum up to one. It has
been observed that though the MV portfolio obtained using the sample covariance
matrix Σ results in better out-of-sample performance than the traditional mean-var-
iance model, it often results in a portfolio with extreme negative weights or short
positions (Clarke et al. 2010; Green and Hollifield 1992). The authors in Green
and Hollifield (1992) asserted that the presence of a dominant factor in the sample
covariance matrix results in an extreme allocation in negative weights. As a result,
researchers started constraining the portfolio weights to achieve a balanced budget.
For instance, Jagannathan and Ma (2003) constrained the MV model with an addi-
tional no-short sale constraint, viz., wi ≥ 0, i = 1, 2, … , N and obtained the no-short
sale portfolios. It was observed that the resultant portfolio is equivalent to solving
the (MV) model when the sample covariance matrix Σ = [𝜎ij ] is replaced with
ΣJM = Σ − (𝛿eT + e𝛿 T ).
Here, e = (1, 1, … , 1)T ∈ ℝN is the vector of ones and 𝛿 = (𝛿1 , 𝛿2 , … , 𝛿N )T are

the Lagrange multipliers corresponding to the non-negativity constraints wi ≥ 0,
i = 1, 2, … , N.
By this method of shrinking the covariance matrix, the large-sized covariances
get reduced (shrunk) and are thus less likely to generate negative weights. Conse-
quently, the portfolios thus generated perform better out-of-sample; however, it is
poorly diversified as many assets with high volatility are entirely ruled out. Moreo-
ver, this non-negativity condition proved expensive in terms of the Sharpe ratio. For
instance, Levy and Ritov (2001) highlighted that the Sharpe ratio could be doubled
for a case of 100 assets by removing the non-negativity constraint.
Subsequently, several other constraints were explored to generate portfolios with
better out-of-sample results without imposing the non-negativity condition on port-
folio weights. We now review the two popularly used constraints in portfolio frame-
work: norm constraints and the cardinality constraints.
13
3.2 Norm‑constrained portfolios
DeMiguel et al. (2009) proposed a general framework for a class of portfolios

obtained by shrinking the portfolio weights vector in the MV model. Their frame-
work relied on solving the (MV) model with an additional norm constraint; that is,
‖w‖l ≤ 𝛿, where 𝛿 is the threshold parameter2 and ‖w‖l denotes the l-norm of the
portfolio weights vector, with l = 1 and l = 2.
The 1-norm and 2-norm constrained portfolio models proposed by DeMiguel
et al. (2009) are as follows:
1-norm constrained portfolio model
N N
� �
(NC1) min wi wj 𝜎ij
i=1 j=1
N
�
s.t. wi = 1,
i=1
‖w‖1 ≤ 𝛿1 ,
∑
where ‖w‖1 = Ni=1 �wi �. The authors observed that the solution of this model (NC1)
with 𝛿1 = 1 coincides with that of the no-short sale constrained (MV) model. Fur-
ther, when 𝛿1 > 1, the model generates a class of portfolios for which the maximum
𝛿 −1
short sale budget, that is, the sum of weights of shorted assets is equal to 1 . As
2
a consequence, the 1-norm constrained portfolio model is expected to follow the
trend of less diversification as that of the (MV) model. Thus, the choice of parame-
ter 𝛿1 helps in generating sparse portfolios, whereas the 2-norm is utilized to gener-
ate diversified portfolios, which is explained below:
2-norm constrained portfolio model
N N
� �
(NC2) min wi wj 𝜎ij
i=1 j=1
N
�
s.t. wi = 1,
i=1
‖w‖22 ≤ 𝛿2 ,
∑
where ‖w‖22 = Ni=1 w2i . The 2-norm constraint can be reformulated as the following
expression involving naive portfolio 1/N:
N ( )
∑ 1 2 1
wi − ≤ 𝛿2 −
i=1
N N
2
The authors in DeMiguel et al. (2009) determine the parameter value 𝛿 using two elaborate techniques,
namely, cross-validation over portfolio variances and maximization of returns in the last period.
13
The above expression bounds the sum of the squared difference between portfolio
weights wi and the naive portfolio 1/N by 𝛿2 − 1∕N, with 1/N portfolio nesting as a
special case when 𝛿2 = 1∕N. As a consequence, one expects the 2-norm portfolio to
trend close to 1/N portfolio and thus a well-diversified portfolio.
Furthermore, DeMiguel et al. (2009) also analyzed the out-of-sample performance
of the norm-constrained portfolios vis-a-vis several related portfolios from literature.
They observed that the norm-constrained portfolios reported better out-of-sample per-
formance in presence of estimation error due to the covariance matrix. For instance,
these portfolios often depicted higher Sharpe ratios with variances similar to those of
the shrinkage models. In addition to this, the utility of the norm-constrained models to
generate sparse and diversified portfolios gave the motivation to consider them in our
proposed work to gauge the impact of diversification in short selling.
3.3 Cardinality‑constrained portfolios
The cardinality-constrained mean-variance (CCMV) portfolio optimization model,

which limits a fixed number of assets K < N to be chosen from total available assets N,
falls into the category of an NP-hard problem. Several researchers have analyzed this
model for different scenarios and proposed several methods for solving it (see, Gao and
Li 2013; Khodamoradi et al. 2021; Shaw et al. 2008).
The general formulation of the (CCMV) model is given as:
(N N ) (N )
∑∑ ∑
(CCMV) min 𝛼 wi wj 𝜎ij − (1 − 𝛼) wi 𝜇i
i=1 j=1 i=1
N
∑
s.t. wi ≤ 1,
i=1
N
∑
zi = K,
i=1
𝜖i zi ≤ wi ≤ 𝛿i zi , i = 1, 2, … , N,
zi ∈ {0, 1}, i = 1, 2, … , N,
where zi are the binary variables with value 1 denoting the selection of ith stock
while 0 indicates that ith stock is not selected, 𝜖i and 𝛿i respectively, denote the
lower and upper bounds on the proportion that can be invested in ith stock (size con-
straints). Note that for short selling, 𝜖i < 0 for i-th asset.
Following the work of Jacobs et al. (2005) and Najafi and Ghasemi (2013), the
(CCMV) model with short selling was further modified by incorporating the short-
rebate term (with risk-free interest rate rf ) in the objective function along with the mean
return by Khodamoradi et al. (2021), given as:
13
( N N
) ( N
) ( N
)
∑ ∑ ∑ ∑
(CSRf) min 𝛼 wi wj 𝜎ij − (1 − 𝛼) wi 𝜇i + (1 − 𝛼) rf hi wi
i=1 j=1 i=1 i=1
N
∑
s.t. wi ≤ 1,
i=1
N
∑
zi = K,
i=1
𝜖i zi ≤ wi ≤ 𝛿i zi , i = 1, 2, … , N,
𝜇i xi ≥ 0, i = 1, 2, … , N,
zi ∈ {0, 1}, i = 1, 2, … , N,
where hi = 0 if 𝜇i ≥ 0 and 0 < hi < 1 when 𝜇i < 0.

The (CSRf) model uses the cardinality constraints and exploits the benefits of
short selling using the risk-neutral interest rate. Though the authors, Khodamoradi
et al. (2021) found better out-of-sample performance and computational advantages
of the (CSRf) model over other variants of (CCMV) model, it suffers from a few
drawbacks. Firstly, there are a lot of parameters to be determined in the model, like
the lower and upper bounds for the size constraints, the bound for the total number
of assets to invest in (cardinality), and the trade-off parameter 𝛼 between the risk
and return. All these parameters are investor-dependent, and there is no yardstick
to measure their ideal choice. Secondly, the model considers both order moments
of the return distribution: mean and variance, thus incurring the effect of estimation
error due to the mean values. The outperformance of (CSRf) in comparison to the
(CCMV) model attributes to the additional short-rebate term in its objective func-
tion, which we also incorporate in our proposed models, described in detail in the
following section.
4 Norm‑constrained minimum variance short‑sale portfolio models
In this section, we explain the proposed models and outline the rationale behind the
specific choice of constraints and the use of the short-rebate factor in the objective
function of the MV model, along with the variance as a measure of risk.
With risk-averse parameter, 0 < 𝛼 < 1, we propose the following norm-con-
strained models with short selling:
13
1-norm constrained minimum variance model with short selling

�N N � � N �
��
(RF-NC1) min 𝛼 wi wj 𝜎ij + (1 − 𝛼) rf hi wi
i=1 j=1 i=1
N
�
s.t. 0 ≤ wi ≤ 1,
i=1
‖w‖1 ≤ 𝜁1 .
2-norm constrained minimum variance model with short selling
�N N � � N �
��
(RF-NC2) min 𝛼 wi wj 𝜎ij + (1 − 𝛼) rf hi wi
i=1 j=1 i=1
N
�
s.t. 0 ≤ wi ≤ 1,
i=1
‖w‖22 ≤ 𝜁2 ,
where hi = 0 if 𝜇i ≥ 0 and hi = c; 0 < c < 1 when 𝜇i < 0. Here, rf is the risk-neutral

interest rate from the margin deposit or collateral (proceeds), and hi denotes the pro-
∑N
portion of interest received by the short seller. Therefore, the term rf i=1 hi wi repre-
sents the short-rebate that the short seller receives.
∑
Remark 1 Using the bounded budget constraint 0 ≤ Ni=1 wi ≤ 1 and some basic
algebraic manipulations, the 1-norm constraint ‖w‖1 ≤ 𝜁1 with threshold parameter
𝜁1 of the (RF-NC1) model can be rewritten as:
∑ 𝜁1
− wi ≤ ,
i∈N(w)
2
where N(w) = {i ∶ wi < 0}. The left-hand side of the above expression is the total
proportion of the wealth that is sold short, and 𝜁1 ∕2 can be comprehended as the
maximum short sale budget. Thus, depending on the investor’s budget for a short
sale, the value of the threshold parameter can be chosen. For the current framework,
however, we use the method of cross-validation over portfolio variances, explained
in detail in Sect. 5.3 for the optimal choice of parameter values 𝜁1 and 𝜁2.
We now briefly state the rationale behind adopting the chosen factors in our pro-
posed models below:
(1) Norm constraints: Instead of using the cardinality constraints that generally lead
to an NP-hard problem and introduce subjectivity in the model, we employ norm
constraints. As observed in DeMiguel et al. (2009), the advantages of using norm
constraints are twofold. Firstly, they are computationally advantageous over car-
dinality constraints as they result in a convex optimization problem. Secondly,
these constraints yield portfolios with better out-of-sample performance in the
13
presence of estimation error due to variance. Between the two, the 1-norm con-
straint is of specific importance as it restricts the short-sale budget.
(2) Bounds on budget constraint: The traditional portfolio models are based on
the total consumption of the budget. This constraint allows an investor to sell
short without limit, resulting in portfolios with dominant short sale positions to
increase return. Though this is a convenient assumption to model, such a sce-
nario is not viable from a practical viewpoint where short-sale assets are limited.
Thus, we propose to bound the budget constraint between 0 and 1. These bounds
ensure no strategy dominates the other and helps yield a balanced proportion of
the budget in the long and short.
(3) Risk-neutral interest rate: Another relevant factor that can be incorporated to
exploit the idea of short selling is the risk-neutral (or risk-free) interest rate. It
is the interest that the investor earns from a risk-neutral investment like fixed
deposits and bonds, among others. This factor has been implemented with the
desire to get an increased return on the portfolio (see, Jacobs et al. 2005; Kho-
damoradi et al. 2021; Najafi and Ghasemi 2013). Jacobs et al. (2005) employed
the concept of short selling using the risk-neutral interest rate with 2n assets,
representing the first n assets in long and the next n in short positions. The port-
folio return with wi ≥ 0 was formulated as:
n 2n 2n
∑ ∑ ∑
Rp = 𝜇i wi + (−𝜇n−i )wi + rf hi wi .
i=1 i=n+1 i=n+1
Remark 2 Realistically, there can be different arrangements of a short sale transac-

tion, where the short seller can earn different interest rates from margin deposit or
proceeds or both. However, we restrict ourselves to using only a general case of risk-
free interest rf , where all other arrangements can easily be modeled according to the
clout between client and broker.
In the following section, we empirically investigate the proposed models over a

set of global indices.
5 Methodology
In this section, we explain the sample data and sample period used to conduct the
empirical analysis along with the rolling window methodology used. In addition to
the proposed models, we solve the following models from literature for the compari-
son analysis.
1. NC1 and NC2 models: 1-norm and 2-norm constrained minimum variance models
(DeMiguel et al. 2009) for comparison with RF-NC1 and RF-NC2, respectively.
2. MV model: Minimum variance portfolio model with short selling allowed for
comparison with both RF-NC1 and RF-NC2.
13
3. CSRf-50% and CSRf-100% models: Cardinality constrained mean-variance model

with short selling and risk-neutral interest rate (Khodamoradi et al. 2021) with
cardinality K = 50%N (CSRf-50%) and K = 100%N (CSRf-100%) for compari-
son with RF-NC1 and RF-NC2, respectively.
4. 1/N portfolio: Equally weighted 1/N portfolios for comparison with both RF-NC1
and RF-NC2.
Note that for a fair comparison among all the models, we keep the value of 𝛼 = 0.9
in the proposed models: RF-NC1 and RF-NC2, and cardinality constrained models:
CSRf-50% and CSRf-100%, giving more weight to the variance term in the overall
empirical analysis. The value of the risk-free interest rate rf is kept as 0.3 and the
value of hi = c, which is the proportion of the interest the short seller receives is
kept as 0.1 for all models throughout the empirical analysis.
5.1 Sample data and sample period
The sample data for the present study consists of weekly closing price data of the
constituents of the following eight global indices, collected for a period of ten years
from April 2010 to March 2020, giving a total of 524 data points. The weekly clos-
ing prices of all constituents of these indices have been extracted from the Bloomb-
erg database management software using the Bloomberg terminal interface on
MS-EXCEL.
1. Data Set 1 (DI): SENSEX (India), 30 assets;

2. Data Set 2 (DII): CSI 100 (China), 60 assets;
3. Data Set 3 (DIII): DAX 100 (Germany), 73 assets;
4. Data Set 4 (DIV): NASDAQ 100 (USA), 79 assets;
5. Data Set 5 (DV): CNX 100 (India), 80 assets;
6. Data Set 6 (DVI): FTSE 100 (UK), 89 assets;
7. Data Set 7 (DVII): NIKKEI 225 (Japan), 214 assets;
8. Data Set 8 (DVIII): S &P 500 (USA), 440 assets.
For each of the above eight data sets, the weekly rate of return for j-th stock in t-th
pc −pc
week is calculated as rjt = jtpc jt−1 ; j = 1, … , N, t = 1, … , T, where pcjt and pcjt−1 are
jt−1
respectively, the closing prices in the t-th and (t − 1)-th week.
5.2 Rolling window strategy
To incorporate the dynamics of financial data, we follow the “rolling window” strat-
egy in which we first choose an in-sample window (training data) of fixed length,
say m and solve all the optimization models. Next, we roll over (shift) the in-sample
13
Table 1 Optimal parameter values obtained from cross-validation

Model Parameter DI DII DIII DIV DV DVI DVII DVIII
NC1 𝛿1 1.25 1.75 1.25 2.00 1.75 2.00 2.00 2.00

NC2 𝛿2 1.00 0.75 0.10 0.10 0.75 0.10 0.10 0.10
RF-NC1 𝜁1 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
RF-NC2 𝜁2 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10
window by a fixed length, say r; that is, we delete the first r weeks and include the
next r weeks for our second in-sample window and compute the second set of port-
folios. The process is repeated until we reach the end of the time horizon T, generat-
ing 𝜏 = ⌊(T − m)∕r⌋3 portfolios corresponding to each model.
For our experiments, we follow a “rolling window” of r = 4 weeks (monthly
re-balancing) over the time horizon of 523 weekly returns data from April 2010
to March 2020 with an in-sample window consisting of 104 weeks and an out-of-
sample window of 4 weeks (testing window), giving a total of 104 windows for each
model. We use R software with CVXR package (Fu et al. 2020) on Windows 64
bits Intel(R) Core(TM) i3-6006U CPU @2.0 GHz processor to run all optimization
models.
5.3 Cross‑validation scheme
To find the optimal values for the threshold parameters, viz. 𝛿1 , 𝛿2 , 𝜁1 , and 𝜁2
involved in the models, NC1, NC2, RF-NC1, and RF-NC2, we adopt a cross vali-
dation scheme as suggested by Husmann et al. (2022). For the 1-norm constrained
models, i.e., NC1 and RF-NC1, the cross-validation is implemented for all values of
the threshold from the set A = {1.00, 1.25, 1.50, 1.75, 2.00} whereas for the 2-norm
constrained models, i.e., NC2 and RF-NC2, the cross-validation is performed for all
values of the threshold from the set B = {0.10, 0.25, 0.50, 0.75, 1}.
We consider a time horizon of T = 523 weekly returns corresponding to the ten
years of data as our sample period for the cross-validation scheme. With 𝛾 as the
underlying model’s threshold parameter, we explain the step-wise cross-validation
scheme in Algorithm 1. We follow this cross-validation scheme for each of the four
norm-constrained models for all the 8 data sets under consideration and record the
optimal values in Table 1.
3
Here ⌊⋅⌋ denotes the greatest integer function or the floor function.
13
Remark 3 The NC1 model results in infeasible portfolios for 𝛿1 < 1, and addition-
ally, to restrict the short sale transaction to a maximum of 1 = 𝜁1 ∕2, the threshold
parameters for the 1-norm constrained models are chosen from set A. On the other
hand, for 𝜁2 > 1, RF-NC2 tends to invest largely in both the long and short. For
instance, for 𝜁2 = 5, the SENSEX data resulted in a total budget investment in long
of 4.16, which not only exceeds the available budget of 1 but also indicates the use
of short sale proceeds for buying long. Also, for NC2, 𝛿2 > 1 does not result in any
significant change in the allocation and thus no notable change in the out-of-sample
performance. Hence, the threshold parameters for the 2-norm constrained models
are chosen from set B.
5.4 Performance metrics
The in-sample and the out-of-sample performance of the portfolios from the pro-
posed models and several other models from the literature are assessed using several
performance measures.
For the in-sample analysis, we focus on the type and size of allocation each model
has assigned to each asset. With 𝜏 as the total number of rolling windows and wi,j as
the weight of ith asset obtained over the jth in-sample period of the jth window;
j = 1, … , 𝜏 , following are some key measures that we consider for the in-sample
analysis:
13
• N-long: average number of assets held long (positive weights)

𝜏 N
1 ∑∑
N-long = 1
𝜏 j=1 i=1 {wi,j >0}
• N-short: average number of assets held short (negative weights)

𝜏 N
1 ∑∑
N-short = 1
𝜏 j=1 i=1 {wi,j <0}
• N-zero: average number of assets not invested in (with zero weight)

𝜏 N
1 ∑∑
N-zero = 1
𝜏 j=1 i=1 {wi,j =0}
• B-long: average proportion of the total budget invested in long assets

𝜏 N
1 ∑∑
B-long = w 1
𝜏 j=1 i=1 i,j {wi,j >0}
• B-short: average proportion of the total budget held short

𝜏 N
1 ∑∑
B-short = w 1
𝜏 j=1 i=1 i,j {wi,j <0}
On the other hand, we carry the out-of-sample analysis based on the following six
popular performance measures:
• Adjusted Mean Return: It is the average of the portfolio return calculated

over 𝜏 out-of-sample periods of 𝜏 windows after taking into the consideration
the short-rebate gain from short sale of assets and is given as:
𝜏 𝜏
1∑ 1∑
AMR = (wj )T (rj − rf hj ) = R (w)
𝜏 j=1 𝜏 j=1 j
Higher values of AMR are preferable.

• Adjusted Variance (AV): A variance adjusted with respect to the short-rebate
gain is given as:
𝜏 𝜏
1 ∑ T 1 ∑
𝛔𝟐 = (wj (rj − rf hj ) − AMR)2 = (R (w) − AMR)2
𝜏 − 1 j=1 𝜏 − 1 j=1 j
Lower values of adjusted variance are preferable.

• Downside Deviation: It is defined as:
13
�
� 𝜏
1 � �
DD = √ � min(Rj (w) − AMR, 0)2
𝜏 j=1
and accounts the downside risk of the portfolio return. Lower values of DD are
desirable.
• Sharpe Ratio: It is a return-risk ratio defined as the average return (here,
adjusted mean return) per unit of risk (𝜎 ) and is given as:
{
AMR
; AMR > 0
Sharpe = SR = 𝜎
0; AMR ≤ 0
Higher values of Sharpe ratio are desirable.

• Sortino Ratio: It is a return-risk ratio with risk measured by downside deviation
and is calculated as:
{
AMR
; AMR > 0
Sortino = DD
0; AMR ≤ 0
Higher values of Sortino ratio are desirable.

• Turnover Ratio: It is the average of the absolute values of trades among the N
assets over the investment period. It is defined as
𝜏−1 N
1 ∑∑
TR = |w − wi,j |
𝜏 − 1 j=1 i=1 i,j+1
Smaller values of turnover ratio are beneficial as they imply lower transaction
costs.
5.5 Statistical tests
To test the statistical significance of the difference between the variances and Sharpe
ratios of the returns of portfolios from any two given models, we use bootstrapping
methodology as suggested by Ledoit and Wolf (2008, 2011).4 In particular, to test
the hypothesis that the Sharpe ratio of the return of portfolio from model x is equal
to that from model y, i.e., H0 ∶ SRx − SRy = 0, we compute a two-sided p-value
using the studentized circular block bootstrap methodology proposed in Ledoit and
Wolf (2008). Next, to test the hypothesis that the variance of the return of portfolio
from model x is equal to that from model y, that is, H0 ∶ 𝜎x − 𝜎y = 0, we calculate
a two-sided p-value using the stationary bootstrap methodology given in Ledoit and
Wolf (2011). For both the tests, we choose M = 1000 bootstrap re-samples and a
block size of b = 5.
4
We use the R codes of Ledoit and Wolf (2008, 2011) available at https://www.econ.uzh.ch/en/people/
faculty/wolf/publications.html to perform the statistical tests.
13
6 Empirical investigation of the proposed models
In this section, we investigate the impact of the bounded budget constraint with the
non-negativity condition and risk-free interest rate (short-rebate) on the performance
of the proposed models: RF-NC1 and RF-NC2.
6.1 Effect of non‑negative budget constraint
To examine the impact of non-negative budget constraint on the performance of the

proposed models, RF-NC1 and RF-NC2, we solve these models with and without
the non-negative budget constraint across the eight data sets and analyze their in-
sample as well as the out-of-sample performances.
Let us denote RF-NC1W and RF-NC2W as the models when the budget con-
∑
straint 0 ≤ Ni=1 wi ≤ 1 in the respective models, RF-NC1, and RF-NC2 is replaced
∑
with Ni=1 wi ≤ 1.5
Table 2 outlines the in-sample observations of the four models across all eight
data sets.
Observations from Table 2: The model RF-NC1W dominates in short selling, as
evident from the N-short and B-short values across all data sets. Note that though
the value of 𝜁1 is obtained as 1 for this model using cross-validation, however, a
similar observation of short sale dominance was also recorded for other values of
𝜁1. In other words, this model hardly utilizes any budget to buy assets long. On the
other hand, model RF-NC1 invests in both the long and short sale assets with bal-
anced weight (B-long is similar to B-short), which is a wiser approach as this model
benefits from both market structures. The bound on the total amount of short sales
is 𝜁1 ∕2 = 0.5 (as 𝜁1 = 1), which is empirically verified across all data sets. Further-
more, both the models, RF-NC1W and RF-NC1, exhibit sparsity (as N-zero> 0).
Hence, these models are ideal for investors who aim to invest in a selective number
of assets and also wish to limit the amount of short sales.
On the contrary, the 2-norm constrained models, RF-NC2W and RF-NC2, select
a similar number of long and short-sale assets but with different budget propor-
tions. Analogous to RF-NC1W, the model RF-NC2W also dominates in terms of
short selling with respect to the budget allocation (B-short > B-long). In contrast,
the model RF-NC2 allocates as much in long as it receives from the short sale pro-
ceeds, and therefore, we favour the selection strategy by RF-NC2 over RF-NC2W.
Moreover, both the models based on the 2-norm constraint demonstrate diversifica-
tion similar to that of the 1/N portfolios; that is, these models utilize all the assets
available (as N-zero=0).
We now present the out-of-sample performance of the models, RF-NC1W,
RF-NC1, RF-NC2W, and RF-NC2 in Table 3.
Observations from Table 3: Between the 1-norm constrained models, RF-NC1W
reported higher mean returns and lower turnover ratio for all data sets than the
5
Note that the value of threshold parameters 𝜁1 and 𝜁2 for the models RF-NC1W and RF-NC2W are the
same as that of RF-NC1 and RF-NC2.
13
Table 2 In-sample performance analysis of proposed models with and without non-negativity of the
budget constraint
Data Set Portfolio N-long N-short N-zero B-long B-short
SENSEX RF-NC1W 1 4 26 0.043 − 0.899

RF-NC1 12 5 13 0.471 − 0.471
RF-NC2W 21 9 0 0.247 − 0.618
RF-NC2 24 6 0 0.553 − 0.553
CSI 100 RF-NC1W 0 5 55 0.000 − 0.837
RF-NC1 21 13 26 0.438 − 0.438
RF-NC2W 38 22 0 0.516 − 1.025
RF-NC2 39 21 0 0.857 − 0.857
DAX 100 RF-NC1W 0 9 65 0.000 − 0.994
RF-NC1 29 18 26 0.500 − 0.500
RF-NC2W 55 18 0 0.639 − 1.131
RF-NC2 57 16 0 1.032 − 1.032
NASDAQ 100 RF-NC1W 2 5 72 0.016 − 0.984
RF-NC1 28 10 42 0.500 − 0.500
RF-NC2W 67 12 0 0.490 − 0.741
RF-NC2 70 9 0 0.718 − 0.718
CNX 100 RF-NC1W 1 8 71 0.037 − 0.934
RF-NC1 27 14 39 0.486 − 0.486
RF-NC2W 58 22 0 0.628 − 1.069
RF-NC2 61 19 0 0.991 − 0.987
FTSE 100 RF-NC1W 0 11 78 0.000 − 0.995
RF-NC1 33 22 34 0.500 − 0.500
RF-NC2W 67 22 0 0.601 − 1.300
RF-NC2 69 20 0 1.169 − 1.169
NIKKEI 225 RF-NC1W 7 12 195 0.034 − 0.966
RF-NC1 80 61 73 0.500 − 0.500
RF-NC2W 145 69 0 1.290 − 1.834
RF-NC2 149 65 0 1.658 − 1.658
S &P 500 RF-NC1W 0 27 413 0.000 − 1.000
RF-NC1 176 68 196 0.500 − 0.500
RF-NC2W 362 78 0 1.566 − 2.204
RF-NC2 373 67 0 2.124 − 2.124
RF-NC1 portfolios. The lower turnover is contributed by the fact that the investment
by the RF-NC1W model is in very few assets, and only short selling is done, which
further elucidates a higher mean return due to the additional return from the risk-
free investment (short-rebate). However, the model RF-NC1 reported better out-
comes in terms of risk measures and performance ratios by achieving lower values
of variance and downside deviation (DD) and higher values for Sharpe and Sortino
ratios across all data sets. This is because the investment in model RF-NC1 is shared
13
Table 3 Out-of-sample performance analysis of proposed models with and without non-negative budget
constraint
Data Set Portfolio Adjusted Adjusted Downside Sharpe Sortino Turnover
Mean Variance Deviation Ratio Ratio Ratio
SENSEX RF-NC1W 0.0244 0.0002 0.0098 1.7516 2.4899 0.6723

RF-NC1 0.0140 0.0000 0.0046 2.3057 3.0204 0.7337
RF-NC2W 0.0175 0.0001 0.0068 1.7098 2.5674 0.4082
RF-NC2 0.0168 0.0001 0.0065 1.8419 2.6012 0.4739
CSI 100 RF-NC1W 0.0222 0.0002 0.0116 1.4406 1.9156 0.6418
RF-NC1 0.0125 0.0000 0.0050 1.9917 2.5237 0.8530
RF-NC2W 0.0295 0.0004 0.0141 1.4795 2.0950 0.7028
RF-NC2 0.0264 0.0003 0.0118 1.6613 2.2289 0.8026
DAX 100 RF-NC1W 0.0291 0.0002 0.0075 2.0556 3.8916 0.7496
RF-NC1 0.0158 0.0000 0.0027 3.6120 5.8204 0.8285
RF-NC2W 0.0350 0.0003 0.0090 2.0208 3.9035 0.6395
RF-NC2 0.0329 0.0001 0.0079 2.8504 4.1755 0.6933
NASDAQ 100 RF-NC1W 0.0268 0.0002 0.0090 2.1350 2.9854 0.6314
RF-NC1 0.0148 0.0000 0.0042 2.6801 3.7975 0.7993
RF-NC2W 0.0204 0.0000 0.0052 2.7356 3.9170 0.6001
RF-NC2 0.0206 0.0000 0.0054 2.6931 3.7975 0.6288
CNX 100 RF-NC1W 0.0252 0.0002 0.0093 1.8729 2.7149 0.7794
RF-NC1 0.0143 0.0000 0.0034 3.2385 4.2034 0.8465
RF-NC2W 0.0307 0.0003 0.0103 1.8868 2.9969 0.7187
RF-NC2 0.0296 0.0002 0.0093 2.1637 3.1799 0.7856
FTSE 100 RF-NC1W 0.0298 0.0001 0.0068 2.5692 4.4112 0.7283
RF-NC1 0.0154 0.0000 0.0019 5.6586 8.0818 0.9035
RF-NC2W 0.0399 0.0002 0.0088 2.8014 4.5469 0.6042
RF-NC2 0.0370 0.0001 0.0079 3.5331 4.6655 0.6815
NIKKEI 225 RF-NC1W 0.0284 0.0002 0.0086 1.9828 3.2936 0.8288
RF-NC1 0.0151 0.0000 0.0019 5.6504 7.9970 1.0851
RF-NC2W 0.0553 0.0009 0.0173 1.8610 3.1991 1.5026
RF-NC2 0.0502 0.0004 0.0143 2.4547 3.5101 1.5871
S &P 500 RF-NC1W 0.0284 0.0000 0.0053 2.9503 5.4074 0.8410
RF-NC1 0.0151 0.0000 0.0014 7.8870 10.551 0.9924
RF-NC2W 0.0654 0.0005 0.0146 2.8814 4.4925 1.4823
RF-NC2 0.0643 0.0004 0.0139 3.1769 4.6148 1.5244
in both long and short-sale assets, thus reducing the overall risk and improving the
overall return-risk profile.
Between the 2-norm constrained models, we observe a similar pattern with RF-
NC2W resulting in higher mean returns than RF-NC2 for all data sets. Considering
risk measures, we note that model RF-NC2 results in lower variance than RF-NC2W
for all data sets and lower DD values for all data sets except for NASDAQ-100.
13
Lower values of risk measures are indicative of an equal proportion of budget shar-
ing in the long and short. Evidently, following the trend of risk measures, the perfor-
mance ratios: Sharpe and Sortino are higher for RF-NC2 than RF-NC2W for all data
sets except for NASDAQ-100.
In a nutshell, the models RF-NC1 and RF-NC2 result in a better allocation in long
and short positions along with an improved risk-return profile in comparison to the
corresponding models RF-NC1W and RF-NC2W. This signifies the importance of
non-negativity condition on the budget constraint when short selling is considered.
6.2 Effect of the short‑rebate term
We now analyze the effect of short-rebate term or risk-free interest rates on the port-
folio allocation and the out-of-sample performance by the proposed models RF-NC1
and RF-NC2. To gauge this, we solve both models for three different values of rf ,
viz., 0.2, 0.3, and 0.5 and record the in-sample and out-of-sample observations in
Tables 4 and 5 respectively.
Observations from Table 4: Considering the portfolios generated by the model
RF-NC1 for different values of rf , we observe that the diversification in long and
short increases with rf . In other words, the portfolios become less sparse as rf takes
higher values which is evident from the decrease in N-zero values with increasing
values of rf . On the other hand, the model RF-NC2 sees a minimal change in diver-
sification of long and short with varying values of rf , with long positions increasing
with increasing rf for most of the data sets.
Observations from Table 5: The out-of-sample performance by the portfolios
generated using the proposed models in terms of AMR, Sharpe, and Sortino ratio
improves evidently with the increasing values of rf . The turnover ratio also sees a
declining trend with increasing values of rf , except for the model RF-NC1 for the
data set CSI 100. The risk measures, DD, and variance, too, see an increasing trend;
however, the increase is not too steep, and the same is balanced by the elevating
return, resulting in an overall improved risk-return profile.
Note that the proposed models were also analyzed without considering the
short-rebate term (that is, rf = 0 ) to examine its impact on asset allocation. We
found that the 1-norm constrained model RF-NC1, without the short-rebate factor
resulted in a zero portfolio6 (for all values of 𝜁1) across all data sets, indicating
the importance of the short-rebate factor in asset allocation. On the other hand,
the 2-norm constrained model RF-NC2 (without rf ) resulted in a portfolio with
very poor weight allocation. For instance, for the data set CNX 100, we observed
that without rf , B-long was only 0.0035 and B-short only −0.0026 , which is too
low as compared to the case when rf is considered (see Table 4). Also, with less
number of assets, these allocations become awfully poor. To cite an example, the
data set SENSEX with 30 assets observes a maximum weight allocation in long
of 0.0002 and in short of −0.0001 when rf = 0 , while with rf = 0.3, these val-
ues are 0.036 and −0.161 respectively. These poor allocations, in turn, resulted
6
A portfolio with no allocation in any asset.
13
Table 4 In-sample performance analysis of proposed models for different values of risk-free interest rate
rf
Data set Performance RF-NC1 with rf values RF-NC2 with rf values
Metrics 0.20 0.30 0.50 0.20 0.30 0.50
SENSEX N-long 12 12 12 24 24 24
N-short 5 5 5 6 6 6
N-zero 13 13 13 0 0 0
B-long 0.471 0.471 0.471 0.555 0.553 0.553
B-short − 0.471 − 0.471 − 0.471 − 0.555 − 0.553 − 0.553
CSI 100 N-long 20 21 21 38 39 40
N-short 12 13 13 22 21 20
N-zero 28 26 26 0 0 0
B-long 0.438 0.438 0.438 0.853 0.857 0.860
B-short − 0.438 − 0.483 − 0.438 − 0.852 − 0.857 − 0.860
DAX 100 N-long 27 29 31 56 57 57
N-short 16 18 17 17 16 16
N-zero 30 26 24 0 0 0
B-long 0.500 0.500 0.500 1.025 1.032 1.038
B-short − 0.500 − 0.500 − 0.500 − 1.025 − 1.032 − 1.038
NASDAQ 100 N-long 25 28 32 67 70 72
N-short 10 10 10 12 9 7
N-zero 44 42 37 0 0 0
B-long 0.500 0.500 0.500 0.726 0.718 0.714
B-short − 0.500 − 0.500 − 0.500 − 0.726 − 0.718 − 0.714
CNX 100 N-long 27 27 29 60 61 63
N-short 14 14 16 20 19 17
N-zero 39 39 35 0 0 0
B-long 0.487 0.486 0.486 0.990 0.991 0.991
B-short − 0.487 − 0.486 − 0.486 − 0.990 − 0.991 − 0.991
FTSE 100 N-long 32 33 44 69 69 70
N-short 20 22 24 20 20 19
N-zero 37 34 21 0 0 0
B-long 0.500 0.500 0.500 1.162 1.169 1.174
B-short − 0.500 − 0.500 − 0.500 − 1.162 − 1.169 − 1.174
NIKKEI 225 N-long 78 80 84 145 149 153
N-short 61 61 60 69 65 61
N-zero 75 73 69 0 0 0
B-long 0.500 0.500 0.500 1.660 1.658 1.657
B-short − 0.500 − 0.500 − 0.500 − 1.660 − 1.658 − 1.657
S &P 500 N-long 180 176 191 367 373 378
N-short 81 68 68 73 67 62
N-zero 179 196 180 0 0 0
B-long 0.500 0.500 0.500 2.118 2.124 2.134
B-short − 0.500 − 0.500 − 0.500 − 2.118 − 2.124 − 2.134
13
Table 5 Out-of-sample performance analysis of proposed models for different values of risk-free interest
rate rf
Data Set Performance RF-NC1 with rf values RF-NC2 with rf values
Measures 0.20 0.30 0.50 0.20 0.30 0.50
SENSEX AMR 0.0093 0.0140 0.0234 0.0113 0.0168 0.0279

AV 0.0000 0.0000 0.0001 0.0001 0.0001 0.0002
DD 0.0040 0.0046 0.0063 0.0051 0.0065 0.0095
Sharpe Ratio 1.6929 2.3057 3.0597 1.5206 1.8419 2.1644
Sortino Ratio 2.3173 3.0204 3.6989 2.2020 2.6012 2.9452
Turnover Ratio 0.7337 0.7337 0.7337 0.4991 0.4739 0.4557
CSI 100 AMR 0.0082 0.0125 0.0213 0.0177 0.0264 0.0438
AV 0.0000 0.0000 0.0001 0.0002 0.0003 0.0006
DD 0.0038 0.0050 0.0078 0.0088 0.0118 0.0183
Sharpe Ratio 1.5826 1.9917 2.3473 1.4346 1.6613 1.8630
Sortino Ratio 2.1385 2.5237 2.7485 1.9963 2.2289 2.3879
Turnover Ratio 0.8511 0.8530 0.8508 0.8339 0.8026 0.7749
DAX 100 AMR 0.0108 0.0158 0.0258 0.0224 0.0329 0.0538
AV 0.0000 0.0000 0.0000 0.0001 0.0001 0.0002
DD 0.0027 0.0027 0.0027 0.0066 0.0079 0.0107
Sharpe Ratio 2.4680 3.6120 5.9209 2.2871 2.8504 3.5286
Sortino Ratio 3.9723 5.8204 9.5097 3.4033 4.1755 5.0138
Turnover Ratio 0.8287 0.8285 0.8333 0.7281 0.6933 0.6653
NASDAQ 100 AMR 0.0099 0.0148 0.0248 0.0137 0.0206 0.0346
AV 0.0000 0.0000 0.0000 0.0000 0.0001 0.0001
DD 0.0040 0.0042 0.0042 0.0045 0.0054 0.0080
Sharpe Ratio 1.8596 2.6801 4.5053 2.1257 2.6931 3.2098
Sortino Ratio 2.5051 3.5243 5.9137 3.0461 3.7975 4.3397
Turnover Ratio 0.8024 0.7993 0.7940 0.6760 0.6289 0.5893
CNX 100 AMR 0.0094 0.0143 0.0240 0.0197 0.0296 0.0495
AV 0.0000 0.0000 0.0000 0.0001 0.0002 0.0004
DD 0.0029 0.0034 0.0046 0.0071 0.0093 0.0144
Sharpe Ratio 2.3517 3.2385 4.3489 1.8143 2.1637 2.5097
Sortino Ratio 3.2192 4.2034 5.1835 2.7928 3.1800 3.4432
Turnover Ratio 0.8470 0.8466 0.8424 0.8317 0.7856 0.7456
FTSE 100 AMR 0.0104 0.0154 0.0255 0.0252 0.0370 0.0606
AV 0.0000 0.0000 0.0000 0.0001 0.0001 0.0002
DD 0.0019 0.0019 0.0019 0.0069 0.0079 0.0102
Sharpe Ratio 3.8572 5.6586 9.4583 2.7678 3.5331 4.5043
Sortino Ratio 5.4894 8.0818 13.442 3.6607 4.6655 5.9250
Turnover Ratio 0.9122 0.9035 0.8617 0.7187 0.6815 0.6500
13
Table 5 (continued)
Data Set Performance RF-NC1 with rf values RF-NC2 with rf values
Measures 0.20 0.30 0.50 0.20 0.30 0.50
NIKKEI 225 AMR 0.0101 0.0151 0.0252 0.0337 0.0502 0.0832

AV 0.0000 0.0000 0.0000 0.0002 0.0004 0.0010
DD 0.0019 0.0019 0.0019 0.0100 0.0143 0.0237
Sharpe Ratio 3.7291 5.6504 9.3544 2.2553 2.4547 2.5799
Sortino Ratio 5.2679 7.9970 13.172 3.3595 3.5101 3.5106
Turnover Ratio 1.1166 1.0851 1.0321 1.6489 1.5871 1.5303
S &P 500 AMR 0.0101 0.0151 0.0251 0.0429 0.0643 0.1073
AV 0.0000 0.0000 0.0000 0.0003 0.0004 0.0009
DD 0.0015 0.0014 0.0015 0.0103 0.0139 0.0222
Sharpe Ratio 5.0457 7.8870 12.854 2.7381 3.1769 3.5584
Sortino Ratio 6.8337 10.551 17.096 4.1766 4.6148 4.8372
Turnover Ratio 1.0507 0.9924 0.9166 1.6084 1.5245 1.4458
in poor out-of-sample performance. Similar observations were recorded for other

data sets as well.
Thus, the empirical results justify that the inclusion of the short-rebate term
not only helps improve out-of-sample performance but also in better allocation of
funds in the long and short in both the proposed models.
7 Comparative analysis of the proposed models
In this section, we carry out the numerical comparison of the proposed models:
RF-NC1 and RF-NC2, with four related models from the literature: NC1, NC2,
MV, CSRf (CSRf-50% and CSRf-100%), along with the equally weighted 1/N
portfolio. The comparative analysis is broadly bifurcated into the in-sample and
out-of-sample analyses. For the in-sample analysis, we focus on diversification
(asset weight allocation) and budget allocation in the long and short by all the
models, and for the out-of-sample analysis, we rank all the models on the basis of
performance metrics considered in the paper.
7.1 In‑sample discussion
Table 6 clocks the in-sample observations, viz., N-long, N-short, N-zero, B-long,
and B-short for all the models. Panel A of Table 6 describes the performance of the
proposed models, RF-NC1 and RF-NC2, whereas Panel B reports the performance
of portfolios from related models in literature, including the equally weighted 1/N
portfolio. From this table, it is evident that RF-NC1, NC1, and CSRf-50% generate
13
sparse portfolios (as N-zero> 0) while the MV, RF-NC2, NC2, and CSRf-100% gen-
erate diversified portfolios (as N-zero= 0).
Portfolios from the models NC1, NC2, and MV in Panel B, where the budget
constraint is of equality type, observe a biased allocation towards the long positions.
Moreover, the budget proportion in the long of greater than one (B-long> 1) indi-
cates the use of proceeds from short sales to buy assets long. For instance, the port-
folio from the model NC1 in NASDAQ-100 yields a total budget of 0.500 from the
short sale transaction as proceeds and invests a total budget of 1.500 in buying assets
long. However, such a scenario is not possible in general as the proceeds from a
short sale are not 100% available for consumption.
On the other hand, the cardinality-constrained portfolios, CSRf-50% and CSRf-
100%, behave differently in their allocation in the long and short, indicating the
effect of cardinality in the asset selection. While CSRf-50% allocates more in shorts
than in long for almost all data sets except CSI-100 and NIKKEI-225, CSRf-100%
clearly dominates in long than in short for all data sets.
The portfolios from Panel A depict a justified allocation in long and short. That
is, the total budget received from short sale transactions as proceeds and the total
budget invested in buying assets long is equal for both proposed models across all
data sets. Therefore, there is no dominance of one strategy over the other, owing
to the bounded budget constraint. To determine the impact of the number of assets
on short selling, the data sets have been arranged in increasing order of the number
of constituent assets. From Table 6, it is evident that the average number of assets
to be short (N-short) generally depicts an increasing trend; however, it is not very
uniform. Concerning the budget, in the case of RF-NC1, we see no impact of the
number of assets since the total amount of short sales is restricted to 𝜁1 ∕2. However,
RF-NC2 spots an increase in the short-sale budget with the increasing number of
assets. In fact, we notice the use of proceeds to buy assets long for four of the eight
data sets considered, namely, DAX 100, FTSE 100, NIKKEI 225, and S &P 500.
Hence, from a practical standpoint of diversification and budget allocation, RF-NC1
proves to be the best choice for short selling as the investor can restrict the total
amount of short sales by tuning the threshold.
7.2 Out‑of‑sample discussion
We now examine and compare the portfolios from the proposed models in Panel A
with the portfolios from related models in literature in Panel B on the basis of their
performance measures calculated over the out-of-sample period. Table 7 records
the out-of-sample performance of the portfolios from all the models across all the
eight global data sets. Table 8 reports the pairwise p-values for the difference in the
portfolio variances and Table 9 reports the pairwise p-values that the Sharpe ratio
between the two portfolios is different. We say that the difference is significant if the
p-value is smaller than 0.05.
We draw the following observations from Tables 7, 8 and 9:
13
Table 6 In-sample observations of proposed models and with portfolios from related models
Data set Portfolios Panel A: Proposed Panel B: Related Models from Literature
Models
RF-NC1 RF-NC2 1/N MV NC1 NC2 CSRf- CSRf-
50% 100%
SENSEX N-long 12 24 30 20 17 20 10 22
N-short 5 6 0 10 5 10 5 5
N-zero 13 0 0 0 8 0 15 3
B-long 0.471 0.553 1.000 1.488 1.125 1.488 0.677 0.565
B-short − 0.471 − 0.553 0.000 − 0.488 − 0.125 − 0.488 − 0.305 − 0.149
CSI 100 N-long 21 39 60 33 21 33 13 37
N-short 13 21 0 27 14 27 15 16
N-zero 26 0 0 0 25 0 32 7
B-long 0.438 0.857 1.000 2.738 1.375 2.643 0.394 0.430
B-short − 0.438 − 0.857 0.000 − 1.738 − 0.375 − 1.643 − 0.485 − 0.251
DAX 100 N-long 29 57 73 18 14 49 20 50
N-short 18 16 0 15 5 24 16 16
N-zero 26 0 0 40 54 0 37 7
B-long 0.500 1.032 1.000 2.248 1.055 1.475 0.558 0.498
B-short − 0.500 − 1.032 0.000 − 1.248 − 0.055 − 0.475 − 0.437 − 0.209
NASDAQ N-long 28 70 79 41 28 51 32 63
100 N-short 10 9 0 38 17 28 6 6
N-zero 42 0 0 0 34 0 42 10
B-long 0.500 0.718 1.000 4.341 1.500 1.592 0.769 0.517
B-short − 0.500 − 0.718 0.000 − 3.341 − 0.500 − 0.592 − 0.153 − 0.074
CNX 100 N-long 27 61 80 44 31 44 25 60
N-short 14 19 0 36 16 36 15 15
N-zero 39 0 0 0 13 0 40 6
B-long 0.486 0.991 1.000 3.394 1.375 3.287 0.634 0.531
B-short − 0.485 − 0.988 0.000 − 2.394 − 0.375 − 2.287 − 0.365 − 0.175
FTSE 100 N-long 33 69 89 48 33 58 25 62
N-short 22 20 0 41 17 31 19 19
N-zero 34 0 0 0 38 0 45 8
B-long 0.500 1.169 1.000 6.079 1.500 1.676 0.561 0.502
B-short − 0.500 − 1.169 0.000 − 5.079 − 0.500 − 0.676 − 0.437 − 0.208
NIKKEI N-long 80 149 214 107 43 123 37 159
225 N-short 61 65 0 107 28 91 49 55
N-zero 73 0 0 0 143 0 128 0
B-long 0.500 1.658 1.000 4.331 1.500 2.357 0.322 0.398
B-short − 0.500 − 1.658 0.000 − 3.331 − 0.500 − 1.357 − 0.456 − 0.209
13
Table 6 (continued)
Data set Portfolios Panel A: Proposed Panel B: Related Models from Literature
Models
RF-NC1 RF-NC2 1/N MV NC1 NC2 CSRf- CSRf-
50% 100%
S &P 500 N-long 176 373 440 219 85 254 137 379
N-short 68 67 0 221 65 186 55 59
N-zero 196 0 0 0 290 0 248 2
B-long 0.500 2.124 1.000 2.940 1.500 2.825 0.622 0.445
B-short − 0.500 − 2.124 0.000 − 1.940 − 0.500 − 1.825 − 0.250 − 0.116
1. Adjusted Mean Return
(1a) The portfolios from the model (MV) achieves the highest mean return fol-
lowed by those from RF-NC2, which achieves the second highest values
for five of the eight data sets, namely DAX 100, NASDAQ 100, FTSE-
100, NIKKEI 225 and S &P 500. In contrast, the 1/N portfolio suffers with
the least mean return for all data sets.
(1b) Amongst the sparse portfolios, viz., from the models RF-NC1, NC1, and
CSRf-50%, we observe that RF-NC1 always outperforms CSRf-50% in
terms of mean return, except for CSI 100. On the other hand, NC1 attains
higher values of mean return than the RF-NC1 across five data sets,
namely CSI 100, NASDAQ 100, FTSE 100, NIKKEI 225, and S &P 500.
(1c) Comparing amongst the diversified portfolios, viz., from the models
RF-NC2, NC2, and CSRf-100%, we see that RF-NC2 always outperforms
CSRf-100%, while it outperforms NC2 for five data sets, namely DAX
100, NASDAQ 100, FTSE-100, NIKKEI 225 and S &P 500.
(1d) Between the portfolios from proposed models in Panel A, RF-NC2
achieves higher values of mean return than RF-NC1 across all data sets.
2. Risk Measures: Adjusted Variance and DD
(2a) The portfolios from the proposed model RF-NC1 generally achieves the
lowest variance across all data sets. Comparing the sparse portfolios using
p-values from Table 8, we observe that the differences between variances
of RF-NC1 are NC1 are statistically significant for five data sets, namely
SENSEX, CSI 100, CNX 100, NIKKEI 225 and S &P 500, while between
RF-NC1 and CSRf-50%, the differences are significant for all data sets
except NASDAQ 100.
(2b) Amongst the diversified portfolios, viz., from the models RF-NC2, NC2,
and CSRf-100%, we discern that CSRf-100% achieves the lowest values
of DD for all data sets, followed by RF-NC2 that performs better than
NC2 for six data sets, except for NIKKEI 225 and S &P 500. In terms of
13
Table 7 Out-of-sample performance comparison of proposed models with portfolios from related models
Dataset Portfolios Panel A: Proposed Models Panel B: Related Models from Literature
RF-NC1 RF-NC2 1/N MV NC1 NC2 CSRf-50% CSRf-100%
SENSEX Adjusted Mean Return 0.0140 0.0168 0.0031 0.0171 0.0063 0.0171 0.0105 0.0060
Adjusted Variance 0.0000 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0000
Downside Deviation 0.0046 0.0065 0.0083 0.0082 0.0069 0.0082 0.0066 0.0046
Sharpe Ratio 2.3057 1.8419 0.2942 1.4285 0.6619 1.4282 1.1796 0.9917
Sortino Ratio 3.0204 2.6012 0.3715 2.0876 0.9067 2.0894 1.5880 1.3031
Turnover Ratio 0.7337 0.4739 0.0000 0.5001 0.3041 0.5000 0.3194 0.2292
CSI-100 Adjusted Mean Return 0.0125 0.0264 0.0041 0.0559 0.0141 0.0530 0.0146 0.0083
Sharpe Ratio 1.9917 1.6613 0.2359 2.7615 1.0715 2.9044 0.9634 0.7476
Sortino Ratio 2.5237 2.2289 0.3061 4.3138 1.7113 4.5113 1.2253 0.9274
Norm constrained minimum variance portfolios with short…
Turnover Ratio 0.8530 0.8026 0.0000 1.6635 0.4749 1.5558 0.3428 0.3221
DAX-100 Adjusted Mean Return 0.0158 0.0329 0.0018 0.0405 0.0056 0.0168 0.0148 0.0074
Sharpe Ratio 3.6120 2.8504 0.1397 0.7656 0.1634 1.3263 1.2052 1.3579
Sortino Ratio 5.8204 4.1755 0.1629 1.3443 0.6071 1.8473 2.2705 1.8801
Turnover Ratio 0.8285 0.6933 0.0000 1.2794 0.1924 0.3598 0.3092 0.2638
NASDAQ 100 Adjusted Mean Return 0.0148 0.0206 0.0038 0.1002 0.0174 0.0202 0.0064 0.0035
Page 27 of 35
Sharpe Ratio 2.6801 2.6931 0.3607 4.9169 2.2014 2.6457 0.7810 0.7009
6
Sortino Ratio 3.5243 3.7975 0.4507 6.9034 2.8220 3.3126 0.9639 0.8621
Turnover Ratio 0.7993 0.6289 0.0000 3.6642 0.6735 0.4745 0.3196 0.2825
13
Table 7 (continued)
6
13
CNX-100 Adjusted Mean Return 0.0143 0.0296 0.0031 0.0751 0.0143 0.0718 0.0125 0.0066
Page 28 of 35
Sharpe Ratio 3.2385 2.1637 0.2642 4.1602 1.6369 4.9330 1.4147 1.1848
Sortino Ratio 4.2034 3.1800 0.3341 6.6086 2.3048 7.4568 2.1260 1.6564
Turnover Ratio 0.8466 0.7856 0.0000 2.7934 0.5782 2.5610 0.3001 0.2597
FTSE-100 Adjusted Mean Return 0.0154 0.0370 0.0017 0.1538 0.0157 0.0213 0.0142 0.0071
Sharpe Ratio 5.6586 3.5331 0.1531 3.8933 1.6678 2.2367 2.0174 1.5815
Sortino Ratio 8.0818 4.6655 0.1778 6.2808 1.9961 2.6247 2.7259 2.0403
Turnover Ratio 0.9035 0.6815 0.0000 7.0254 0.7517 0.5561 0.3430 0.2352
NIKKEI 225 Adjusted Mean Return 0.0151 0.0502 0.0016 0.1015 0.0170 0.0428 0.0139 0.0068
Sharpe Ratio 5.6504 2.4547 0.0978 4.1926 1.3673 3.8247 0.8577 1.0129
Sortino Ratio 7.9970 3.5101 0.1214 6.2612 1.7422 4.9550 1.5614 1.3874
Turnover Ratio 1.0851 1.5871 0.0000 2.8669 0.8872 0.8260 0.4118 0.1833
V. Dhingra et al.
Table 7 (continued)
S &P 500 Adjusted Mean Return 0.0151 0.0643 0.0023 0.0601 0.0167 0.0566 0.0084 0.0043
Sharpe Ratio 7.8870 3.1769 0.2206 6.3959 2.2471 5.9653 1.3783 1.4723
Sortino Ratio 10.551 4.6148 0.2643 8.3285 2.8035 7.7320 1.8215 1.8776
Turnover Ratio 0.9924 1.5245 0.0000 1.4552 1.1233 1.2782 0.3450 0.1238
Norm constrained minimum variance portfolios with short…
Page 29 of 35
6
13
Table 8 Pairwise p-values for the difference in variances computed using the bootstrap methodology in
Ledoit and Wolf (2011)
Panel A Panel B DI DII DIII DIV DV DVI DVII DVIII
RF-NC1 1/N 0.009 0.002 0.018 0.020 0.002 0.147 0.001 0.003
MV 0.001 0.001 0.001 0.002 0.001 0.001 0.001 0.001
NC1 0.005 0.006 0.158 0.213 0.008 0.151 0.002 0.001
NC2 0.003 0.001 0.002 0.284 0.001 0.460 0.002 0.001
CSRf-50% 0.015 0.002 0.024 0.148 0.002 0.001 0.008 0.001
CSRf-100% 0.979 0.023 0.383 0.669 0.149 0.002 0.001 0.006
RF-NC2 1/N 0.341 0.753 0.634 0.095 0.219 0.878 0.212 0.035
MV 0.010 0.100 0.001 0.001 0.033 0.001 0.266 0.001
NC1 0.856 0.392 0.420 0.861 0.107 0.715 0.053 0.001
NC2 0.003 0.446 0.715 0.995 0.623 0.765 0.019 0.001
CSRf-50% 0.840 0.761 0.773 0.678 0.046 0.002 0.529 0.001
CSRf-100% 0.001 0.260 0.001 0.035 0.001 0.001 0.001 0.001
Table 9 Pairwise p-values for the difference in Sharpe ratios computed using the studentized circular
bootstrap methodolgy in Ledoit and Wolf (2008)
Panel A Panel B DI DII DIII DIV DV DVI DVII DVIII
RF-NC1 1/N 0.003 0.001 0.002 0.005 0.014 0.001 0.001 0.001
MV 0.020 0.096 0.002 0.018 0.184 0.114 0.209 0.316
NC1 0.002 0.027 0.002 0.549 0.049 0.001 0.003 0.001
NC2 0.023 0.068 0.013 0.963 0.033 0.229 0.135 0.151
CSRf-50% 0.006 0.015 0.021 0.009 0.020 0.001 0.003 0.001
CSRf-100% 0.003 0.008 0.016 0.004 0.006 0.001 0.003 0.001
RF-NC2 1/N 0.001 0.002 0.001 0.001 0.001 0.001 0.001 0.001
MV 0.107 0.017 0.001 0.008 0.001 0.496 0.009 0.018
NC1 0.001 0.106 0.001 0.435 0.414 0.101 0.074 0.122
NC2 0.113 0.028 0.049 0.949 0.012 0.408 0.222 0.020
CSRf-50% 0.016 0.017 0.001 0.001 0.096 0.001 0.001 0.005
CSRf-100% 0.002 0.006 0.001 0.001 0.006 0.001 0.001 0.004
variance as well, CSRf-100% achieves lower variance than RF-NC2 for

all data sets, and the differences are statistically significant for all data
sets except CSI 100. On the other hand, RF-NC2 and NC2 depict similar
values for variances for all data sets except for NIKKEI 225 and S &P
500, where RF-NC2 proves riskier. The same is validated by the p-values,
which are statistically significant for only SENSEX, NIKKEI 225, and S
&P 500.
(2c) The portfolios from the MV model achieve the highest values of adjusted
variance and DD for all the data sets, proving to be the riskiest of all.
Additionally, the difference in variances between MV and RF-NC1 are
13
statistically significant across all data sets. In contrast, between MV and

RF-NC2, the differences are significant for six data sets, except CSI 100
and NIKKEI 225.
(2d) The 1/N portfolios achieve the highest values of DD for SENSEX, CSI
100, and S &P 500 and the second highest values of DD for other data
sets, proving unfavourable from a risk perspective. It records higher vari-
ance than RF-NC1, and the differences are significant across all data sets
except FTSE 100. On the other hand, the variances of RF-NC2 and 1/N are
observed to be similar for all data sets except S &P 500, where RF-NC2
proves riskier, and the same is validated by the p-values.
(2e) Between the portfolios from proposed models in Panel A, RF-NC1 records
lower values of risk measures than RF-NC2 for all data sets, thus proving
advantageous from a risk perspective.
3. Performance Ratios: Sharpe, Sortino and the Turnover ratios
(3a) Both the portfolios from Panel A outperform the equally weighted 1/N
portfolios, and cardinality-constrained portfolios, CSRf-50% and CSRf-
100% from Panel B in terms of both Sortino and Sharpe ratios for all
data sets. Moreover, the differences in the Sharpe ratios are statistically
significant across all data sets.
(3b) Comparing the 1-norm constrained portfolios, viz., RF-NC1 and NC1, we
observe that RF-NC1 records higher values of both Sortino and Sharpe
ratios, and the differences in their Sharpe ratios are statistically significant
for all data sets except for NASDAQ 100. However, in terms of turnover
ratio, NC1 proves favourable. On the contrary, we notice mixed results
between the 2-norm constrained portfolios. While RF-NC2 dominates
NC2 for four data sets, namely SENSEX, DAX 100, NASDAQ 100, and
FTSE 100, NC2 dominates RF-NC2 for the other four in terms of both
Sharpe and Sortino ratios.
(3c) Between the proposed models in Panel A, RF-NC1 outperforms RF-NC2
in terms of both Sharpe and Sortino ratios for all the data sets, except for
NASDAQ 100. However, RF-NC2 performs better in terms of the turnover
ratio by achieving lower values than RF-NC1 over six data sets, except
NIKKEI 225 and S &P 500.
(3d) The 1/N portfolios achieve the lowest values of the Sharpe and Sortino
ratios for all data sets. None of the proposed models record the worst val-
ues for any performance measure across any of the data sets considered.
(3e) In terms of turnover ratio, the MV portfolios perform worst by recording
the highest values of turnover ratio for all data sets. Portfolios from the
cardinality-constrained models, viz., CSRf-50% and CSRf-100%, attain
lower turnover ratios than the portfolios from norm-constrained models,
viz., RF-NC1, RF-NC2, NC1, and NC2 over all data sets.
The overall analysis can be summarized as follows:
13
1. The equality budget constraint, as in the MV, NC1, and NC2 models, yields port-
folios with investment in long more than the available budget indicating the use of
short sale proceeds, which is not viable. This motivated us to modify the budget
constraint in our models, which proves favourable with the norm constraints.
In particular, the bounded budget with the 1-norm constraint helps restricts the
short sale budget, and an investor can easily avoid the scenario of the use of short
sale proceeds. The 2-norm constraints, however, fail to impress in this regard,
especially when the number of assets under consideration is large.
2. The non-negativity condition of budget in the proposed models ensures equal
proportions in both the market movements, i.e., long and short, and no domi-
nance of one over the other. This helps reduce the overall risk, as depicted in the
out-of-sample performance of the proposed models over other related portfolios,
especially in terms of risk and performance ratios.
3. The outperformance of proposed models, RF-NC1 and RF-NC2, over the cardi-
nality-constrained models, CSRf-50% and CSRf-100% underlines the importance
of norm constraints, which perform well in the presence of estimation error due
to variances. The poor performance of CSRf-50% and CSRf-100% also hints at
the impact of estimation error due to the mean vector considered in the models.
4. The portfolios from the MV model outperformed the proposed models, RF-NC1
and RF-NC2, in terms of AMR; however, they also proved to be the riskiest of all.
This is because of huge allocation in the long and short, exceeding the available
budget. Thus, though MV may seem to be an attractive choice in terms of return,
it is not a practical one.
5. The proposed model RF-NC1 proves to be an intelligent choice when short-
selling is considered, as it overcomes several limitations of other related models.
It helps generate portfolios with superior out-of-sample performance in terms of
both the risk as well as several performance ratios. An additional highlight of the
model is its flexibility in tuning the short sale budget with the choice of threshold
parameter of the 1-norm constraint.
8 Conclusion
In the present work, we consider the minimum variance framework to model short
selling by examining several constraints that aptly consider the various practical
settings of a short sale transaction. To enhance the asset selection in the long and
short, we exploit the additional interest from the short-rebate by maximizing it in the
objective function of the model. In constraints, we impose the norm bounds to gauge
the impact of diversification on short selling. The 1-norm constraint helped generate
sparse portfolios, while the 2-norm constraint gave well-diversified portfolios. Addi-
tionally, we bounded the budget between 0 and 1, which helped in allocating bal-
anced funds in the long and short, thereby avoiding the dominance of one strategy
over the other, resulting in a better risk-return profile.
The empirical analysis, carried across eight global indices for ten years from
April 2010 to March 2020, highlights the importance of the specific choice of
constraints and the short-rebate term in the proposed model. In comparison with
13
several related models from the literature, we found that the proposed models out-
performed the norm-constrained models and the minimum variance model in terms
of risk measures and performance ratios, suggesting the importance of the right
choice of budget constraint as well as the short-rebate in long-short selection. The
outperformance over the cardinality-constrained models indicates how the norm
constraints are a better choice to generate a better diversification in long-short while
also winning over the computational difficulty. Between the proposed models, the
1-norm constrained model proves more favorable for a short sale scenario, because
firstly it generates statistically significant portfolios as compared to other related
models in terms of variance and Sharpe ratio. Secondly, the threshold parameter of
the 1-norm constraint restricts the short sale budget, allowing the investor to tune
the short sale budget.
To sum up, short selling is an attractive yet risky choice; however, it can be bene-
ficial and profitable if calculated positions are taken and a wise long-short allocation
is done. The proposed model with the 1-norm constraint balances both strategies
and exploits the benefits of short-selling by generating portfolios with superior out-
of-sample performance while managing and minimizing risk.
Acknowledgements The authors sincerely thank the Associate Editor and the anonymous reviewers for
their valuable comments and suggestions, which have considerably improved the presentation and quality
of the paper. The authors acknowledge the support of the Department of Management Studies, IIT Roor-
kee, India, for providing access to the Bloomberg Database to collect data. The first author would also
like to thank the Ministry of Human Resource and Development (MHRD), New Delhi, India, for financial
support.
Data availability The data sets for the current study have been fetched by the authors from the Bloomb-
erg Database Management software, accessed through the Department of Management Sciences, IIT
Roorkee, India. The data is privately fetched and hence not publicly available; however, can be made
available from the corresponding author on a reasonable request.
Declarations
Conflict of interest The authors also have no competing interests to declare that are relevant to the content
of this paper.
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Computational Management Science (2023) 20:6

Norm constrained minimum variance portfolios

Vrinda Dhingra1 · Shiv Kumar Gupta1 · Amita Sharma2

Received: 11 April 2022 / Accepted: 27 December 2022

Keywords Minimum variance portfolio model · Norm constraints · Short selling ·

* Shiv Kumar Gupta

2 Motivation and contributions

convex optimization problem. Secondly, these constraints yield portfolios with

• We analyze 1- and 2-norm constraints along with a bounded budget constraint

3 Notation and related portfolio models

3.1 Minimum variance portfolios

Here, e = (1, 1, … , 1)T ∈ ℝN is the vector of ones and 𝛿 = (𝛿1 , 𝛿2 , … , 𝛿N )T are

DeMiguel et al. (2009) proposed a general framework for a class of portfolios

The cardinality-constrained mean-variance (CCMV) portfolio optimization model,

where hi = 0 if 𝜇i ≥ 0 and 0 < hi < 1 when 𝜇i < 0.

4 Norm‑constrained minimum variance short‑sale portfolio models

1-norm constrained minimum variance model with short selling

where hi = 0 if 𝜇i ≥ 0 and hi = c; 0 < c < 1 when 𝜇i < 0. Here, rf is the risk-neutral

Remark 2 Realistically, there can be different arrangements of a short sale transac-

In the following section, we empirically investigate the proposed models over a

3. CSRf-50% and CSRf-100% models: Cardinality constrained mean-variance model

5.1 Sample data and sample period

1. Data Set 1 (DI): SENSEX (India), 30 assets;

5.2 Rolling window strategy

Table 1 Optimal parameter values obtained from cross-validation

NC1 𝛿1 1.25 1.75 1.25 2.00 1.75 2.00 2.00 2.00

• N-long: average number of assets held long (positive weights)

• N-short: average number of assets held short (negative weights)

• N-zero: average number of assets not invested in (with zero weight)

• B-long: average proportion of the total budget invested in long assets

• B-short: average proportion of the total budget held short

• Adjusted Mean Return: It is the average of the portfolio return calculated

Higher values of AMR are preferable.

Lower values of adjusted variance are preferable.

Higher values of Sharpe ratio are desirable.

Higher values of Sortino ratio are desirable.

6 Empirical investigation of the proposed models

6.1 Effect of non‑negative budget constraint

To examine the impact of non-negative budget constraint on the performance of the

SENSEX RF-NC1W 1 4 26 0.043 − 0.899

SENSEX RF-NC1W 0.0244 0.0002 0.0098 1.7516 2.4899 0.6723

6.2 Effect of the short‑rebate term

SENSEX AMR 0.0093 0.0140 0.0234 0.0113 0.0168 0.0279

NIKKEI 225 AMR 0.0101 0.0151 0.0252 0.0337 0.0502 0.0832

in poor out-of-sample performance. Similar observations were recorded for other

7 Comparative analysis of the proposed models

1. Adjusted Mean Return

2. Risk Measures: Adjusted Variance and DD

variance as well, CSRf-100% achieves lower variance than RF-NC2 for

statistically significant across all data sets. In contrast, between MV and

3. Performance Ratios: Sharpe, Sortino and the Turnover ratios

The overall analysis can be summarized as follows:

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2 Motivation and contributions

3 Notation and related portfolio models

3.1 Minimum variance portfolios

4 Norm‑constrained minimum variance short‑sale portfolio models

5.1 Sample data and sample period

5.2 Rolling window strategy

6 Empirical investigation of the proposed models

6.1 Effect of non‑negative budget constraint

6.2 Effect of the short‑rebate term

7 Comparative analysis of the proposed models