How Does the Ledoit and Wolf Shrinkage Estimator Improve a Real Estate Portfolio?

Portfolio theories are meant to provide a method for managing assets and constructing portfolios. Meanwhile, the mean-variance technique has been heavily criticized by some academics, and its application to real estate portfolio is questionable (Cheng and Liang, 2000). Indeed, the mean-variance analysis is quite sensitive to estimation errors, and traditional real estate databases can represent a huge pitfall to portfolio construction. Therefore, we look for a method to lessen the effect of inputs upon the optimization process; the shrinkage estimator appears to show some advantages in modeling real estate portfolios. This study employs the shrinkage estimator scheme of Ledoit and Wolf (2004) to examine the effect of a corner solution on the allocations. This process limits the impact of estimation errors on the optimization process, resulting in a distinctive investment strategy.