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The structural Sharpe model under t-distributions


Manuel Galeaa; David Cademartorib; Filidor Vilcac
a
Universidad de Valparaíso and Laboratorio de Análisis Estocástico, Chile b Escuela de Comercio,
Pontificia Universidad Católica de Valparaíso, Chile c Departamento de Estatística, Universidade
Estadual de Campinas, Brazil

Online publication date: 19 November 2010

To cite this Article Galea, Manuel , Cademartori, David and Vilca, Filidor(2010) 'The structural Sharpe model under t-
distributions', Journal of Applied Statistics, 37: 12, 1979 — 1990
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Journal of Applied Statistics
Vol. 37, No. 12, December 2010, 1979–1990

The structural Sharpe model under


t-distributions
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Manuel Galeaa∗ , David Cademartorib and Filidor Vilcac


a Universidadde Valparaíso and Laboratorio de Análisis Estocástico, Chile; b Escuela de Comercio,
Pontificia Universidad Católica de Valparaíso, Chile; c Departamento de Estatística, Universidade
Estadual de Campinas, Brazil

(Received 22 August 2008; final version received 23 July 2009)

In this paper we consider Sharpe’s single-index model or Sharpe’s model, by assuming that the returns
obtained follow a multivariate t elliptical distribution. Also, given that the returns of the market are not
observable, the statistical analysis was made in the context of an errors-in-variables model. In order to
analyze the sensibility to possible outliers and/or atypical returns of the maximum likelihood estimators
the local influence method [10] was implemented. The results are illustrated by using a set of shares of
companies belonging to the Chilean Stock Market. The main conclusion is that the t model with small
degrees of freedom is able to incorporate possible outliers and influential returns in the data.

Keywords: diagnostics; t-distribution; errors-in-variables models; portfolios; Sharpe model

1. Introduction
The empirical market model or Sharpe’s single-index model, ShM, is usually used to build port-
folios, see [1,7,15]. The main object of this paper is the study of local influence and diagnostics
in the ShM, assuming that the returns follow a multivariate t elliptical distribution. Also, as the
return on the market portfolio is unobservable, we work with the ShM in the framework of an
errors-in-variables model (or measurement error model; [18]).
Outliers and the detection of influent observations are important steps in the analysis of a data
set. There are several ways of evaluating the influence of perturbations in the data set and in the
model given the parameter estimates. Important reviews can be found in the books by Cook and
Weisberg [11] and Chatterjee and Hadi [9] and in the paper by [10]. On the other hand, there are
just a few works in the literature on diagnostics and influence of observations in the ShM. Several
authors have extended the local influence method to various regression models (see, for example
[14,19,20,35], among others).

∗ Corresponding author. Email: manuel.galea@uv.cl

ISSN 0266-4763 print/ISSN 1360-0532 online


© 2010 Taylor & Francis
DOI: 10.1080/02664760903207316
http://www.informaworld.com
1980 M. Galea et al.

As typically considered in the literature, the relevance of using the t-distribution is related to
its capability to downweight influential returns. On the other hand, there is empirical evidence
that share returns have distributions with heavier tails than the normal ones [5,8,17,34,36]. In
Section 2, the structural ShM is considered, and in Section 3 the main concepts of local influence
are revised, together with the delta matrix for weighted cases and scale perturbation scheme. In
Section 4 an illustration of the methodology is presented by using a set of shares of companies
belonging to the Chilean Stock Market and finally in Section 5 some conclusions are presented.

2. t-structural Sharpe model


The Sharpe’s single-index model [29], establishes a linear relationship between the returns of a
share and the return of the market. Let Rkj be a random variable, which denotes the return of asset j
in the k-period and rkm denotes the return of the market portfolio during the k-period, k = 1, . . . , n
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and j = 1, . . . , p. The ShM is given by

Rk = α + βrkm + k , (1)

where, Rk = (Rk1 , . . . , Rkp )T , α = (α1 , . . . , αp )T , β = (β1 , . . . , βp )T and k = (k1 , . . . , kp )T


are vectors of random errors iid Np (0, ), with  = Diag(φ1 , . . . , φp ) independent of rkm , which
in turn are iid N(μm , φm ) and βj is the systematic risk of the asset j . The total risk of the asset
j can be written as Var(Rkj ) = βj2 φm + φj . Then we have that the vectors Zk = (rkm , RTk )T ,
k = 1, . . . , n, are iid Np+1 (μ,V), with
   
μm φm φm β T
μ= and V = . (2)
α + βμm φm β φm ββT + 

Though model (1)–(2) is frequently used to build portfolios, see [1,7,15], they suffer from
the same lack of robustness against outlying/influential observations as other statistical models
based on the normal distribution. Thus, the normal model is sensitive to the atypical returns which
frequently arise in the real world, especially in Latin American markets.
Nowadays, there is a wide variety of methods to analyze data in the presence of outliers. An
approach to this issue is the identification and deletion of outliers, followed by statistical inference
through maximum likelihood based on the normal distribution [3,9,11]. Another method is the
accommodation of extreme observations by using classic robust procedures. On this line, by
modifying the maximum likelihood method, robust methods have been developed, so outliers
have less influence on the final estimates [25,28].
A third possibility is the use of symmetrical distributions with heavier tails than the normal
distribution, which allows reducing the influence of outliers on maximum likelihood estimators
(MLEs). Within these kinds of distributions, the one that is most used as an alternative is the t-
distribution, due to its conceptual and computational simplicity. Several authors have considered
the multivariate t-distribution as an alternative to the normal model because it can naturally accom-
modate outliers present in the data. Thus, the t model provides a robust procedure for analysing
data sets which may present outliers. Sutradar and Ali [31] consider maximum likelihood estima-
tion in the multivariate t regression model. Lange et al. [22] discuss the use of the t-distribution
in regression and in problems related to multivariate analysis. Sutradar [30] has considered a
score test aiming at testing whether the covariance matrix is equal to some specified covariance
matrix (diagonal, for example), using the t-distribution; Bolfarine and Galea-Rojas, [6] use the
t-distribution in structural comparative calibration models. More recently, Pinheiro et al. [27]
proposed algorithms for robust estimation in linear mixed effects models using the multivariate
t-distribution and Cysneiros and Paula [12] stated the robustness of the test of hypotheses in the
presence of extreme observations in linear models using the multivariate t-distribution also. For
Journal of Applied Statistics 1981

an extension to symmetrical distributions see [13]. The t-distribution incorporates an additional


parameter, ν, namely the degrees of freedom, which allows adjusting for the kurtosis of the
distribution. This parameter can be fixed previously and Lange et al. [22] and Berkane et al. [4]
recommend taking ν = 4 or, otherwise, getting information for it from the data set. We treat ν as
a known constant throughout the paper.
Moreover, as the return of the market is not observable rkm , for the influence diagnostics analysis
we consider a version of the model (1)–(2) in the framework of astructural errors-in-variables
model [2,18]. In effect, let Rkm be the realized return in time period k for the market portfolio, a
proxy for rkm and we suppose that Rkm = rkm + k0 , where k0 are measurement error iid’s with
mean zero and scale parameter φ0 , independent of rkm . The model in matrix notation is given by

Zk = a + brkm + ek = a + Krk , (3)


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where a = (0, α1 , . . . , αp )T , b = (1, β1 , . . . , βp )T are q × 1 vectors, with q = p + 1, Zk =


(Rkm , RTk )T , k = 1, . . . , n, ek = (k0 , k1 , . . . , kp )T are q × 1 random vectors, K = (b, I p ), a
matrix p × q and rk = (rkm , ekT )T random vectors of dimension (q + 1) × 1, k = 1, . . . , n,
iid, with parameter of position (μm , 0T )T and scale matrix D = Diag(φm , D(φ)) with D(φ) =
Diag(φ0 , . . . , φp ). The main advantage of this model over the traditional regression models is
that it implicitly models the errors in the proxy variables. Moreover, as for p ≥ 2, the model is
identifiable, see [2], we can use the maximum likelihood to estimate the parameters and test the
hypothesis under study. For an interesting discussion on measurement errors in financial models,
see [24].
As in [6], it is assumed that the unobservable vectors rk are independently distributed as a
multivariate t-distribution with location vector (μm , 0T )T and diagonal scale matrix D. Then
the distribution of the returns, Zk , becomes a multivariate t-distribution with location vector
μ = a + bμm and scale matrix  = φm bbT + D(φ). That is, Z1 , . . . , Zn are iid tq (μ, ; ν), with
density given by
fz (z) = ||−1/2 g((z − μ)T −1 (z − μ)), z ∈ Rq , (4)

where g(d) = k(q, ν)(1 + d/ν)−1/2(ν+q) , k(q, ν) = ((q + ν)/2)/ (ν/2)(νπ )q/2 and d =
(z − μ)T −1 (z − μ). Assuming the above we obtain the t-structural Sharpe model, SShM.
The main object of this paper is to apply the local influence method to SShM (3) and (4). To
estimate θ = (μm , αT , βT , φm , φT )T , we used the EM algorithm, see [6]. To test the hypothesis
under study we can use asymptotic tests such as likelihood ratio and score.

3. Influence diagnostics
The detection of atypical and/or influential returns is an important step in the estimation of
parameters in the ShM, especially of the systematic risk. There are several alternatives to evaluate
the influence of perturbation in the data and/or in the model on the parameter estimators. For
example, see [9,11].
Case deletion is a common way to assess the effect of an observation on the estimation process.
This is a global influence analysis, since the effect of observation is evaluated by eliminating
it from the set of data. Alternatively, local influence is based more on geometric differentiation
rather than the elimination of observations. A differential comparison of estimators is used before
and after perturbing the data and/or model assumptions. In order to evaluate the robustness of the
MLE to possible atypical returns in the set of data, the local influence method to ShM by using
the t-distribution was implemented. As in [10], we use the likelihood displacement to evaluate the
local influence.
1982 M. Galea et al.

Indeed, the logarithm of the likelihood function for the model (3)–(4) is given by


n
l(θ) = lk (θ), (5)
k=1

where lk (θ) = log k(q, ν) − 21 log || − 21 (ν + q) log(1 + dk /ν), dk = (Zk − μ)T −1 (Zk − μ),
is the contribution from the kth return to the likelihood, k = 1, . . . , n. Note that in Equation
(5) the contributions lk (θ) are equally weighted. A perturbed log-likelihood function – allowing
different weight for the returns – can be defined by


n
l(θ/ω) = ωk lk (θ), (6)
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k=1

where ω = (ω1 , . . . , ωn )T is the vector of weights of the contributions from each return to the
likelihood and ω0 = 1n = (1, . . . , 1)T is the non-perturbation point, that is to say, where l(θ/ω0 ) =
l(θ). This perturbation scheme is intended to evaluate whether the contribution of the returns with
different weights affects the MLE of θ. Perhaps, this is the method most commonly used to evaluate
the influence of a small modification of the model. Let  θ ω be the MLE of θ in the perturbed model.
The influence of the perturbation ω on the MLE can be evaluated by the likelihood displacement
defined by
LD(ω) = 2(l( θ) − l(θ ω )). (7)
Cook [10] proposes to study the local behavior of LD(ω) around of ω0 , using the normal curvature
Cl of LD(ω) in ω0 in the direction of some unitary vector l and it shows that:

Cl = 2 | l T
T L−1
l |, l = 1, (8)

where L is the observed information matrix and


is a matrix 3q × n given by
=
(
1 (θ), . . . ,
n (θ)), both evaluated at θ = 
θ, where


k (θ) = (
k (μm ),
Tk (α),
Tk (β),
k (φm ),
Tk (φ))T , (9)

where
∂lk (θ) 1 ∂log|| ν + q

k (γ) = =− − (ν + dk )−1 dkγ ,
∂γ 2 ∂γ 2
with dkγ = ∂dk /∂γ, γ = μm , α, β, φm , φ; k = 1, . . . , n.
The model (3)–(4) are assumed to be homoskedastic, that is, the scale matrix of returns, Zk , is
assumed to be a constant. In general, this assumption is not reasonable for financial data, especially
for dealing with high frequency data, which have variable volatility. To analyze the sensitivity of
the MLE, we implement a perturbation scale scheme. Indeed, we assume that the scale matrix of
the returns is given by /ωk , k = 1, . . . , n. In this case we have that

1 ν(ν + q)

k (γ) = − dkγ , (10)
2 (ν + dk )2

for γ = μm , α, β, φm , φ and k = 1, . . . , n.
The components ∂log||/∂γ, dkγ and the elements of the observed information matrix are
presented in the appendix.
Let l max be the direction of maximum normal curvature, which is the perturbation that produces
the greatest local change in  θ. The most influential elements of the data can be identified by their
Journal of Applied Statistics 1983

large components of the vector l max . Moreover, l max is just the eigenvector corresponding to the
largest eigenvalue of B =
T L−1
.
Another important direction, according to [16] (see also [33]) is l = ekn , which corresponds to
the k-position, where there is one. In that case, the normal curvature, called the total local influence
of case k, is given by Ck = 2|eTkn Bekn | = 2|bkk |, where bkk is the kth element diagonal of B,
k = 1, . . . , n. Verbeke and Molenberghs
 [33] propose to consider the kth observation influential
if Ck is larger than the cutoff value 2 nk=1 Ck /n. We use l max and Ck as the diagnostics for local
influence.

4. Application
The data correspond to monthly returns of shares from the Chilean Stock Market. We use the
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Selective Index of Prices of Shares, IPSA, as returns of the Chilean Stock Market. The data
correspond to the period from January 1990 to June 2004, and were obtained from Economatica.
We illustrate the methodology with 10 companies in the following order: Cementos, Cervezas,
Cmpc, Copec, Concha y Toro (CyT), Entel, Endesa, Vapores, Cuprum and Chilectra. Figure 1
shows the mean and the standard deviation of the returns of each company for the period under
study. One can observe that Cuprum, which is a pension fund, is the company with the highest
mean return, but also the one that has the highest risk in the period.
The means, standard deviations (SD), coefficients of skewness and kurtosis, as well as tests for
autocorrelation, heteroskedasticity and normality of the monthly returns are presented in Table 1.
As can be seen, all returns have a moderate positive skewness, except CyT company. The 10 com-
panies and the IPSA present high kurtosis. These coefficients give us initial evidence about the
absence of normality in the monthly returns. In fact, the normality hypothesis is rejected in all cases
using the Jarque-Bera (JB) test. Among the 10 companies and the IPSA, the χ 2 -tests for the pres-
ence of autocorrelation (lag 1) reveal that only Cuprum has significant autocorrelation, using a level
of 5%. The χ 2 -tests for the presence of autocorrelation of lag j , for j = 3, 6 present similar results.
Table 1 also presents tests for generalized autoregressive conditional heteroskedasticity
(GARCH). The Lagrange Multipliers test (LM) (see, for example, [23]) for Garch(1, 1) effects
0.15

CUPRUM
0.14

ENTEL
0.13

CONCHA Y TORO
Standard deviation
0.12

CEMENTOS
0.11

CERVEZAS
CHILECTR
A
0.10

VAPORES
0.09

CMPC ENDESA
COPEC
0.08

0.015 0.020 0.025 0.030 0.035 0.040 0.045 0.050


Mean

Figure 1. Scatter plots of the means and standard deviation of the returns of the 10 firms.
1984 M. Galea et al.
Table 1. Summary statistics for monthly returns of ten companies and IPSA. In parenthesis p-values.

Company Mean SD Skewness Kurtosis χ2 LM JB

Cementos 0.0256 0.1214 1.2540 6.1594 1.2758 (0.2587) 0.0053 (0.9417) 130.564 (0.0000)
Cervezas 0.0236 0.1056 0.5546 4.1995 0.0111 (0.9163) 0.5383 (0.4631) 21.9499 (0.0000)
Cmpc 0.0195 0.0909 1.0148 4.9999 0.2328 (0.6294) 0.5030 (0.4782) 37.8493 (0.0000)
Copec 0.0239 0.0903 0.5983 4.2290 0.5126 (0.4740) 0.0293 (0.8642) 6.45350 (0.0396)
CyT 0.0292 0.1287 3.1381 23.4518 0.1650 (0.6846) 0.0402 (0.8412) 3342.15 (0.0000)
Entel 0.0206 0.1327 0.5803 4.7429 2.3919 (0.1220) 0.0122 (0.9231) 04.8887 (0.0867)
Endesa 0.0224 0.0918 0.2411 4.4033 0.0030 (0.9563) 0.0063 (0.9367) 29.0569 (0.0000)
Vapores 0.0197 0.0976 1.0300 4.4425 1.4737 (0.2248) 0.2131 (0.6444) 49.2259 (0.0000)
Cuprum 0.0489 0.1460 1.8687 8.2902 5.7337 (0.0166) 0.0039 (0.9505) 68003.2 (0.0000)
Chilectra 0.0251 0.0926 0.5910 4.8886 1.6957 (0.1928) 0.6105 (0.4346) 09.8617 (0.0072)
IPSA 0.0194 0.0697 0.0588 4.9994 2.0462 (0.1526) 0.0933 (0.7600) 51.0250 (0.0000)
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shows that none of the companies, including IPSA, exhibit significant GARCH patterns. Although
these tests do not exclude more general forms of conditional heteroskedasticity, these results
are consistent with other results appearing in the literature, indicating that the monthly returns
generally have little (or no) GARCH effects. For an interesting discussion see [21]. Hence, the
assumption of returns iid, in this data set seems plausible.
The value of ν was set using the procedure proposed by [22], this is, to define a grid of values
for ν, and the one that maximizes the log-likelihood is chosen. In this case ν = 5 is the value of
the degree of freedom that maximizes the likelihood function, and will be used to illustrate the
methodology.
Lange et al. [22] proposed the Mahalanobis-like distance dk ( θ) for checking the fit of the t
models and for identifying outliers. Figure 2 displays the transformed distance plots, see [22],
for the normal and t models with ν = 5, t 5 , for Chilean stock market data. As seen, the t 5 model
seems to present a best fit. In effect, the maximum log-likelihood for the normal model is 1991.96
and for the t 5 model the maximum log-likelihood is 2113.01, corresponding to the likelihood ratio
statistic of 242.1. This indicates that the t 5 model fits the data significantly better than the normal
model. Table 2 presents the maximum likelihood estimate for parameters of the model using the
normal and t 5 -distributions. The standard errors were estimated using the observed information
matrix.
Figure 3 presents the index plots of |l max | for the scale perturbation for the normal and t 5
models. As can be observed from this figure, case 14 is the most influential in the MLE in the

8 3

6 2

4
Observed value

Observed value

1
2
0
0
−1
−2

−4 −2

−6 −3
−3 −2 −1 0 1 2 3 −3 −2 −1 0 1 2 3
Theoretical quantile Theoretical quantile

Figure 2. Plots of Transformed Distances for the Normal (left side) and t 5 (right side) Models.
Journal of Applied Statistics 1985
Table 2. Maximum likelihood estimates using t 5 and normal, with their respective standard errors in
parenthesis.

Estimates
Parameters t 5 model Normal model

μm 0.0075 (0.0045) 0.0194 (0.0053)


α1 −0.0009 (0.0064) 0.0079 (0.0081)
α2 0.0030 (0.0066) 0.0069 (0.0068)
α3 0.0097 (0.0062) 0.0166 (0.0071)
α4 0.0064 (0.0051) 0.0068 (0.0052)
α5 0.0050 (0.0062) 0.0109 (0.0087)
α6 −0.0035 (0.0074) −0.0008 (0.0085)
α7 0.0001 (0.0044) 0.0012 (0.0040)
α8 0.0048 (0.0062) 0.0097 (0.0071)
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α9 0.0187 (0.0076) 0.0296 (0.0101)


α10 0.0061 (0.0052) 0.0076 (0.0054)
β1 0.8548 (0.1199) 0.9114 (0.1132)
β2 0.9283 (0.1237) 0.8621 (0.0946)
β3 0.1954 (0.1203) 0.1504 (0.0990)
β4 0.9371 (0.0883) 0.8802 (0.0722)
β5 0.7658 (0.1167) 0.9414 (0.1218)
β6 1.0481 (0.1394) 1.1054 (0.1181)
β7 1.0991 (0.0831) 1.0938 (0.0562)
β8 0.5438 (0.1174) 0.5185 (0.0989)
β9 0.9249 (0.1409) 0.9965 (0.1416)
β10 0.8658 (0.0940) 0.8998 (0.0742)
φm 0.0029 (0.0004) 0.0048 (0.0005)
φ0 0.0003 (0.0003) 0.0000a (0.0001)
φ1 0.0059 (0.0008) 0.0107 (0.0012)
φ2 0.0060 (0.0008) 0.0075 (0.0008)
φ3 0.0059 (0.0007) 0.0081 (0.0009)
φ4 0.0033 (0.0004) 0.0044 (0.0005)
φ5 0.0055 (0.0007) 0.0122 (0.0014)
φ6 0.0078 (0.0010) 0.0116 (0.0012)
φ7 0.0021 (0.0004) 0.0026 (0.0003)
φ8 0.0057 (0.0007) 0.0082 (0.0009)
φ9 0.0083 (0.0011) 0.0164 (0.0019)
φ10 0.0035 (0.0004) 0.0046 (0.0005)

Note: a Value < 0.0001.

1 1
0.9 0.9
0.8 14 0.8
0.7 0.7
0.6 0.6
| lmax |

| lmax |

0.5 0.5
0.4 0.4
0.3 0.3
0.2 0.2
0.1 0.1
0 0
0 20 40 60 80 100 120 140 160 0 20 40 60 80 100 120 140 160
Index Index

Figure 3. Index plots of |l max | for scale perturbation in the Normal (left side) and t 5 (right side) models.
1986 M. Galea et al.
0.35

0.3 14

0.25
Standard deviation

0.2

0.15 104

0.1
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0.05

0
−0.3 −0.2 −0.1 0 0.1 0.2 0.3 0.4
Mean

Figure 4. Scatter plots for means and standard deviations of the returns.

normal model. The index plot of Ck shows the same observation as potentially influential and
this is not shown here. As hoped, in the index plots of |l max | for the t 5 model no influential
returns appear, showing the robustness of the t model to extreme returns. Note that observation
14, detected as potentially influential corresponds to the maximum mean return of the 10 firms in
the analyzed period. See figure 4, where the scatter plots for means and standard deviations of the
monthly returns of the firms considered are presented. In the normal model, the return 104, August
1998, corresponds to the Asian crisis that strongly affected the Chilean and world capital market,
was not detected by the schemes of cases and scale perturbations. Finally, month 14, February
1991, corresponds to the month when the limits of pension funds to invest on equities were
changed. We think that these factors could possibly affect the price of shares pushing them up.
See Figure 4.
From now on, we will build three portfolios, considering the 10 firms and using the methodology
proposed by Elton and Gruber [15]. We consider three models; the usual Sharpe model (without

Table 3. Portfolios built with the three models and performance measure.

Campany Sharpe model Normal model t 5 model

Cementos – 0.051 –
Cervezas 0.102 0.049 –
Cmpc 0.099 0.250 0.238
Copec 0.127 0.081 0.139
CyT 0.091 0.090 0.001
Entel 0.092 – –
Endesa 0.141 – –
Vapores – 0.101 –
Cuprum 0.127 0.271 0.512
Chilectra 0.222 0.107 0.102
Sharpe measure 0.265 0.367 0.167
Jensen measure 0.009 0.015 0.012
Treynor measure 0.024 0.035 0.018
Journal of Applied Statistics 1987

measurement error), used by Elton and Gruber [15], and the Sharpe model discussed here (with
measurement error), under the assumption of normality (ν → ∞) and the t 5 Structural Sharpe
model. We also compute the efficiency of the portfolios using three different indexes, Sharpe,
Jensen and Treynor. The results are presented in Table 3. It is possible to observe notorious
difference between the three portfolios. The portfolio built with the Sharpe model with mea-
surement error, under the assumption of normality (Normal model), has the better relationship
return/risk.

5. Conclusions
In this paper we have specified the Sharpe model in the context of measurement errors models
[18], considering a more realistic assumption, that is, the return of the market is not observable.
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Moreover, instead of the usual assumption of normality we have considered the t multivariate
distribution in order to model the return. This distribution has tails heavier than the normal
distribution, allowing us to reduce the influence of atypical returns over the MLE. In this way, the
use of the t-distribution gives a more robust procedure for the data analysis, see [22]. Also, we
present the local influence method to detect the possible atypical returns in the data, a phenomena
very common in emerging markets. As can be see the implementation of the methodology is very
simple and has a low computational cost.
The topics discussed in this paper are illustrated with the data of the Chilean capital market. As
was expected, the portfolios built up with different statistical models show different results, and
in this case the portfolio using the Sharpe model with measurement errors come up with better
efficiency indices.
Finally, we would like to stress the importance of statistical modeling to build portfolios, and
also the importance of implementing diagnostic techniques, given that atypical returns greatly
influence the building of portfolios, especially in emerging markets, as shown in a recent empirical
study made by van der Hart et al. [32].
This empirical study provides new evidence on the robustness aspects of the MLE for the
t-distribution with small degrees of freedom, as also shown by Lange et al. [22] in regression and
multivariate analysis. Nevertheless, it also shows the need to use diagnostic techniques in models
whose tails are heavier than those of the normal distribution.

Acknowledgment
The authors acknowledge the partial financial support from Projects Fondecyt 1070919, Laboratorio de Análisis
Estocástico, PBCT-ACT13 and DGI Pontificia Universidad Católica de Valparaíso, Chile. Helpful comments from two
anonymous reviewers are also acknowledged.

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Appendix 1. The observed information matrix in the ShM


In this appendix the observed information matrix is obtained for the ShM. We have that, see (9),

∂lk (θ) 1 ∂log|| ν + q


=− − (ν + dk )−1 dkγ , (A1)
∂γ 2 ∂γ 2

with dkγ = ∂dk /∂γ, γ = μm , α, β, φm , φ and dk = X Tk −1 X k = q1k − τ q2k


2
, X k = Zk − a −
bμm , q1k = X k D (φ)X k , q2k = X k D (φ)b, k = 1, . . . , n, τ = φm /c and c = 1 + φm bT D −1
T −1 T −1
Journal of Applied Statistics 1989

(φ)b. Further, using results in [26] related to vector derivatives it follows that,
∂ log || ∂log|| c−1
= 0, γ = μm , α, = ,
∂γ ∂φm cφm
∂log|| ∂log||
= −τ D −2 (φ)D(b)b + D −1 (φ)1q , = 2τ D −1 (ψ)β,
∂φ ∂β
dkμm = −2q2k /c, dkα = −2I(p) −1 X k ,
dkβ = −2qk D −1 (ψ)(Rk − α − qk β), dkφm = −c−2 q2k
2
,
dkφ = −D −2 (φ)D(X k )X k + 2τ q2k D −2 (φ)D(b)X k − τ 2 q2k
2
D −2 (φ)D(b)b,
where, qk = μm + τ q2k , ψ = (φ1 , . . . , φp )T , W k = Rk − α − βμm , Rk = (Rk1 , . . . , Rkp )T and
I(p) = (0, Ip ).
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From Equation (A1) it follows that the observed, per element, information matrix is given by
 2 
∂ lk (θ)
Lk = Lk (θ/Zk ) = − , (A2)
∂γ∂τ T
where
∂ 2 lk 1 ∂ 2 log|| ν + q ν+q
T
=− + (ν + dk )−2 dkγ dkτ T − (ν + dk )−1 dkγτ T ,
∂γ∂τ 2 ∂γ∂τ T 2 2
with dkγτ T = ∂ 2 dk /∂γ∂τ T , k = 1, 2, . . . , n and γ, τ = μm , α, β, φm , φ, where
∂ 2 log ||
= 0, τ = μm , α; γ = μm , α, β, φm , φ,
∂τ∂γ T
∂ 2 log||
= 2c−2 D −1 (ψ)β,
∂β∂φm
∂ 2 log|| 1
= − 2 2 (c − 1)2 ,
∂φm ∂φm c φm
∂ 2 log||
= −2τ [D1 (β) − τ D −1 (ψ)βbT D(b)D −2 (φ)],
∂β∂φ
∂ 2 log||
= 2τ [D −1 (ψ) − 2τ M 1 ],
∂β∂β
∂ 2 log||
= −c−2 bT D(b)D −2 (φ),
∂φm ∂φT
∂ 2 log||
= −D −2 (φ) − τ 2 D(b)D −1 (φ)MD −1 (φ)D(b) + 2τ D 2 (b)D −3 (φ),
∂φ∂φT
dkμm μm = 2bT −1 b,
dkμx αT = 2bT −1 IT(p) ,
dkμm βT = −2c−1Ak ,
dkμm φm = 2q2k (c − 1)/c2 φm ,
dkμm φT = 2c−1 (Zk − a − qk b)T D −2 (φ)D(b),
dkααT = 2I(p) −1 IT(p) ,
dkαβT = 2qk [D−1 (ψ) − 2τ M 1 ] + 2τ D−1 (ψ)β(Rk − α)T D−1 (ψ),
1990 M. Galea et al.

dkαφm = 2c−2 q2k D −1 (ψ)β,


dkαφT = 2I(p) −1 D −1 (φ)[D(X k ) − τ q2k D(b)],
dkββT = 2qk2 D −1 (ψ) − 2τ D −1 (ψ)W k Ak − 2τ (qk + q2k τ )D −1 (ψ)βAk ,
dkβφm = −2c−2 q2k ATk ,
dkβφT = 2qk D1 (W k ) + 2τATk (Zk − a − qk b)T D(b)D −2 (φ) − 2qk q2k τ D1 (β),
dkφm φm = 2c−3 (c − 1)q2k
2
/φm ,
dkφm φT = −2τ c−2 q2k
2 T
b D(b)D −2 (φ) + 2c−2 q2k X Tk D(b)D −2 (φ),
dkφφT = 2D −3 (φ)D 2 (X k ) − 4τ q2k D −3 (φ)D(b)D(X k ) + 2(τ q2k )2 D −3 (φ)D(b)D(b)
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− 2τ D −2 (φ)D(b)(Zk − a − qk b)(Zk − a − qk b)T D(b)D −2 (φ),


where D1 (W k ) = [0p×1 , D −2 (ψ)D(W k )], D1 (β) = [0p×1 , D −2 (ψ)D(β)], Ak = (Rk − α −
2qk β)T D −1 (ψ), M = D −1 (φ)bbT D −1 (φ), M 1 = D −1 (ψ)ββT D −1 (ψ) and k = 1, . . . , n.

Thus, the observed information matrix is L = nk=1 Lk ( θ/Zk ).

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