EFFICIENCY LOSS AND CONSTRAINTS ON PORTFOLIO HOLDINGS

This paper examines the degree of portfolio inefficiency subject to va rious constraints on portfolio weights. When portfolio weights are unc onstrained, the posterior loss in expected return on the NYSE-AMEX mar ket portfolio is over 20% (annualized). In contrast, when portfolio we ights are constrained to be nonnegative, the posterior loss in expecte d return is only about 4% (annualized). In addition, short-sale constr aints greatly reduce uncertainty in inferences about portfolio efficie ncy. (C) 1998 Elsevier Science S.A. All rights reserved.