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A benchmark of finding the criteria for optimal portfolio choice

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  1. Abstract
  2. Introduction
  3. Modeling the dynamic portfolio decision in incomplete market
  4. Portfolio choice with event jumps
  5. Dynamic active portfolio management
    1. Benchmark portfolio
    2. Growth optimal portfolio
    3. Solution for optimal portfolio return
    4. Criteria for adjusting portfolio choice
    5. Numeric example
  6. Conclusion
  7. Appendix
  8. References

In today's rapidly changing economic environments, global portfolio investors are invariably confronted with dynamic and fluid choice of criteria that enable them to exercise subjective judgment on asset portfolio choice decisions. The subjective investment portfolio choice includes the discretion to purchase some assets that do not meet its normal investment criteria, when they perceive unusual information which incurs event jumps in the asset return. This paper studies on what criterion or criteria should be used when the asset in the investment portfolio is subject to event jumps as well as how the criterion or criteria can be found. We use marginal excess return in the value add return function for indicating the return decreasing under information impact and finding a critical value related to the growth optimum portfolio choice on a risk adjusted basis. We reveal, as a special case, the optimal portfolio is equivalent to the benchmark portfolio, if the investor is myopic of constant relative risk aversion. Managers of the large multinational firms and investment funds usually seek the highest total portfolio return over time that is consistent with emphases on both capital appreciation and investment income/return under a specified risk level.

[...] The corresponding optimal policies obtained there are all constant proportions, or in constant mix, portfolio allocation strategies, whereby the portfolio is continuously rebalanced so as to always keep a constant proportion of wealth in the various asset classes, regardless of the level of instant wealth Our use of marginal excess return in the value add return function for indicating the return decreasing under information impact and finding a critical value related to the growth optimum portfolio choice on a risk adjusted basis. [...]


[...] Ziemba World-Wide Asset and Liability Modelling, Cambridge University Press. Browne, S. (1999) Beating a moving target: Optimal portfolio strategies for outperforming a stochastic benchmark. Finance ad Stochastics 275-294. Browne, S. (2000). Risk-constrained dynamic active portfolio management, Management Science, 1188-1199. Christensen, M. M., and Platen, E. (2005) A general benchmark model for stochastic jump sizes, Working paper. Cox, John C. and Chi-Fu Huang (1989) Optimal consumption and portfolio when asset prices follow a diffusion process, Journal of Economic Theory, Vol 33-83. Detemple, J. B. (1986) Asset pricing in an [...]


[...] The optimal portfolio return shows that actively managed portfolio can be of value added over the benchmark portfolio on a risk adjusted basis. No arbitrage is often associated with the existence of a state price density or equivalent martingale measure, see Duffie (2001). In the benchmark framework, the object used as a reference unit for pricing purposes is a portfolio having a maximal growth rate, the growth optimal portfolio (GOP). Under the standard assumptions of risk-neutral pricing the inverse of the discounted GOP is the Radon-Nikodym derivative of a risk-neutral measure with respect to the empirical measure. [...]

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