Conditioning the Information in Portfolio Optimization

Carlo Sala and Giovanni Barone-Adesi
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Carlo Sala: Swiss Finance Institute
Giovanni Barone-Adesi: University of Lugano and Swiss Finance Institute

No 15-50, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper proposes a theoretical analysis on the impacts of using a suboptimal information set on the three main components used in asset pricing, namely the risk physical and neutral measures and the relative pricing kernel. The analysis is carried out by means of a portfolio optimization problem for a small and rational investor. Solving for the maximal expected utility of terminal wealth, we prove the existence of an information premium between what is required by the theory, a complete information set thus a fully conditional measure, and what is instead achievable by en econometrician. Searching for the best bounds, we then study the impact of the premium on the pricing kernel. Finally, exploiting the strong interconnection between the pricing kernel and its densities, the extension to the risk-neutral measure follows naturally.

Keywords: Portfolio optimization problem; Levy-Ito mixed model; Pricing kernel; Information premium; Optimal bounds (search for similar items in EconPapers)
JEL-codes: C61 G10 G11 G12 G14 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2015-10, Revised 2016-04
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1550

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