A New Portfolio Optimization Model Under Tracking-Error Constraint with Linear Uncertainty Distributions

Tingting Yang () and Xiaoxia Huang ()
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Tingting Yang: Changzhou University
Xiaoxia Huang: University of Science and Technology Beijing

Journal of Optimization Theory and Applications, 2022, vol. 195, issue 2, No 16, 723-747

Abstract: Abstract Enhanced index tracking problem is the issue of selecting a tracking portfolio to outperform the benchmark return with a minimum tracking error. In this paper, we address the enhanced index tracking problem based on uncertainty theory where stock returns are treated as uncertain variables instead of random variables. First, we propose a nonlinear uncertain optimization model, i.e., uncertain mean-absolute downside deviation enhanced index tracking model. Then, we give the analytical solution of the proposed optimization model when stock returns take linear uncertainty distributions. Based on the solution, we find that tracking portfolio frontier is a continuous curve composed of at most $$n-1$$ n - 1 different line segments. Furthermore, we give the condition that tracking portfolio return and risk increase with benchmark return and risk, respectively. Finally, we offer some experiments and show that our proposed model is effective in controlling the tracking error.

Keywords: Portfolio selection; Uncertain programming; Enhanced index tracking model; Uncertainty theory; C61 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10957-022-02116-w

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