OPTIMAL PORTFOLIO CONSTRUCTION UNDER PARTIAL INFORMATION FOR A BALANCED FUND

Simon Keel (), Florian Herzog, Hans P. Geering and Lorenz M. Schumann
Additional contact information
Simon Keel: Measurement and Control Laboratory (IMRT), ETH Zurich, CH-8092 Zurich, Switzerland
Florian Herzog: Measurement and Control Laboratory (IMRT), ETH Zurich, CH-8092 Zurich, Switzerland
Hans P. Geering: Measurement and Control Laboratory (IMRT), ETH Zurich, CH-8092 Zurich, Switzerland
Lorenz M. Schumann: swissQuant Group AG, Universitätsstr. 9, CH-8006 Zurich, Switzerland

International Journal of Theoretical and Applied Finance (IJTAF), 2007, vol. 10, issue 06, 1015-1042

Abstract: The model parameters in optimal asset allocation problems are often assumed to be deterministic. This is not a realistic assumption since most parameters are not known exactly and therefore have to be estimated. We consider investment opportunities which are modeled as local geometric Brownian motions whose drift terms may be stochastic and not necessarily measurable. The drift terms of the risky assets are assumed to be affine functions of some arbitrary factors. These factors themselves may be stochastic processes. They are modeled to have a mean-reverting behavior. We consider two types of factors, namely observable and unobservable ones. The closed-form solution of the general problem is derived. The investor is assumed to have either constant relative risk aversion (CRRA) or constant absolute risk aversion (CARA). The optimal asset allocation under partial information is derived by transforming the problem into a full-information problem, where the solution is well known. The analytical result is empirically tested in a real-world application. In our case, we consider the optimal management of a balanced fund mandate. The unobservable risk factors are estimated with a Kalman filter. We compare the results of the partial-information strategy with the corresponding full-information strategy. We find that using a partial-information approach yields much better results in terms of Sharpe ratios than the full-information approach.

Keywords: Investment models; stochastic control; partial information; portfolio management; balanced fund (search for similar items in EconPapers)
Date: 2007
References: View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024907004536
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:10:y:2007:i:06:n:s0219024907004536

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024907004536

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().