Portfolio selection with exploration of new investment assets

Luca De Gennaro Aquino, Didier Sornette and Moris S. Strub

European Journal of Operational Research, 2023, vol. 310, issue 2, 773-792

Abstract: We introduce a model for portfolio selection with an extendable investment universe where an agent with mean-variance preferences faces a trade-off between exploiting existing and exploring for new investment opportunities. When the agent chooses to explore, a new risky asset is discovered and the agent subsequently invests in the extended universe. We first provide conditions for wellposedness and characterize the optimal amount devoted to exploration. Our model shows that incremental exploration does not pay off, that it is increasingly worthwhile to explore in worse market environments, and that investment performance measured by the Sharpe ratio is increasing in the initial wealth of the agent indicating that richer agents can make better use of new investment opportunities. We further generalize our model and verify the robustness of the main findings with regard to various modeling assumptions.

Keywords: Portfolio optimization; Mean-variance preferences; Investment analysis; Exploration vs. exploitation (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:310:y:2023:i:2:p:773-792

DOI: 10.1016/j.ejor.2023.03.017

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