PRACTICAL INVESTMENT CONSEQUENCES OF THE SCALARIZATION PARAMETER FORMULATION IN DYNAMIC MEAN–VARIANCE PORTFOLIO OPTIMIZATION
Pieter M. van Staden (),
Duy-Minh Dang () and
Peter A. Forsyth
Additional contact information
Pieter M. van Staden: David R. Cheriton School of Computer Science, University of Waterloo, Waterloo, ON N2L 3G1, Canada
Duy-Minh Dang: School of Mathematics and Physics, The University of Queensland, St Lucia, Brisbane 4072, Australia
Peter A. Forsyth: David R. Cheriton School of Computer Science, University of Waterloo, Waterloo, ON N2L 3G1, Canada
International Journal of Theoretical and Applied Finance (IJTAF), 2021, vol. 24, issue 05, 1-49
Abstract:
We consider the practical investment consequences of implementing the two most popular formulations of the scalarization (or risk-aversion) parameter in the time-consistent dynamic mean–variance (MV) portfolio optimization problem. Specifically, we compare results using a scalarization parameter assumed to be (i) constant and (ii) inversely proportional to the investor’s wealth. Since the link between the scalarization parameter formulation and risk preferences is known to be nontrivial (even in the case where a constant scalarization parameter is used), the comparison is viewed from the perspective of an investor who is otherwise agnostic regarding the philosophical motivations underlying the different formulations and their relation to theoretical risk-aversion considerations, and instead simply wishes to compare investment outcomes of the different strategies. In order to consider the investment problem in a realistic setting, we extend some known results to allow for the case where the risky asset follows a jump-diffusion process, and examine multiple sets of plausible investment constraints that are applied simultaneously. We show that the investment strategies obtained using a scalarization parameter that is inversely proportional to wealth, which enjoys widespread popularity in the literature applying MV optimization in institutional settings, can exhibit some undesirable and impractical characteristics.
Keywords: Asset allocation; constrained optimal control; time consistent; mean–variance (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (2)
Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024921500291
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:24:y:2021:i:05:n:s0219024921500291
Ordering information: This journal article can be ordered from
DOI: 10.1142/S0219024921500291
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 ().