Differential Evolution and Combinatorial Search for Constrained Index Tracking

Thiemo Krink, Stefan Mittnik and Sandra Paterlini

Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) from Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi"

Abstract: Index tracking is a valuable low-cost alternative to active portfolio management. The implementation of a quantitative approach, however, is a major challenge from an optimization perspective. The optimal selection of a group of assets that can replicate the index of a much larger portfolio requires both to find the optimal subset of assets and to fine-tune their weights. The former is a combinatorial, the latter a continuous numerical problem. Both problems need to be addressed simultaneously, because whether or not a selection of assets is promising depends on the allocation weights and vice versa. Moreover, the problem is usually of high dimension. Typically, an optimal subset of 30-150 positions out of 100-600 need to be selected and their weights determined. Search heuristics can be a viable and valuable alternative to traditional methods, which often cannot deal with the problem. In this paper, we propose a new optimization method, which is partly based on Differential Evolution (DE) and on combinatorial search. The main advantage of our method is that it can tackle index tracking problem as complex as it is, generating accurate and robust results.

Keywords: Index Tracking; Passive Asset Management; Differential Evolution; Combinatorial Search (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
Pages: pages 34
Date: 2009-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (56)

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Journal Article: Differential evolution and combinatorial search for constrained index-tracking (2009)
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