The premium of dynamic trading
AbstractIt is well established that, in a market with inclusion of a risk-free asset, the single-period mean-variance efficient frontier is a straight line tangent to the risky region, a fact that is the very foundation of the classical CAPM. In this paper, it is shown that, in a continuous-time market where the risky prices are described by Ito processes and the investment opportunity set is deterministic (albeit time-varying), any efficient portfolio must involve allocation to the risk-free asset at any time. As a result, the dynamic mean-variance efficient frontier, although still a straight line, is strictly above the entire risky region. This in turn suggests a positive premium, in terms of the Sharpe ratio of the efficient frontier, arising from dynamic trading. Another implication is that the inclusion of a risk-free asset boosts the Sharpe ratio of the efficient frontier, which again contrasts sharply with the single-period case.
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Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Quantitative Finance.
Volume (Year): 11 (2011)
Issue (Month): 1 ()
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- Di Giacinto, Marina & Federico, Salvatore & Gozzi, Fausto & Vigna, Elena, 2014.
"Income drawdown option with minimum guarantee,"
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