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On the Evolution of Investment Strategies and the Kelly Rule – A Darwinian Approach

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  • Terje Lensberg

    (Norwegian School of Economics and Business Administration)

  • Klaus Reiner Schenk-Hoppe

    (University of Leeds, Business School and School of Mathematics)

Abstract

This paper complements theoretical studies on the Kelly rule in evolutionary finance by studying a Darwinian model of selection and reproduction in which the diversity of investment strategies is maintained through genetic programming. We find that investment strategies which optimize long-term performance can emerge in markets populated by unsophisticated investors. Regardless whether the market is complete or incomplete and whether states are i.i.d. or Markov, the Kelly rule is obtained as the asymptotic outcome. With pricedependent rather than just state-dependent investment strategies, the market portfolio plays an important role as a protection against severe losses in volatile markets.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 06-38.

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Length: 29 pages
Date of creation: Dec 2006
Date of revision:
Handle: RePEc:chf:rpseri:rp0638

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Web page: http://www.SwissFinanceInstitute.ch
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Related research

Keywords: Evolutionary finance; portfolio choice; asset pricing; genetic programming;

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References

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  1. Christopher J. Neely & Paul A. Weller & Robert Dittmar, 1997. "Is technical analysis in the foreign exchange market profitable? a genetic programming approach," Working Papers 1996-006, Federal Reserve Bank of St. Louis.
  2. Igor Evstigneev & Thorsten Hens & Klaus Schenk-Hoppé, 2006. "Evolutionary stable stock markets," Economic Theory, Springer, vol. 27(2), pages 449-468, January.
  3. Terje Lensberg & Business Administration, . "Investment Behaviour Under Knightian Uncertainty - an Evolutionary Approach," Computing in Economics and Finance 1997 144, Society for Computational Economics.
  4. Peter Bossaerts & Charles Plott & William R. Zame, 2005. "Prices and Portfolio Choices in Financial Markets: Theory and Experiments," UCLA Economics Working Papers 840, UCLA Department of Economics.
  5. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(4), pages 703-38, August.
  6. De Long, J Bradford, et al, 1991. "The Survival of Noise Traders in Financial Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 1-19, January.
  7. Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, . "Market Selection of Financial Trading Strategies: Global Stability," IEW - Working Papers 083, Institute for Empirical Research in Economics - University of Zurich.
  8. C. H. Hommes, 2001. "Financial markets as nonlinear adaptive evolutionary systems," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 1(1), pages 149-167.
  9. Arifovic, Jasmina, 1996. "The Behavior of the Exchange Rate in the Genetic Algorithm and Experimental Economies," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(3), pages 510-41, June.
  10. Rabah Amir & Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, 2002. "Market Selection and Survival of Investment Strategies," Discussion Papers 02-16, University of Copenhagen. Department of Economics.
  11. Hens, Thorsten & Schenk-Hoppe, Klaus Reiner, 2005. "Evolutionary stability of portfolio rules in incomplete markets," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 43-66, February.
  12. Lawrence Blume & David Easley, 2006. "If You're so Smart, why Aren't You Rich? Belief Selection in Complete and Incomplete Markets," Econometrica, Econometric Society, Econometric Society, vol. 74(4), pages 929-966, 07.
  13. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
  14. Shapley, Lloyd S & Shubik, Martin, 1977. "Trade Using One Commodity as a Means of Payment," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(5), pages 937-68, October.
  15. Allen, Franklin & Karjalainen, Risto, 1999. "Using genetic algorithms to find technical trading rules," Journal of Financial Economics, Elsevier, vol. 51(2), pages 245-271, February.
  16. Sandroni, Alvaro, 2005. "Market selection when markets are incomplete," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 91-104, February.
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Citations

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Cited by:
  1. Lensberg, Terje & Schenk-Hoppé, Klaus Reiner & Ladley, Dan, 2012. "Costs and Benefits of Speculation," Discussion Papers 2012/12, Department of Business and Management Science, Norwegian School of Economics.
  2. Dan Ladley & Seth Bullock, 2008. "The Strategic Exploitation of Limited Information and Opportunity in Networked Markets," Computational Economics, Society for Computational Economics, vol. 32(3), pages 295-315, October.
  3. Witte, Björn-Christopher, 2011. "Fund managers - why the best might be the worst: On the evolutionary vigor of risk-seeking behavior," BERG Working Paper Series 81, Bamberg University, Bamberg Economic Research Group.
  4. Witte, Björn-Christopher, 2012. "Fund managers - Why the best might be the worst: On the evolutionary vigor of risk-seeking behavior," Economics Discussion Papers 2012-20, Kiel Institute for the World Economy.
  5. Igor V. EVSTIGNEEVY & Thorsten HENS & Klaus Reiner SCHENK-HOPPE, . "An evolutionary financial market model with a risk-free asset," Swiss Finance Institute Research Paper Series, Swiss Finance Institute 10-36, Swiss Finance Institute.

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