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

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Author Info
Terje Lensberg (Norwegian School of Economics and Business Administration)
Klaus Reiner Schenk-Hoppe (University of Leeds, Business School and School of Mathematics)

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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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Publisher 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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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
C63 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computational Techniques

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Amir, Rabah & Evstigneev, Igor V. & Hens, Thorsten & Schenk-Hoppe, Klaus Reiner, 2005. "Market selection and survival of investment strategies," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 105-122, February. [Downloadable!] (restricted)
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  2. 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. [Downloadable!] (restricted)
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  3. Shapley, Lloyd S & Shubik, Martin, 1977. "Trade Using One Commodity as a Means of Payment," Journal of Political Economy, University of Chicago Press, vol. 85(5), pages 937-68, October. [Downloadable!] (restricted)
  4. Cars H. Hommes, 2001. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," Tinbergen Institute Discussion Papers 01-014/1, Tinbergen Institute. [Downloadable!]
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  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, vol. 98(4), pages 703-38, August. [Downloadable!] (restricted)
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  6. Lensberg, Terje, 1999. "Investment behavior under Knightian uncertainty - An evolutionary approach," Journal of Economic Dynamics and Control, Elsevier, vol. 23(9-10), pages 1587-1604, September. [Downloadable!] (restricted)
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  7. Igor Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, 2003. "Evolutionary Stable Stock Markets," Discussion Papers 03-39, University of Copenhagen. Department of Economics. [Downloadable!]
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  8. Arifovic, Jasmina, 1996. "The Behavior of the Exchange Rate in the Genetic Algorithm and Experimental Economies," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 510-41, June. [Downloadable!] (restricted)
  9. Allen, Franklin & Karjalainen, Risto, 1999. "Using genetic algorithms to find technical trading rules1," Journal of Financial Economics, Elsevier, vol. 51(2), pages 245-271, February. [Downloadable!] (restricted)
  10. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October. [Downloadable!] (restricted)
  11. Dittmar, Robert & Neely, Christopher J & Weller, Paul, 1996. "Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach," CEPR Discussion Papers 1480, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  12. 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. [Downloadable!]
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  13. Sandroni, Alvaro, 2005. "Market selection when markets are incomplete," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 91-104, February. [Downloadable!] (restricted)
  14. Larry Blume & David Easley, 2001. "If You're So Smart, Why Aren't You Rich? Belief Selection in Complete and Incomplete Markets," Cowles Foundation Discussion Papers 1319, Cowles Foundation, Yale University. [Downloadable!]
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  15. Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, . "Market Selection of Financial Trading Strategies: Global Stability," IEW - Working Papers iewwp083, Institute for Empirical Research in Economics - IEW. [Downloadable!]
  16. De Long, J Bradford, et al, 1991. "The Survival of Noise Traders in Financial Markets," Journal of Business, University of Chicago Press, vol. 64(1), pages 1-19, January. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Dan Ladley & Seth Bullock, 2008. "The Strategic Exploitation of Limited Information and Opportunity in Networked Markets," Computational Economics, Springer, vol. 32(3), pages 295-315, October. [Downloadable!] (restricted)
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