Portfolio Selection with Heavy Tails
AbstractConsider the portfolio problem of choosing the mix between stocks and bonds under a downside risk constraint. Typically stock returns exhibit fatter tails than bonds corresponding to their greater downside risk. Downside risk criteria like the safety first criterion therefore often select corner solutions in the sense of a bonds only portfolio. This is due to a focus on the asymptotically dominating first order Pareto term of the portfolio return distribution. We show that if second order terms are taken into account, a balanced solution emerges. The theory is applied to empirical examples from the literature. This discussion paper has resulted in a publication in the Journal of Empirical Finance , 2007, 14(3).
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-009/2.
Date of creation: 17 Jan 2005
Date of revision: 04 Oct 2006
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safety first; heavy tails; portfolio diversification;
Other versions of this item:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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