Optimal guaranteed return portfolios and the casino effect
AbstractIn this paper, we address the problem of maximizing expected return subject to a worst case return constraint by composing a portfolio that may consist of cash, holdings in a stock market index and options on the index. We derive properties of optimal and feasible portfolios and present a linear programming model to solve the problem. The optimal portfolios have pay-off functions that reflect a gambling policy. We show that optimal solutions to a large class of portfolio models that maximize expected return subject to downside risk constraints are driven by this casino effect and present tractable conditions under which it occurs in our model. We propose to control the casino effect by using chance constraints. Using results from financial theory we formulate an LP model that maximizes expected return subject to worst case return constraints and chance constraints on achieving prespecified levels of return. The results are illustrated with real life data on the S&P 500 index.
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Bibliographic InfoPaper provided by VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics in its series Serie Research Memoranda with number 0025.
Date of creation: 1997
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Find related papers by JEL classification:
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-03-14 (All new papers)
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