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Differential Evolution and Combinatorial Search for Constrained Index Tracking

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Author Info

  • Thiemo Krink
  • Stefan Mittnik

    ()

  • Sandra Paterlini

    ()

Abstract

Index tracking is a valuable low-cost alternative to active portfolio management. The implementation of a quantitative approach, however, is a major challenge from an optimization perspective. The optimal selection of a group of assets that can replicate the index of a much larger portfolio requires both to find the optimal subset of assets and to fine-tune their weights. The former is a combinatorial, the latter a continuous numerical problem. Both problems need to be addressed simultaneously, because whether or not a selection of assets is promising depends on the allocation weights and vice versa. Moreover, the problem is usually of high dimension. Typically, an optimal subset of 30-150 positions out of 100-600 need to be selected and their weights determined. Search heuristics can be a viable and valuable alternative to traditional methods, which often cannot deal with the problem. In this paper, we propose a new optimization method, which is partly based on Differential Evolution (DE) and on combinatorial search. The main advantage of our method is that it can tackle index tracking problem as complex as it is, generating accurate and robust results.

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Bibliographic Info

Paper provided by Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi" in its series Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) with number 09032.

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Length: pages 34
Date of creation: Mar 2009
Date of revision:
Handle: RePEc:mod:wcefin:09032

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Web page: http://www.economia.unimore.it
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Related research

Keywords: Index Tracking; Passive Asset Management; Differential Evolution; Combinatorial Search;

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Cited by:
  1. Chiara Pederzoli & Costanza Torricelli, 2010. "A parsimonious default prediction model for Italian SMEs," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 10061, Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi".
  2. Monica Billio & Massimiliano Caporin & Michele Costola, 2012. "Backward/forward optimal combination of performance measures for equity screening," Working Papers 2012_13, Department of Economics, University of Venice "Ca' Foscari".
  3. Marianna Lyra, 2010. "Heuristic Strategies in Finance – An Overview," Working Papers 045, COMISEF.
  4. Ardia, David & Boudt, Kris & Carl, Peter & Mullen, Katharine M. & Peterson, Brian, 2010. "Differential Evolution (DEoptim) for Non-Convex Portfolio Optimization," MPRA Paper 22135, University Library of Munich, Germany.
  5. Thiemo Krink & Sandra Paterlini, 2011. "Multiobjective optimization using differential evolution for real-world portfolio optimization," Computational Management Science, Springer, vol. 8(1), pages 157-179, April.

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