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Safety-first portfolio optimization: Fixed versus random target

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  • Singer, Nico

Abstract

This paper analyzes the safety-first portfolio model under two different target assumptions, the fixed target, which is commonly assumed in the literature, and the random target, which has played only a minor role so far. As both targets can be easily motivated, the open question is, which target choice leads to a better performance? We answer this question by comparing optimal expected portfolio returns of the fixed and the random target strategy. Assuming multivariate normal returns the answer is: (1) The random target strategy outperforms the fixed target strategy if the portfolio return and the random target are positively correlated and riskless investing is prohibited, (2) the fixed target strategy outperforms the random target strategy if the portfolio return and the random target are not positively correlated and riskless investing is allowed. The first result is practically most relevant, in particular for institutional portfolio management and the skilled private investor, which is supported by an empirical analysis. Furthermore, we show that these results also hold when relaxing the normal assumption.

Suggested Citation

  • Singer, Nico, 2010. "Safety-first portfolio optimization: Fixed versus random target," Thuenen-Series of Applied Economic Theory 113, University of Rostock, Institute of Economics.
    • Handle: RePEc:zbw:roswps:113
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    References listed on IDEAS

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    Cited by:

    1. Singer, Nico, 2011. "A behavioral portfolio analysis of retirement portfolios," Thuenen-Series of Applied Economic Theory 104, University of Rostock, Institute of Economics.

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    More about this item

    Keywords

    safety-first; portfolio optimization; random target; benchmarking;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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