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No arbitrage and a linear portfolio selection model

Author

Listed:
  • Renato Bruni

    (Università di Roma “Sapienza”, Dip. di Ingegneria Informatica, Automatica e Gestionale)

  • Francesco Cesarone

    (Università degli Studi Roma Tre, Dip. di Studi Aziendali)

  • Andrea Scozzari

    (Università degli Studi “Niccolò Cusano” - Telematica, Roma, Facoltà di Economia)

  • Fabio Tardella

    (Università di Roma “Sapienza”, Dip. Metodi e Modelli per l''Economia, il Territorio e la Finanza)

Abstract

We propose a linear bi-objective optimization approach to the problem of finding a portfolio that maximizes average excess return with respect to a benchmark index while minimizing underperformance over a learning period. We establish some theoretical results linking classical No Arbitrage conditions to the existence of a feasible portfolio for our model that strictly outperforms the index. Empirical analyses on publicly available real-world financial datasets show the effectiveness of the model and confirm the described theoretical results.

Suggested Citation

  • Renato Bruni & Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2013. "No arbitrage and a linear portfolio selection model," Economics Bulletin, AccessEcon, vol. 33(2), pages 1247-1258.
    • Handle: RePEc:ebl:ecbull:eb-13-00221
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    References listed on IDEAS

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    1. Csaba Fábián & Gautam Mitra & Diana Roman & Victor Zverovich, 2011. "An enhanced model for portfolio choice with SSD criteria: a constructive approach," Quantitative Finance, Taylor & Francis Journals, vol. 11(10), pages 1525-1534.
    2. Andrea Scozzari & Fabio Tardella & Sandra Paterlini & Thiemo Krink, 2013. "Exact and heuristic approaches for the index tracking problem with UCITS constraints," Annals of Operations Research, Springer, vol. 205(1), pages 235-250, May.
    3. Renato Bruni & Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2012. "A new stochastic dominance approach to enhanced index tracking problems," Economics Bulletin, AccessEcon, vol. 32(4), pages 3460-3470.
    4. Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2013. "A new method for mean-variance portfolio optimization with cardinality constraints," Annals of Operations Research, Springer, vol. 205(1), pages 213-234, May.
    5. Beasley, J. E. & Meade, N. & Chang, T. -J., 2003. "An evolutionary heuristic for the index tracking problem," European Journal of Operational Research, Elsevier, vol. 148(3), pages 621-643, August.
    6. N. Meade & J. E. Beasley, 2011. "Detection of momentum effects using an index out-performance strategy," Quantitative Finance, Taylor & Francis Journals, vol. 11(2), pages 313-326.
    7. Prisman, Eliezer Z, 1986. "Valuation of Risky Assets in Arbitrage Free Economies with Frictions," Journal of Finance, American Finance Association, vol. 41(3), pages 545-557, July.
    8. Carol Alexander & Anca Dimitriu, 2005. "Indexing, cointegration and equity market regimes," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 10(3), pages 213-231.
    9. Dose, Christian & Cincotti, Silvano, 2005. "Clustering of financial time series with application to index and enhanced index tracking portfolio," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 355(1), pages 145-151.
    10. Canakgoz, N.A. & Beasley, J.E., 2009. "Mixed-integer programming approaches for index tracking and enhanced indexation," European Journal of Operational Research, Elsevier, vol. 196(1), pages 384-399, July.
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    Citations

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    Cited by:

    1. Francesco Cesarone & Jacopo Moretti & Fabio Tardella, 2016. "Optimally chosen small portfolios are better than large ones," Economics Bulletin, AccessEcon, vol. 36(4), pages 1876-1891.
    2. Francesco Cesarone & Raffaello Cesetti & Giuseppe Orlando & Manuel Luis Martino & Jacopo Maria Ricci, 2022. "Comparing SSD-Efficient Portfolios with a Skewed Reference Distribution," Mathematics, MDPI, vol. 11(1), pages 1-20, December.
    3. Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2015. "Linear vs. quadratic portfolio selection models with hard real-world constraints," Computational Management Science, Springer, vol. 12(3), pages 345-370, July.
    4. Jongbin Jung & Seongmoon Kim, 2017. "Developing a dynamic portfolio selection model with a self-adjusted rebalancing method," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 68(7), pages 766-779, July.
    5. Francesco Cesarone & Justo Puerto, 2024. "New approximate stochastic dominance approaches for Enhanced Indexation models," Papers 2401.12669, arXiv.org.
    6. Cesarone, Francesco & Lampariello, Lorenzo & Sagratella, Simone, 2019. "A risk-gain dominance maximization approach to enhanced index tracking," Finance Research Letters, Elsevier, vol. 29(C), pages 231-238.
    7. Bruni, Renato & Cesarone, Francesco & Scozzari, Andrea & Tardella, Fabio, 2017. "On exact and approximate stochastic dominance strategies for portfolio selection," European Journal of Operational Research, Elsevier, vol. 259(1), pages 322-329.

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    More about this item

    Keywords

    Enhanced Index Tracking; Asset Management; Portfolio Selection; No Arbitrage; Linear Programming;
    All these keywords.

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • G1 - Financial Economics - - General Financial Markets

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