Active portfolio management with benchmarking: Adding a value-at-risk constraint
We examine the impact of adding a value-at-risk (VaR) constraint to the problem of an active manager who seeks to outperform a benchmark while minimizing tracking error variance (TEV) by using the model of Roll [1992. A mean/variance analysis of tracking error. Journal of Portfolio Management 18, 13-22]. We obtain three main results. First, portfolios on the constrained mean-TEV boundary still exhibit three-fund separation, but the weights of the three funds when the constraint binds differ from those in Roll's model. Second, the constraint mitigates the problem that when an active manager seeks to outperform a benchmark using the mean-TEV model, he or she selects an inefficient portfolio. Finally, when short sales are disallowed, the extent to which the constraint reduces the optimal portfolio's efficiency loss can still be notable but is smaller than when short sales are allowed.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Gordon J. Alexander & Alexandre M. Baptista, 2004. "A Comparison of VaR and CVaR Constraints on Portfolio Selection with the Mean-Variance Model," Management Science, INFORMS, vol. 50(9), pages 1261-1273, September.
- Brennan, Michael J., 1993. "Agency and Asset Pricing," University of California at Los Angeles, Anderson Graduate School of Management qt53k014sd, Anderson Graduate School of Management, UCLA.
- Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, vol. 55(5), pages 2311-2331, October.
- Juan-Pedro Gomez & Fernando Zapatero, 2003. "Asset pricing implications of benchmarking: a two-factor CAPM," The European Journal of Finance, Taylor & Francis Journals, vol. 9(4), pages 343-357.
- Chevalier, Judith & Ellison, Glenn, 1997.
"Risk Taking by Mutual Funds as a Response to Incentives,"
Journal of Political Economy,
University of Chicago Press, vol. 105(6), pages 1167-1200, December.
- Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
- Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
- Mark Grinblatt & Sheridan Titman, 1989. "Adverse Risk Incentives and the Design of Performance-Based Contracts," Management Science, INFORMS, vol. 35(7), pages 807-822, July.
- Mark Grinblatt & Sheridan Titman, "undated". "Adverse Risk Incentives and the Design of Performance-Based Contracts," Rodney L. White Center for Financial Research Working Papers 21-88, Wharton School Rodney L. White Center for Financial Research.
- Berk, Jonathan B., 1997. "Necessary Conditions for the CAPM," Journal of Economic Theory, Elsevier, vol. 73(1), pages 245-257, March.
- Admati, Anat R & Pfleiderer, Paul, 1997. "Does It All Add Up? Benchmarks and the Compensation of Active Portfolio Managers," The Journal of Business, University of Chicago Press, vol. 70(3), pages 323-350, July.
- Alexander, Gordon J. & Baptista, Alexandre M., 2002. "Economic implications of using a mean-VaR model for portfolio selection: A comparison with mean-variance analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1159-1193, July.
- Alexander, Gordon J. & Baptista, Alexandre M., 2006. "Does the Basle Capital Accord reduce bank fragility? An assessment of the value-at-risk approach," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1631-1660, October.
- Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
- Bertsimas, Dimitris & Lauprete, Geoffrey J. & Samarov, Alexander, 2004. "Shortfall as a risk measure: properties, optimization and applications," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1353-1381, April.
- Edwin J. Elton & Martin J. Gruber & Christopher R. Blake, 2003. "Incentive Fees and Mutual Funds," Journal of Finance, American Finance Association, vol. 58(2), pages 779-804, 04.
- Tokat, Yesim & Rachev, Svetlozar T. & Schwartz, Eduardo S., 2003. "The stable non-Gaussian asset allocation: a comparison with the classical Gaussian approach," Journal of Economic Dynamics and Control, Elsevier, vol. 27(6), pages 937-969, April.
- Jennifer Carpenter, 1999. "Does Option Compensation Increase Managerial Risk Appetite?," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-076, New York University, Leonard N. Stern School of Business-.
- Erik R. Sirri & Peter Tufano, 1998. "Costly Search and Mutual Fund Flows," Journal of Finance, American Finance Association, vol. 53(5), pages 1589-1622, October.
- Starks, Laura T., 1987. "Performance Incentive Fees: An Agency Theoretic Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 17-32, March.
- Merton, Robert C., 1972. "An Analytic Derivation of the Efficient Portfolio Frontier," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 7(04), pages 1851-1872, September.
- Owen, Joel & Rabinovitch, Ramon, 1983. " On the Class of Elliptical Distributions and Their Applications to the Theory of Portfolio Choice," Journal of Finance, American Finance Association, vol. 38(3), pages 745-752, June.
- Almazan, Andres & Brown, Keith C. & Carlson, Murray & Chapman, David A., 2004. "Why constrain your mutual fund manager?," Journal of Financial Economics, Elsevier, vol. 73(2), pages 289-321, August.
- Alexander, Gordon J, 1993. " Short Selling and Efficient Sets," Journal of Finance, American Finance Association, vol. 48(4), pages 1497-1506, September. Full references (including those not matched with items on IDEAS)