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A financial modeling approach to industry exchange-traded funds selection

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  • Conlon, Thomas
  • Cotter, John
  • Kovalenko, Illia
  • Post, Thierry

Abstract

This study uses a comprehensive approach to optimize the portfolio allocation to equity sector Exchange Traded Funds. We combine data on the market prices of options written on the funds, the Heston stochastic volatility model, risk premium transformation, copulas, and optimization with stochastic dominance constraints. This comprehensive strategy provides significant performance out-of-sample gains relative to the passive and active alternative strategies, both before and after accounting for risk and transaction costs. Our findings point at market inefficiencies that can be exploited using sector funds, past public data, and blending multiple methods.

Suggested Citation

  • Conlon, Thomas & Cotter, John & Kovalenko, Illia & Post, Thierry, 2023. "A financial modeling approach to industry exchange-traded funds selection," Journal of Empirical Finance, Elsevier, vol. 74(C).
    • Handle: RePEc:eee:empfin:v:74:y:2023:i:c:s0927539823001081
    DOI: 10.1016/j.jempfin.2023.101441
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    More about this item

    Keywords

    Sector exchange traded funds; Portfolio optimization; Option-implied distribution; Copulas; Stochastic dominance;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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