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An info-gap approach to managing portfolios of assets with uncertain returns

Listed author(s):
  • Bryan Beresford-Smith
Registered author(s):

    Purpose - The purpose of this paper is to provide a quantitative methodology based on information-gap decision theory for dealing with (true) Knightian uncertainty in the management of portfolios of assets with uncertain returns. Design/methodology/approach - Portfolio managers aim to maximize returns for given levels of risk. Since future returns on assets are uncertain the expected return on a portfolio of assets can be subject to significant uncertainty. Information-gap decision theory is used to construct portfolios that are robust against uncertainty. Findings - Using the added dimensions of aspirational parameters and performance requirements in information-gap theory, the paper shows that one cannot simultaneously have two robust-optimal portfolios that outperform a specified return and a benchmark portfolio unless one of the portfolios has arbitrarily large long and short positions. Research limitations/implications - The paper has considered only one uncertainty model and two performance requirements in an information-gap analysis over a particular time frame. Alternative uncertainty models could be introduced and benchmarking against proxy portfolios and competitors are examples of additional performance requirements that could be incorporated in an information-gap analysis. Practical implications - An additional methodology for applying information-gap modeling to portfolio management has been provided. Originality/value - This paper provides a new and novel approach for managing portfolios in the face of uncertainties in future asset returns.

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    Article provided by Emerald Group Publishing in its journal The Journal of Risk Finance.

    Volume (Year): 10 (2009)
    Issue (Month): 3 (May)
    Pages: 277-287

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    Handle: RePEc:eme:jrfpps:v:10:y:2009:i:3:p:277-287
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