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An alternative strategy for balancing profit maximization and risk reduction

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  • Youssef El Khatib
  • Farangiz Mukhamedova

Abstract

Portfolio diversification is a central theme in modern investment theory. We revisit the classic return–risk trade-off and propose an alternative objective Qλ(w)=μ⊤w+λ(w⊤Σw)−1/2 that balances higher expected returns with a direct penalty on portfolio volatility via the inverse standard deviation. This objective belongs to the axiomatic class of mean–variance preferences (as formalised by [1] for additively separable forms) and admits tractable solutions, including a closed-form characterisation in the two-asset case. In rolling out-of-sample backtests on standard Fama–French equity portfolios with realistic trading costs and long-only constraints, Qλ delivers statistically significantly lower realised volatility (paired t-test p

Suggested Citation

  • Youssef El Khatib & Farangiz Mukhamedova, 2026. "An alternative strategy for balancing profit maximization and risk reduction," PLOS ONE, Public Library of Science, vol. 21(5), pages 1-21, May.
    • Handle: RePEc:plo:pone00:0348577
    DOI: 10.1371/journal.pone.0348577
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