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Jump-diffusion risk-sensitive benchmarked asset management with traditional and alternative data

Author

Listed:
  • Mark Davis

    (Imperial College London)

  • Sébastien Lleo

    (NEOMA Business School)

Abstract

This paper addresses errors in mean return estimates in continuous-time asset allocation models. A standard approach postulates that stochastic factors explain expected asset returns. The problem is then to estimate these factors from observed asset prices via filtering. Recent advances have also combined asset prices with expert opinions to improve the estimates. However, these methods have limitations: stocks prices favor momentum strategies, and expert opinions require careful debiasing. To resolve these issues, we propose a jump-diffusion risk-sensitive benchmarked asset management model in which investors estimate the factors from both traditional and alternative data. We show that this model admits a unique $$C^{1,2}$$ C 1 , 2 solution, and we derive the optimal investment policy in quasi-closed form. We find that investors construct their portfolios from a passive core and an active satellite. The passive core adds considerations for jump risk to a simple benchmark replication. The active satellite blends security selection, and factor tilts with event-driven strategies unique to jump-diffusion problems. Thus, our model explains the most popular investment strategies. Furthermore, the improved expert forecast model and the introduction of alternative data provide factor tilters with new tools to sharpen their asset allocation.

Suggested Citation

  • Mark Davis & Sébastien Lleo, 2024. "Jump-diffusion risk-sensitive benchmarked asset management with traditional and alternative data," Annals of Operations Research, Springer, vol. 336(1), pages 661-689, May.
  • Handle: RePEc:spr:annopr:v:336:y:2024:i:1:d:10.1007_s10479-022-05130-3
    DOI: 10.1007/s10479-022-05130-3
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    References listed on IDEAS

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