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A Large Deviation Approach To Portfolio Management

Author

Listed:
  • L. GARDIOL

    (Swiss Banking Institute, University of Zurich, 14 Platten strasse, 8032 Zurich, Switzerland)

  • R. GIBSON

    (Swiss Banking Institute, University of Zurich, 14 Platten strasse, 8032 Zurich, Switzerland)

  • P.-A. BARES

    (Institut de Physique Théorique, École Polytechnique Fédérale de Lausanne, CH-1015 Lausanne, Switzerland)

  • R. CONT

    (Institut de Physique Théorique, École Polytechnique Fédérale de Lausanne, CH-1015 Lausanne, Switzerland)

  • S. GYGER

    (Institut de Physique Théorique, École Polytechnique Fédérale de Lausanne, CH-1015 Lausanne, Switzerland)

Abstract

We propose a new framework to measure the risk of a single asset and of a portfolio of financial assets which takes the agent's investment horizon into account. The methodology is based on the moderate and large deviations theory in its simplest form. We show how it can be used to select optimal portfolios given investors' planning horizons and preferences for fatter right or left tails. For practical purposes, we introduce a new parameter, the "dilation exponent" α to characterize asset returns' distributions beyond the information contained in the mean-variance framework. We estimate α for Swiss individual stocks and for MSCI country and sector stock market indices. Finally, we show how to use the dilation exponent in conjunction with Sharpe's ratio for portfolio allocation purposes.

Suggested Citation

  • L. Gardiol & R. Gibson & P.-A. Bares & R. Cont & S. Gyger, 2000. "A Large Deviation Approach To Portfolio Management," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 617-639.
    • Handle: RePEc:wsi:ijtafx:v:03:y:2000:i:04:n:s0219024900000140
    DOI: 10.1142/S0219024900000140
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    Cited by:

    1. Huyen Pham, 2007. "Some applications and methods of large deviations in finance and insurance," Papers math/0702473, arXiv.org, revised Feb 2007.

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