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Portfolio selection: A target-distribution approach

Author

Listed:
  • Lassance, Nathan

    (Université catholique de Louvain, LIDAM/LFIN, Belgium)

  • Vrins, Frédéric

    (Université catholique de Louvain, LIDAM/LFIN, Belgium)

Abstract

We introduce a novel framework for the portfolio selection problem in which investors aim to target a return distribution, and the optimal portfolio has a return distribution as close as possible to the targeted one. The proposed framework can be applied to a variety of investment objectives. In this paper, we focus on improving the higher moments of mean-variance-efficient portfolios by designing the target so that its first two moments match those of the chosen efficient portfolio but has more desirable higher moments. We show theoretically that the optimal portfolio is in general different from the mean-variance portfolio, but remains mean-variance efficient when asset returns are Gaussian. Otherwise, it can move away from the efficient frontier to better match the higher moments of the target distribution. An extensive empirical analysis using three characteristic-sorted datasets and a dataset of 100 individual stocks indicates that the proposed framework delivers a satisfying compromise between mean-variance efficiency and improved higher moments.

Suggested Citation

  • Lassance, Nathan & Vrins, Frédéric, 2023. "Portfolio selection: A target-distribution approach," LIDAM Reprints LFIN 2023004, Université catholique de Louvain, Louvain Finance (LFIN).
    • Handle: RePEc:ajf:louvlr:2023004
    DOI: https://doi.org/10.1016/j.ejor.2023.02.014
    Note: In: European Journal of Operational Research, 2023
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    Cited by:

    1. Miao, Kathleen E. & Pesenti, Silvana M., 2025. "Robust elicitable functionals," European Journal of Operational Research, Elsevier, vol. 326(2), pages 311-325.
    2. Zsurkis, Gabriel & Nicolau, João & Rodrigues, Paulo M.M., 2024. "First passage times in portfolio optimization: A novel nonparametric approach," European Journal of Operational Research, Elsevier, vol. 312(3), pages 1074-1085.
    3. Kathleen E. Miao & Silvana M. Pesenti, 2024. "Robust Elicitable Functionals," Papers 2409.04412, arXiv.org, revised Feb 2025.

    More about this item

    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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