Outperformance Portfolio Optimization via the Equivalence of Pure and Randomized Hypothesis Testing
We study the portfolio problem of maximizing the outperformance probability over a random benchmark through dynamic trading with a fixed initial capital. Under a general incomplete market framework, this stochastic control problem can be formulated as a composite pure hypothesis testing problem. We analyze the connection between this pure testing problem and its randomized counterpart, and from latter we derive a dual representation for the maximal outperformance probability. Moreover, in a complete market setting, we provide a closed-form solution to the problem of beating a leveraged exchange traded fund. For a general benchmark under an incomplete stochastic factor model, we provide the Hamilton-Jacobi-Bellman PDE characterization for the maximal outperformance probability.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Erhan Bayraktar & Yu-Jui Huang & Qingshuo Song, 2010. "Outperforming the market portfolio with a given probability," Papers 1006.3224, arXiv.org, revised Aug 2012.
- Jarrow, Robert A., 2010. "Understanding the risk of leveraged ETFs," Finance Research Letters, Elsevier, vol. 7(3), pages 135-139, September.
- Alexander Schied, 2004. "On the Neyman-Pearson problem for law-invariant risk measures and robust utility functionals," Papers math/0407127, arXiv.org.
- Marc Romano & Nizar Touzi, 1997. "Contingent Claims and Market Completeness in a Stochastic Volatility Model," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 399-412.
- Birgit Rudloff, 2007. "Convex Hedging in Incomplete Markets," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(5), pages 437-452.
- Hans Föllmer & Alexander Schied, 2002. "Convex measures of risk and trading constraints," Finance and Stochastics, Springer, vol. 6(4), pages 429-447.
- Hans FÃllmer & Peter Leukert, 1999. "Quantile hedging," Finance and Stochastics, Springer, vol. 3(3), pages 251-273.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1109.5316. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.