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Portfolio Optimization under Correlation Constraint

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  • Aditya Maheshwari
  • Traian Pirvu

Abstract

We consider the problem of portfolio optimization with a correlation constraint. The framework is the multiperiod stochastic financial market setting with one tradable stock, stochastic income and a non-tradable index. The correlation constraint is imposed on the portfolio and the non-tradable index at some benchmark time horizon. The goal is to maximize portofolio's expected exponential utility subject to the correlation constraint. Two types of optimal portfolio strategies are considered: the subgame perfect and the precommitment ones. We find analytical expressions for the constrained subgame perfect (CSGP) and the constrained precommitment (CPC) portfolio strategies. Both these portfolio strategies yield significantly lower risk when compared to the unconstrained setting, at the cost of a small utility loss. The performance of the CSGP and CPC portfolio strategies is similar.

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  • Aditya Maheshwari & Traian Pirvu, 2019. "Portfolio Optimization under Correlation Constraint," Papers 1912.12521, arXiv.org.
  • Handle: RePEc:arx:papers:1912.12521
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    References listed on IDEAS

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    1. C. Bernard & D. Cornilly & S. Vanduffel, 2018. "Optimal portfolios under a correlation constraint," Quantitative Finance, Taylor & Francis Journals, vol. 18(3), pages 333-345, March.
    2. Farzad Pourbabaee & Minsuk Kwak & Traian A. Pirvu, 2016. "Risk minimization and portfolio diversification," Quantitative Finance, Taylor & Francis Journals, vol. 16(9), pages 1325-1332, September.
    3. Bernard, C. & Vanduffel, S., 2014. "Mean–variance optimal portfolios in the presence of a benchmark with applications to fraud detection," European Journal of Operational Research, Elsevier, vol. 234(2), pages 469-480.
    4. Huiling Wu, 2013. "Time-Consistent Strategies for a Multiperiod Mean-Variance Portfolio Selection Problem," Journal of Applied Mathematics, Hindawi, vol. 2013, pages 1-13, April.
    5. Traian A. Pirvu & Huayue Zhang, 2013. "Utility Indifference Pricing: A Time Consistent Approach," Applied Mathematical Finance, Taylor & Francis Journals, vol. 20(4), pages 304-326, September.
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