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Optimal guaranteed return portfolios and the casino effect

Author

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  • Dert, Cees

    (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)

  • Oldenkamp, Bart

Abstract

In this paper, we address the problem of maximizing expected return subject to a worst case return constraint by composing a portfolio that may consist of cash, holdings in a stock market index and options on the index. We derive properties of optimal and feasible portfolios and present a linear programming model to solve the problem. The optimal portfolios have pay-off functions that reflect a gambling policy. We show that optimal solutions to a large class of portfolio models that maximize expected return subject to downside risk constraints are driven by this casino effect and present tractable conditions under which it occurs in our model. We propose to control the casino effect by using chance constraints. Using results from financial theory we formulate an LP model that maximizes expected return subject to worst case return constraints and chance constraints on achieving prespecified levels of return. The results are illustrated with real life data on the S&P 500 index.

Suggested Citation

  • Dert, Cees & Oldenkamp, Bart, 1997. "Optimal guaranteed return portfolios and the casino effect," Serie Research Memoranda 0025, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
    • Handle: RePEc:vua:wpaper:1997-25
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    References listed on IDEAS

    as
    1. Philip H. Dybvig, 1988. "Inefficient Dynamic Portfolio Strategies or How to Throw Away a Million Dollars in the Stock Market," The Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 67-88.
    2. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
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    Cited by:

    1. Fengmin Xu & Jieao Ma, 2023. "Intelligent option portfolio model with perspective of shadow price and risk-free profit," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-28, December.
    2. Jansen, Dennis W. & Koedijk, Kees G. & de Vries, Casper G., 2000. "Portfolio selection with limited downside risk," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 247-269, November.
    3. Gulpinar, Nalan & Rustem, Berc, 2007. "Robust optimal decisions with imprecise forecasts," Computational Statistics & Data Analysis, Elsevier, vol. 51(7), pages 3595-3611, April.

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    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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