Abstract
The most common equity mandate in the financial industry is to try to outperform an externally given benchmark with known weights. The standard quantitative approach to do this is to optimize the portfolio over short time horizons consecutively, using one-period models. However, it is not clear that this approach actually yields good performance in the long run. We provide a theoretical justification to this methodology by verifying that applying the one-period benchmark-relative mean-variance portfolio, i.e., the industry standard optimal portfolio, continuously is in fact the solution to a specific continuous time portfolio optimization problem: a maximum expected utility problem for an investor who is compared against a benchmark and evaluates her performance based on exponential utility at a deterministic future date.
Similar content being viewed by others
References
Davis, M.H.A., Varaiya, P.: Dynamic programming conditions for partially observed stochastic systems. SIAM J. Control 11, 226–261 (1973)
Fleming, W.H., Soner, H.M.: Controlled Markov Processes and Viscosity Solutions. Springer, New York (2006)
Hua, R.H., Sorensen, E.H., Qian, E.E.: Quantitative Equity Portfolio Management. Chapman & Hall, London (2007)
Karatzas, I., Shreve, S.E.: Methods of Mathematical Finance. Springer, New York (1998)
Korn, R.: Optimal Portfolios. World Scientific, Singapore (1997)
Korn, R.: The martingale optimality principle in finance: the best you can is good enough. WILMOTT (July), 61–67 (2003)
Korn, R., Korn, E.: Option Pricing and Portfolio Optimization. AMS, Providence (2001)
Pliska, S.R.: A stochastic calculus model of continuous trading: optimal portfolios. Math. Oper. Res. 11, 371–382 (1986)
Revuz, D., Yor, M.: Continuous Martingales and Brownian Motion. Springer, Berlin (1999)
Rogers, L.C.G., Williams, D.: Diffusions, Markov Processes and Martingales, vol. 2. Wiley, Chichester (1987)
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Korn, R., Lindberg, C. Portfolio optimization for an investor with a benchmark. Decisions Econ Finan 37, 373–384 (2014). https://doi.org/10.1007/s10203-013-0148-8
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10203-013-0148-8