Dynamic core-satellite investing using higher order moments: an explicit solution

Abstract

The goal of core-satellite investing is to optimally balance the portfolio allocation between a core and satellite investment. This paper provides an explicit solution when the investor's optimality criterion is the third-order and fourth-order expansion of the expected utility function, respectively. Based on a numeric example, we document the sensitivity of the proposed weights to coskewness and cokurtosis components. Finally, we use ETFs to examine the portfolio performance of the core-satellite strategy with higher order moments. We document that integrating the higher order moment in core-satellite investing can improve the financial performance of a portfolio.

Keywords:

• Higher order moments
• Explicit solution
• Core-satellite investing
• Sensitivity

JEL Classifications:

• G11
• C61

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For more convenient expression, we report the moments for the percentage log return in percentage point, but in the subsequent analysis, the moments of the log return are used.

Additional information

Funding

This work was partially supported by the Characteristic & Preponderant Discipline of Key Construction Universities in Zhejiang Province (Zhejiang Gongshang University-Statistics) and the Collaborative Innovation Center of Statistical Data Engineering Technology & Application. National Natural Science Foundation of China [grant number 71771187, 72011530149, 72163029] and Fundamental Research Funds for the Central Universities in China [grant number JBK190602].