Ambiguity in portfolio selection

Abstract

In this paper, we consider the problem of finding optimal portfolios in cases when the underlying probability model is not perfectly known. For the sake of robustness, a maximin approach is applied which uses a ‘confidence set’ for the probability distribution. The approach shows the tradeoff between return, risk and robustness in view of the model ambiguity. As a consequence, a monetary value of information in the model can be determined.

Keywords:

• Portfolio optimization
• Robustness
• Minimax

Notes

†We are indebted to a referee for pointing this out to us and also led us to discover the second condition for having found a saddle point in step 5 of the algorithm.