Outperformance portfolio optimization via the equivalence of pure and randomized hypothesis testing

DOI10.1007/S00780-013-0213-8zbMATH Open1275.91124arXiv1109.5316OpenAlexW3123709402MaRDI QIDQ377458FDOQ377458

Authors: Tim Leung, Qingshuo Song, Jie Yang 

Publication date: 6 November 2013

Published in: Finance and Stochastics (Search for Journal in Brave)

Abstract: We study the portfolio problem of maximizing the outperformance probability over a random benchmark through dynamic trading with a fixed initial capital. Under a general incomplete market framework, this stochastic control problem can be formulated as a composite pure hypothesis testing problem. We analyze the connection between this pure testing problem and its randomized counterpart, and from latter we derive a dual representation for the maximal outperformance probability. Moreover, in a complete market setting, we provide a closed-form solution to the problem of beating a leveraged exchange traded fund. For a general benchmark under an incomplete stochastic factor model, we provide the Hamilton-Jacobi-Bellman PDE characterization for the maximal outperformance probability.

Full work available at URL: https://arxiv.org/abs/1109.5316

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zbMATH Keywords

hypothesis testingNeyman-Pearson lemmaportfolio optimizationquantile hedgingstochastic benchmark

Mathematics Subject Classification ID

Applications of statistics to actuarial sciences and financial mathematics (62P05) Portfolio theory (91G10) Applications of stochastic analysis (to PDEs, etc.) (60H30)

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Cited In (5)

• Quantile hedging in a semi-static market with model uncertainty
• Reaching goals under ambiguity: continuous-time optimal portfolio selection
• \(K\)-fold cross validation performance comparisons of six naive portfolio selection rules: how naive can you be and still have successful out-of-sample portfolio performance?
• On portfolio choice by maximizing the outperformance probability
• Weak convergence of path-dependent SDEs in basket credit default swap pricing with contagion risk

Uses Software

• MathOverflow

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