Myopic robust index tracking with Bregman divergence

DOI10.1080/14697688.2021.1950918MaRDI QIDQ5068089zbMATH OpenOpenAlexFDO

Authors Pavel V. Shevchenko, Wei Wu, Spiridon Penev

Publication date 5 April 2022

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1908.07659

zbMATH Keywords

Bregman divergenceindex trackingKullback-Leibler divergencerobust index tracking

Mathematics Subject Classification ID

Portfolio theory (91G10)

Abstract: Index tracking is a popular form of asset management. Typically, a quadratic function is used to define the tracking error of a portfolio and the look back approach is applied to solve the index tracking problem. We argue that a forward looking approach is more suitable, whereby the tracking error is expressed as expectation of a function of the difference between the returns of the index and of the portfolio. We also assume that there is an uncertainty in the distribution of the assets, hence a robust version of the optimization problem needs to be adopted. We use Bregman divergence in describing the deviation between the nominal and actual distribution of the components of the index. In this scenario, we derive the optimal robust index tracking strategy in a semi-analytical form as a solution of a system of nonlinear equations. Several numerical results are presented that allow us to compare the performance of this robust strategy with the optimal non-robust strategy. We show that, especially during market downturns, the robust strategy can be very advantageous.

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Cited in

(4)

• Robust portfolio selection for index tracking
• Factor-based robust index tracking
• A discrete-time benchmark tracking problem in two markets subject to random environments
• Enhanced indexation: can volatility timing improve portfolio performance?

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