Portfolio Optimization under Correlation Constraint

19 Pages Posted: 13 Jan 2020

See all articles by Aditya Maheshwari

Aditya Maheshwari

Bank of America - Bank of America Securities

Traian A. Pirvu

McMaster University

Date Written: December 23, 2019

Abstract

We consider the problem of portfolio optimization with a correlation constraint. The frame- work is the multiperiod stochastic financial market setting with one tradable stock, stochastic income and a non-tradable index. The correlation constraint is imposed on the portfolio and the non-tradable index at some benchmark time horizon. The goal is to maximize portofolio’s expected exponential utility subject to the correlation constraint. Two types of optimal portfolio strategies are considered: the subgame perfect and the precommitment ones. We find analytical expressions for the constrained subgame perfect (CSGP) and the constrained precommitment (CPC) portfolio strategies. Both these portfolio strategies yield significantly lower risk when compared to the unconstrained setting, at the cost of a small utility loss. The performance of the CSGP and CPC portfolio strategies is similar.

Keywords: portfolio optimization, correlation constraints

JEL Classification: C02, C63

Suggested Citation

Maheshwari, Aditya and Pirvu, Traian Adrian, Portfolio Optimization under Correlation Constraint (December 23, 2019). Available at SSRN: https://ssrn.com/abstract=3508860 or http://dx.doi.org/10.2139/ssrn.3508860

Aditya Maheshwari

Bank of America - Bank of America Securities ( email )

United States

Traian Adrian Pirvu (Contact Author)

McMaster University ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

HOME PAGE: http://ms.mcmaster.ca/~tpirvu/

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