Portfolio Theory for Squared Returns Correlated Across Time
43 Pages Posted: 26 Jul 2015 Last revised: 2 Mar 2016
Date Written: January 20, 2016
Allowing for correlated squared returns across two consecutive periods, portfolio theory for two periods is developed. This correlation makes it necessary to work with non-Gaussian models. The two period conic portfolio problem is formulated and implemented. This development leads to a mean ask price frontier, where the latter employs concave distortions. The modeling permits access to skewness via randomized drifts. Optimal portfolios maximize a conservative market value seen as a bid price for the portfolio. On the mean ask price frontier we observe a tradeoff between the deterministic and random drifts and the volatility costs of increasing the deterministic drift. From a historical perspective we also implement a mean variance analysis. The resulting mean variance frontier is three dimensional expressing the minimal variance as a function of the targeted levels for the deterministic and random drift.
Keywords: Correlated Gamma Processes, Distorted Expectations, Conic Portfolio Theory
JEL Classification: G10, G11, G13
Suggested Citation: Suggested Citation