Markowitz with Regret

58 Pages Posted: 24 Sep 2018

See all articles by Rainer Baule

Rainer Baule

University of Hagen

Olaf Korn

University of Goettingen (Gottingen)

Laura-Chloé Kuntz

University of Goettingen (Gottingen) - Chair of Finance

Date Written: August 21, 2018

Abstract

Providing a framework to integrate regret as an additional decision criterion in Markowitz's model of portfolio selection, we propose two different views on regret: An investor might feel regret with respect to the ex-post best alternative either in terms of return or in terms of preference value. Under both views, regret can be captured by adjusting the vector of expected returns or alternatively by adjusting the return covariance matrix, retaining the tractability of the Markowitz model. The regret model, however, has very different implications for how asset characteristics affect optimal portfolios. While the impact of the skewness of an asset is strengthened, the impact of the variance shrinks. Moreover, we show for a variety of real portfolios that the effects of regret on optimal portfolio weights and the ex-ante return distribution are large.

Keywords: portfolio selection, regret aversion, regret risk

JEL Classification: D81, G11, G40

Suggested Citation

Baule, Rainer and Korn, Olaf and Kuntz, Laura-Chloé, Markowitz with Regret (August 21, 2018). Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3243773

Rainer Baule (Contact Author)

University of Hagen ( email )

Universitaetsstrasse 41
Hagen, 58097
Germany

Olaf Korn

University of Goettingen (Gottingen) ( email )

Platz der Gottinger Sieben 3
Gottingen, D-37073
Germany
++49 551 39 7265 (Phone)
++49 551 39 7665 (Fax)

Laura-Chloé Kuntz

University of Goettingen (Gottingen) - Chair of Finance ( email )

Göttingen
Germany

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