Portfolio Choice with Path-Dependent Preferences

Kritzman, Mark and Li, Ding and Qiu, Grace (Tiantian) and Turkington, David, Portfolio Choice with Path-Dependent Scenarios (January 15, 2021). Financial Analysts Journal, 2021, 77(1): 90–100.

Posted: 15 Jun 2020 Last revised: 30 Mar 2021

See all articles by Mark Kritzman

Mark Kritzman

Windham Capital Management

Ding Li

GIC Private Limited

Grace (Tiantian) Qiu

GIC

David Turkington

State Street Associates

Date Written: January 15, 2021

Abstract

Many sophisticated investors rely on scenario analysis to select a portfolio. These investors define prospective economic scenarios, assign probabilities to them, translate the scenarios into expected asset class returns, and select the portfolio with the highest expected return or expected utility, given all these inputs. With this approach, the investor only considers single period outcomes. The authors propose a new approach to scenario analysis that enables investors to consider sequential outcomes. They define prospective scenarios, not as average values of economic variables, but as paths for these variables. And they measure the likelihood that these paths will prevail in the future based on their statistical similarity to the historical sequences of these variables. The authors also employ a novel forecasting technique called partial sample regression to map economic outcomes onto asset class returns. This process allows investors to evaluate portfolios based on the likelihood they will produce a certain pattern of returns over a specified investment horizon.

Keywords: Informativeness, Mahalanobis Distance, Partial Sample Regression, Relevance, Scenario Analysis, Statistical Similarity

JEL Classification: A10, C00, C01, C02, C10, G00, G01, G10, G11, G17

Suggested Citation

Kritzman, Mark and Li, Ding and Qiu, Grace (Tiantian) and Turkington, David, Portfolio Choice with Path-Dependent Preferences (January 15, 2021). Kritzman, Mark and Li, Ding and Qiu, Grace (Tiantian) and Turkington, David, Portfolio Choice with Path-Dependent Scenarios (January 15, 2021). Financial Analysts Journal, 2021, 77(1): 90–100. , Available at SSRN: https://ssrn.com/abstract=3611095 or http://dx.doi.org/10.2139/ssrn.3611095

Mark Kritzman (Contact Author)

Windham Capital Management ( email )

800 Boylston Street
30th Floor
Boston, MA 02199
United States
6174193900 (Phone)
6172365034 (Fax)

Ding Li

GIC Private Limited ( email )

168 Robinson Road
#37-01
Singapore, 068912
Singapore

Grace (Tiantian) Qiu

GIC ( email )

280 Park Avenue, 9th floor
New York, NY 10017
United States

David Turkington

State Street Associates ( email )

United States

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