Portfolios - EDHEC-Risk
Portfolios - EDHEC-Risk
Portfolios - EDHEC-Risk
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“Fund Separation Theorem” Approach to TE Control<br />
• Fund separation theorems recognize that t risk and performance<br />
are conflicting objectives that are best managed when managed<br />
separately.<br />
• In simple words, the optimal solution in the presence of TE<br />
constraints is a mixture of some proxy for a well-diversified MSR<br />
portfolio and the CW benchmark, here the risk-free asset:(*)<br />
w<br />
⎛ ⎞<br />
= −<br />
CW MSR<br />
⎟<br />
w<br />
t = c<br />
t w<br />
t + 1<br />
⎝ γσ<br />
14243 144<br />
243<br />
⎠ 4<br />
* λt<br />
MSR λt<br />
t w<br />
t +<br />
1<br />
γσ<br />
⎜<br />
t<br />
t<br />
speculative demand<br />
HD w.r.t. benchmark risk<br />
( − c<br />
CW<br />
t ) w<br />
t<br />
• The risk-aversion parameter γ is calibrated to as to reach a<br />
target TE level; for a given γ, the weight allocated to the<br />
improved vs. CW portfolio is a function of market conditions.<br />
29<br />
(*) Result based on constrained maximization of expected CRRA utility of terminal wealth relative to CW benchmark.
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