Target-Seeking Decompositions of Multi-Period Optimal Portfolios

45 Pages Posted: 28 Feb 2013 Last revised: 30 Dec 2013

See all articles by Xin Xu

Xin Xu

Unisys Machine Learning and Advanced Analytics Services

Date Written: December 10, 2013

Abstract

We identify decompositions of multi-period optimal portfolios, in which each subportfolio is dedicated to achieving a single investment target, in dynamic models with Von Neumann-Morgenstern preferences and diffusion asset returns (“Merton’s problem”). These decompositions rest on recognizing the equivalence between Merton’s problem and a generalized Mean-Variance Optimization problem. We show that the special properties of the component sub-portfolios facilitate empirical implementation of dynamic asset allocation, and provide new insights into how multi-period optimal portfolios can be constructed. A practical application is examined, which entails a “divide-and-conquer” approach for long-term investors, like pension funds, to develop asset allocation strategies.

Keywords: Portfolio Management, Portfolio Decomposition, Merton’s Problem, Multiperiod, Asset Allocation, Dynamic Programming, Mean Variance Optimization, Zero-Cost Portfolios, Long-term Investments

JEL Classification: G11

Suggested Citation

Xu, Xin, Target-Seeking Decompositions of Multi-Period Optimal Portfolios (December 10, 2013). Available at SSRN: https://ssrn.com/abstract=2223788 or http://dx.doi.org/10.2139/ssrn.2223788

Xin Xu (Contact Author)

Unisys Machine Learning and Advanced Analytics Services ( email )

PO Box 288
Concord West, NSW 2138
Australia

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