Behavioral Benchmarked Investment Management with Expert Forecasts
55 Pages Posted: 18 Feb 2021
Date Written: December 20, 2020
We propose a continuous-time portfolio selection model that explains the active-passive continuum. Our model illuminates the pivotal role of expert opinions and factors in the asset allocation process. In the model, investors aim to outperform a benchmark. As securities and benchmark's drift depends on unobservable factors, portfolio selection becomes a partial observation risk-sensitive control problem. We find that the optimal investment policy combines Kelly, benchmark-tracking, and intertemporal hedging portfolios. The Kelly portfolio sums two alpha-generating strategies. Our simulation reveals the importance of debiasing expert opinions and shows that factor choice is crucial at every stage of the investment process.
Keywords: active management, benchmark, expert opinions, Kalman filter, Kelly criterion, risk-sensitive stochastic control
JEL Classification: C32, C60, G11.
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