Behavioral Benchmarked Investment Management with Expert Forecasts

55 Pages Posted: 18 Feb 2021

See all articles by Sebastien Lleo

Sebastien Lleo

NEOMA Business School

Mark Davis

Imperial College London

Date Written: December 20, 2020

Abstract

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.

Suggested Citation

Lleo, Sebastien and Davis, Mark, Behavioral Benchmarked Investment Management with Expert Forecasts (December 20, 2020). Available at SSRN: https://ssrn.com/abstract=3754205 or http://dx.doi.org/10.2139/ssrn.3754205

Sebastien Lleo (Contact Author)

NEOMA Business School ( email )

Reims
France

Mark Davis

Imperial College London ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom
02075948486 (Phone)

HOME PAGE: http://www.ma.ic.ac.uk/~mdavis

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