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Dynamical optimization theory of a diversified portfolio

Author

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  • Marsili, Matteo
  • Maslov, Sergei
  • Zhang, Yi-Cheng

Abstract

We propose and study a simple model of dynamical redistribution of capital in a diversified portfolio. We consider a hypothetical situation of a portfolio composed of N uncorrelated stocks. Each stock price follows a multiplicative random walk with identical drift and dispersion. The rules of our model naturally give rise to power law tails in the distribution of capital fractions invested in different stocks. The exponent of this scale free distribution is calculated in both discrete and continuous time formalism. It is demonstrated that the dynamical redistribution strategy results in a larger typical growth rate of the capital than a static “buy-and-hold” strategy. In the large N limit the typical growth rate is shown to asymptotically approach that of the expectation value of the stock price. The finite dimensional variant of the model is shown to describe the partition function of directed polymers in random media.

Suggested Citation

  • Marsili, Matteo & Maslov, Sergei & Zhang, Yi-Cheng, 1998. "Dynamical optimization theory of a diversified portfolio," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 253(1), pages 403-418.
    • Handle: RePEc:eee:phsmap:v:253:y:1998:i:1:p:403-418
    DOI: 10.1016/S0378-4371(98)00075-2
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    Citations

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    Cited by:

    1. David Morton de Lachapelle & Damien Challet, 2009. "Turnover, account value and diversification of real traders: evidence of collective portfolio optimizing behavior," Papers 0912.4723, arXiv.org, revised Jun 2010.
    2. Sorin Solomon & Nataša Golo, 2015. "Microeconomic structure determines macroeconomic dynamics: Aoki defeats the representative agent," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 10(1), pages 5-30, April.
    3. Jan Lorenz & Fabian Paetzel & Frank Schweitzer, 2013. "Redistribution Spurs Growth by Using a Portfolio Effect on Risky Human Capital," PLOS ONE, Public Library of Science, vol. 8(2), pages 1-13, February.
    4. Stojkoski, Viktor, 2024. "Measures of physical mixing evaluate the economic mobility of the typical individual," Chaos, Solitons & Fractals, Elsevier, vol. 180(C).
    5. Sornette, Didier, 1998. "Large deviations and portfolio optimization," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 256(1), pages 251-283.
    6. Davide Fiaschi - Matteo Marsili, 2004. "Community structure and labour market segmentation in a stochastic model of," Computing in Economics and Finance 2004 239, Society for Computational Economics.
    7. G. Yaari & D. Stauffer & S. Solomon, 2008. "Intermittency and Localization," Papers 0802.3541, arXiv.org, revised Mar 2008.
    8. Metzig, Cornelia & Gordon, Mirta B., 2014. "A model for scaling in firms’ size and growth rate distribution," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 398(C), pages 264-279.
    9. Paolo Laureti & Matus Medo & Yi-Cheng Zhang, 2010. "Analysis of Kelly-optimal portfolios," Quantitative Finance, Taylor & Francis Journals, vol. 10(7), pages 689-697.

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