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Portfolio Optimization under Correlation Constraint

Author

Listed:
  • Aditya Maheshwari

    (Bank of America Securities, New York, NY 10036, USA)

  • Traian A. Pirvu

    (Department of Mathematics and Statistics, McMaster University, 1280 Main Street West, Hamilton, ON L8S 4K1, Canada)

Abstract

We consider the problem of portfolio optimization with a correlation constraint. The framework is the multi-period stochastic financial market setting with one tradable stock, stochastic income, and a non-tradable index. The correlation constraint is imposed on the portfolio and the non-tradable index at some benchmark time horizon. The goal is to maximize a portofolio’s expected exponential utility subject to the correlation constraint. Two types of optimal portfolio strategies are considered: the subgame perfect and the precommitment ones. We find analytical expressions for the constrained subgame perfect (CSGP) and the constrained precommitment (CPC) portfolio strategies. Both these portfolio strategies yield significantly lower risk when compared to the unconstrained setting, at the cost of a small utility loss. The performance of the CSGP and CPC portfolio strategies is similar.

Suggested Citation

  • Aditya Maheshwari & Traian A. Pirvu, 2020. "Portfolio Optimization under Correlation Constraint," Risks, MDPI, vol. 8(1), pages 1-18, February.
    • Handle: RePEc:gam:jrisks:v:8:y:2020:i:1:p:15-:d:317375
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    References listed on IDEAS

    as
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