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How to Keep Your Portfolio Close in Risk and Diversification to a Desired Benchmark

Author

Listed:
  • Argimiro Arratia

    (Universitat Politécnica de Catalunya)

  • Henryk Gzyl

    (IESA)

  • Silvia Mayoral

    (Universidad Carlos III de Madrid)

Abstract

The standard approach to portfolio management consists of determining the best trade-off between risk and return. This usually results in portfolios concentrated in a small collection of the available assets. To offset this one can start with a well-diversified portfolio, to be regarded as a benchmark, then search for a portfolio that improves upon its return. The main issue is that the search has to be carried out in a neighborhood in which diversification is maintained and the risk is under control. Here we examine three ways of defining the neighborhood of the well-diversified portfolio, and see that the nature of the optimal portfolio within that neighborhood changes considerably. As there is no universal choice for the distance between portfolios, this poses an interesting and hard problem for the portfolio manager.

Suggested Citation

  • Argimiro Arratia & Henryk Gzyl & Silvia Mayoral, 2024. "How to Keep Your Portfolio Close in Risk and Diversification to a Desired Benchmark," Computational Economics, Springer;Society for Computational Economics, vol. 64(3), pages 1489-1505, September.
    • Handle: RePEc:kap:compec:v:64:y:2024:i:3:d:10.1007_s10614-023-10485-1
    DOI: 10.1007/s10614-023-10485-1
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    References listed on IDEAS

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