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On portfolios generated by optimal transport

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  • Ting-Kam Leonard Wong

Abstract

First introduced by Fernholz in stochastic portfolio theory, functionally generated portfolio allows its investment performance to be attributed to directly observable and easily interpretable market quantities. In previous works we showed that Fernholz's multiplicatively generated portfolio has deep connections with optimal transport and the information geometry of exponentially concave functions. Recently, Karatzas and Ruf introduced a new additive portfolio generation whose relation with optimal transport was studied by Vervuurt. We show that additively generated portfolio can be interpreted in terms of the well-known dually flat information geometry of Bregman divergence. Moreover, we characterize, in a sense to be made precise, all possible forms of functional portfolio constructions that contain additive and multiplicative generations as special cases. Each construction involves a divergence functional on the unit simplex measuring the market volatility captured, and admits a pathwise decomposition for the portfolio value. We illustrate with an empirical example.

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  • Ting-Kam Leonard Wong, 2017. "On portfolios generated by optimal transport," Papers 1709.03169, arXiv.org, revised Sep 2017.
    • Handle: RePEc:arx:papers:1709.03169
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    References listed on IDEAS

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    1. Adrian Banner & Daniel Fernholz, 2008. "Short-term relative arbitrage in volatility-stabilized markets," Annals of Finance, Springer, vol. 4(4), pages 445-454, October.
    2. Alexander Vervuurt & Ioannis Karatzas, 2015. "Diversity-Weighted Portfolios with Negative Parameter," Papers 1504.01026, arXiv.org, revised Jul 2015.
    3. Karatzas, Ioannis & Ruf, Johannes, 2017. "Trading strategies generated by Lyapunov functions," LSE Research Online Documents on Economics 69177, London School of Economics and Political Science, LSE Library.
    4. Scott Willenbrock, 2011. "Diversification Return, Portfolio Rebalancing, and the Commodity Return Puzzle," Papers 1109.1256, arXiv.org.
    5. Robert Fernholz & Ioannis Karatzas & Constantinos Kardaras, 2005. "Diversity and relative arbitrage in equity markets," Finance and Stochastics, Springer, vol. 9(1), pages 1-27, January.
    6. Ioannis Karatzas & Johannes Ruf, 2017. "Trading strategies generated by Lyapunov functions," Finance and Stochastics, Springer, vol. 21(3), pages 753-787, July.
    7. Alexander Vervuurt & Ioannis Karatzas, 2015. "Diversity-weighted portfolios with negative parameter," Annals of Finance, Springer, vol. 11(3), pages 411-432, November.
    8. Soumik Pal, 2016. "Exponentially concave functions and high dimensional stochastic portfolio theory," Papers 1603.01865, arXiv.org, revised Mar 2016.
    9. Ting-Kam Wong, 2015. "Optimization of relative arbitrage," Annals of Finance, Springer, vol. 11(3), pages 345-382, November.
    10. Robert Fernholz, 1999. "Portfolio Generating Functions," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar, chapter 15, pages 344-367, World Scientific Publishing Co. Pte. Ltd..
    11. E. Robert Fernholz & Ioannis Karatzas & Johannes Ruf, 2016. "Volatility and Arbitrage," Papers 1608.06121, arXiv.org.
    12. Robert Fernholz & Ioannis Karatzas, 2005. "Relative arbitrage in volatility-stabilized markets," Annals of Finance, Springer, vol. 1(2), pages 149-177, November.
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    Cited by:

    1. Erhan Bayraktar & Donghan Kim & Abhishek Tilva, 2024. "Quantifying dimensional change in stochastic portfolio theory," Mathematical Finance, Wiley Blackwell, vol. 34(3), pages 977-1021, July.
    2. Gabriel Khan & Jun Zhang, 2018. "On the K\"ahler Geometry of Certain Optimal Transport Problems," Papers 1812.00032, arXiv.org, revised Aug 2019.
    3. Ruf, Johannes & Xie, Kangjianan, 2019. "Generalized Lyapunov functions and functionally generated trading strategies," LSE Research Online Documents on Economics 100023, London School of Economics and Political Science, LSE Library.
    4. repec:ehl:lserod:102424 is not listed on IDEAS
    5. Johannes Ruf & Kangjianan Xie, 2018. "Generalised Lyapunov Functions and Functionally Generated Trading Strategies," Papers 1801.07817, arXiv.org.

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