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Conditioning the Information in Portfolio Optimization

Author

Listed:
  • Carlo Sala

    (Swiss Finance Institute)

  • Giovanni Barone-Adesi

    (University of Lugano and Swiss Finance Institute)

Abstract

This paper proposes a theoretical analysis on the impacts of using a suboptimal information set on the three main components used in asset pricing, namely the risk physical and neutral measures and the relative pricing kernel. The analysis is carried out by means of a portfolio optimization problem for a small and rational investor. Solving for the maximal expected utility of terminal wealth, we prove the existence of an information premium between what is required by the theory, a complete information set thus a fully conditional measure, and what is instead achievable by en econometrician. Searching for the best bounds, we then study the impact of the premium on the pricing kernel. Finally, exploiting the strong interconnection between the pricing kernel and its densities, the extension to the risk-neutral measure follows naturally.

Suggested Citation

  • Carlo Sala & Giovanni Barone-Adesi, 2015. "Conditioning the Information in Portfolio Optimization," Swiss Finance Institute Research Paper Series 15-50, Swiss Finance Institute, revised Apr 2016.
    • Handle: RePEc:chf:rpseri:rp1550
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    File URL: http://ssrn.com/abstract=2675090
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    Cited by:

    1. L. Theron & G. van Vuuren, 2020. "Exploring the Behaviour of Actively Managed, Maximally Diversified Portfolios," Studies in Economics and Econometrics, Taylor & Francis Journals, vol. 44(2), pages 49-72, August.

    More about this item

    Keywords

    Portfolio optimization problem; Levy-Ito mixed model; Pricing kernel; Information premium; Optimal bounds;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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