Conditioning the Information in Portfolio Optimization

32 Pages Posted: 16 Oct 2015 Last revised: 10 Nov 2016

See all articles by Carlo Sala

Carlo Sala

ESADE Business School

Giovanni Barone-Adesi

University of Lugano; Swiss Finance Institute

Date Written: April 14, 2016

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.

Keywords: Portfolio optimization problem, Levy-Ito mixed model, Pricing kernel, Information premium, Optimal bounds

JEL Classification: G10, G11, G12, G14, C61

Suggested Citation

Sala, Carlo and Barone-Adesi, Giovanni, Conditioning the Information in Portfolio Optimization (April 14, 2016). Swiss Finance Institute Research Paper No. 15-50, 29th Australasian Finance and Banking Conference 2016, Available at SSRN: https://ssrn.com/abstract=2675090 or http://dx.doi.org/10.2139/ssrn.2675090

Carlo Sala (Contact Author)

ESADE Business School ( email )

Avenida de Torreblanca 59
Barcelona, Barcelona 08172
Spain

HOME PAGE: http://www.people.usi.ch/salaca

Giovanni Barone-Adesi

University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Swiss Finance Institute

c/o University of Geneva
40 Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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