Unconstrained Strategies and the Variance-Kurtosis Trade-Off

27 Pages Posted: 7 Jun 2014 Last revised: 3 Sep 2014

See all articles by Andrew Kumiega

Andrew Kumiega

Illinois Institute of Technology - Stuart School of Business

Ben Van Vliet

Illinois Institute of Technology - Stuart School of Business

Apostolos Xanthopoulos

Date Written: March 25, 2014

Abstract

In this paper, we study unconstrained strategies through a re-specification of classic meanvariance utility and, as a reference implementation, a long-only strategy based on Canadian and U.S. bond markets. First, we capture the underlying economic forces that drive benchmark indices in the two economies as orthogonal components of yields. We find that bond indices in the two markets are sensitive to components that account for lesser total yield variability. Next, we develop a new polynomial utility function that captures the kurtosis effects found in the sensitivities to lower-eigenvector components. In our unconstrained strategy, excess kurtosis triggers portfolio adjustments and the resulting returns outperform those of traditional meanvariance optimization. The re-specified utility function introduces iso-risk contour lines that account for abrupt adjustments of portfolios to eigenvectors of hidden influence.

Keywords: Unconstrained strategies, portfolio optimization, polynomial utility maximization, principal component analysis

JEL Classification: G11, G15, C22

Suggested Citation

Kumiega, Andrew and Van Vliet, Ben and Xanthopoulos, Apostolos, Unconstrained Strategies and the Variance-Kurtosis Trade-Off (March 25, 2014). Applied Financial Economics, Vol. 24, No. 15, 2014, Available at SSRN: https://ssrn.com/abstract=2445648 or http://dx.doi.org/10.2139/ssrn.2445648

Andrew Kumiega

Illinois Institute of Technology - Stuart School of Business ( email )

Stuart Graduate School of Business
565 W. Adams St.
Chicago, IL 60661
United States

Ben Van Vliet (Contact Author)

Illinois Institute of Technology - Stuart School of Business ( email )

Stuart Graduate School of Business
565 W. Adams St.
Chicago, IL 60661
United States

No contact information is available for Apostolos Xanthopoulos

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