Factor-based robust index tracking

Factor-based robust index tracking

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Article ID: iaor20171930
Volume: 18
Issue: 2
Start Page Number: 443
End Page Number: 466
Publication Date: Jun 2017
Journal: Optimization and Engineering
Authors: ,
Keywords: optimization, decision, investment, simulation
Abstract:

We consider a robust optimization approach for the problem of tracking a benchmark portfolio. A strict subset of assets are selected from the benchmark such that the expected return is maximized subject to both risk and tracking error limits. A robust version of the Fama‐French 3 factor model is developed whereby uncertatiny sets for the expected return and factor loading matrix are generated. The resulting model is a mixed integer second‐order conic problem. Computational results in tracking the S&P 100 out of sample show that the robust model can generate tracking portfolios that have better tracking error and Sharpe ratio than those generated by the nominal model.

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