747. Reducing Investment Risk through Diversification in Benchmark Investing
Invited abstract in session WB-9: Algotrading and Market strategies, stream OR in Finance and Insurance .
Wednesday, 10:30-12:00Room: Clarendon SR 2.01
Authors (first author is the speaker)
| 1. | Mario Maggi
|
| Department of Economics and Management, University of Pavia | |
| 2. | Pierpaolo Uberti
|
| University of Milano Bicocca |
Abstract
In finance, it is widely acknowledged that diversifying an investment portfolio can help mitigate risk. This paper presents a novel method for efficiently decomposing a set of financial returns to reduce the risk associated with benchmark portfolios by working on diversification. We introduce "pseudo-principal portfolios," a set of orthogonal portfolios derived from a modified version of principal component analysis (PCA). Our theoretical framework establishes a connection between traditional mean-variance optimization and pseudo-principal portfolios, while also highlighting several key properties that have significant implications for financial decision-making. Furthermore, we propose an approach to constructively blend any given benchmark portfolio with a limited number of pseudo-principal portfolios. Our results are validated through both in-sample and out-of-sample analyses using real-world financial data, illustrating the effectiveness of this novel risk reduction strategy.
Keywords
- Risk Analysis and Management
- Finance and Banking
Status: accepted
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