Portfolio selection with exploration of new investment assets
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Portfolio selection with exploration of new investment assets. / De Gennaro Aquino, Luca; Sornette, Didier; Strub, Moris S.
In: European Journal of Operational Research, Vol. 310, No. 2, 2023, p. 773-792.Research output: Contribution to journal › Journal article › Research › peer-review
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TY - JOUR
T1 - Portfolio selection with exploration of new investment assets
AU - De Gennaro Aquino, Luca
AU - Sornette, Didier
AU - Strub, Moris S.
N1 - Publisher Copyright: © 2023 Elsevier B.V.
PY - 2023
Y1 - 2023
N2 - We introduce a model for portfolio selection with an extendable investment universe where an agent with mean-variance preferences faces a trade-off between exploiting existing and exploring for new investment opportunities. When the agent chooses to explore, a new risky asset is discovered and the agent subsequently invests in the extended universe. We first provide conditions for wellposedness and characterize the optimal amount devoted to exploration. Our model shows that incremental exploration does not pay off, that it is increasingly worthwhile to explore in worse market environments, and that investment performance measured by the Sharpe ratio is increasing in the initial wealth of the agent indicating that richer agents can make better use of new investment opportunities. We further generalize our model and verify the robustness of the main findings with regard to various modeling assumptions.
AB - We introduce a model for portfolio selection with an extendable investment universe where an agent with mean-variance preferences faces a trade-off between exploiting existing and exploring for new investment opportunities. When the agent chooses to explore, a new risky asset is discovered and the agent subsequently invests in the extended universe. We first provide conditions for wellposedness and characterize the optimal amount devoted to exploration. Our model shows that incremental exploration does not pay off, that it is increasingly worthwhile to explore in worse market environments, and that investment performance measured by the Sharpe ratio is increasing in the initial wealth of the agent indicating that richer agents can make better use of new investment opportunities. We further generalize our model and verify the robustness of the main findings with regard to various modeling assumptions.
KW - Exploration vs. exploitation
KW - Investment analysis
KW - Mean-variance preferences
KW - Portfolio optimization
UR - http://www.scopus.com/inward/record.url?scp=85152684211&partnerID=8YFLogxK
U2 - 10.1016/j.ejor.2023.03.017
DO - 10.1016/j.ejor.2023.03.017
M3 - Journal article
AN - SCOPUS:85152684211
VL - 310
SP - 773
EP - 792
JO - European Journal of Operational Research
JF - European Journal of Operational Research
SN - 0377-2217
IS - 2
ER -
ID: 359600363