Optimizing tracking error-constrained portfolios
Date
2018Author
Maxwell, Michael
Daly, Michael
Thomson, Daniel
Van Vuuren, Gary
Metadata
Show full item recordAbstract
Active portfolios subject to tracking error (TE) constraints are the typical setup for active
managers tasked with outperforming a benchmark. The risk and return relationship of such
constrained portfolios is described by an ellipse in traditional mean-variance space and the
ellipse
’
s flat shape suggests an additional constraint which improves the performance of the
active portfolio. Although subsequent work isolated and explored different portfolios subject to
these constraints, absolute portfolio risk has been consistently ignored. A different restriction
–
maximization of the traditional Sharpe ratio on the constant TE frontier in absolute risk/return
space
–
is added here to the existing constraint set, and a method to generate this portfolio is
explained. The resultant portfolio has a lower volatility and higher return than the benchmark, it
satisfies the TE constraint
and
the ratio of excess absolute return to risk is maximized (i.e.
maximum Sharpe ratio in absolute space)
URI
http://hdl.handle.net/10394/30708https://doi.org/10.1080/00036846.2018.1488069
https://www.tandfonline.com/doi/full/10.1080/00036846.2018.1488069