Optimal asset allocation: Risk and information uncertainty

Abstract

In asset allocation problem, the distribution of the assets is usually assumed to be known in order to identify the optimal portfolio. In practice, we need to estimate their distribution. The estimations are not necessarily accurate and it is known as the uncertainty problem. Many researches show that most people are uncertainty aversion and this affects their investment strategy. In this article, we consider risk and information uncertainty under a common asset allocation framework. The effects of risk premium and covariance uncertainty are demonstrated by the worst scenario in a set of measures generated by a relative entropy constraint. The nature of the uncertainty and its impacts on the asset allocation are discussed.

Data‐Driven Robust Credit Portfolio Optimization for Investment Decisions in P2P Lending

“…In the studies of Hansen and Sargent [25] and Calafiore [26], relative entropy is used to model uncertainty and obtain the optimal investment decision. Yam et al [6] derive a robust mean-variance optimization model with relative entropy constrains on the uncertainty of the interaction between the returns of different assets and discuss its mathematical and financial properties in portfolio selection.…”

“…Yam et al [6] prove that the robust mean-variance portfolio selection model based on relative entropy method (RMV-RE) can be formulated as quadratic optimization problem, which is a tractable formulation and can be efficiently solved. That is,…”

“…Our work is somewhat related to the paper by Guo et al [5] and the paper by Yam et al [6]. Guo et al [5] introduce the instance-based framework into credit risk assessment of P2P loan and use the classical mean-variance model to obtain the optimal allocation.…”

“…Guo et al [5] introduce the instance-based framework into credit risk assessment of P2P loan and use the classical mean-variance model to obtain the optimal allocation. Yam et al [6] derive a robust mean-variance optimization model with relative entropy constrains on the uncertainty of the interaction between the returns of different assets and discuss its mathematical and financial properties in portfolio selection. Although some other scholars have contributed novel insights into credit risk assessment of P2P lending and robust optimization, to the best of our knowledge, few have taken both into consideration synthetically.…”

“…And as decreases, the investor's confidence is weaker. The details of the proof are referred to by Yam et al[6].…”