On a Model of Portfolio Selection with Benchmark

Niklas Wagner
2000 Social Science Research Network  
quadratic tracking approach. Referring to Roll, the procedure can be labelled as tracking error-variance (TEV) optimisation. Recently, Chow (1995) proposed a target function, which includes both an EV and a TEV component. Previous work on tracking approaches • Has neither given a theoretical justification nor a model to investors' tracking behaviour; • Has not made clear as to whether focus in the target function should lie on the TEV or on the TEV and EV criterion; and • An analytical solution
more » ... to a general tracking model has not yet been derived, except to a restricted one Abstract Evidently, the theoretical foundation of behavioural portfolio selection fundamentally differs from the concept of rational portfolio selection under uncertainty. Behavioural portfolio selection with respect to some given benchmark portfolio violates classical axioms of rationality. The paper proposes a unified behavioural model of portfolio selection, which incorporates rational portfolio selection as well as benchmarking and derives its analytical solution. In the model, the manager's utility function is based on regret theory and has two instead of one objective variable. The corresponding 'EVC criterion' helps to clarify controversial issues in portfolio selection and allows for testable implications.
doi:10.2139/ssrn.239482 fatcat:4yuidmi4tbagdosxvo4atyhpli