Multi-period portfolio optimization with alpha decay
This research paper appeared in The International Journal of Financial Engineering and Risk Management Special Issue on Applications of Optimization in Finance.
The traditional Markowitz MVO approach is based on a single-period model. Single period models do not utilize any data or decisions beyond the rebalancing time horizon with the result that their policies are "myopic" in nature. For long-term investors, multi-period optimization offers the opportunity to make "wait-and-see" policy decisions by including approximate forecasts and long-term policy decisions beyond the rebalancing time horizon. We consider portfolio optimization with a composite alpha signal that is composed of a short-term and a long-term alpha signal. The short-term alpha better predicts returns at the end of the rebalancing period but it decays quickly, i.e., it has less memory of its previous values. On the other hand, the long-term alpha has less predictive power than the short-term alpha but it decays slowly. We develop a simple
Authors: Kartik Sivaramakrishnan Dieter Vandenbussche
Head of Equity Research