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.
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.
We develop a simple two stage multi-period model that incorporates this alpha model to construct the optimal portfolio at the end of the rebalancing period.
We compare this model with the traditional single-period MVO model on a simulated example from Israelov & Katz and also a large strategy with realistic constraints and show that the multi-period model tends to generate portfolios that are likely to have a better realized performance.