Related papers: Leverage and Uncertainty
We build a simple model of leveraged asset purchases with margin calls. Investment funds use what is perhaps the most basic financial strategy, called "value investing", i.e. systematically attempting to buy underpriced assets. When funds…
In modern portfolio theory, the balancing of expected returns on investments against uncertainties in those returns is aided by the use of utility functions. The Kelly criterion offers another approach, rooted in information theory, that…
When trading incurs proportional costs, leverage can scale an asset's return only up to a maximum multiple, which is sensitive to its volatility and liquidity. In a model with one safe and one risky asset, with constant investment…
While the Kelly portfolio has many desirable properties, including optimal long-term growth rate, the resulting investment strategy is rather aggressive. In this paper, we suggest a unified approach to the risk assessment of the Kelly…
The Kelly criterion provides a general framework for optimizing the growth rate of an investment portfolio over time by maximizing the expected logarithmic utility of wealth. However, the optimality condition of the Kelly criterion is…
Excessive leverage, i.e. the abuse of debt financing, is considered one of the primary factors in the default of financial institutions. Systemic risk results from correlations between individual default probabilities that cannot be…
The leverage effect-- the correlation between an asset's return and its volatility-- has played a key role in forecasting and understanding volatility and risk. While it is a long standing consensus that leverage effects exist and improve…
The focal point of this paper is the so-called Kelly Criterion, a prescription for optimal resource allocation among a set of gambles which are repeated over time. The criterion calls for maximization of the expected value of the…
The article presents a translation of some widespread financial terminology into the language of decision theory. For instance, financial leverage can be regarded as an object of choice or a decision. We show how the optics of decision…
In the world of modern financial theory, portfolio construction has traditionally operated under at least one of two central assumptions: the constraints are derived from a utility function and/or the multivariate probability distribution…
We examine the problem of optimal portfolio allocation within the framework of utility theory. We apply exponential utility to derive the optimal diversification strategy and logarithmic utility to determine the optimal leverage. We enhance…
Fat tails in financial time series and increase of stocks cross-correlations in high volatility periods are puzzling facts that ask for new paradigms. Both points are of key importance in fundamental research as well as in Risk Management…
Betting markets are gaining in popularity. Mean beliefs generally differ from prices in prediction markets. Logarithmic utility is employed to study the risk and return adjustments to prices. Some consequences are described. A modified…
The original Kelly criterion provides a strategy to maximize the long-term growth of winnings in a sequence of simple Bernoulli bets with an edge, that is, when the expected return on each bet is positive. The objective of this work is to…
Uncertainty is a pervasive challenge in decision and risk management and it is usually studied by quantification and modeling. Interestingly, engineers and other decision makers usually manage uncertainty with strategies such as…
Prompted by a recent experiment by Victor Haghani and Richard Dewey, this note generalises the Kelly strategy (optimal for simple investment games with log utility) to a large class of practical utility functions and including the effect of…
Reliability (survival analysis, to biostatisticians) is a key ingredient for mak- ing decisions that mitigate the risk of failure. The other key ingredient is utility. A decision theoretic framework harnesses the two, but to invoke this…
The leverage effect refers to the well-established relationship between returns and volatility. When returns fall, volatility increases. We examine the role of the leverage effect with regards to generating density forecasts of equity…
We combine forward investment performance processes and ambiguity averse portfolio selection. We introduce the notion of robust forward criteria which addresses the issues of ambiguity in model specification and in preferences and…
We propose a random walk model of asset returns where the parameters depend on market stress. Stress is measured by, e.g., the value of an implied volatility index. We show that model parameters including standard deviations and…