Journal of Risk

Mostly prior-free asset allocation

Sylvain Chassang

  • The author proposes a novel coherent framework for asset allocation when the past ceases to predict the future.
  • The key insight is to replace probability with game theory, and consider the performance of portfolios against an adversarial market.
  • The paper shows how to build asset allocation strategies that guarantee low drawdowns against both safe, and risky reference assets.
  • The resulting asset allocation strategies improve on classical risk-management strategies such as CPPI or volatility control.

This paper develops a prior-free version of Harry Markowitz’s efficient portfolio theory, which allows the decision maker to express their preferences with regard to risk and reward, even though they are unable to express a prior over potentially nonstationary returns. The corresponding optimal allocation strategies are admissible and interior, and they exhibit a form of momentum. Empirically, prior-free efficient allocation strategies successfully exploit the time-varying risk premiums present in historical returns.

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