Forward-Looking Information in Portfolio Selection

Download or read book Forward-Looking Information in Portfolio Selection written by Christian Vial and published by . This book was released on 2013 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This thesis analyzes the informational content of option-implied information in a portfolio optimization context. Options are intended to price future contingencies and thus incorporate the market's expectations about future states. Using this implied information inherent in exchange-traded options allows us to extract forward-looking density functions and moments of the underlying securities. For this purpose, we apply different techniques to interpolate the distribution and moments inherent in Dow Jones Industrial Average (DJIA) and S&P 100 constituent options. We analyze the resulting information relative to different portfolio allocation strategies, and examine whether option-implied portfolios outperform their historical counterparts. For the period of analysis from January 1996 to January 2012 we find that options add forecasting power to a portfolio optimization problem. However, although option-implied portfolios outperform those based on historical information, differences are often insignificant. Only one strategy (BICM Adjusted) significantly outperforms the benchmark portfolios at all times. We can attribute this to its consideration of higher-order implied moments. The results for different optimization strategies and estimation periods are robust, and suggest that forward-looking information is inherent in exchange-traded options. In specific situations, this option-implied information proves to be a reasonable alternative to historical moment estimators.