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The Nematrian pages on return forecasting
explore some of the ways in which we can assess the possible future return
characteristics of different investment ideas. However, it is not enough merely
to be able to identify promising ideas. One must also construct suitable
portfolios that encapsulate these ideas in a suitably risk controlled framework,
perhaps using tools such as set out in the Nematrian pages on risk measurement.
This activity, if carried out in a quantitative manner, is
typically referred to as portfolio optimisation. There is a rich body of
mathematics that focuses on optimisation. In pages linked to this one we explore
some of this material and how it can be applied to asset management and
asset-liability management. We also explore other ways of approaching the
portfolio construction problem (e.g. reverse optimisation that potentially
circumvent some of the challenges that otherwise arise with purely quantitative
The main portfolio optimisation techniques currently
summarised on the Nematrian website are:
(c) Ideas on how
these may be refined to make them better suited at handling extreme events,
including use of Independent
Components Analysis, see also Malcolm Kemp’s book on Extreme Events: Robust
Portfolio Construction in the Presence of Fat Tails.
The Nematrian website also provides tools for carrying out reverse
optimisation, i.e. derivation of implied alphas.