On portfolios generated by optimal transport (1709.03169v3)

Abstract: First introduced by Fernholz in stochastic portfolio theory, functionally generated portfolio allows its investment performance to be attributed to directly observable and easily interpretable market quantities. In previous works we showed that Fernholz's multiplicatively generated portfolio has deep connections with optimal transport and the information geometry of exponentially concave functions. Recently, Karatzas and Ruf introduced a new additive portfolio generation whose relation with optimal transport was studied by Vervuurt. We show that additively generated portfolio can be interpreted in terms of the well-known dually flat information geometry of Bregman divergence. Moreover, we characterize, in a sense to be made precise, all possible forms of functional portfolio constructions that contain additive and multiplicative generations as special cases. Each construction involves a divergence functional on the unit simplex measuring the market volatility captured, and admits a pathwise decomposition for the portfolio value. We illustrate with an empirical example.