Trading multiple mean reversion

TL;DR

This paper develops a semi-explicit optimal control solution for managing portfolios of multiple mean-reverting assets, analyzing how to optimally include assets with varying mean reversion properties.

Contribution

It introduces a novel semi-explicit solution to the portfolio optimization problem involving multiple mean-reverting assets, accounting for parameter mis-specification.

Findings

Optimal portfolio strategies depend on asset mean reversion properties.

Including assets with zero mean reversion can be beneficial under certain conditions.

Parameter mis-specification impacts the optimal control and portfolio performance.

Abstract

How should one construct a portfolio from multiple mean-reverting assets? Should one add an asset to portfolio even if the asset has zero mean reversion? We consider a position management problem for an agent trading multiple mean-reverting assets. We solve an optimal control problem for an agent with power utility, and present a semi-explicit solution. The nearly explicit nature of the solution allows us to study the effects of parameter mis-specification, and derive a number of properties of the optimal solution.