Volume 3 • Issue 2 | September 2019
Maximum Entropy Approach to Portfolio Optimization: Economic Justification of an Intuitive Diversity Idea
Laxman Bokati, Vladik Kreinovich
Abstract:
The traditional Markowitz approach to portfolio optimization assumes that we know the means, variances, and covariances of the return rates of all the financial instruments. In some practical situations, however, we do not have enough information to determine the variances and covariances, we only know the means. To provide a reasonable portfolio allocation for such cases, researchers proposed a heuristic maximum entropy approach. In this paper, we provide an economic justification for this heuristic idea.
JEL classification: C58, G11, C440