Active portfolio management with benchmarking: Adding a value-at-risk constraint

Gordon J. Alexander, Alexandre M. Baptista

Research output: Contribution to journalArticlepeer-review

50 Scopus citations


We examine the impact of adding a value-at-risk (VaR) constraint to the problem of an active manager who seeks to outperform a benchmark while minimizing tracking error variance (TEV) by using the model of Roll [1992. A mean/variance analysis of tracking error. Journal of Portfolio Management 18, 13-22]. We obtain three main results. First, portfolios on the constrained mean-TEV boundary still exhibit three-fund separation, but the weights of the three funds when the constraint binds differ from those in Roll's model. Second, the constraint mitigates the problem that when an active manager seeks to outperform a benchmark using the mean-TEV model, he or she selects an inefficient portfolio. Finally, when short sales are disallowed, the extent to which the constraint reduces the optimal portfolio's efficiency loss can still be notable but is smaller than when short sales are allowed.

Original languageEnglish (US)
Pages (from-to)779-820
Number of pages42
JournalJournal of Economic Dynamics and Control
Issue number3
StatePublished - Mar 2008

Bibliographical note

Copyright 2008 Elsevier B.V., All rights reserved.


  • Benchmarking
  • Portfolio choice
  • Risk management
  • Tracking error
  • VaR


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