TBD manuscript No.
(will be inserted by the editor)
Min-Regret Methods in Portfolio Transition
Minimizing the cost of regret protection option
Andrei Ordine
Received: date / Accepted: date
Abstract Investors often regret their trades. Regret
can significantly impact their strategic decisions, for
example, by making them abandon a pre-planned in-
vestment strategy during stressed market conditions.
Therefore, minimizing expected regret is a prudent way
to construct investment strategies. We propose to mea-
sure the cost of regret as a price of regret protection
option, and apply this new metric to portfolio transi-
tion strategies, where the objective is to increase (or de-
crease) risky exposures over a specified period of time.
Regret-averse investors should design their portfolio tran-
sition with low cost of regret.
Keywords min-regret methods · portfolio transition ·
option pricing
1 Introduction
The classical economics theory views the questions of
market timing as irrelevant and assumes that investors
follow a prescribed set of rational behaviour rules. In re-
ality, investors’ decision making is more complex, and
involves regret. Retail investors are known for mistim-
ing the markets, liquidating their equity positions dur-
ing market corrections and buying during rallies ([3]).
We hypothesize that regret is the driving factor behind
the retail investor decisions.
The problem equally affects institutional investors:
for example, an asset manager that decides to increase
the equity holdings in a portfolio and completes the
increase just before a major market correction will face
questions from the client or the board of trustees, and
may be punished for a theoretically correct decision.
Address(es) of author(s) should be given
Electronic copy available at: https://ssrn.com/abstract=3006742
Also, many active programs are terminated early due
to a period of regretful under-performance.
Intuitively, brokers and asset managers understand
this situation well, and use approaches such as dollar
cost averaging to perform client portfolio transitions.
Yet there is very few published articles on this topic.
The article [1] provides arguments why dollar-cost av-
eraging minimizes the maximum regret of an investor;
another article [2] claims that the dollar-cost averaging
is always sub-optimal for utility-maximizing investors.
In our view, the sub-optimality is valid within the as-
sumptions of utility maximization - but the true in-
vestor preferences are more complex than maximizing
expected mean return-variance utility.
In this article, we consider that an investor can buy
a ”regret protection” option to compensate for the re-
gret, subject to a strike or a deductible. The regret pro-
tection option pays the difference between the ”perfect-
foresight” portfolio profit-and-loss, which uses the best
retrospective trade point or points, and the actual strat-
egy profit-and-loss, less the strike. If the difference is
below the strike, the investor receives nothing from the
option. As can be seen, this is a ”look-back” option, as
its value depends on the market return path.
The price of this option can be used to measure the
expected regret, and we call it the cost of regret. We
suggest that minimizing the cost of regret in designing
the trading strategy is a prudent way to protect against
regret and its effects on investment policy execution.
The main practical application of our research is
portfolio transition, or changing the portfolio composi-
tion from the current point to the desired allocation.
These allocations can be expressed in holdings or in
weight terms. The straight-line rule is to linearly in-
crease or decrease each weight or holding from the cur-
rent value to the target value.
2 Andrei Ordine
One of the conclusions is that, in the short horizon,
investors should risk-up their portfolios just slightly
faster than with a straight-line rule. On a longer tran-
sition period, the investors should use a concave trajec-
tory, moving faster in the beginning. Intuitively, this is
because in the short horizon, profits and losses on an
investment can be viewed as symmetric: the chance of
losing 5% is the same as the chance of gaining 5%. In
the long run, the losses are still limited to the initial in-
vestment, but the gains are unlimited, so staying under-
invested for an extensive period of time has asymmetric
regret - the regret is higher in a up-market scenario than
in its mirror-image down-market scenario.
It should be noted that the price of the regret pro-
tection option can be measured using traditional exotic
option pricing tools, which of course are not perfect
in their assumptions of normal market return distribu-
tion, but can nevertheless provide insights in construct-
ing low-regret strategies. Importantly, under reasonably
loose assumptions, the option price does not depend on
the real-world asset return assumptions and can be es-
timated in the risk-neutral space.
The applications of our work go beyond portfolio
transition questions. The cost of regret framework can
be applied in any situation where the investment per-
formance is evaluated post-factum with hindsight - the
regret protection option can be defined in any such set-
ting, with the payoff equal to the performance difference
between the actual strategy and a ”crystal ball” strat-
egy that uses some knowledge of future market. Low
cost of regret protection indicates strategies that are ro-
bust to market timing, parameter estimation, or other
modeling decisions. The cost of regret protection can be
used as a metric on its own, but can also be combined
with other investor objectives when doing strategy op-
timization.
The article is organized as follows. In the first sec-
tion, we present a simple example that succinctly il-
lustrates the problem and the method. We then move
to an example of factor allocation transition. We close
with the conclusions and future research.
2 Simple example of equity trade
Suppose that a trader has an order from a client to
buy N = 100 shares of a company, and has T = 100
weeks to complete the purchase. The trader can buy all
shares at the beginning (t = 0), at the end (t = T ), in
the middle of the transition period (t = T /2), or in any
other way. We define a general strategy by the sequence
qt , t = 0 . . . T , where qt ≥ 0 is the fraction of the total
Electronic copy available at: https://ssrn.com/abstract=3006742
quantity purchased during week t at price St . We have
X
qt = 1.
t=0...T
Imagine that the trader has decided to buy all shares
right away, at the price S0 , to make things easier, and
in the next month, the price drops 20%. Immediately,
the client calls on the phone and screams in excitement:
”Did you see the shares just lost 20%? I hope you are
executing my buy order right now!”. Needless to say,
the client’s mood changes as soon as he learned that all
of the shares have been already bought and he just lost
20%.
Imagine, on the the hand, that the trader procras-
tinated and did nothing with the order, and the share
price increased 20%. The client calls on the phone and
happily tells the trader - I hope my order is now done!
Of course, in this situation, the client is upset as he
learns that he is still in cash.
In these examples, the client and the trader experi-
ence regret. In the first case, the regret is from commit-
ting all money at once, in the second case, the regret is
from inaction. But how do we measure the regret? At
the end of the 100-week trade period, we calculate the
dollar amount of regret as the difference between the av-
erage price that the trader’s strategy has achieved and
the best (i.e. lowest) price through the trade period:
!
X
N· qt St − min St
t=0...T
t=0...T
This is because the client regrets not buying the shares
at the lowest price.
We assume the client has tolerance for K dollars of
regret per one share. The trader can consider protecting
himself against regret via a lookback option that pays
the following amount at time T:
!
X
N · max qt St − min St − K, 0
t=0...T
t=0...T
The price of this option can be estimated as follows:
!
X
N · e−rT E max qt St − min St − K, 0
t=0...T
t=0...T
Here r is the ”risk-free” rate and the stock price is as-
sumed to be following the log-Brownian motion process
with the risk-neutral drift, described in section 3. We as-
sume the risk-free rate r = 0, initial stock price S0 = 1,
stock price volatility 14%.
First we consider 4 simple strategies: buy all shares
at start, equal purchase every week, 50% at start and
50% at end, and all at end. Table 1 shows the cost of
regret for each strategy.
Min-Regret Methods in Portfolio Transition 3

Table 1 Cost of regret for simple strategies, per share the loss is naturally limited by the amount of money in-
vested - while the gains are, on the long horizon, poten-
Strategy Cost of regret
tially unlimited. Therefore, being under-invested early
All at start 0.063 on creates additional regret.
Equal purchase weekly 0.044
Equal at start and end 0.049
Now we move to the multi-asset setting.
All at end 0.070

3 Example of portfolio transition

Stylized Transition Paths
1

0.9
Path number In our previous example, we defined the low-regret eq-
0.8
uity purchase strategy. However, in a typical asset man-
1 ager transition problems, the setting is multi-asset or
Quantity of equity purchased

0.7

25
multi-factor, and the portfolio exposures are expressed
0.6
30
in terms of weights or exposures, not in terms of equity
0.5 units or dollar holdings. In this section, we define the
0.4 cost of regret for the multi-asset portfolio transition.
60
0.3 Just like in the simple equity purchase example,
0.2
at the end of the transition, we are compared against
0.1
the retrospective ”strategy” that assumes some knowl-
edge of the future market return path. It is reason-
0
10 20 30 40 50 60
Time, weeks
70 80 90 100 able to assume that such strategy will monotonically
increase/decrease the weight of each asset, connecting
Fig. 1 Stylized transition paths: 1=fast, the top path, the starting exposures to the target exposures. We use
30=linear path, 60=slow, the bottom path the following notations. The market return is defined
as the sequence of vectors:
Cost of regret for stylized transition paths
0.052
R0 , . . . , R T
0.051

0.05 Each vector’s dimension is equal to the number of assets

in the portfolio.
0.049
The portfolio weights, defined by the transition strat-
Cost of regret

0.048
egy, are as follows:
0.047 25:
lowest−regret
transition path Start = w0 , . . . , wT = T arget
0.046

0.045 The portfolio return is then equal to:

0.044
−1
TY
0.043
10 20 30 40 50 60
R= (1 + wn Rn ) − 1
Transition path (1=fast, 60=slow, 30=linear) n=0

Fig. 2 Cost of regret for stylized transition paths The comparison point, the best portfolio return with
the perfect foresight, can be defined as the following
maximum:
As can be seen, the gradual buying of equal number
−1
TY
of shares each week has the lowest cost of regret among
the 4 strategies considered. RP F = max (1 + w̃n Rn ) − 1
w̃
n=0
We also consider a continuous family of transition
paths, as shown in figure 1. Each path starts with 0, The maximum is taken subject to the following condi-
and completes the transition at the end of the 100-week tions:
period. The cost of regret for each of the paths in the w̃0 = w0
family is shown in figure 2. The conclusion is that the
lowest-regret approach to trading is slightly faster than w̃T = wT
linear, within the stylized family of paths. and one of the following for each asset k:
The reason why the transition should be slightly
faster than linear is the asymmetry of the asset return: w̃0k ≤ w̃1k ≤ ... ≤ w̃Tk
4 Andrei Ordine
Table 2 Multi-asset portfolio transition
Asset Starting weight Ending weight
CAD Cash 0% -20%
CAD Equity 9% 9%
DM LargeMid Equity 50% 61%
EM LargeMid Equity 6% 10%
G7 Bonds 14% 29%
CAD Bonds 22% 11%
or
w̃0k ≥ w̃1k ≥ ... ≥ w̃Tk
Note that we require the weights to either increase or
decrease for each exposure (non-strictly). This is be-
cause, in practice, portfolio managers use monotonic
transition paths, so we express the regret against the
universe of monotonic transitions. We can consider other
types of perfect-foresight constraints, such as only buy-
ing / only selling, this depends on particular applica-
tions. Note that if we have a cash position among the
exposures, we do not enforce the monotonicity condi-
tion on it.
Again, the monotonicity conditions for the expo-
sures are somewhat subjective. They are similar to the
requirement that we only buy equities in the simplified
example in the previous section. The perfect-foresight
strategy cannot be completely unconstrained: nobody
can be expected to know the daily return for each as-
set, each day in advance. Had that been the case, the
perfect foresight return is unlimited.
The regret is then defined as the difference in returns
between the perfect-foresight transition and the actual
transition:
RP F − R
The regret protection option price can then be calcu-
lated as the following expectation, assuming the ”stan-
dard” risk-neutral portfolio dynamics as detailed in sec-
tion 5.
A · e−rT E max (RP F − R − K, 0) .
Here A is the amount of dollars invested at time 0, K
is the regret tolerance in the simple return terms, and
r is the risk-free rate. Again, we assume K = 0.1 and
r = 0.
As a demonstration, we calculate a low-regret port-
folio transition for the assets, starting and ending points
as shown in table 2. The transition is over a period of
200 days, on a weekly frequency. We use the stylized
family of transition paths, applied to the given start-
ing and ending weights. The resulting cost of regret for
each of the stylized paths is shown in chart 3. Sim-
ilarly, the low-regret transition is slightly faster than
Cost of Regret for Stylized Transition Paths:
x 10
−3 Multiasset Portfolio
2.6
2.4
2.2
2
Cost of regret
1.8
20:
1.6
lowest−regret
transition path
1.4
1.2
1
0.8
10 20 30 40 50
Transition Path (1=fast, 60=slow, 30=linear)
60
Fig. 3 Cost of regret for stylized transition paths, multi-asset
portfolio
linear. Of course, this analysis is in many ways similar
to the one-asset case as we transition all assets at the
same speed, scaled to their initial and target weights.
A more comprehensive analysis would involve finding
an unconstrained low-regret path - this would require
solving the mathematically difficult functional calcu-
lus problem of finding the lowest-regret transition in
the multi-asset setting without assuming any family of
transition paths.
4 Conclusions and the general framework
We have laid out a min-regret portfolio transition frame-
work for a multi-asset setting. The notions of assets
and factors here are completely interchangeable, so any
portfolio transition can be handled with ease. However,
in this paper, we made a number of simplifying assump-
tions. The Geometric Brownian Motion model of the
stock market is not perfect, so using a more realistic dis-
tributional model can give a more accurate low-regret
transition path.
Moreover, the market does not have constant volatil-
ity: as market practitioners know, the market goes through
periods of calm and periods of stress, and both peri-
ods are ”sticky” - volatility begets volatility and calm
begets calm. We have started working on a transition
in the setting where the markets switch regimes, and
the first indication is that the low-regret approach is to
move faster in high-volatility regimes. Another impor-
tant question deals with adjusting the transition strat-
egy after a sharp market move. Our future work will
investigate these questions in detail.
The min-regret framework applications are not lim-
ited to the portfolio transition questions. The min-regret
framework can be efficiently applied in any situation
Min-Regret Methods in Portfolio Transition 5

where the investment performance can be judged post-

factum, with some assumptions of the forecasting abil-
ity, be that market entry point forecast or the forecast
of expected returns and correlations. For example, the
min-regret methods are used in robust portfolio opti-
mization. Generally, min-regret methods are helpful in
situations where the forecasting ability of investors is
limited, as they provide investment solutions that are
robust to a wide range of market outcomes.

5 Appendix: Asset price model

This section briefly describes the Geometric Brownian

Motion asset price process. While we acknowledge that
the model ignores many properties of real markets, it
appears sufficient to illustrate our min-regret transition
approach.
For a single stock, the Geometric Brownian Motion
is a stochastic process that solves the following stochas-
tic differential equation:

dSt = µSt dt + σSt dWt

The solution to the equation is the following stochastic

process:
σ2
  
St = S0 exp µ− t + σWt
2
The first two moments of the stock price at time t are:

S0 eµT

and  2 
S02 e2µT eσ T − 1 .

The multi-asset Geometric Brownian Motion is defined

similarly - each asset i satisfies the stochastic equation

dSti = µi Sti dt + σi Sti dWti

and the underlying Wiener processes are correlated.

References

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Financial and Quantitative Analysis, Vol 14, Issue 2 (1979)
3. Andrew Clare, Nick Motson, Do UK retail investors buy
at the top and sell at the bottom?, Working Paper, Cen-
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September 2010