TRACKING ERRORS, REGRET, AND TACTICAL ASSET ALLOCATION

The authors argue that optimization with respect to tracking errors is rooted in a framework where investors are averse to the pain of regre t. Regret comes when decisions to deviate from the benchmark turn out badly. Tactical asset allocation involves deviations from a benchmark portfolio and therefore may lead to regret. The authors show how tacti cal asset allocators can optimize allocations given the conflicting de sires to maximize positive tracking errors and minimize regret.