The effect of threshold selection in intervention rebalancing TEV strategies upon return and risk

TEV investment strategies aim to construct financial portfolios that replicate as best as possible the underlying benchmark (such as a financial index) in terms of tracking error volatility (TEV). However, as he market situation is prone to changes and may change considerably over the investment horizon, it may happen that the replication portfolio diverges from the benchmark in its performance and its composition must be reconsidered. One of the approaches is to rebalance only when the deviation of the replication portfolio from the benchmark with respect to cumulative returns is high and exceeds a pre-specified threshold. In the framework of intervention rebalancing strategies, the paper studies the effect of selecting the value of this crucial parameter upon the return and risk of the replication portfolio.