PT - JOURNAL ARTICLE AU - Lydia J. Chan AU - Sunder R. Ramkumar TI - Tracking Error Rebalancing AID - 10.3905/jpm.2011.37.4.054 DP - 2011 Jul 31 TA - The Journal of Portfolio Management PG - 54--66 VI - 37 IP - 4 4099 - https://pm-research.com/content/37/4/54.short 4100 - https://pm-research.com/content/37/4/54.full AB - The goal of strategic rebalancing is to limit unintended drift or tracking error from the strategic policy benchmark without incurring large transaction costs. Traditional rebalancing, however, specifies fixed bands around each asset class and can result in significant tracking error and high transaction costs in stressed markets, as volatility and illiquidity increase. Tracking error rebalancing is an alternative approach in which investors directly monitor tracking error (rather than asset class misweights) and ensure that tracking error stays below a specified threshold using trades that minimize transaction costs. Rather than trading all assets that breach the fixed bands, investors use current estimates of volatilities and costs to determine the trades that result in the most risk reduction per unit cost. In stressed markets, this strategy can help avoid trades in illiquid assets and exploit asset class relationships to reduce risk at significantly lower costs.TOPICS: Equity portfolio management, volatility measures, exchanges/markets/clearinghouses