Scenario generation for portfolio selection problems with tail risk measure

Fairbrother, Jamie and Turner, Amanda and Wallace, Stein (2015) Scenario generation for portfolio selection problems with tail risk measure.

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Tail risk measures such as the conditional value-at-risk are useful in the context of portfolio selection for quantifying potential losses in worst cases. However, for scenario-based problems these are problematic: because the value of a tail risk measure only depends on a small subset of the support of the distribution of asset returns, traditional scenario based methods, which spread scenarios evenly across the whole support of the distribution, yield very unstable solutions unless we use a very large number scenarios. In this paper we propose a problem-driven scenario generation methodology for portfolio selection problems using a tail risk measure where the the asset returns have elliptical or near-elliptical distribution. Our approach in effect prioritizes the construction of scenarios in the areas of the distribution which correspond to the tail losses of feasible portfolios. The methodology is shown to work particularly well when the distribution of assets returns are positively correlated and heavy-tailed, and the performance is shown to improve as we tighten the constraints on feasible assets.

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Journal Article
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q-fin.RM ; math.OC
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11 May 2016 13:32
Last Modified:
11 Jun 2019 02:49