Portfolio Optimization within a Wasserstein Ball

DOI10.1137/22M1496803MaRDI QIDQ6091091zbMATH OpenOpenAlexFDO

Authors Silvana M. Pesenti, Sebastian Jaimungal

Publication date 23 November 2023

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2012.04500

zbMATH Keywords

copulaportfolio allocationrisk measuresWasserstein distance

Mathematics Subject Classification ID

Characterization and structure theory for multivariate probability distributions; copulas (62H05) Portfolio theory (91G10) Statistical methods; risk measures (91G70)

Abstract: We study the problem of active portfolio management where an investor aims to outperform a benchmark strategy's risk profile while not deviating too far from it. Specifically, an investor considers alternative strategies whose terminal wealth lie within a Wasserstein ball surrounding a benchmark's -- being distributionally close -- and that have a specified dependence/copula -- tying state-by-state outcomes -- to it. The investor then chooses the alternative strategy that minimises a distortion risk measure of terminal wealth. In a general (complete) market model, we prove that an optimal dynamic strategy exists and provide its characterisation through the notion of isotonic projections. We further propose a simulation approach to calculate the optimal strategy's terminal wealth, making our approach applicable to a wide range of market models. Finally, we illustrate how investors with different copula and risk preferences invest and improve upon the benchmark using the Tail Value-at-Risk, inverse S-shaped, and lower- and upper-tail distortion risk measures as examples. We find that investors' optimal terminal wealth distribution has larger probability masses in regions that reduce their risk measure relative to the benchmark while preserving the benchmark's structure.

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Cited in

(7)

• Distributionally robust optimization with Wasserstein metric for multi-period portfolio selection under uncertainty
• Robust insurance design with distortion risk measures
• Robust reinforcement learning with dynamic distortion risk measures
• Portfolio optimization with background risk and diversification based on uncertain random programming
• Pareto-optimal insurance under robust distortion risk measures
• Optimal transport divergences induced by scoring functions
• Distributionally robust insurance under the Wasserstein distance

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