Robust Portfolio Optimization: A Stochastic Evaluation of Worst-Case Scenarios

Paulo Rotella Junior, Luiz Celio Souza Rocha, Rogerio Santana Peruchi, Giancarlo Aquila, Karel Janda and Edson de Oliveira Pamplona
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Luiz Celio Souza Rocha: Department of Management, Federal Institute of Education, Science and Technology - North of Minas Gerais, Brazil
Rogerio Santana Peruchi: Department of Production Engineering, Federal University of Paraiba, Brazil
Giancarlo Aquila: IEPG, Federal University of Itajuba, Brazil
Edson de Oliveira Pamplona: Institute of Production and Management Engineering, Federal University of Itajuba, Brazil

No 2022/03, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: This article presents a new approach for building robust portfolios based on stochastic efficiency analysis and periods of market downturn. The empirical analysis is done on assets traded on the Brazil Stock Exchange, B3 (Brasil, Bolsa, Balcao). We start with information on the assets from periods of market downturn (worst-case) and we group them using hierarchical clustering. Then we do stochastic efficiency analysis on these data using the Chance Constrained Data Envelopment Analysis (CCDEA) model. Finally, we use a classical model of capital allocation to obtain the optimal share of each asset. Our model is able to accommodate investors who exhibit different risk behaviors (from conservatives to risky investors) by varying the level of probability in fulfilling the constraints (1-αi) of the CCDEA model. We show that the optimal portfolios constructed with the use of information from periods of market downturns perform better for the Sharpe ratio (SR) in the validation period. The combined use of these approaches, using also fundamentalist variables and information on market downturns, allows us to build robust portfolios, with higher cumulative returns in the validation period, and portfolios with lower beta values.

Keywords: Robust optimization; Stochastic evaluation; Chance Constrained DEA; Worst-case markets; Portfolios (search for similar items in EconPapers)
JEL-codes: C38 C61 G11 G14 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2022-03, Revised 2022-03
New Economics Papers: this item is included in nep-cmp, nep-eff, nep-ore and nep-rmg
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https://ies.fsv.cuni.cz/en/veda-vyzkum/working-papers/6584 (application/pdf)

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Journal Article: Robust portfolio optimization: a stochastic evaluation of worst-case scenarios (2023)
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