Risk‐sensitive Markov decision processes with long‐run CVaR criterion

Li Xia, Luyao Zhang and Peter W. Glynn

Production and Operations Management, 2023, vol. 32, issue 12, 4049-4067

Abstract: CVaR (Conditional value at risk) is a risk metric widely used in finance. However, dynamically optimizing CVaR is difficult, because it is not a standard Markov decision process (MDP) and the principle of dynamic programming fails. In this paper, we study the infinite‐horizon discrete‐time MDP with a long‐run CVaR criterion, from the view of sensitivity‐based optimization. By introducing a pseudo‐CVaR metric, we reformulate the problem as a bilevel MDP model and derive a CVaR difference formula that quantifies the difference of long‐run CVaR under any two policies. The optimality of deterministic policies is derived. We obtain a so‐called Bellman local optimality equation for CVaR, which is a necessary and sufficient condition for locally optimal policies and only necessary for globally optimal policies. A CVaR derivative formula is also derived for providing more sensitivity information. Then we develop a policy iteration type algorithm to efficiently optimize CVaR, which is shown to converge to a local optimum in mixed policy space. Furthermore, based on the sensitivity analysis of our bilevel MDP formulation and critical points, we develop a globally optimal algorithm. The piecewise linearity and segment convexity of the optimal pseudo‐CVaR function are also established. Our main results and algorithms are further extended to optimize the mean and CVaR simultaneously. Finally, we conduct numerical experiments relating to portfolio management to demonstrate the main results. Our work sheds light on dynamically optimizing CVaR from a sensitivity viewpoint.

Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://doi.org/10.1111/poms.14077

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:popmgt:v:32:y:2023:i:12:p:4049-4067

Ordering information: This journal article can be ordered from
http://onlinelibrary ... 1111/(ISSN)1937-5956

Access Statistics for this article

Production and Operations Management is currently edited by Kalyan Singhal

More articles in Production and Operations Management from Production and Operations Management Society
Bibliographic data for series maintained by Wiley Content Delivery ().