Bayesian portfolio selection using VaR and CVaR

Taras Bodnar, Mathias Lindholm, Vilhelm Niklasson and Erik Thorsén

Applied Mathematics and Computation, 2022, vol. 427, issue C

Abstract: We study the optimal portfolio allocation problem from a Bayesian perspective using value at risk (VaR) and conditional value at risk (CVaR) as risk measures. By applying the posterior predictive distribution for the future portfolio return, we derive relevant quantities needed in the computations of VaR and CVaR, and express the optimal portfolio weights in terms of observed data only. This is in contrast to the conventional method where the optimal solution is based on unobserved quantities which are estimated. We also obtain the expressions for the weights of the global minimum VaR (GMVaR) and global minimum CVaR (GMCVaR) portfolios, and specify conditions for their existence. It is shown that these portfolios may not exist if the level used for the VaR or CVaR computation are too low. By using simulation and real market data, we compare the new Bayesian approach to the conventional plug-in method by studying the accuracy of the GMVaR portfolio and by analysing the estimated efficient frontiers. It is concluded that the Bayesian approach outperforms the conventional one, in particular at predicting the out-of-sample VaR.

Keywords: Bayesian inference; Posterior predictive distribution; Optimal portfolio; VaR; CVaR (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:apmaco:v:427:y:2022:i:c:s0096300322002041

DOI: 10.1016/j.amc.2022.127120

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