Optimal portfolio selection with VaR and portfolio insurance constraints under rank-dependent expected utility theory

Hui Mi and Zuo Quan Xu

Insurance: Mathematics and Economics, 2023, vol. 110, issue C, 82-105

Abstract: This paper investigates two optimal portfolio selection problems for a rank-dependent utility investor who needs to manage his risk exposure: one with a single Value-at-Risk (VaR) constraint and the other with joint VaR and portfolio insurance constraints. The two models generalize existing models under expected utility theory and behavioral theory. The martingale method, quantile formulation, and relaxation method are used to obtain explicit optimal solutions. We have specifically identified an equivalent condition under which the VaR constraint is effective. A numerical analysis is carried out to demonstrate theoretical results, and additional financial insights are presented. We find that, in bad market states, the risk of the optimal investment outcome is reduced when compared to existing models without or with one constraint.

Keywords: Portfolio optimization; Rank-dependent expected utility; Quantile formulation; Relaxation method; VaR constraint (search for similar items in EconPapers)
JEL-codes: C61 G11 G41 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:110:y:2023:i:c:p:82-105

DOI: 10.1016/j.insmatheco.2023.02.004

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