Downside risk optimization with random targets and portfolio amplitude

Zinoviy Landsman, Udi Makov, Jing Yao and Ming Zhou

The European Journal of Finance, 2022, vol. 28, issue 16, 1642-1663

Abstract: In this paper, we discuss downside risk optimization in the context of portfolio selection. We derive explicit solutions to the optimal portfolios that minimize the downside risk with respect to constant targets and random targets. In doing so, we propose using portfolio amplitude, a new measure in the literature, to characterize the portfolio selection under the downside risk optimization. Particularly, we demonstrate a mechanism by which the random target inputs its impact into the system and alters the optimal solution. Our results underpin why investors prefer holding some specific assets in following random targets and provide explanations for some special investment strategies, such as constructing a stock portfolio following a bond index. We present numerical examples of stock portfolio management to support our theoretical results.

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:taf:eurjfi:v:28:y:2022:i:16:p:1642-1663

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DOI: 10.1080/1351847X.2021.1991421

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