DYNAMIC MEAN-VARIANCE PORTFOLIOS WITH RISK BUDGET

Sheng-Feng Luo ()
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Sheng-Feng Luo: Department of Finance, Chung Yuan Christian University, 200 Chung Pei Road, Taoyuan 32023, Taiwan

International Journal of Theoretical and Applied Finance (IJTAF), 2020, vol. 23, issue 01, 1-16

Abstract: We study a dynamic mean-variance portfolio selection problem subject to possible limit of market risk. Three measures of market risk are considered: value-at-risk, expected shortfall, and median shortfall. They are all calculated in a dynamic consistent sense. After applying the technique of delta-normal approximation, we can explicitly solve for the optimal solution and calculate the economic loss brought by the risk budget constraint. With the analytical results obtained, influential factors of economic loss are then explored by which some guidelines on trading practice are proposed. The guidelines are independent of risk measures, and are valuable to both institutions and regulators, for they suggest that an institutional investor would spontaneously obey good investment discipline to avoid potential impact of risk constraint. This result meets the purpose of external regulation from the perspective of market discipline.

Keywords: Portfolio selection; value-at-risk; expected shortfall; median shortfall; Hamilton–Jacobi–Bellman equation; certainty equivalence (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1142/S0219024920500077

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