Robust Optimization of Rank-Dependent Models with Uncertain Probabilities

Guanyu Jin, Roger Laeven and Dick den Hertog

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Abstract: This paper studies distributionally robust optimization for a large class of risk measures with ambiguity sets defined by $\phi$-divergences. The risk measures are allowed to be non-linear in probabilities, are represented by a Choquet integral possibly induced by a probability weighting function, and include many well-known examples (for example, CVaR, Mean-Median Deviation, Gini-type). Optimization for this class of robust risk measures is challenging due to their rank-dependent nature. We show that for many types of probability weighting functions including concave, convex and inverse $S$-shaped, the robust optimization problem can be reformulated into a rank-independent problem. In the case of a concave probability weighting function, the problem can be further reformulated into a convex optimization problem with finitely many constraints that admits explicit conic representability for a collection of canonical examples. While the number of constraints in general scales exponentially with the dimension of the state space, we circumvent this dimensionality curse and provide two types of upper and lower bounds algorithms. They yield tight upper and lower bounds on the exact optimal value and are formally shown to converge asymptotically. This is illustrated numerically in two examples given by a robust newsvendor problem and a robust portfolio choice problem.

Date: 2025-02, Revised 2025-02
New Economics Papers: this item is included in nep-mic
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