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Risk management for mathematical optimization under uncertainty

Larraitz Aranburu Laka, Laureano F. Escudero Bueno, María Araceli Garín Martín, María Merino Maestre and Gloria Pérez Sainz de Rozas

No Biltoki;2016-01, BILTOKI from Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística)

Abstract: We present a general multistage stochastic mixed 0-1 problem where the uncertainty appears everywhere in the objective function, constraints matrix and right-hand-side. The uncertainty is represented by a scenario tree that can be a symmetric or a nonsymmetric one. The stochastic model is converted in a mixed 0-1 Deterministic Equivalent Model in compact representation. Due to the difficulty of the problem, the solution offered by the stochastic model has been traditionally obtained by optimizing the objective function expected value (i.e., mean) over the scenarios, usually, along a time horizon. This approach (so named risk neutral) has the inconvenience of providing a solution that ignores the variance of the objective value of the scenarios and, so, the occurrence of scenarios with an objective value below the expected one. Alternatively, we present several approaches for risk averse management, namely, a scenario immunization strategy, the optimization of the well known Value-at-Risk (VaR) and several variants of the Conditional Value-at-Risk strategies, the optimization of the expected mean minus the weighted probability of having a "bad" scenario to occur for the given solution provided by the model, the optimization of the objective function expected value subject to stochastic dominance constraints (SDC) for a set of profiles given by the pairs of threshold objective values and either bounds on the probability of not reaching the thresholds or the expected shortfall over them, and the optimization of a mixture of the VaR and SDC strategies.

Keywords: multistage stochastic mixed 0-1 optimization; scenario analysis; mixed 0-1 Deterministic Equivalent Model; risk aversion measures; scenario immunization; VaR; CVAR; mean-risk; stochastic dominance constraints (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-rmg and nep-upt
Date: 2016
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Dpto. de Econometría y Estadística, Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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