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The economic value of controlling for large losses in portfolio selection

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  • Dias, Alexandra

Abstract

Research on asset pricing has shown that investor preferences include asymmetry and tail heaviness which affects the composition of optimal portfolios. This article investigates the out-of-sample economic value of introducing the risk of very large losses in portfolio selection. We combine mean–variance analysis with conditional Value-at-Risk using the subadditivity property of conditional Value-at-Risk, and we introduce a two stage method that preserves diversification while controlling for large losses. We find that strategies that account both for variance and the probability of large losses outperform efficient mean–variance portfolios, during and after the global financial crisis.

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  • Dias, Alexandra, 2016. "The economic value of controlling for large losses in portfolio selection," Journal of Banking & Finance, Elsevier, vol. 72(S), pages 81-91.
    • Handle: RePEc:eee:jbfina:v:72:y:2016:i:s:p:s81-s91
    DOI: 10.1016/j.jbankfin.2016.04.016
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    More about this item

    Keywords

    Portfolio selection; Portfolio tail probability; Conditional Value-at-Risk; Risk management;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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