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Portfolio optimization when risk factors are conditionally varying and heavy tailed

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Author Info

  • Toker Doganoglu
  • Christoph Hartz
  • Stefan Mittnik

    ()

Abstract

Assumptions about the dynamic and distributional behavior of risk factors are crucial for the construction of optimal portfolios and for risk assessment. Although asset returns are generally characterized by conditionally varying volatilities and fat tails, the normal distribution with constant variance continues to be the standard framework in portfolio management. Here we propose a practical approach to portfolio selection. It takes both the conditionally varying volatility and the fat-tailedness of risk factors explicitly into account, while retaining analytical tractability and ease of implementation. An application to a portfolio of nine German DAX stocks illustrates that the model is strongly favored by the data and that it is practically implementable. Copyright Springer Science+Business Media, LLC 2007

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File URL: http://hdl.handle.net/10.1007/s10614-006-9071-1
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Bibliographic Info

Article provided by Society for Computational Economics in its journal Computational Economics.

Volume (Year): 29 (2007)
Issue (Month): 3 (May)
Pages: 333-354

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Handle: RePEc:kap:compec:v:29:y:2007:i:3:p:333-354

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Web page: http://www.springerlink.com/link.asp?id=100248
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Keywords: Multivariate stable distribution; Index model; Portfolio optimization; Value-at-risk; Model adequacy;

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References

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  1. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
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Cited by:
  1. Thiemo Krink & Sandra Paterlini, 2008. "Differential Evolution for Multiobjective Portfolio Optimization," Center for Economic Research (RECent) 021, University of Modena and Reggio E., Dept. of Economics.
  2. Matteo Bonato, 2012. "Modeling fat tails in stock returns: a multivariate stable-GARCH approach," Computational Statistics, Springer, vol. 27(3), pages 499-521, September.
  3. Simon A. BRODA & Markus HAAS & Jochen KRAUSE & Marc S. PAOLELLA & Sven C. STEUDE, . "Stable Mixture GARCH Models," Swiss Finance Institute Research Paper Series 11-39, Swiss Finance Institute.

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