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Multivariate dependence and portfolio optimization algorithms under illiquid market scenarios

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  • Al Janabi, Mazin A.M.
  • Arreola Hernandez, Jose
  • Berger, Theo
  • Nguyen, Duc Khuong

Abstract

We propose a model for optimizing structured portfolios with liquidity-adjusted Value-at-Risk (LVaR) constraints, whereby linear correlations between assets are replaced by the multivariate nonlinear dependence structure based on Dynamic conditional correlation t-copula modeling. Our portfolio optimization algorithm minimizes the LVaR function under adverse market circumstances and multiple operational and financial constraints. When considering a diversified portfolio of international stock and commodity market indices under multiple realistic portfolio optimization scenarios, the obtained results consistently show the superiority of our approach, relative to other competing portfolio strategies including the minimum-variance, risk-parity and equally weighted portfolio allocations.

Suggested Citation

  • Al Janabi, Mazin A.M. & Arreola Hernandez, Jose & Berger, Theo & Nguyen, Duc Khuong, 2017. "Multivariate dependence and portfolio optimization algorithms under illiquid market scenarios," European Journal of Operational Research, Elsevier, vol. 259(3), pages 1121-1131.
  • Handle: RePEc:eee:ejores:v:259:y:2017:i:3:p:1121-1131
    DOI: 10.1016/j.ejor.2016.11.019
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    1. repec:eee:intfin:v:56:y:2018:i:c:p:104-127 is not listed on IDEAS
    2. repec:eee:finana:v:58:y:2018:i:c:p:153-165 is not listed on IDEAS
    3. Shahzad, Syed Jawad Hussain & Arreola-Hernandez, Jose & Bekiros, Stelios & Shahbaz, Muhammad & Kayani, Ghulam Mujtaba, 2018. "A systemic risk analysis of Islamic equity markets using vine copula and delta CoVaR modeling," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 56(C), pages 104-127.

    More about this item

    Keywords

    Finance; Dynamic copulas; LVaR; Dependence structure; Portfolio optimization algorithm;

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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