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Portfolio optimization with optimal expected utility risk measures

Author

Listed:
  • S. Geissel

    (University of Applied Sciences Trier)

  • H. Graf

    (Nuertingen-Geislingen University)

  • J. Herbinger

    (Ludwig-Maximilians-University Munich)

  • F. T. Seifried

    (University of Trier)

Abstract

The purpose of this article is to evaluate optimal expected utility risk measures (OEU) in a risk-constrained portfolio optimization context where the expected portfolio return is maximized. We compare the portfolio optimization with OEU constraint to a portfolio selection model using value at risk as constraint. The former is a coherent risk measure for utility functions with constant relative risk aversion and allows individual specifications to the investor’s risk attitude and time preference. In a case study with three indices, we investigate how these theoretical differences influence the performance of the portfolio selection strategies. A copula approach with univariate ARMA-GARCH models is used in a rolling forecast to simulate monthly future returns and calculate the derived measures for the optimization. The results of this study illustrate that both optimization strategies perform considerably better than an equally weighted portfolio and a buy and hold portfolio. Moreover, our results illustrate that portfolio optimization with OEU constraint experiences individualized effects, e.g., less risk-averse investors lose more portfolio value in the financial crises but outperform their more risk-averse counterparts in bull markets.

Suggested Citation

  • S. Geissel & H. Graf & J. Herbinger & F. T. Seifried, 2022. "Portfolio optimization with optimal expected utility risk measures," Annals of Operations Research, Springer, vol. 309(1), pages 59-77, February.
    • Handle: RePEc:spr:annopr:v:309:y:2022:i:1:d:10.1007_s10479-021-04403-7
    DOI: 10.1007/s10479-021-04403-7
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    References listed on IDEAS

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    More about this item

    Keywords

    Optimal expected utility; Portfolio optimization; Risk measures; Value at risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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