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On dynamic spectral risk measures, a limit theorem and optimal portfolio allocation

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  • Dilip Madan
  • Martijn Pistorius
  • Mitja Stadje

Abstract

In this paper we propose the notion of continuous-time dynamic spectral risk-measure (DSR). Adopting a Poisson random measure setting, we define this class of dynamic coherent risk-measures in terms of certain backward stochastic differential equations. By establishing a functional limit theorem, we show that DSRs may be considered to be (strongly) time-consistent continuous-time extensions of iterated spectral risk-measures, which are obtained by iterating a given spectral risk-measure (such as Expected Shortfall) along a given time-grid. Specifically, we demonstrate that any DSR arises in the limit of a sequence of such iterated spectral risk-measures driven by lattice-random walks, under suitable scaling and vanishing time- and spatial-mesh sizes. To illustrate its use in financial optimisation problems, we analyse a dynamic portfolio optimisation problem under a DSR.

Suggested Citation

  • Dilip Madan & Martijn Pistorius & Mitja Stadje, 2013. "On dynamic spectral risk measures, a limit theorem and optimal portfolio allocation," Papers 1301.3531, arXiv.org, revised Apr 2017.
    • Handle: RePEc:arx:papers:1301.3531
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    References listed on IDEAS

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    Cited by:

    1. Yoshihiro Shirai, 2023. "A Levy-driven Ornstein-Uhlenbeck process for the valuation of credit index swaptions," Papers 2301.05332, arXiv.org, revised Oct 2023.
    2. Sun, Xianming & Gan, Siqing & Vanmaele, Michèle, 2015. "Analytical approximation for distorted expectations," Statistics & Probability Letters, Elsevier, vol. 107(C), pages 246-252.
    3. Engsner Hampus & Lindskog Filip, 2020. "Continuous-time limits of multi-period cost-of-capital margins," Statistics & Risk Modeling, De Gruyter, vol. 37(3-4), pages 79-106, July.
    4. Dilip B. Madan & Wim Schoutens & King Wang, 2020. "Bilateral multiple gamma returns: Their risks and rewards," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 7(01), pages 1-27, March.
    5. Dilip B. Madan & Wim Schoutens, 2019. "Equilibrium Asset Returns In Financial Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(02), pages 1-43, March.
    6. Yoshihiro Shirai, 2022. "Extreme Measures in Continuous Time Conic Finace," Papers 2210.13671, arXiv.org, revised Oct 2023.
    7. Samuel N. Cohen, 2016. "Data-driven nonlinear expectations for statistical uncertainty in decisions," Papers 1609.06545, arXiv.org.
    8. Weiping Wu & Yu Lin & Jianjun Gao & Ke Zhou, 2023. "Mean-variance hybrid portfolio optimization with quantile-based risk measure," Papers 2303.15830, arXiv.org, revised Apr 2023.

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