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A Heuristic Approach to Portfolio Optimization

Author

Listed:
  • Manfred Gilli

    (Department of Econometrics, University of Geneva, Switzerland)

  • Evis Këllezi

    (Department of Econometrics and FAME, University of Geneva, Switzerland)

Abstract

Constraints on downside risk, measured by shortfall probability, expected shortfall, semi-variance etc., lead to optimal asset allocations which differ from the meanvariance optimum. The resulting optimization problem can become quite complex as it exhibits multiple local extrema and discontinuities, in particular if we also introduce constraints restricting the trading variables to integers, constraints on the holding size of assets or on the maximum number of different assets in the portfolio. In such situations classical optimization methods fail to work efficiently and heuristic optimization techniques can be the only way out. The paper shows how a particular optimization heuristic, called threshold accepting, can be successfully used to solve complex portfolio choice problems.

Suggested Citation

  • Manfred Gilli & Evis Këllezi, 2000. "A Heuristic Approach to Portfolio Optimization," FAME Research Paper Series rp20, International Center for Financial Asset Management and Engineering.
    • Handle: RePEc:fam:rpseri:rp20
    as

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    File URL: http://www.swissfinanceinstitute.ch/rp20.pdf
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    References listed on IDEAS

    as
    1. Ron Dembo & Dan Rosen, 1999. "The practice of portfolio replication. A practical overview of forward and inverse problems," Annals of Operations Research, Springer, vol. 85(0), pages 267-284, January.
    2. Gunter Dueck & Peter Winker, 1992. "New concepts and algorithms for portfolio choice," Applied Stochastic Models and Data Analysis, John Wiley & Sons, vol. 8(3), pages 159-178, September.
    3. Arzac, Enrique R. & Bawa, Vijay S., 1977. "Portfolio choice and equilibrium in capital markets with safety-first investors," Journal of Financial Economics, Elsevier, vol. 4(3), pages 277-288, May.
    4. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
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    Cited by:

    1. Ralph Steuer & Yue Qi & Markus Hirschberger, 2007. "Suitable-portfolio investors, nondominated frontier sensitivity, and the effect of multiple objectives on standard portfolio selection," Annals of Operations Research, Springer, vol. 152(1), pages 297-317, July.

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    More about this item

    Keywords

    Portfolio Optimization; Downside Risk Measures; Heuristic Optimization Threshold Accepting.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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