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Mean-semivariance optimal portfolios in discrete time using a game-theoretic approach
Stockholm University, Faculty of Science, Department of Mathematics.ORCID iD: 0000-0003-3184-2879
Stockholm University, Faculty of Science, Department of Mathematics.ORCID iD: 0000-0001-9228-0369
2025 (English)In: International Journal of Theoretical and Applied Finance, ISSN 0219-0249Article in journal (Refereed) Published
Abstract [en]

This paper introduces a novel recursive scheme for optimal asset allocation based on a mean–semivariance reward functional and a game-theoretic approach in a discrete-time setting. Unlike established frameworks that can handle variance as a risk measure, this study shifts focus to semivariance, which cannot be handled by existing theory due to aspects of its definition, including the use of an indicator function. To address this problem and the corresponding challenges of time inconsistency in multi-period investment decisions, we propose an extended Bellman equation to find a Nash equilibrium. The main contribution of this paper is a computational framework and a numerical investigation of a semivariance-based allocation strategy, based on an extended Bellman equation. Our analysis is restricted to the two-asset case — one risky and one risk-free asset — as a proof of concept, leaving multi-asset extensions for future work. The results of the numerical study indicate that our proposed method shows potential in achieving favorable investment outcomes.

Place, publisher, year, edition, pages
2025.
Keywords [en]
Time inconsistency, optimal portfolio, semivariance, equilibrium control
National Category
Probability Theory and Statistics
Identifiers
URN: urn:nbn:se:su:diva-231302DOI: 10.1142/S0219024925500104Scopus ID: 2-s2.0-105011872564OAI: oai:DiVA.org:su-231302DiVA, id: diva2:1872760
Available from: 2024-06-18 Created: 2024-06-18 Last updated: 2025-08-29
In thesis
1. Discrete-time portfolio theory
Open this publication in new window or tab >>Discrete-time portfolio theory
2024 (English)Doctoral thesis, comprehensive summary (Other academic)
Abstract [en]

This thesis contributes to the field of statistical and mathematical finance by introducing novel Bayesian and game-theoretic methods in discrete-time portfolio theory. These methodologies enhance the precision and adaptability of investment strategies and risk management, particularly in complex market environments. The work is structured around five papers.

Paper I introduces a Bayesian framework for optimizing portfolio allocation, utilizing value at risk (VaR) and conditional value at risk (CVaR) as risk measures. This approach leverages the posterior predictive distribution to derive portfolio weights directly from observed data, contrasting with traditional methods that rely on estimates of unobserved variables. The benefit of the Bayesian method is demonstrated through simulations and empirical comparisons, particularly in predicting out-of-sample VaR.

Paper II presents a dynamic Bayesian approach to incorporate volatility clustering into VaR and CVaR estimation, utilizing hyperparameters based on different rolling windows to adapt quickly to changing market conditions. This method shows distinct advantages over existing models by adjusting the certainty and expected values of prior distributions in response to volatility changes, offering improved risk estimates during market turbulence.

Paper III develops a Bayesian inference procedure for tangency portfolios by establishing a new conjugate prior directly for the optimal portfolio weights, integrating high-frequency returns and a market condition metric, such as the CBOE Volatility Index (VIX) or Economic Policy Uncertainty Index (EPU). This approach enables direct inference on portfolio weights, and backtesting suggests potential advantages over traditional strategies in real-world scenarios.

Paper IV addresses the construction of tangency portfolios under short-selling constraints, using the same reparameterized asset return model within a Bayesian context as in Paper III. An innovative prior enforces positive weight constraints. The effectiveness of this method is empirically validated with selected stocks, highlighting its potential to enhance risk-adjusted returns.

Paper V innovates within a game-theoretic framework by introducing a recursive scheme for asset allocation using a mean-semivariance reward functional to better reflect investors' aversion to downside risk. This approach resolves the time-inconsistency problem in multi-period investments through an extended Bellman equation, effectively reaching a Nash equilibrium as demonstrated by an extensive numerical study.

Collectively, these studies provide a cohesive advancement in statistical and mathematical finance, demonstrating the effectiveness of Bayesian methods and game-theoretic approaches in improving the theoretical and practical aspects of portfolio optimization and risk management.

Place, publisher, year, edition, pages
Stockholm: Department of Mathematics, Stockholm University, 2024. p. 49
Keywords
Bayesian statistics, Optimal portfolio, Risk estimation, Volatility clustering, Time inconsistency
National Category
Probability Theory and Statistics
Research subject
Mathematical Statistics
Identifiers
urn:nbn:se:su:diva-231305 (URN)978-91-8014-845-0 (ISBN)978-91-8014-846-7 (ISBN)
Public defence
2024-09-06, lärosal 15, hus 2, Albano, Albanovägen 18, Stockholm, 13:00 (English)
Opponent
Supervisors
Available from: 2024-08-14 Created: 2024-06-18 Last updated: 2024-07-02Bibliographically approved

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Lindensjö, KristofferNiklasson, Vilhelm

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