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Discrete-time portfolio theory
Stockholm University, Faculty of Science, Department of Mathematics.
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 [en]
Bayesian statistics, Optimal portfolio, Risk estimation, Volatility clustering, Time inconsistency
National Category
Probability Theory and Statistics
Research subject
Mathematical Statistics
Identifiers
URN: urn:nbn:se:su:diva-231305ISBN: 978-91-8014-845-0 (print)ISBN: 978-91-8014-846-7 (electronic)OAI: oai:DiVA.org:su-231305DiVA, id: diva2:1872852
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
List of papers
1. Bayesian portfolio selection using VaR and CVaR
Open this publication in new window or tab >>Bayesian portfolio selection using VaR and CVaR
2022 (English)In: Applied Mathematics and Computation, ISSN 0096-3003, E-ISSN 1873-5649, Vol. 427, article id 127120Article in journal (Refereed) Published
Abstract [en]

We study the optimal portfolio allocation problem from a Bayesian perspective using value at risk (VaR) and conditional value at risk (CVaR) as risk measures. By applying the posterior predictive distribution for the future portfolio return, we derive relevant quantities needed in the computations of VaR and CVaR, and express the optimal portfolio weights in terms of observed data only. This is in contrast to the conventional method where the optimal solution is based on unobserved quantities which are estimated. We also obtain the expressions for the weights of the global minimum VaR (GMVaR) and global minimum CVaR (GMCVaR) portfolios, and specify conditions for their existence. It is shown that these portfolios may not exist if the level used for the VaR or CVaR computation are too low. By using simulation and real market data, we compare the new Bayesian approach to the conventional plug-in method by studying the accuracy of the GMVaR portfolio and by analysing the estimated efficient frontiers. It is concluded that the Bayesian approach outperforms the conventional one, in particular at predicting the out-of-sample VaR.

Keywords
Bayesian inference, Posterior predictive distribution, Optimal portfolio, VaR, CVaR
National Category
Probability Theory and Statistics
Identifiers
urn:nbn:se:su:diva-204573 (URN)10.1016/j.amc.2022.127120 (DOI)000821677600002 ()2-s2.0-85128255109 (Scopus ID)
Available from: 2022-05-10 Created: 2022-05-10 Last updated: 2024-06-18Bibliographically approved
2. Volatility-sensitive Bayesian estimation of portfolio VaR and CVaR
Open this publication in new window or tab >>Volatility-sensitive Bayesian estimation of portfolio VaR and CVaR
(English)In: Journal of Risk, ISSN 1465-1211, E-ISSN 1755-2842Article in journal (Refereed) Accepted
National Category
Probability Theory and Statistics
Identifiers
urn:nbn:se:su:diva-231299 (URN)
Available from: 2024-06-18 Created: 2024-06-18 Last updated: 2024-06-19
3. Incorporating different sources of information for Bayesian optimal portfolio selection
Open this publication in new window or tab >>Incorporating different sources of information for Bayesian optimal portfolio selection
2024 (English)In: Journal of business & economic statistics, ISSN 0735-0015, E-ISSN 1537-2707Article in journal (Other academic) Epub ahead of print
Abstract [en]

This paper introduces Bayesian inference procedures for tangency portfolios, with a primary focus on deriving a new conjugate prior for portfolioweights. This approach not only enables direct inference about the weightsbut also seamlessly integrates additional information into the prior specification. Specifically, it automatically incorporates high-frequency returns and amarket condition metric (MCM), exemplified by the CBOE Volatility Index(VIX) and Economic Policy Uncertainty Index (EPU), significantly enhancing the decision-making process for optimal portfolio construction. While theJeffreys prior is also acknowledged, emphasis is placed on the advantages andpractical applications of the conjugate prior. An extensive empirical studyreveals that our method, leveraging this conjugate prior, consistently outperforms existing trading strategies in the majority of examined cases.

Keywords
Conjugate prior, EPU, high-frequency data, Jeffreys prior, value-weighted portfolio, VIX
National Category
Probability Theory and Statistics
Identifiers
urn:nbn:se:su:diva-231304 (URN)10.1080/07350015.2024.2379361 (DOI)
Available from: 2024-06-18 Created: 2024-06-18 Last updated: 2024-07-12
4. Constructing Bayesian tangency portfolios under short-selling restrictions
Open this publication in new window or tab >>Constructing Bayesian tangency portfolios under short-selling restrictions
2024 (English)In: Finance Research Letters, ISSN 1544-6123, E-ISSN 1544-6131, Vol. 62, article id 105065Article in journal (Refereed) Published
Abstract [en]

We address the challenge of constructing tangency portfolios in the context of short-selling restrictions. Utilizing Bayesian techniques, we reparameterize the asset return model, enabling direct determination of priors for the tangency portfolio weights. This facilitates the integration of non-negative weight constraints into an investor’s prior beliefs, resulting in a posterior distribution focused exclusively on non-negative values. Portfolio weight estimators are subsequently derived via the Markov Chain Monte Carlo (MCMC) methodology. Our novel Bayesian approach is empirically illustrated using the most significant stocks in the S&P 500 index. The method showcases promising results in terms of risk-adjusted returns and interpretability.

Keywords
Bayesian inference, Tangency portfolio, MCMC, Parameter uncertainty
National Category
Probability Theory and Statistics Economics
Identifiers
urn:nbn:se:su:diva-227786 (URN)10.1016/j.frl.2024.105065 (DOI)001181756900001 ()2-s2.0-85183988859 (Scopus ID)
Available from: 2024-04-10 Created: 2024-04-10 Last updated: 2024-06-19Bibliographically approved
5. Mean-semivariance optimal portfolios in discrete time using a game-theoretic approach
Open this publication in new window or tab >>Mean-semivariance optimal portfolios in discrete time using a game-theoretic approach
(English)Manuscript (preprint) (Other academic)
National Category
Probability Theory and Statistics
Identifiers
urn:nbn:se:su:diva-231302 (URN)
Available from: 2024-06-18 Created: 2024-06-18 Last updated: 2024-06-19

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