Downside Risk Approach for Multi-Objective Portfolio Optimization

Abstract

This paper presents a multi-objective portfolio model with the expected return as a performance measure and the expected worst-case return as a risk measure. The problems are formulated as a triple-objectivemixed integer program. One of the problem objectives is to allocate the wealth on different securities to optimize the portfolio return. The portfolio approach has allowed the two popular in financial engineering percentile measures of risk, value-at-risk (VaR) and conditional valueat- risk (CVaR) to be applied. The decision maker can assess the value of portfolio return and the risk level, and can decide how to invest in a real life situation comparing with ideal (optimal) portfolio solutions. The concave efficient frontiers illustrate the trade-off between the conditional value-at-risk and the expected return of the portfolio. Numerical examples based on historical daily input data from the Warsaw Stock Exchange are presented and selected computational results are provided. The computational experiments show that the proposed solution approach provides the decision maker with a simple tool for evaluating the relationship between the expected and the worst-case portfolio return.