Taming tail risk: Regularized multiple β worst-case cvar portfolio

Abstract

The importance of proper tail risk management is a crucial component of the investment process and conditional Value at Risk (CVaR) is often used as a tail risk measure. CVaR is the asymmetric risk measure that controls and manages the downside risk of a portfolio while symmetric risk measures such as variance consider both upside and downside risk. In fact, minimum CVaR portfolio is a promising alternative to traditional mean-variance optimization. However, there are three major challenges in the minimum CVaR portfolio. Firstly, when using CVaR as a risk measure, we need to determine the distribution of asset returns, but it is difficult to actually grasp the distribution; therefore, we need to invest in a situation where the distribution is uncertain. Secondly, the minimum CVaR portfolio is formulated with a single β and may output significantly different portfolios depending on the β. Finally, most portfolio allocation strategies do not account for transaction costs incurred by each rebalancing of the portfolio. In order to improve these challenges, we propose a Regularized Multiple β Worst-case CVaR (RM-WCVaR) portfolio. The characteristics of this portfolio are as follows: it makes CVaR robust with worst-case CVaR which is still an asymmetric risk measure, it is stable among multiple β, and against changes in weights over time. We perform experiments on well-known benchmarks to evaluate the proposed portfolio.RM-WCVaR demonstrates superior performance of having both higher risk-adjusted returns and lower maximum drawdown.