Foster-Hart optimal Portfolios

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Title: Foster-Hart optimal Portfolios
Authors: Anand, Abhinav
Li, Tiantian
Kurosaki, Tetsuo
Kim, Young Shin
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Date: Jul-2016
Abstract: We reinvestigate the classic portfolio optimization problem where the notion of portfolio risk is captured by the 'Foster–Hart risk'—a new, bankruptcy-proof, reserve based measure of risk, extremely sensitive to left tail events (Foster and Hart, 2009). To include financial market frictions induced by market microstructure, we employ a general, ex-ante transaction cost function with fixed, linear and quadratic penalty terms in the objective function. We represent the US equity market by the Dow Jones Industrial Average (DJIA) index and study the performance of the Foster–Hart optimal DJIA portfolio. In order to capture the skewed and leptokurtotic nature of real life stock returns, we model the returns of the DJIA constituents as an ARMA–GARCH process with multivariate 'normal tempered stable' innovations. We demonstrate that the Foster–Hart optimal portfolio’s performance is superior to those obtained under several techniques currently in use in academia and industry.
Funding Details: Science Foundation Ireland
Type of material: Journal Article
Publisher: Elsevier
Journal: Journal of Banking and Finance
Volume: 68
Start page: 117
End page: 130
Copyright (published version): 2016 Elsevier
Keywords: ARMA–GARCH modelNormal tempered stable distributionFoster-Hart riskValue-at-Risk (VaR)Average Value-at-Risk (AVaR)Reward risk ratio
DOI: 10.1016/j.jbankfin.2016.03.011
Language: en
Status of Item: Peer reviewed
Appears in Collections:FMC² Research Collection
Business Research Collection

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