Portfolio diversification based on ratios of risk measures

Mathias Barkhagen, Brian Fleming, Sergio Garcia Quiles, Jacek Gondzio, Joerg Kalcsics, Jens Kroeske, Sotirios Sabanis, Arne Staal

Research output: Working paper

Abstract / Description of output

A new framework for portfolio diversification is introduced which goes beyond the classical mean-variance theory and other known portfolio allocation strategies such as risk parity. It is based on a novel concept called portfolio dimensionality and ultimately relies on the minimization of ratios of convex functions. The latter arises naturally due to our requirements that diversification measures should be leverage invariant and related to the tail properties of the distribution of portfolio returns. This paper introduces this new framework and its relationship to standardized higher order moments of portfolio returns. Moreover, it addresses the main drawbacks of standard diversification methodologies which are based primarily on estimates of covariance matrices. Maximizing portfolio dimensionality leads to highly non-trivial optimization problems with objective functions which are typically non-convex with potentially multiple local optima. Two complementary global optimization algorithms are thus presented. For problems of moderate size, a deterministic Branch and Bound algorithm is developed, whereas for problems of larger size a stochastic global optimization algorithm based on Gradient Langevin Dynamics is given. We demonstrate through numerical experiments that the introduced diversification measures possess desired properties as introduced in the portfolio diversification literature.
Original languageEnglish
Publication statusPublished - 3 Jun 2019

Keywords / Materials (for Non-textual outputs)

  • q-fin.PM
  • math.OC
  • q-fin.RM


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