Systemic Risk Driven Portfolio Selection

52 Pages Posted: 12 Jun 2019 Last revised: 23 Aug 2021

See all articles by Agostino Capponi

Agostino Capponi

Columbia University - Department of Industrial Engineering and Operations Research

Alexey Rubtsov

Global Risk Institute

Date Written: August 21, 2021

Abstract

We consider an investor who trades off tail risk and expected growth of the investment. We measure tail risk through portfolio's expected losses conditioned on the occurrence of a systemic event: financial market loss being exactly at, or at least at, its VaR level and investor's portfolio losses being above their CoVaR level. We decompose the solution to the investment problem in terms of the Markowitz mean--variance portfolio and an adjustment for systemic risk. We show that VaR and CoVaR confidence levels control, respectively, the relative sensitivity of the investor's objective function to portfolio--market correlation and portfolio variance. Our empirical analysis demonstrates that the investor attains higher risk-adjusted returns, compared to well-known benchmark portfolio criteria, during times of market downturn. Portfolios that perform best under adverse market conditions are less diversified and invest on a few stocks which have low correlation with the market.

Keywords: Systemic risk, Portfolio selection, Risk management, VaR, CoVaR, Risk-adjusted returns

JEL Classification: G01, G11, G20, G28

Suggested Citation

Capponi, Agostino and Rubtsov, Alexey, Systemic Risk Driven Portfolio Selection (August 21, 2021). Available at SSRN: https://ssrn.com/abstract=3394471 or http://dx.doi.org/10.2139/ssrn.3394471

Agostino Capponi (Contact Author)

Columbia University - Department of Industrial Engineering and Operations Research ( email )

Alexey Rubtsov

Global Risk Institute ( email )

55 University Avenue, Suite 1801
Toronto, ON M5J 2H7
Canada

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