Constructing Long/Short Portfolios with the Omega Ratio

21 Pages Posted: 27 Oct 2008

See all articles by Manfred Gilli

Manfred Gilli

University of Geneva - Research Center for Statistics; Swiss Finance Institute

Enrico Schumann

Independent

Giacomo di Tollo

Ca Foscari University of Venice - Dipartimento di Economia

Gerda Cabej

University of Geneva

Abstract

We construct portfolios with an alternative selection criterion, the Omega function, which can be expressed as the ratio of two partial moments of the returns distribution. Finding Omega-optimal portfolios, in particular under realistic constraints like cardinality restrictions, requires to solve non-convex optimisation problems. Since standard (gradient-based) optimisation methods fail here, we suggest to use a heuristic technique (Threshold Accepting). The main purpose of the paper is to investigate the empirical performance of the selected portfolios, especially the effects of allowing short positions. Many studies on portfolio optimisation assume that short sales are not allowed. This is despite the fact that theoretically, short positions can improve the risk-return characteristics of a portfolio, and practically, institutional investors can and do sell stocks short. We investigate whether removing the non-negativity constraint really improves out-of-sample portfolio performance under realistic assumptions, that is when optimal weights need to be estimated from the data, different transaction costs apply to long and short positions or short selling is restricted to specific assets.

Keywords: Optimisation heuristics, Threshold Accepting, Portfolio Optimisation

JEL Classification: C61, C63, G11

Suggested Citation

Gilli, Manfred and Schumann, Enrico and di Tollo, Giacomo and Cabej, Gerda, Constructing Long/Short Portfolios with the Omega Ratio. Swiss Finance Institute Research Paper No. 08-34. Available at SSRN: https://ssrn.com/abstract=1289269 or http://dx.doi.org/10.2139/ssrn.1289269

Manfred Gilli (Contact Author)

University of Geneva - Research Center for Statistics ( email )

Geneva
Switzerland
+41223798222 (Phone)
+41223798299 (Fax)

HOME PAGE: http://www.unige.ch/ses/metri/gilli/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Enrico Schumann

Independent ( email )

No Address Available

Giacomo Di Tollo

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

Gerda Cabej

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

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