Optimal Portfolio Selection with a Shortfall Probability Constraint: Evidence from Alternative Distribution Functions

39 Pages Posted: 22 Jan 2010 Last revised: 7 Feb 2010

Date Written: January 20, 2010

Abstract

We propose a new approach to optimal portfolio selection in a downside risk framework that allocates assets by maximizing expected return subject to a shortfall probability constraint, reflecting the typical desire of a risk-averse investor to limit the maximum likely loss. Our empirical results indicate that the loss-averse portfolio outperforms the widely-used mean-variance approach based on the cumulative cash values, geometric mean returns, and average risk-adjusted returns. We also evaluate the relative performance of the loss-averse portfolio with normal, symmetric thin-tailed, symmetric fat-tailed, and skewed fat-tailed return distributions in terms of average return, average risk, and average risk-adjusted return.

Keywords: portfolio allocation, kurtosis, skewness

JEL Classification: G12, C13, C22

Suggested Citation

Akcay, Yalcin and Yalcin, Atakan, Optimal Portfolio Selection with a Shortfall Probability Constraint: Evidence from Alternative Distribution Functions (January 20, 2010). Available at SSRN: https://ssrn.com/abstract=1539407 or http://dx.doi.org/10.2139/ssrn.1539407

Yalcin Akcay

Koc University ( email )

Rumelifeneri Yolu
34450 Saryer
Istanbul, 34450
Turkey

Atakan Yalcin (Contact Author)

Ozyegin University ( email )

Nisantepe Mahallesi
Alemdag, Cekmekoy
Istanbul, 34794
Turkey
+90-216-564-9587 (Phone)
+90-216-564-9045 (Fax)

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