Robust Portfolio Optimization with Value-At-Risk Adjusted Sharpe Ratio

Journal of Asset Management, 14(5):293-305, 2013

22 Pages Posted: 13 Sep 2012 Last revised: 18 Jan 2014

See all articles by Geng Deng

Geng Deng

Wells Fargo

Tim Dulaney

Securities and Exchange Commission

Craig J. McCann

Securities Litigation and Consulting Group

Olivia Wang

Securities Litigation & Consulting Group

Date Written: November 5, 2013

Abstract

We propose a robust portfolio optimization approach based on Value-at-Risk (VaR) adjusted Sharpe ratios. Traditional Sharpe ratio estimates based on limited historical return data are subject to estimation errors. Portfolio optimization based on traditional Sharpe ratios ignores this uncertainty in parameter estimation from historical data and is therefore not robust. In this paper, we propose a robust portfolio optimization framework that selects the portfolio with the largest worse-case-scenario Sharpe ratios. We show that this framework is equivalent to maximizing the Sharpe ratio reduced by the VaR of the Sharpe ratio and highlight the relationship between the VaR-adjusted Sharpe ratios and other modi ed Sharpe ratios proposed in the literature. In addition, we present both numerical and empirical results comparing optimal portfolios generated by the approach advocated here and those generated by alternative optimization approaches.

Keywords: Sharpe Ratio, Robust Portfolio Optimization, Value-at-Risk

JEL Classification: C61, G11

Suggested Citation

Deng, Geng and Dulaney, Tim and McCann, Craig J. and Wang, Olivia, Robust Portfolio Optimization with Value-At-Risk Adjusted Sharpe Ratio (November 5, 2013). Journal of Asset Management, 14(5):293-305, 2013. Available at SSRN: https://ssrn.com/abstract=2146219 or http://dx.doi.org/10.2139/ssrn.2146219

Geng Deng (Contact Author)

Wells Fargo ( email )

1753 Pinnacle Dr
7th Floor
Mc Lean, VA Virginia 22102
United States

Tim Dulaney

Securities and Exchange Commission ( email )

100 F Street, NW
Washington, DC 20549-1105
United States

Craig J. McCann

Securities Litigation and Consulting Group ( email )

3998 Fair Ridge Drive, Suite 250
Fairfax, VA 22033
United States

Olivia Wang

Securities Litigation & Consulting Group ( email )

3998 Fair Ridge Drive, Suite 250
Fairfax, VA 22033
United States
7035936770 (Phone)

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