Polynomial Goal Programming and the Implicit Higher Moment Preferences of U.S. Institutional Investors in Hedge Funds

Financial Markets and Portfolio Management, Forthcoming

43 Pages Posted: 2 Jan 2014

See all articles by Juliane Proelss

Juliane Proelss

Concordia University, Quebec; Trier University of Applied Sciences

Denis Schweizer

Concordia University

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2014

Abstract

Polynomial goal programming (PGP) is a flexible method that allows investor preferences for different moments of the return distribution of financial assets to be included in the portfolio optimization. The method is intuitive and particularly suitable for incorporating investor preferences in higher moments of the return distribution. However, until now, PGP has not been able to meet its full potential because it requires quantification of “real” preference parameters toward those moments. To date, the chosen preference parameters have been selected somewhat “arbitrarily”. Our goal is to calculate implied sets of preference parameters by using investors’ choices of and the importance they attribute to risk and performance measures. We use three groups of institutional investors — pension funds, insurance companies, and endowments — and derive implied sets of preference parameters in the context of a hedge fund portfolio optimization. To determine “real” preferences for the higher moments of the portfolio return distribution, we first fit implied preference parameters so that the PGP optimal portfolio is identical to the desired hedge fund portfolio. With the obtained economically justified sets of preference parameters, the well-established PGP framework can be employed more efficiently to derive allocations that satisfy institutional investor expectations for hedge fund investments. Furthermore, the implied preference parameters enable fund of hedge fund managers and other investment managers to derive optimal portfolio allocations based on specific investor expectations. Moreover, the importance of individual moments, as well as their marginal rates of substitution, can be assessed.

Keywords: Polynomial Goal Programming, Fund of Hedge Funds, Higher Moments, Investor Preferences

JEL Classification: G11, G23

Suggested Citation

Proelss, Juliane and Schweizer, Denis, Polynomial Goal Programming and the Implicit Higher Moment Preferences of U.S. Institutional Investors in Hedge Funds (January 1, 2014). Financial Markets and Portfolio Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2373651

Juliane Proelss

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

Trier University of Applied Sciences ( email )

Scheidershof
Trier, 54293
Germany

Denis Schweizer (Contact Author)

Concordia University ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada
+1 (514) 848-2424 ext. 2926 (Phone)
+1 (514) 848-4500 (Fax)

HOME PAGE: http://www.concordia.ca/jmsb/faculty/denis-schweizer.html

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