Comparative Analysis of Linear Portfolio Rebalancing Strategies: An Application to Hedge Funds

U of Florida ISE Research Report No. 2001-11

36 Pages Posted: 22 Jan 2002

See all articles by Pavlo A. Krokhmal

Pavlo A. Krokhmal

University of Florida - Department of Industrial and Systems Engineering

Stanislav P. Uryasev

University of Florida

Grigory M. Zrazhevsky

University of Florida - Department of Industrial and Systems Engineering

Date Written: November 2001

Abstract

This paper applies formal risk management methodologies to optimization of a portfolio of hedge funds (fund of funds). We compare recently developed risk management methodologies: Conditional Value-at-Risk and Conditional Drawdown-at-Risk with more established Mean-Absolute Deviation, Maximum Loss, and Market Neutrality approaches. The common property of considered risk management techniques is that they admit the formulation of a portfolio optimization model as a linear programming (LP) problem. LP formulations allow for implementing efficient and robust portfolio allocation algorithms, which can successfully handle optimization problems with thousands of instruments and scenarios. The performance of various risk constraints is investigated and discussed in detail for in-sample and out-of-sample testing of the algorithm. The numerical experiments show that imposing risk constraints may improve the "real" performance of a portfolio rebalancing strategy in out-of-sample runs. It is beneficial to combine several types of risk constraints that control different sources of risk.

Keywords: Hedge funds, linear portfolio rebalancing strategies, risk management, conditional value-at-risk, conditional drawdown-at-risk, mean absolute deviation, maximum loss, market neutrality, in-sample testing, out-of-sample testing

JEL Classification: G11, G23

Suggested Citation

Krokhmal, Pavlo A. and Uryasev, Stanislav P. and Zrazhevsky, Grigory M., Comparative Analysis of Linear Portfolio Rebalancing Strategies: An Application to Hedge Funds (November 2001). U of Florida ISE Research Report No. 2001-11, Available at SSRN: https://ssrn.com/abstract=297639 or http://dx.doi.org/10.2139/ssrn.297639

Pavlo A. Krokhmal

University of Florida - Department of Industrial and Systems Engineering ( email )

303 Weil Hall
Gainesville, FL 32611-6595
United States
352-392-6757 (Phone)
352-392-3537 (Fax)

Stanislav P. Uryasev (Contact Author)

University of Florida ( email )

303 Weil Hall
Gainesville, FL 32611-6595
United States
352-392-3091 (Phone)
352-392-3537 (Fax)

HOME PAGE: http://www.ise.ufl.edu/uryasev/

Grigory M. Zrazhevsky

University of Florida - Department of Industrial and Systems Engineering

303 Weil Hall
Gainesville, FL 32611-6595
United States

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