Portfolio Optimization with DARA Stochastic Dominance Constraints

43 Pages Posted: 2 Nov 2017 Last revised: 12 Nov 2018

See all articles by Milos Kopa

Milos Kopa

Charles University in Prague - Faculty of Mathematics and Physics

Thierry Post

Graduate School of Business of Nazarbayev University

Date Written: November 1, 2017

Abstract

An optimization method is developed for constructing investment portfolios which stochastically dominate a given benchmark for all decreasing absolute risk-averse investors, using Quadratic Programming. The method is applied to standard data sets of historical returns of equity price reversal and momentum portfolios. The proposed optimization method improves upon the performance of Mean-Variance optimization by tens to hundreds of basis points per annum, for low to medium risk levels. The improvements critically depend on imposing the complex condition of Decreasing Absolute Risk Aversion in addition to the simpler conditions of global risk aversion and decreasing risk aversion.

Keywords: Portfolio choice, Stochastic Dominance, Decreasing Absolute Risk Aversion, Quadratic Programming, Active investment strategies

JEL Classification: C61, D81, G11

Suggested Citation

Kopa, Milos and Post, Thierry, Portfolio Optimization with DARA Stochastic Dominance Constraints (November 1, 2017). Available at SSRN: https://ssrn.com/abstract=3063141 or http://dx.doi.org/10.2139/ssrn.3063141

Milos Kopa

Charles University in Prague - Faculty of Mathematics and Physics ( email )

Sokolovska 83
Prague, 186 75
Czech Republic

Thierry Post (Contact Author)

Graduate School of Business of Nazarbayev University ( email )

53 Kabanbay Batyra Avenue
Astana, 010000
Kazakhstan

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