Optimized Portfolio Using a Forward-Looking Expected Tail Loss

33 Pages Posted: 31 Oct 2019 Last revised: 8 Sep 2021

See all articles by Anthony Sanford

Anthony Sanford

HEC Montreal - Department of Finance

Date Written: October 23, 2019

Abstract

In this paper, I construct an optimal portfolio by minimizing the expected tail loss (ETL) derived from the forward-looking natural distribution of the Recovery Theorem (RT). The RT is one of the first successful attempts at deriving an unparameterized natural distribution of future asset returns. This distribution can be used as the criterion function in an expected tail loss (ETL) portfolio optimization problem. I find that the portfolio constructed using the RT outperforms both the equally-weighted portfolio and a portfolio constructed using historical ETL. The portfolio constructed using the RT has the smallest historical tail loss, smallest maximum drawdown, highest Sortino Ratio, and highest Sharpe Ratio.

Keywords: Recovery theorem, portfolio theory, expected shortfall

JEL Classification: G00, G1, G12

Suggested Citation

Sanford, Anthony, Optimized Portfolio Using a Forward-Looking Expected Tail Loss (October 23, 2019). Finance Research Letters, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3316249 or http://dx.doi.org/10.2139/ssrn.3316249

Anthony Sanford (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

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