Systemic Risk Driven Portfolio Selection

40 Pages Posted: 12 Jun 2019

Date Written: May 25, 2019

Abstract

We consider an investor who maximizes portfolio's expected returns conditioned on the occurrence of a systemic event: financial system return being at, or at most at, its VaR level and portfolio's returns being below the CoVaR level. We obtain a closed-form solution to the portfolio selection problem, and show how VaR and CoVaR quantiles control, respectively, the relative importance of "portfolio-system correlation" and "portfolio variance". Our empirical analysis demonstrates that the investor attains a higher Sharpe ratio, compared to well known benchmark portfolio criteria, during times of market downturn. Portfolios that perform best in adverse market conditions are less diversi fied and concentrate on few stocks whose correlation with the fi nancial system is low.

Keywords: Systemic Risk, Portfolio Selection, Risk Management, Sharpe Ratios

JEL Classification: G01, G11, G20, G28

Suggested Citation

Capponi, Agostino and Rubtsov, Alexey, Systemic Risk Driven Portfolio Selection (May 25, 2019). Available at SSRN: https://ssrn.com/abstract=3394471 or http://dx.doi.org/10.2139/ssrn.3394471

Agostino Capponi (Contact Author)

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Alexey Rubtsov

Global Risk Institute ( email )

55 University Avenue, Suite 1801
Toronto, ON M5J 2H7
Canada

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