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Portfolio Optimization using the Entropic Value-at-Risk: An Investor Preference Approach

Kühn, Kevin Fabian LU and Kuznetsova, Polina LU (2020) NEKN02 20201
Department of Economics
Abstract
It is very important for an investor to choose an accurate and effective risk measure when optimizing a portfolio of different assets. Recently, in addition to the standard risk measures such as variance or Value-at-Risk (VaR), more developed risk measures have emerged and one of them is the entropic Value-at-Risk (EVaR). This paper is testing the hypothesis stated by Ahmadi-Javid and Fallah-Tafti (2019) that entropic Value-at-Risk (EVaR) is the better risk measure to use in the portfolio optimization. To achieve this goal, the EVaR-optimized portfolio is compared to the mean-variance optimized portfolio (MV) for investors with different preferences. These preferences are exhibited through utility functions starting from the traditional... (More)
It is very important for an investor to choose an accurate and effective risk measure when optimizing a portfolio of different assets. Recently, in addition to the standard risk measures such as variance or Value-at-Risk (VaR), more developed risk measures have emerged and one of them is the entropic Value-at-Risk (EVaR). This paper is testing the hypothesis stated by Ahmadi-Javid and Fallah-Tafti (2019) that entropic Value-at-Risk (EVaR) is the better risk measure to use in the portfolio optimization. To achieve this goal, the EVaR-optimized portfolio is compared to the mean-variance optimized portfolio (MV) for investors with different preferences. These preferences are exhibited through utility functions starting from the traditional utility functions such as the power and the exponential utility function and finishing with more complex functions such as the bilinear and S-shaped utility function. The conducted tests have shown that under different utility functions investors had different preferences for these two portfolios. EVaR optimized portfolio was mostly preferred by investors with the bilinear utility function when the kink has a negative value, which means that more risk averse investors were preferring this portfolio. (Less)
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author
Kühn, Kevin Fabian LU and Kuznetsova, Polina LU
supervisor
organization
course
NEKN02 20201
year
type
H1 - Master's Degree (One Year)
subject
keywords
Mean-variance framework, entropic value-at-risk, utility functions, risk preference, portfolio optimization
language
English
id
9014278
date added to LUP
2020-08-29 11:18:20
date last changed
2020-08-29 11:18:20
@misc{9014278,
  abstract     = {{It is very important for an investor to choose an accurate and effective risk measure when optimizing a portfolio of different assets. Recently, in addition to the standard risk measures such as variance or Value-at-Risk (VaR), more developed risk measures have emerged and one of them is the entropic Value-at-Risk (EVaR). This paper is testing the hypothesis stated by Ahmadi-Javid and Fallah-Tafti (2019) that entropic Value-at-Risk (EVaR) is the better risk measure to use in the portfolio optimization. To achieve this goal, the EVaR-optimized portfolio is compared to the mean-variance optimized portfolio (MV) for investors with different preferences. These preferences are exhibited through utility functions starting from the traditional utility functions such as the power and the exponential utility function and finishing with more complex functions such as the bilinear and S-shaped utility function. The conducted tests have shown that under different utility functions investors had different preferences for these two portfolios. EVaR optimized portfolio was mostly preferred by investors with the bilinear utility function when the kink has a negative value, which means that more risk averse investors were preferring this portfolio.}},
  author       = {{Kühn, Kevin Fabian and Kuznetsova, Polina}},
  language     = {{eng}},
  note         = {{Student Paper}},
  title        = {{Portfolio Optimization using the Entropic Value-at-Risk: An Investor Preference Approach}},
  year         = {{2020}},
}