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661. Sparse spanning portfolios and under-diversification with second-order stochastic dominance
Invited abstract in session WA-63: Novel Optimization Models in Finance, stream OR in Banking, Finance and Insurance: New Tools for Risk Management.
Wednesday, 8:30-10:00Room: S14 (building: 101)
Authors (first author is the speaker)
| 1. | Nikolas Topaloglou
|
| International and European Economic Studies, Athens University of Economics and Business | |
| 2. | Stelios Arvanitis
|
| Athens University of Economics and Business | |
| 3. | Olivier Scaillet
|
| University of Geneva |
Abstract
We develop and implement methods for determining whether relaxing sparsity con- straints on portfolios improves the investment opportunity set for risk-averse investors. We formulate a new estimation procedure for sparse second-order stochastic spanning based on a greedy algorithm and Linear Programming. We show the optimal recovery of the sparse solution asymptotically whether spanning holds or not. From large equity datasets, we estimate the expected utility loss due to possible under-diversification, and find that there is no benefit from expanding a sparse opportunity set beyond 45 assets. The optimal sparse portfolio invests in 10 industry sectors and cuts tail risk when compared to a sparse mean-variance portfolio. On a rolling-window basis, the number of assets shrinks to 25 assets in crisis periods, while standard factor models cannot explain the performance of the sparse portfolios.
Keywords
- Programming, Linear
- Financial Modelling
Status: accepted
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