Skewness persistence with optimal portfolio selection

Mirza

Economic Research-Ekonomska Istraživanja

et al. 2017

Stock markets play an important role in spurring economic growth and development through diversification opportunities. However, diversification cannot be truly achieved if we continue to ignore additional dimensions of risk, namely skewness and kurtosis. This study incorporates higher moments of risk to form a mean-varianceskewness-kurtosis based framework for portfolio optimisation. Inclusion of higher moments in optimisation framework acknowledges the risk of asymmetric returns and fat-tail risk and can help investors in formulating optimal portfolios of stocks which can be significantly divergent from the ones they obtain through the Markowitz meanvariance optimisation. Our results confirm the presence of tradeoff between returns and additional dimensions of risk in Pakistan Stock Exchange (PSX) and strongly suggest including them in the optimisation framework to avoid sub-optimal decisions and to curtail exposure towards higher moments of risks.

Section: Literature Reviewmentioning

confidence: 99%

Portfolio optimisation with higher moments of risk at the Pakistan Stock Exchange

Mirza

Economic Research-Ekonomska Istraživanja

et al. 2017

“…It has subsequently been used by Lai, 6 Chunhachinda et al, 7 Sun and Yan 8 and Prakash et al 9 to solve portfolio selection problems involving a significant degree of skewness. Here, we adapt the basic PGP approach to the context of FoHF portfolio selection.…”

Section: Portfolio Selection In a Four-moment Frameworkmentioning

confidence: 99%

Fund of hedge funds portfolio selection: A multiple-objective approach

Davies

Kat²,

Lu³

2009

J Deriv Hedge Funds

is an Associate at UBS (London). She is a Structurer in the Fund Derivatives Structuring team. Her research is on the detailed characterisation of hedge fund portfolio returns and optimisation within a mean-variance-skewnesskurtosis framework.Correspondence: Ryan J. Davies, Finance Division, Babson College, 224 Tomasso Hall, Babson Park, MA 02457-0310, USA E-mail: rdavies@babson.edu PRACTICAL APPLICATIONS Hedge funds exhibit complex, non-normal return distributions. In this context, it is difficult for investors to determine how much capital to allocate across different hedge fund strategies. Standard mean-variance portfolio theory and performance measures based on it (for example, the Sharpe ratio) may be inappropriate. The paper proposes an alternative portfolio allocation technique based on polynomial goal programming (PGP) that is simple to implement and computationally robust.ABSTRACT This paper develops a technique for fund of hedge funds to allocate capital across different hedge fund strategies and traditional asset classes. Our adaptation of the polynomial goal programming optimisation method incorporates investor preferences for higher return moments, such as skewness and kurtosis, and provides computational advantages over rival methods. We show how optimal allocations depend on the interaction between strategies, as measured by covariance, co-skewness and co-kurtosis. We also demonstrate the importance of constructing 'like for like' representative portfolios that reflect the investment opportunities available to different-sized funds. Our empirical results www.palgrave-journals.com/jdhf/ reveal the importance of equity market neutral funds as volatility and kurtosis reducers and of global macro funds as portfolio skewness enhancers.

“…The large literature on skewness includes the seminal papers by Samuelson (1970), Kraus and Litzenberger (1976), Simkowitz and Beedles (1978) and Singleton and Wingender (1986). There are many more recent studies, including for example those by Chunhachinda et al (1997), Harvey and Siddique (2000), Sun and Yan (2003) and Adcock (2004). Asymmetry is a particularly important feature of the returns on options, arising because of the truncation of the return distribution at the exercise price.…”

Section: Background and Literature Reviewmentioning

confidence: 99%

Measuring portfolio performance using a modified measure of risk

Adcock¹

2007

J Asset Manag

This paper reports the results of an investigation into the properties of a theoretical modification of beta proposed by Leland (1999) and based on earlier work of Rubinstein (1976). It is shown that when returns are elliptically symmetric that beta is the appropriate measure of risk and that there are other situations the which modified beta will be similar to the traditional measure based on the CAPM. For the case where returns have a normal distribution, it is shown that either the criterion either does not exist or that it reduces exactly to the conventional beta. It is therefore conjectured that the modified measure will only be useful for portfolios which have non-standard return distributions which incorporate skewness. For such situations, it is shown how to estimate the measure using regression and how to compare the resulting statistic with a traditional estimated beta using Hotelling's test. An empirical study based on stocks from the FTSE350 does not find evidence to support the use of the new measure even in the presence of skewness.