Numerical methods for stochastic programs with second order dominance constraints with applications to portfolio optimization

Meskarian, Rudabeh, Fliege, Joerg and Xu, Huifu (2012) Numerical methods for stochastic programs with second order dominance constraints with applications to portfolio optimization. European Journal of Operational Research, 216 (2), 376-385. (doi:10.1016/j.ejor.2011.07.044).

Abstract

Inspired by the successful applications of the stochastic optimization with second order stochastic dominance (SSD) model in portfolio optimization, we study new numerical methods for a general SSD model where the underlying functions are not necessarily linear. Specifically, we penalize the SSD constraints to the objective under Slater’s constraint qualification and then apply the well known stochastic approximation (SA) method and the level function method to solve the penalized problem. Both methods are iterative: the former requires to calculate an approximate subgradient of the objective function of the penalized problem at each iterate while the latter requires to calculate a subgradient. Under some moderate conditions, we show that w.p.1 the sequence of approximated solutions generated by the SA method converges to an optimal solution of the true problem. As for the level function method, the convergence is deterministic and in some cases we are able to estimate the number of iterations for a given precision. Both methods are applied to portfolio optimization problem where the return functions are not necessarily linear and some numerical test results are reported.

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Contributors

Author: Joerg Fliege

Author: Huifu Xu

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