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Portfolio selection under systemic risk

Portfolio selection under systemic risk
Portfolio selection under systemic risk

This paper proposes a modified Sharpe ratio to construct optimal portfolios under systemic events. The portfolio allocation problem is solved analytically under the absence of short-selling restrictions and numerically when short-selling restrictions are imposed. This approach is made operational by embedding it in a multivariate dynamic setting using dynamic conditional correlation and copula models. We evaluate the out-of-sample performance of our portfolio empirically over the period 2007 to 2020 using ex post final wealth paths and systemic risk metrics against mean–variance, equally weighted, and global minimum variance portfolios. Our portfolio outperforms all competitors under market distress and remains competitive in noncrisis periods.

conditional tail risk, conditional volatility models, portfolio allocation, Sharpe ratio, systemic risk
0022-2879
Lin, Weidong
f4bfc3ba-2d7b-48af-9ae8-ff9443c10daf
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Taamouti, Abderrahim
649f733f-f640-4fc8-b5a5-9152f9c12032
Lin, Weidong
f4bfc3ba-2d7b-48af-9ae8-ff9443c10daf
Olmo, Jose
706f68c8-f991-4959-8245-6657a591056e
Taamouti, Abderrahim
649f733f-f640-4fc8-b5a5-9152f9c12032

Lin, Weidong, Olmo, Jose and Taamouti, Abderrahim (2023) Portfolio selection under systemic risk. Journal of Money, Credit and Banking. (doi:10.1111/jmcb.13038).

Record type: Article

Abstract

This paper proposes a modified Sharpe ratio to construct optimal portfolios under systemic events. The portfolio allocation problem is solved analytically under the absence of short-selling restrictions and numerically when short-selling restrictions are imposed. This approach is made operational by embedding it in a multivariate dynamic setting using dynamic conditional correlation and copula models. We evaluate the out-of-sample performance of our portfolio empirically over the period 2007 to 2020 using ex post final wealth paths and systemic risk metrics against mean–variance, equally weighted, and global minimum variance portfolios. Our portfolio outperforms all competitors under market distress and remains competitive in noncrisis periods.

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More information

Accepted/In Press date: 31 January 2023
e-pub ahead of print date: 6 March 2023
Published date: 6 March 2023
Additional Information: Publisher Copyright: © 2023 The Authors. Journal of Money, Credit and Banking published by Wiley Periodicals LLC on behalf of Ohio State University.
Keywords: conditional tail risk, conditional volatility models, portfolio allocation, Sharpe ratio, systemic risk

Identifiers

Local EPrints ID: 476545
URI: http://eprints.soton.ac.uk/id/eprint/476545
ISSN: 0022-2879
PURE UUID: 74c537a2-715a-4568-a22a-00b19c36da0c
ORCID for Jose Olmo: ORCID iD orcid.org/0000-0002-0437-7812

Catalogue record

Date deposited: 05 May 2023 16:38
Last modified: 16 Jun 2023 01:43

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Contributors

Author: Weidong Lin
Author: Jose Olmo ORCID iD
Author: Abderrahim Taamouti

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