Recent advancements in robust optimization for investment management

Abstract

Robust optimization has become a widely implemented approach in investment management for incorporating uncertainty into financial models. The first applications were to asset allocation and equity portfolio construction. Significant advancements in robust portfolio optimization took place since it gained popularity almost two decades ago for improving classical models on portfolio optimization. Recently, studies applying the worst-case framework to bond portfolio construction, currency hedging, and option pricing have appeared in the practitioner-oriented literature. Our focus in this paper is on recent advancements to categorize robust optimization models into asset allocation at the asset class level and portfolio selection at the individual asset level, and we further separate robust portfolio selection approaches specific to each asset class. This organization provides a clear overview on how robust optimization is extensively implemented in investment management.

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Fig. 1
Fig. 2

Notes

  1. 1.

    A survey of robust asset allocation is also presented in Scutellà and Recchia (2013).

  2. 2.

    In both Figs. 1 and 2, the allocation to stocks decreases whereas the allocation to bonds increases as the portfolio return level is raised. This is observed because bonds have relatively high expected return with low variance and stocks have negative expected return with high variance during the first 3 months of 2016.

  3. 3.

    Kim et al. (2016b) provide a detailed explanation on how to formulate robust stock portfolio problems and also a step-by-step guide on finding optimal robust stock portfolios using MATLAB.

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Acknowledgements

This research was supported by Basic Science Research Program through the National Research Foundation of Korea (NRF) funded by the Ministry of Science, ICT & Future Planning (NRF-2016R1C1B1014492).

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Correspondence to Frank J. Fabozzi.

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Kim, J.H., Kim, W.C. & Fabozzi, F.J. Recent advancements in robust optimization for investment management. Ann Oper Res 266, 183–198 (2018). https://doi.org/10.1007/s10479-017-2573-5

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Keywords

  • Robust optimization
  • Asset allocation
  • Portfolio selection
  • Investment management