Portfolio Optimization with Entropic Value-at-Risk

The entropic value-at-risk (EVaR) is a new coherent risk measure, which is an upper bound for both the value-at-risk (VaR) and conditional value-at-risk (CVaR). As important properties, the EVaR is strongly monotone over its domain and strictly monotone over a broad sub-domain including all continuous distributions, while well-known monotone risk measures, such as VaR and CVaR lack these properties. A key feature for a risk measure, besides its financial properties, is its applicability in large-scale sample-based portfolio optimization. If the negative return of an investment portfolio is a differentiable convex function, the portfolio optimization with the EVaR results in a differentiable convex program whose number of variables and constraints is independent of the sample size, which is not the case for the VaR and CVaR. This enables us to design an efficient algorithm using differentiable convex optimization. Our extensive numerical study shows the high efficiency of the algorithm in large scales, compared to the existing convex optimization software packages. The computational efficiency of the EVaR portfolio optimization approach is also compared with that of CVaR-based portfolio optimization. This comparison shows that the EVaR approach generally performs similarly, and it outperforms as the sample size increases. Moreover, the comparison of the portfolios obtained for a real case by the EVaR and CVaR approaches shows that the EVaR approach can find portfolios with better expectations and VaR values at high confidence levels.

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