Article ID: | iaor19991838 |
Country: | United States |
Volume: | 44 |
Issue: | 5 |
Start Page Number: | 673 |
End Page Number: | 683 |
Publication Date: | May 1998 |
Journal: | Management Science |
Authors: | Young Martin R. |
Keywords: | investment, values, optimization |
A new principle for choosing portfolios based on historical returns data is introduced; the optimal portfolio based on this principle is the solution to a simple linear programming problem. This principle uses minimum return rather than variance as a measure of risk. In particular, the portfolio is chosen that minimizes the maximum loss over all past observation periods, for a given level of return. This objective function avoids the logical problems of a quadratic (nonmonotone) utility function implied by mean-variance portfolio selection rules. The resulting minimax portfolios are diversified; for normal returns data, the portfolios are nearly equivalent to those chosen by a mean-variance rule. Framing the portfolio selection process as a linear optimization problem also makes it feasible to constrain certain decision variables to be integer, or 0–1, valued; this feature facilitates the use of more complex decision-making models, including models with fixed transaction charges and models with Boolean-type constraints on allocations.