We are grateful for valuable suggestions from the editor, Gerald D. Gay, and an anonymous referee that greatly improved the quality of this article. We also thank Turan G. Bali for valuable comments on an earlier version of this article.
OPTIMAL PORTFOLIO SELECTION WITH A SHORTFALL PROBABILITY CONSTRAINT: EVIDENCE FROM ALTERNATIVE DISTRIBUTION FUNCTIONS
Article first published online: 18 MAR 2010
© 2010 The Southern Finance Association and the Southwestern Finance Association
Journal of Financial Research
Volume 33, Issue 1, pages 77–102, Spring 2010
How to Cite
Akcay, Y. and Yalcin, A. (2010), OPTIMAL PORTFOLIO SELECTION WITH A SHORTFALL PROBABILITY CONSTRAINT: EVIDENCE FROM ALTERNATIVE DISTRIBUTION FUNCTIONS. Journal of Financial Research, 33: 77–102. doi: 10.1111/j.1475-6803.2009.01263.x
- Issue published online: 18 MAR 2010
- Article first published online: 18 MAR 2010
We propose a new approach to optimal portfolio selection in a downside risk framework that allocates assets by maximizing expected return subject to a shortfall probability constraint, reflecting the typical desire of a risk-averse investor to limit the maximum likely loss. Our empirical results indicate that the loss-averse portfolio outperforms the widely used mean-variance approach based on the cumulative cash values, geometric mean returns, and average risk-adjusted returns. We also evaluate the relative performance of the loss-averse portfolio with normal, symmetric thin-tailed, symmetric fat-tailed, and skewed fat-tailed return distributions in terms of average return, risk, and average risk-adjusted return.