Fabio Caccioli, “Instabilities in portfolio optimization and regularization”

Tuesday November 4  2014
Scuola Normale Superiore
Aula Bianchi

Fabio Caccioli
University College London


We consider the problem of portfolio selection in presence of market impact, and we show that including a term which accounts for finite liquidity in portfolio optimization naturally mitigates the instabilities that arise in the estimation of coherent risk measures. This is because taking into account the impact of trading in the market is mathematically equivalent to introducing a regularization on the risk measure. We show that the impact function determines which regularizer is to be used, and we characterize the typical behavior of the optimal portfolio in the limit of large portfolio sizes for the case of Expected Shortfall.