[R-SIG-Finance] Réf. : Re: solve.QP (for portfolio optimization)

Christian Prinoth Christian.Prinoth at epsilonsgr.it
Wed Jan 10 15:16:33 CET 2007


IMHO opinion, the concept of correlation is not so useful in this context. I think that if you wish to contain overall variance you are much better off trying to contain risk exposures (eg, net sector exposure etc.), than trying to offset correlations (or betas!) between different assets, since those are way too unstable.

Christian Prinoth
cp at epsilonsgr.it
+39-0288102355


> -----Original Message-----
> From: guillaume.nicoulaud at halbis.com
> [mailto:guillaume.nicoulaud at halbis.com]
> Sent: Wednesday, 10 January, 2007 15:04
> To: Christian Prinoth
> Cc: r-sig-finance at stat.math.ethz.ch;
> r-sig-finance-bounces at stat.math.ethz.ch
> Subject: Réf. : Re: [R-SIG-Finance] solve.QP (for portfolio
> optimization)
>
> --- about Christian's two-step approach ---
>
> I've tryed this. The issue is that provided we want to
> minimize the *overall* portfolio variance we have to manage
> potential correlations between longs and shorts (e.g. if some
> of your longs are "anti-correlated" - is that the correct word?
> - with some of your shorts). In my tests, simple equally
> weighted portfolios are less volatiles.
>
> --- Brian wrote ---
> " Markowitz style optimization will try to minimize variance
> across the entire portfolio.  You *want* the short portfolio
> to decline in value, as much as possible. "
>
> I agree. Yet I could think the same way for my long
> portfolio: I want these stocks to increase in value as much
> as possible.
> So in the end the question is about minimizing variance in
> general [or not]. At the moment, this is what I'm trying to
> do (also I agree with your concerns on Markowitz-like
> frameworks and will keep your suggestions in mind).
>
> G
>
>
>
>
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>                                                         Pour
> :   <r-sig-finance at stat.math.ethz.ch>                        
>                                                         cc : 
>                                                             
>                                                         Objet
> :  Re: [R-SIG-Finance] solve.QP (for portfolio optimization)
>              "Christian Prinoth"                             
>                                                             
>              <Christian.Prinoth at epsilonsgr.it>               
>                                                             
>              Envoyé par :                                    
>                                                             
>              r-sig-finance-bounces at stat.math.ethz.           
>                                                             
>              ch                                              
>                                                             
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>                                                             
>              10/01/2007 14:35                                
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>
>
>
> If the goal is to build some kind of market neutral position,
> one could also take a 2-step approach:
>
> 1) build an optimized long portfolio that maximizes some
> score\expected return\whatever
> 2) build a short portfolio that minimizes that same score,
> while constraining risk exposure (however defined) to be
> similar to that of the long portfolio.
>
> This way it is easier to specify leverage, number of positions etc.
>
> Christian Prinoth
> cp at epsilonsgr.it
> +39-0288102355
>
>
> > -----Original Message-----
> > From: r-sig-finance-bounces at stat.math.ethz.ch
> > [mailto:r-sig-finance-bounces at stat.math.ethz.ch] On Behalf
> Of Brian G.
> > Peterson
> > Sent: Wednesday, 10 January, 2007 14:06
> > To: r-sig-finance at stat.math.ethz.ch
> > Subject: Re: [R-SIG-Finance] solve.QP (for portfolio optimization)
> >
> > On Wednesday 10 January 2007 06:26,
> > guillaume.nicoulaud at halbis.com wrote:
> > > --- Brian wrote ---
> > >
> > > "You may find, as many others in the optimization
> literature have,
> > > that the short portfolio requires a different optimization
> > approach."
> > >
> > > I did... and it actually doesn't work! That's why I would like to
> > > optimize the whole portfolio instead of doing this
> > separatly for longs
> > > and shorts (in a Markowitz-like framework *for now*).
> >
> > Markowitz style optimization will try to minimize variance
> across the
> > entire portfolio.  You *want* the short portfolio to
> decline in value,
> > as much as possible.
> >
> > While it should be possible to constrain individual
> instruments to be
> > on the short portfolio, I haven't worked with the solve.QP function
> > constraints in enough detail to give you any pointers there, and I
> > don't think a minimum variance portfolio is really what you want.
> >
> > Perhaps you can be a little more specific on the problems
> you had with
> > trying to optimize the long and short portfolios separately?
> >
> > I'll give a couple examples of approaches that could work well for
> > your short portfolio (your exact circumstances will vary
> based on the
> > instruments you're constructing a portfolio over, of
> course).  In your
> > short portfolio, you have previously made some forecast that the
> > instruments in the short portfolio will decline in value. 
> You need to
> > make some decision about how much to short, from the limits
> you have
> > on total short positions in your portfolio. One method of
> choosing how
> > much to short is based on your confidence in your price
> target: higher
> > confidence equals a larger short position.  Another method
> is to use
> > some other appropriate measure of risk, like downside deviation or
> > average
> > drawdown: larger [downside risk measure] equals larger
> short position,
> > because the instrument tends to move further down in price.
> >
> > Regards,
> >
> >    - Brian
> >
> > --
> > http://braverock.com/brian/resume-quant.pdf
> >
> > _______________________________________________
> > R-SIG-Finance at stat.math.ethz.ch mailing list
> > https://stat.ethz.ch/mailman/listinfo/r-sig-finance
> >
>
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