Portfolio Objectives for Simulated Returns on Undervalued and Overvalued Stocks

Summary

The document asks how to choose portfolio weights for stocks classified as undervalued or overvalued, given simulated return scenarios. It contrasts minimizing conditional Value at Risk, also called expected shortfall, with maximizing profit for a more risk-tolerant investor. It also raises using the upper quartile of each stock’s returns as a way to identify potentially profitable assets, while acknowledging that the undervalued and overvalued labels do not by themselves establish future price behavior.

No answer, optimization procedure, or empirical evidence is supplied, so the proposed intuition is not validated. Selecting assets by each stock’s best return quantile alone also leaves portfolio interactions and the investor’s full risk-return preference unspecified. The useful takeaway is the framing of competing objectives and the need to define a portfolio criterion; the document does not establish that either valuation group or a particular return quantile is a reliable allocation signal.

Key ideas

• The proposed portfolio problem uses simulated stock returns to select asset weights.
• Minimizing expected shortfall and maximizing profit express different risk preferences.
• The question considers upper-tail returns as a possible way to rank assets.
• Undervaluation and overvaluation alone do not determine future stock performance.
• The document provides no empirical test or optimization method to validate its proposed intuition.

Tags

# Opposite of Value-at-Risk. Criteria for Optimization


# Opposite of Value-at-Risk. Criteria for Optimization












I'm trying to optimize portfolio of undervalued and portfolio of overvalued stocks. I have simulated scenarios of stock returns, and based on them I would like to find optimal weights. One criteria is just to minimize Conditional Value-at-Risk (ES), another - maximize profit (for risky investor). The simple intuition is that risky investor would take overvalued stock because it may continue growing; the defensive one will take undervalued since they are less likely to go lower. (I see that this logic is very very far from perfect, nevertheless, it may have a chance to live). So, there are 2 main questions:

1)Does it make sense to take quantile for 25% highest returns for each stock, and based on this find "likely the most profitable" assets? (Something like an opposite for value at risk).

2)Are there any specific criteria for optimizing porfolio of only undervalued/overvalued stocks? I understand that the question is vague because under/overvalued doesn't imply any specific in behaviour of stock. However, maybe there are some, and I would be glad to hear them. Thank you in advance!

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.