Robust Portfolio Optimization Under Multi-Factor Stochastic Volatility

Summary

The paper derives an optimal robust portfolio strategy for investors facing uncertainty about a multi-factor stochastic volatility model. It considers portfolios with and without derivatives and formulates the strategy under a worst-case scenario, making model ambiguity part of the allocation decision. The study also compares the robust strategy with alternatives that ignore uncertainty and assesses the resulting welfare effects.

Further analyses examine how derivative trading changes portfolio selection and extend the framework to asset-price jumps and correlated volatility factors. Numerical experiments illustrate portfolio behavior and utility loss. The abstract does not report specific parameter choices, data, or quantitative results, so it offers a description of the framework rather than enough detail to judge its empirical performance or practical implementation.

Key ideas

• The paper derives robust portfolio choices under a multi-factor stochastic volatility model.
• It compares decisions made under model ambiguity with strategies that disregard uncertainty.
• The analysis includes cases with and without derivative trading.
• Extensions consider price jumps and correlation among volatility factors.
• Numerical experiments illustrate portfolio behavior and utility loss.

Tags

# Robust portfolio optimization with multi-factor stochastic volatility


# Robust portfolio optimization with multi-factor stochastic volatility









This paper studies a robust portfolio optimization problem under the multi-factor volatility model introduced by Christoffersen et al. (2009). The optimal strategy is derived analytically under the worst-case scenario with or without derivative trading. To illustrate the effects of ambiguity, we compare our optimal robust strategy with some strategies that ignore the information of uncertainty, and provide the corresponding welfare analysis. The effects of derivative trading to the optimal portfolio selection are also discussed by considering alternative strategies. Our study is further extended to the cases with jump risks in asset price and correlated volatility factors, respectively. Numerical experiments are provided to demonstrate the behavior of the optimal portfolio and utility loss.

Shown in full with attribution under the source's licence. Licence: abstract CC0

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