CAPM-like formulae and good deal absence with ambiguous setting and coherent risk measure

Risk measures beyond the variance have shown theoretical advantages when addressing some classical problems of Financial Economics, at least if asymmetries and/or heavy tails are involved. Nevertheless, in portfolio selection they have provoked several caveats such as the existence of good deals in most of the arbitrage free pricing models. In other words, models such as Black and Scholes or Heston allow investors to build sequences of strategies whose expected return tends to in nite and whose risk remains bounded or tends to minus in nite. This paper studies whether this drawback still holds if the investor is facing the presence of multiple priors, as well as the properties of optimal portfolios in a good deal free ambiguous framework. With respect to the rst objective, we show that there are four possible results. If the investor uncertainty is too high he/she has no incentives to buy risky assets. As the uncertainty (set of priors) decreases the interest in risky securities increases. If her/his uncertainty becomes too low then two types of good deal may arise. Consequently, there is a very important di¤erence between the ambiguous and the non ambiguous setting. Under ambiguity the investor uncertainty may increase in such a manner that the model becomes good deal free and presents a market price of risk as close as possible to that re ected by the investor empirical evidence. Hence, ambiguity may help to overcome some meaningless ndings in asset pricing. With respect to our second objective, good deal free ambiguous models imply the existence of a benchmark generating a robust capital market line. The robust (worst-case) risk of every strategy may be divided into systemic and speci c, and no robust return is paid by the speci c robust risk. A couple of betas may be associated with every strategy, and extensions of the CAPM most important formulas will be proved.Partially supported by "RD-Sistemas S.A", Welzia Management SGIIC SA and "MICINN" (Spain, Grant ECO2009-14457-C04

Ambiguity in asset pricing and portfolio choice: a review of the literature

A growing body of empirical evidence suggests that investors’ behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.Capital assets pricing model ; Investments

Data-driven Distributionally Robust Optimization Using the Wasserstein Metric: Performance Guarantees and Tractable Reformulations

We consider stochastic programs where the distribution of the uncertain parameters is only observable through a finite training dataset. Using the Wasserstein metric, we construct a ball in the space of (multivariate and non-discrete) probability distributions centered at the uniform distribution on the training samples, and we seek decisions that perform best in view of the worst-case distribution within this Wasserstein ball. The state-of-the-art methods for solving the resulting distributionally robust optimization problems rely on global optimization techniques, which quickly become computationally excruciating. In this paper we demonstrate that, under mild assumptions, the distributionally robust optimization problems over Wasserstein balls can in fact be reformulated as finite convex programs---in many interesting cases even as tractable linear programs. Leveraging recent measure concentration results, we also show that their solutions enjoy powerful finite-sample performance guarantees. Our theoretical results are exemplified in mean-risk portfolio optimization as well as uncertainty quantification.Comment: 42 pages, 10 figure

Theory and Applications of Robust Optimization

In this paper we survey the primary research, both theoretical and applied, in the area of Robust Optimization (RO). Our focus is on the computational attractiveness of RO approaches, as well as the modeling power and broad applicability of the methodology. In addition to surveying prominent theoretical results of RO, we also present some recent results linking RO to adaptable models for multi-stage decision-making problems. Finally, we highlight applications of RO across a wide spectrum of domains, including finance, statistics, learning, and various areas of engineering.Comment: 50 page

Bank competition and financial stability

Under the traditional"competition-fragility"view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative"competition-stability"view, more market power in the loan market may result in greater bank risk as the higher interest rates charged to loan customers make it more difficult to repay loans and exacerbate moral hazard and adverse selection problems. But even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. The authors test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8,235 banks in 23 developed nations. The results suggest that - consistent with the traditional"competition-fragility"view - banks with a greater degree of market power also have less overall risk exposure. The data also provide some support for one element of the"competition-stability"view - that market power increases loan portfolio risk. The authors show that this risk may be offset in part by higher equity capital ratios.Banks&Banking Reform,Debt Markets,Access to Finance,,Markets and Market Access