Application of Guided Local Search (GLS) in Portfolio Optimization

Portfolio optimization is a major activity in any operating business. Conventional portfolio optimization research makes simplifying assumptions; for example, they assume no constraint in how many assets one holds (cardinality constraint). They also assume no minimum and maximum holding sizes (holding size constraint). Once these assumptions are relaxed, conventional methods become inapplicable, and hence new methods are needed to tackle this challenge. Threshold Accepting is an established algorithm in the extended portfolio optimization problem. In this paper, an algorithm called Guided Local Search (GLS) is applied using an accurate and efficient designed hill climbing algorithm, named HC-C-R. GLS sitting on HC-C-R is for the purpose of solving the extended portfolio optimization problem. The improved hill climbing algorithm is tested on standard portfolio optimization problem. Results are compared (benchmarked) with the Threshold Accepting (TA) algorithm, a well-known algorithm for portfolio optimization and are also compared with its original algorithm HC-C-R. Results show that GLS sitting on HC-C-R is more effective than HC-C-R and the algorithms are more effective than TA. Keywords: Portfolio Optimization; Algorithm; Guided Local Search; GLS, Threshold Acceptanc

Efficient and Simple Heuristic Algorithm for Portfolio Optimization

Markowitz model considers what is termed as standard portfolio optimization. The portfolio optimization problem is a problem which based on asset allocation and diversification for maximum return with minimum risk. Thus, the standard portfolio optimization problem happens when the constraints considered are budget and no-short selling. In reality however, portfolio optimization has realistic constraints to be incorporated such as holding sizes, cardinality and transaction cost. When realistic constraints are added into portfolio optimization problem, it becomes too complex to be solved by standard optimization methods which in this case turns to be an extended portfolio optimization problem. Markowitz solution and the standard methods like quadratic programming become inapplicable. With such limitation, heuristic methods are usually used to deal with this extended portfolio optimization problem. Therefore, this paper proposes a heuristic algorithm for the extended portfolio optimization problem. It is a hill climbing algorithm named Hill Climbing Simple (HC-S) which is then validated by solving the standard Markowitz model. In fact, the proposed algorithm is benchmarked with the quadratic programming (QP), which is a standard method. By benchmarking HC-S with QP, it showed that HC-S can attains similar accurate solutions. Also, HC-S demonstrated to be more effective and efficient than threshold accepting (TA), an established algorithm for portfolio optimization since HC-S find solutions with significant higher objective value and require less computing time as compared to standard methods

Differential Evolution for Multiobjective Portfolio Optimization

Financial portfolio optimization is a challenging problem. First, the problem is multiobjective (i.e.: minimize risk and maximize profit) and the objective functions are often multimodal and non smooth (e.g.: value at risk). Second, managers have often to face real-world constraints, which are typically non-linear. Hence, conventional optimization techniques, such as quadratic programming, cannot be used. Stochastic search heuristic can be an attractive alternative. In this paper, we propose a new multiobjective algorithm for portfolio optimization: DEMPO - Differential Evolution for Multiobjective Portfolio Optimization. The main advantage of this new algorithm is its generality, i.e., the ability to tackle a portfolio optimization task as it is, without simplifications. Our empirical results show the capability of our approach of obtaining highly accurate results in very reasonable runtime, in comparison with quadratic programming and another state-of-art search heuristic, the so-called NSGA II.Portfolio Optimization, Multiobjective, Real-world Constraints, Value at Risk, Expected Shortfall, Differential Evolution

Belief Propagation Algorithm for Portfolio Optimization Problems

The typical behavior of optimal solutions to portfolio optimization problems with absolute deviation and expected shortfall models using replica analysis was pioneeringly estimated by S. Ciliberti and M. M\'ezard [Eur. Phys. B. 57, 175 (2007)]; however, they have not yet developed an approximate derivation method for finding the optimal portfolio with respect to a given return set. In this study, an approximation algorithm based on belief propagation for the portfolio optimization problem is presented using the Bethe free energy formalism, and the consistency of the numerical experimental results of the proposed algorithm with those of replica analysis is confirmed. Furthermore, the conjecture of H. Konno and H. Yamazaki, that the optimal solutions with the absolute deviation model and with the mean-variance model have the same typical behavior, is verified using replica analysis and the belief propagation algorithm.Comment: 5 pages, 2 figures, to submit to EP

An Evolutionary Approach to Multistage Portfolio Optimization

Portfolio optimization is an important problem in quantitative finance due to its application in asset management and corporate financial decision making. This involves quantitatively selecting the optimal portfolio for an investor given their asset return distribution assumptions, investment objectives and constraints. Analytical portfolio optimization methods suffer from limitations in terms of the problem specification and modelling assumptions that can be used. Therefore, a heuristic approach is taken where Monte Carlo simulations generate the investment scenarios and' a problem specific evolutionary algorithm is used to find the optimal portfolio asset allocations. Asset allocation is known to be the most important determinant of a portfolio's investment performance and also affects its risk/return characteristics. The inclusion of equity options in an equity portfolio should enable an investor to improve their efficient frontier due to options having a nonlinear payoff. Therefore, a research area of significant importance to equity investors, in which little research has been carried out, is the optimal asset allocation in equity options for an equity investor. A purpose of my thesis is to carry out an original analysis of the impact of allowing the purchase of put options and/or sale of call options for an equity investor. An investigation is also carried out into the effect ofchanging the investor's risk measure on the optimal asset allocation. A dynamic investment strategy obtained through multistage portfolio optimization has the potential to result in a superior investment strategy to that obtained from a single period portfolio optimization. Therefore, a novel analysis of the degree of the benefits of a dynamic investment strategy for an equity portfolio is performed. In particular, the ability of a dynamic investment strategy to mimic the effects ofthe inclusion ofequity options in an equity portfolio is investigated. The portfolio optimization problem is solved using evolutionary algorithms, due to their ability incorporate methods from a wide range of heuristic algorithms. Initially, it is shown how the problem specific parts ofmy evolutionary algorithm have been designed to solve my original portfolio optimization problem. Due to developments in evolutionary algorithms and the variety of design structures possible, a purpose of my thesis is to investigate the suitability of alternative algorithm design structures. A comparison is made of the performance of two existing algorithms, firstly the single objective stepping stone island model, where each island represents a different risk aversion parameter, and secondly the multi-objective Non-Dominated Sorting Genetic Algorithm2. Innovative hybrids of these algorithms which also incorporate features from multi-objective evolutionary algorithms, multiple population models and local search heuristics are then proposed. . A novel way is developed for solving the portfolio optimization by dividing my problem solution into two parts and then applying a multi-objective cooperative coevolution evolutionary algorithm. The first solution part consists of the asset allocation weights within the equity portfolio while the second solution part consists 'ofthe asset allocation weights within the equity options and the asset allocation weights between the different asset classes. An original portfolio optimization multiobjective evolutionary algorithm that uses an island model to represent different risk measures is also proposed.Imperial Users onl

A method for selecting an effective investment project portfolio

A new algorithm for selecting an effective investment project portfolio from a collection of projects developed by a company has been presented in this paper. The problem of selecting an investment project was formulated as multi-objective optimization problem. The algorithm is suited for enterprises with multistage production cycles, e.g. enterprises in the metallurgical or chemical industry. During the selection process the method takes into account statistical and economic interdependencies existing among projects. Upon choosing projects the algorithm takes into account twp criteria: maximization of the expected NPV and minimization of project portfolio risk. A company may develop an effective investment project portfolio for a few years ahead. The algorithm makes it possible to search for Pareto optimal solutions. It links computer simulation methods with a genetic algorithm and standard procedure for linear optimization. An example of the use of the algorithm for selecting projects in the metallurgical industry is presented.mathematical programming, portfolio selection, risk, simulation