Recursive risk measures under regime switching applied to portfolio selection

• Published in: Quantitative finance Vol. 17; no. 9; pp. 1457 - 1476
• Main Authors: Chen, Zhiping, Liu, Jia, Hui, Yongchang
• Format: Journal Article
• Language: English
• Published: Routledge 02-09-2017
• Subjects: Conditional value-at-risk; Dynamic portfolio selection; Factor model; Recursive risk measure; Regime switching; Time consistency
• ISSN: 1469-7688; 1469-7696
• DOI: 10.1080/14697688.2016.1267393

In this paper, we define the conditional risk measure under regime switching and derive a class of time consistent multi-period risk measures. To do so, we describe the information process with regime switching in a product space associated with the product of two filtrations. Moreover, we show how to establish the corresponding multi-stage portfolio selection models using the time consistent multi-period risk measure for medium-term or long-term investments. Take the conditional value-at-risk measure as an example, we demonstrate the resulting multi-stage portfolio selection problem can be transformed into a second-order cone programming problem. Finally, we carry out a series of empirical tests to illustrate the superior performance of the proposed random framework and the corresponding multi-stage portfolio selection model.