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Roy’s Safety-First Portfolio Principle in Financial Risk Management of Disastrous Events
Company: Risk Analysis
Company Url: Click here to open
Year Of Publication: 2012
Month Of Publication: February
Resource Link: Click here to open
Download Count: 0
View Count: 771
Comment Num: 0
Language: English
Source: article
Who Can Read: Free
Date: 2-16-2012
Publisher: Administrator
Summary
The safety-first principle advocates an optimal portfolio strategy generated from minimizing the disaster probability, while subject to the budget constraint and the mean constraint that the expected final wealth is not less than a preselected disaster level. This article studies the dynamic safety-first principle in continuous time and its application in asset and liability management. We reveal that the distortion resulting from dropping the mean constraint, as a common practice to approximate the original Roy’s setting, either leads to a trivial case or changes the problem nature completely to a target-reaching problem, which produces a highly leveraged trading strategy. Recognizing the ill-posed nature of the corresponding Lagrangian method when retaining the mean constraint, we modify the original safety-first formulation by imposing an upper bound on the funding level. This model revision enables us to solve completely the safety-first asset-liability problem by a martingale approach and to derive an optimal policy that follows faithfully the spirit of the safety-first principle and demonstrates a prominent nature of fighting
Author(s)
Wong, Hoi Ying Sign in to follow this author
Li, Duan Sign in to follow this author
Chiu, Mei Choi Sign in to follow this author
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