Mean‐Semivariance Efficient Frontier: A Downside Risk Model for Portfolio Selection

An ongoing stream in financial analysis proposes mean‐semivariance in place of mean‐variance as an alternative approach to portfolio selection, since segments of investors are more averse to returns below the mean value than to deviations above and below the mean value. Accordingly, this paper searches for a stochastic programming model in which the portfolio semivariance is the objective function to be minimized subject to standard parametric constraints, which leads to the mean‐semivariance efficient frontier. The proposed model relies on an empirically tested basis, say, portfolio diversification and the empirical validity of Sharpe's beta regression equation relating each asset return to the market. From this basis, the portfolio semivariance matrix form is strictly mathematically derived, thus an operational quadratic objective function is obtained without resorting to heuristics. Ease of computation is highlighted by a numerical example, which allows one to compare the results from the proposed mean‐semivariance approach with those derived from the traditional mean‐variance model.

[1]  J. Neumann,et al.  Theory of Games and Economic Behavior. , 1945 .

[2]  W. Sharpe CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK* , 1964 .

[3]  R Burr Porter,et al.  Semivariance and Stochastic Dominance: A Comparison , 1974 .

[4]  P. Fishburn Mean-Risk Analysis with Risk Associated with Below-Target Returns , 1977 .

[5]  T. Copeland,et al.  Financial Theory and Corporate Policy. , 1980 .

[6]  J. Kallberg,et al.  Comparison of Alternative Utility Functions in Portfolio Selection Problems , 1983 .

[7]  Robert H. Jeffrey,et al.  A new paradigm for Portfolio risk , 1984 .

[8]  Philip H. Dybvig Short Sales Restrictions and Kinks on the Mean Variance Frontier , 1984 .

[9]  W. Sharpe,et al.  Mean-Variance Analysis in Portfolio Choice and Capital Markets , 1987 .

[10]  J. Ingersoll Theory of Financial Decision Making , 1987 .

[11]  H. Markowitz Mean—Variance Analysis , 1989 .

[12]  L. A. Balzer Measuring Investment Risk , 1994 .

[13]  F. Sortino,et al.  Performance Measurement in a Downside Risk Framework , 1994 .

[14]  David N. Nawrocki Portfolio analysis with a large universe of assets , 1996 .

[15]  Paul D. Kaplan,et al.  Semivariance in Risk-Based Index Construction , 1997 .

[16]  C. Romero,et al.  Multiple Criteria Decision Making and its Applications to Economic Problems , 1998 .

[17]  Enrique Ballestero,et al.  Approximating the optimum portfolio for an investor with particular preferences , 1998, J. Oper. Res. Soc..

[18]  Stephen E. Satchell,et al.  Statistical properties of the sample semi-variance , 2002 .

[19]  Prasanna Chandra,et al.  Investment Analysis and Portfolio Management , 2004 .