Active allocation of systematic risk and control of risk sensitivity in portfolio optimization

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

7 Scopus Citations
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  • Yingjie Li
  • Shushang Zhu
  • Donghui Li
  • Duan Li


Original languageEnglish
Pages (from-to)556-570
Journal / PublicationEuropean Journal of Operational Research
Issue number3
Online published20 Feb 2013
Publication statusPublished - 1 Aug 2013
Externally publishedYes


Portfolio risk can be decomposed into two parts, the systematic risk and the nonsystematic risk. It is well known that the nonsystematic risk can be eliminated by diversification, while the systematic risk cannot. Thus, the portfolio risk, except for that of undiversified small portfolios, is always dominated by the systematic risk. In this paper, under the mean-variance framework, we propose a model for actively allocating the systematic risk in portfolio optimization, which can also be interpreted as a model of controlling risk sensitivity in portfolio selection. Although the resulting problem is, in general, a notorious non-convex quadratically constrained quadratic program, the problem formulation is of some special structures due to the features of the defined marginal systematic risk contribution and the way to model the systematic risk via a factor model. By exploiting such special problem characteristics, we design an efficient and globally convergent branch-and-bound solution algorithm, based on a second-order cone relaxation. While empirical study demonstrates that the proposed model is a preferred tool for active portfolio risk management, numerical experiments also show that the proposed solution method is more efficient when compared to the commercial software BARON.

Research Area(s)

  • Branch-and-bound, Factor model, Risk sensitivity, Second-order cone program, Systematic risk