Robust ranking and portfolio optimization

The portfolio optimization problem has attracted researchers from many disciplines to resolve the issue of poor out-of-sample performance due to estimation errors in the expected returns. A popular method is to use assets' ordering information, expressed in the form of preferences over the stocks, instead of the exact expected returns for portfolio construction. Motivating from the fact that the ranking itself is often described with uncertainty, we introduce a generic robust ranking model and apply it to portfolio optimization. In this problem, there are n objects whose ranking R is in a discrete uncertainty set. We want to find a weight vector w that maximizes some generic objective function f(w, R) for the worst realization of the ranking. This robust ranking problem is a mixed integer minimax problem and is very difficult to solve in general. We apply the column generation method, where constraints are efficiently generated by solving a network flow problem, to solve this robust ranking problem. For empirical tests, we use post announcement earning drifts to obtain ranking uncertainty set for stocks in the DJIA index. We show our robust portfolios produce smaller risk and higher Sharpe ratios compared to their nonrobust counterparts. (This is a joint work with Andrew Lo at MIT.) Biography Dr. Nguyen is a visiting research assistant professor at the Department of Civil and Environmental Engineering at UIUC. He holds a B.Eng. in Software Systems Engineering from RMIT in Australia in 2002, an MS in High Performance Computation for Engineered Systems from Singapore-MIT Alliance in 2004 and a Ph.D. in Operations Research from MIT in June 2009. Dr. Nguyen is interested in applying Operations Research to a wide range of applications that include complex system modeling, robust statistical analysis, transportation, and quantitative finance (portfolio optimization, hedge fund strategies). He is currently working on a biofuel development project to study the complex engineered systems and their interplay with the natural environment and social-economic factors. Dr. Nguyen is a finalist in the INFORMS Nicholson Student Paper Competition in 2008. He has worked for some financial firms (Credit Suisse, Fidelity) and IT and logistics firms (FujitsuSiemens, PSA, ATCRC). Location: 101 Transportation Building Date: Thursday, December 3, 2009 Time: 4-5 p.m.