Dynamic Tracking Error with Shortfall Control Using Stochastic Programming

Abstract

In this contribution we propose a dynamic tracking error problem and we consider the problem of monitoring at discrete point the shortfall of the portfolio below a set of given reference levels of wealth. We formulate and solve the resulting dynamic optimization problem using stochastic programming. The resulting problem allows for a great flexibility in the combination of a tracking goal and a downside risk protection through a discrete monitoring of the shortfalls. We provide the results of a out-of-sample simulation experiments, on real data, for different portfolio configurations and different market conditions.