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Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model

Investors wish to obtain the best trade-off between the return and risk. In portfolio optimization, the mean-absolute deviation model has been used to achieve the target rate of return and minimize the risk. However, the maximization of entropy is not considered in the mean-absolute deviation model...

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Autores principales: Lam, Weng Siew, Lam, Weng Hoe, Jaaman, Saiful Hafizah
Formato: Online Artículo Texto
Lenguaje:English
Publicado: MDPI 2021
Materias:
Acceso en línea:https://www.ncbi.nlm.nih.gov/pmc/articles/PMC8534353/
https://www.ncbi.nlm.nih.gov/pubmed/34681990
http://dx.doi.org/10.3390/e23101266
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author Lam, Weng Siew
Lam, Weng Hoe
Jaaman, Saiful Hafizah
author_facet Lam, Weng Siew
Lam, Weng Hoe
Jaaman, Saiful Hafizah
author_sort Lam, Weng Siew
collection PubMed
description Investors wish to obtain the best trade-off between the return and risk. In portfolio optimization, the mean-absolute deviation model has been used to achieve the target rate of return and minimize the risk. However, the maximization of entropy is not considered in the mean-absolute deviation model according to past studies. In fact, higher entropy values give higher portfolio diversifications, which can reduce portfolio risk. Therefore, this paper aims to propose a multi-objective optimization model, namely a mean-absolute deviation-entropy model for portfolio optimization by incorporating the maximization of entropy. In addition, the proposed model incorporates the optimal value of each objective function using a goal-programming approach. The objective functions of the proposed model are to maximize the mean return, minimize the absolute deviation and maximize the entropy of the portfolio. The proposed model is illustrated using returns of stocks of the Dow Jones Industrial Average that are listed in the New York Stock Exchange. This study will be of significant impact to investors because the results show that the proposed model outperforms the mean-absolute deviation model and the naive diversification strategy by giving higher a performance ratio. Furthermore, the proposed model generates higher portfolio mean returns than the MAD model and the naive diversification strategy. Investors will be able to generate a well-diversified portfolio in order to minimize unsystematic risk with the proposed model.
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spelling pubmed-85343532021-10-23 Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model Lam, Weng Siew Lam, Weng Hoe Jaaman, Saiful Hafizah Entropy (Basel) Article Investors wish to obtain the best trade-off between the return and risk. In portfolio optimization, the mean-absolute deviation model has been used to achieve the target rate of return and minimize the risk. However, the maximization of entropy is not considered in the mean-absolute deviation model according to past studies. In fact, higher entropy values give higher portfolio diversifications, which can reduce portfolio risk. Therefore, this paper aims to propose a multi-objective optimization model, namely a mean-absolute deviation-entropy model for portfolio optimization by incorporating the maximization of entropy. In addition, the proposed model incorporates the optimal value of each objective function using a goal-programming approach. The objective functions of the proposed model are to maximize the mean return, minimize the absolute deviation and maximize the entropy of the portfolio. The proposed model is illustrated using returns of stocks of the Dow Jones Industrial Average that are listed in the New York Stock Exchange. This study will be of significant impact to investors because the results show that the proposed model outperforms the mean-absolute deviation model and the naive diversification strategy by giving higher a performance ratio. Furthermore, the proposed model generates higher portfolio mean returns than the MAD model and the naive diversification strategy. Investors will be able to generate a well-diversified portfolio in order to minimize unsystematic risk with the proposed model. MDPI 2021-09-28 /pmc/articles/PMC8534353/ /pubmed/34681990 http://dx.doi.org/10.3390/e23101266 Text en © 2021 by the authors. https://creativecommons.org/licenses/by/4.0/Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (https://creativecommons.org/licenses/by/4.0/).
spellingShingle Article
Lam, Weng Siew
Lam, Weng Hoe
Jaaman, Saiful Hafizah
Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title_full Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title_fullStr Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title_full_unstemmed Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title_short Portfolio Optimization with a Mean–Absolute Deviation–Entropy Multi-Objective Model
title_sort portfolio optimization with a mean–absolute deviation–entropy multi-objective model
topic Article
url https://www.ncbi.nlm.nih.gov/pmc/articles/PMC8534353/
https://www.ncbi.nlm.nih.gov/pubmed/34681990
http://dx.doi.org/10.3390/e23101266
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