Inverse Optimization of Convex Risk Functions
Abstract
The theory of convex risk functions has now been well established as the basis for identifying the families of risk functions that should be used in risk averse optimization problems. Despite its theoretical appeal, the implementation of a convex risk function remains difficult, as there is little guidance regarding how a convex risk function should be chosen so that it also well represents one's own risk preferences. In this paper, we address this issue through the lens of inverse optimization. Specifically, given solution data from some (forward) riskaverse optimization problems we develop an inverse optimization framework that generates a risk function that renders the solutions optimal for the forward problems. The framework incorporates the wellknown properties of convex risk functions, namely, monotonicity, convexity, translation invariance, and law invariance, as the general information about candidate risk functions, and also the feedbacks from individuals, which include an initial estimate of the risk function and pairwise comparisons among random losses, as the more specific information. Our framework is particularly novel in that unlike classical inverse optimization, no parametric assumption is made about the risk function, i.e. it is nonparametric. We show how the resulting inverse optimization problems can be reformulated as convex programs and are polynomially solvable if the corresponding forward problems are polynomially solvable. We illustrate the imputed risk functions in a portfolio selection problem and demonstrate their practical value using reallife data.
 Publication:

arXiv eprints
 Pub Date:
 July 2016
 arXiv:
 arXiv:1607.07099
 Bibcode:
 2016arXiv160707099Y
 Keywords:

 Mathematics  Optimization and Control;
 Quantitative Finance  Computational Finance;
 Quantitative Finance  Mathematical Finance;
 Quantitative Finance  Risk Management