Department of Industrial Engineering and Management Systems, Amirkabir University of Technology, P.O. Box 15875-4413, Tehran, Iran
This paper develops a multi-period portfolio optimization model that utilizes hedging decisions in a dynamic setting. In this regard, a portfolio of options and underlying stocks is constructed and different time-varying Greek letters are utilized to mitigate the market risk. The presented model considers rebalancing decisions during the planning horizon. It assumes an investor aiming to maximize his/her wealth at the end of the planning horizon, while controlling the investor’s regret during the planning horizon. The uncertainty of asset prices is represented in terms of a scenario tree. In addition, a scenario generation method is presented that characterizes the temporal correlations and dependence structure of asset returns. Also, it preserves marginal distributions of asset returns. To investigate the effect of hedging strategies, we first implement the scenario generation method on a set of stocks selected from New York Stock Exchange (NYSE). Numerical results show the high performance of the scenario generation method. Then, the multi-period portfolio optimization model is implemented via the generated scenario tree. Results show that incorporation of options remarkably reduces the investor’s risk. Finally, different hedging strategies are assessed by imposing bounds on the values of Greek letters and a discussion about numerical results is presented.