Can switching between risk measures lead to better portfolio optimization?

Abstract

This article proposes a technique that involves switching between risk measures in different market environments, to capture the well-documented dynamic nature of risk within a portfolio optimization setting. In-sample results show categorically that switching between various measures, such as CVaR, time-varying (GARCH) variances and simple standard deviations, can lead to a better performance than using any single measure. Using a logistic probability model to determine when to switch between alternatives, out-of -sample results also show positive results. Given that this study only applies a basic switching system, it lends itself to easy application by practitioners through its simplicity, intuitive appeal and computational feasibility.