CVaR Regression Based on the Relation between CVaR and Mixed-Quantile Quadrangles

• Main Authors: Alex Golodnikov, Viktor Kuzmenko, Stan Uryasev
• Format: Article
• Language: English
• Published: MDPI AG 2019-06-01
• Series: Journal of Risk and Financial Management
• Subjects: quantile; VaR; quadrangle; CVaR; conditional value-at-risk; expected shortfall; ES; superquantile; deviation; risk; error; regret; minimization; CVaR estimation; regression; linear regression; linear programming; portfolio safeguard; PSG
• Online Access: https://www.mdpi.com/1911-8074/12/3/107

A popular risk measure, conditional value-at-risk (CVaR), is called expected shortfall (ES) in financial applications. The research presented involved developing algorithms for the implementation of linear regression for estimating CVaR as a function of some factors. Such regression is called CVaR (superquantile) regression. The main statement of this paper is: CVaR linear regression can be reduced to minimizing the Rockafellar error function with linear programming. The theoretical basis for the analysis is established with the quadrangle theory of risk functions. We derived relationships between elements of CVaR quadrangle and mixed-quantile quadrangle for discrete distributions with equally probable atoms. The deviation in the CVaR quadrangle is an integral. We present two equivalent variants of discretization of this integral, which resulted in two sets of parameters for the mixed-quantile quadrangle. For the first set of parameters, the minimization of error from the CVaR quadrangle is equivalent to the minimization of the Rockafellar error from the mixed-quantile quadrangle. Alternatively, a two-stage procedure based on the decomposition theorem can be used for CVaR linear regression with both sets of parameters. This procedure is valid because the deviation in the mixed-quantile quadrangle (called mixed CVaR deviation) coincides with the deviation in the CVaR quadrangle for both sets of parameters. We illustrated theoretical results with a case study demonstrating the numerical efficiency of the suggested approach. The case study codes, data, and results are posted on the website. The case study was done with the Portfolio Safeguard (PSG) optimization package, which has precoded risk, deviation, and error functions for the considered quadrangles.