Multistage optimization of option portfolio using higher order coherent risk measures

Choosing a suitable risk measure to optimize an option portfolio’s performance represents a significant challenge. This paper is concerned with illustrating the advantages of Higher order coherent risk measures to evaluate option risk’s evolution. It discusses the detailed implementation of the resulting dynamic risk optimization problem using stochastic programming. We propose an algorithmic procedure to optimize an option portfolio based on minimization of conditional higher order coherent risk measures. Illustrative examples demonstrate some advantages in the performance of the portfolio’s levels when higher order coherent risk measures are used in the risk optimization criterion.

► We apply Higher Order Risk Measures (HORM) to optimization of an option portfolio. ► We illustrate the use of multistage risk averse optimization to the above problem. ► We apply the method for portfolio of European options using suitable scenarios. ► We demonstrate the striking improvements when HORM is used as a criterion.