Multiobjective Financial Portfolio Design: A Hybrid Evolutionary Approach

Abstract

A principal challenge in modern computational finance is efficient portfolio design - portfolio optimization followed by decision-making. Optimization based on even the widely used Markowitz two-objective mean-variance approach becomes computationally challenging for real-life portfolios. Practical portfolio design introduces further complexity as it requires the optimization of multiple return and risk measures subject to a variety of risk and regulatory constraints. Further, some of these measures may be nonlinear and nonconvex, presenting a daunting challenge to conventional optimization approaches. We introduce a powerful hybrid multiobjective optimization approach that combines evolutionary computation with linear programming to simultaneously maximize these return measures, minimize these risk measures, and identify the efficient frontier of portfolios that satisfy all constraints. We also present a novel interactive graphical decision-making method that allows the decision-maker to quickly down-select to a small subset of efficient portfolios. The approach has been tested on real-life portfolios with hundreds to thousands of assets, and is currently being used for investment decision-making in industry.