Quotation Rudloff, Birgit, Street, Alexandre, Valladão, Davi. 2014. Time consistency and risk averse dynamic decision models: Definition, interpretation and practical consequences. European Journal of Operational Research 234 (3): S. 743-750.


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Abstract

This paper aims at resolving a major obstacle to practical usage of time- consistent risk-averse decision models. The recursive objective function, generally used to ensure time consistency, is complex and has no clear/direct interpretation. Practitioners rather choose a simpler and more intuitive formulation, even though it may lead to a time inconsistent policy. Based on rigorous mathematical foundations, we impel practical usage of time consistent models as we provide practitioners with an intuitive economic interpretation for the referred recursive objective function. We also discourage time-inconsistent models by arguing that the associated policies are suboptimal. We developed a new methodology to compute the sub-optimality gap associated with a time-inconsistent policy, providing practitioners with an objective method to quantify practical consequences of time inconsistency. Our results hold for a quite general class of problems and we choose, without loss of generality, a CVaR-based portfolio selection application to illustrate the developed concepts.

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Publication's profile

Status of publication Published
Affiliation WU
Type of publication Journal article
Journal European Journal of Operational Research (EJOR)
Citation Index SCI
WU Journalrating 2009 A
WU-Journal-Rating new FIN-A, INF-A, STRAT-A, WH-A
Language English
Title Time consistency and risk averse dynamic decision models: Definition, interpretation and practical consequences
Volume 234
Number 3
Year 2014
Page from 743
Page to 750
Reviewed? Y
URL http://www.optimization-online.org/DB_FILE/2010/12/2860.pdf
DOI http://dx.doi.org/10.1016/j.ejor.2013.11.037

Associations

People
Rudloff, Birgit (Details)
External
Street, Alexandre (Pontifical Catholic University of Rio de Janeiro, Brazil)
Valladão, Davi (Pontifical Catholic University of Rio de Janeiro, Brazil)
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