Portfolio Construction - Incorporating Stress Scenarios

I'm using the finaince toolbox to build optimal portfolios. I'm trying to find a way to incorproate stress scenarios. For example, optimize portfolio Sharpe (or plot the optimial frontier) subject to a stress scenario loss of no greater than X. Is there a way to do this? I couldn't find anything online.

Answer 1

[Shivam Lahoti]

Hi Christopher,

To optimize a portfolio's Sharpe ratio or plot the efficient frontier while incorporating a stress scenario constraint where the loss does not exceed a threshold X, you would integrate a custom constraint into the optimization process. This constraint would calculate the portfolio's potential loss under the defined stress scenario and ensure it remains below X. By using MATLAB's Financial Toolbox, you can define this constraint as part of your optimization function, typically with ‘fmincon’. The custom constraint would be an inequality condition that the solver must satisfy, alongside the standard portfolio optimization constraints.

To understand more about 'fmincon', refer to the below documentation.

https://www.mathworks.com/help/optim/ug/fmincon.html

Regards,

Shivam.