Constructing risk measures from uncertainty sets

Abstract

We illustrate the correspondence between uncertainty sets in robust optimization and some popular risk measures in finance and show how robust optimization can be used to generalize the concepts of these risk measures. We also show that by using properly defined uncertainty sets in robust optimization models, one can construct coherent risk measures and address the issue of the computational tractability of the resulting formulations. Our results have implications for efficient portfolio optimization under different measures of risk. © 2009 INFORMS.