Inverse Optimization of Convex Risk Functions

TL;DR

This paper develops a non-parametric inverse optimization framework to infer convex risk functions from solution data, aiding personalized risk modeling in risk-averse optimization without assuming specific parametric forms.

Contribution

It introduces a novel non-parametric inverse optimization approach for convex risk functions, incorporating key properties and feedback, with convex reformulations and practical portfolio applications.

Findings

Reformulates inverse risk function estimation as convex programs

Demonstrates polynomial solvability when forward problems are polynomial

Validates the approach with real-life portfolio data

Abstract

The theory of convex risk functions has now been well established as the basis for identifying the families of risk functions that should be used in risk averse optimization problems. Despite its theoretical appeal, the implementation of a convex risk function remains difficult, as there is little guidance regarding how a convex risk function should be chosen so that it also well represents one's own risk preferences. In this paper, we address this issue through the lens of inverse optimization. Specifically, given solution data from some (forward) risk-averse optimization problems we develop an inverse optimization framework that generates a risk function that renders the solutions optimal for the forward problems. The framework incorporates the well-known properties of convex risk functions, namely, monotonicity, convexity, translation invariance, and law invariance, as the general information about candidate risk functions, and also the feedbacks from individuals, which include an initial estimate of the risk function and pairwise comparisons among random losses, as the more specific information. Our framework is particularly novel in that unlike classical inverse optimization, no parametric assumption is made about the risk function, i.e. it is non-parametric. We show how the resulting inverse optimization problems can be reformulated as convex programs and are polynomially solvable if the corresponding forward problems are polynomially solvable. We illustrate the imputed risk functions in a portfolio selection problem and demonstrate their practical value using real-life data.