Bacterial foraging based approaches to portfolio optimization with liquidity risk

This paper proposes a bacterial foraging based approach for portfolio optimization problem. We develop an improved portfolio optimization model by introducing the endogenous and exogenous liquidity risk and the corresponding indexes are designed to measure the endogenous/exogenous liquidity risk, respectively. Bacterial foraging optimization (BFO) is employed to find the optimal set of portfolio weights in the improved Mean-Variance model. BFO-LDC which is a modified BFO with linear deceasing chemotaxis step is proposed to further improve the performance of BFO. With four benchmark functions, BFO-LDC is proved to have better performance than the original BFO. And then comparisons of the results produced by BFO, BFO-LDC, particle swarm optimization (PSO), and genetic algorithms (GAs) for the proposed portfolio optimization model are presented. Simulation results show that BFOs can obtain both near optimal and the practically feasible solutions to the liquidity risk portfolio optimization problem. In addition, BFO-LDC outperforms BFO in most cases. (c) 2012 Elsevier B.V. All rights reserved.