Safety-first portfolio optimization after September 11, 2001

Purpose – The purpose of this paper is to apply safety-first portfolio principles in an environment where financial risk exists because of the probability of terrorist attacks, where the catastrophic events of September 11, 2001 (911) are the focal point of the analysis. Design/methodology/approach – Safety-first portfolios of US equities bilaterally combined with 12 developed and emerging region global equity indices are obtained for 911. Extreme value theory and safety-first principles are used to optimize these portfolios for US risk-averse investors. The actual performances of all portfolios in the post-911 period are compared to the optimal results. The robustness of the results is examined by replicating the analysis for the period following July 7, 2006, when no actual terrorist attacks occurred on US soil. Findings – Optimal ex ante (ex post) safety-first portfolios on 911 have high (low) US weights, and on July 7, 2006 low US weights. The differences are attributed to changes in market projections and/or conditions. In all cases, wealth is preserved even without the ex post optimal portfolios. Practical implications – Safety-first portfolio optimization can protect wealth given financial risks of extreme events like terrorist attacks. Originality/value – The paper shows that quantitative assessments of financial risk are feasible, even though uncertainty with experts' risk assessments of extreme events such as 911 exists because of limited historical data and low probability of occurrence. The results are useful to investors developing international diversification strategies to protect wealth given the risks of terrorist attacks.