Sequential Optimization of CVaR

Abstract: This paper studies optimization of the Conditional Value at Risk (CVaR) for a discounted total-cost Markov Decision Process (MDP) with finite state and action sets. This CVaR optimization problem can be reformulated as a Robust MDP(RMDP) with a compact state space. States in this RMDP are the original states of the problems augmented with tail risk levels, and the Decision Maker (DM) knows only the initial tail risk level at the initial state and time. Thus, in order to find an optimal policy following this approach, the DM needs to solve an RMDP with incomplete state observations because after the first move, the DM observes the states of the system, but the tail risk levels are unknown. This paper shows that for the CVaR optimization problem the corresponding RMDP can be solved by using the methods of convex analysis. This paper introduces the algorithm for computing and implementing an optimal CVaR policy by using the value function for the version of this RMDP with completely observable tail risk levels at all states. This algorithm and the major results of the paper are presented for a more general problem of optimization of sum of a mean and CVaR for possibly different cost functions.