#01-01 Stochastic Programming Models for Asset Liability Management
#01-02 The Value of Integrative Risk Management for Insurance Products with Guarantees
#01-03 Extending Credit Risk (Pricing) Models for The Simulation of Portfolios of Interest Rate and Credit Risk Sensitive Securities
#01-04 Tracking Bond Indices in an Integrated Market and Credit Risk Environment
#01-05 The Tail that Wags the Dog: Integrating Credit Risk in Asset Portfolios
#01-06 Parallelization, Optimization, and Performance Analysis of Portfolio Choice Models
#01-07 Real R&D Options with Endogenous and Exogenous Learning
#01-08 Portfolio Choice and Liquidity Constraints
#01-09 Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion
#01-10 Borrowing Constraints, Portfolio Choice, and Precautionary Motives
#01-11 Debt Revolvers for Self Control
#01-12 Equity Culture and Household Behavior
#01-13 Asset and Liability Modelling for Participating Policies with Guarantees
#01-14 Resolving a Real Options Paradox with Incomplete Information: After All, Why Learn?
#01-15 Real Options with Incomplete Information and Multi-Dimensional Random Controls
#01-16 Household Portfolios: An International Comparison
#01-17 Calibration and Computation of Household Portfolio Models
#01-18 Enterprise-wide Asset and Liability Management: Issues, Institutions, and Models
#01-19 Artificial Neural Networks for Valuation of Financial Derivatives and Customized Option Embedded Contracts
#01-20 Real (Investment) Option Games with Incomplete Information and Learning Spillovers
#01-21 www.Personal_Asset_Allocation
#01-22 Assets of Cyprus Households: Lessons from the First Cyprus Survey of Consumer Finances
#01-23 CVaR Models with Selective Hedging for International Asset Allocation
#01-24 Hysteresis Models of Investment with Multiple Uncertainties and Exchange Rate Risk
#01-25 Integrated Simulation and Optimisation Models for Tracking International Fixed Income Indices
#01-26 Real Options and Investment Under Uncertainty: an Overview
#01-27 Flexibility and Commitment in Strategic Investments
Abstracts and downloadable
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Stochastic Programming Models for Asset Liability Management
Roy Kouwenberg and Stavros A. Zenios, May 2001 |
Abstract Stochastic programming is a powerful modelling paradigm for asset and liability management problems. It incorporates in a common framework multiple correlated sources of risk for both the asset and liability side, takes a long time horizon perspective, accommodates different levels of risk aversion and allows for dynamic portfolio rebalancing while satisfying operational or regulatory restrictions and policy requirements. This chapter introduces stochastic programming models for broad classes of asset and liability management problems, describes procedures for generating the requisite event trees, discusses the validity of model results for illustrative applications, compares stochastic programming with alternative modelling approaches, and hinges upon solution techniques and computational issues.
In Handbook of Asset and Liability Management, Volume 2, North-Holland Handbooks in Finance, 2007
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The Value of Integrative Risk Management for Insurance Products with Guarantees
Andrea Consiglio, Flavio Cocco and Stavros A. Zenios, April 2001 |
Abstract Insurers increasingly offer policies that converge with the products of the capital markets and they face pressing needs for integrative asset and liability management strategies. In this paper we show that an integrative approach - based on scenario optimization modelling - adds value to the risk management process, when compared to traditional methods. Empirical analysis with products offered by the Italian insurance industry are presented. The results have implications for the design of competitive insurance policies, and some examples are analyzed.
Journal of Risk Finance, pp. 6-16, Spring 200, (Listed as "Best Paper" of the Journal for 2001)
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Extending Credit Risk (Pricing) Models for the Simulation of Portfolios of Interest Rate and Credit Risk Sensitive Securities
Norbert J. Jobst and Stavros A. Zenios, June 2001
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Abstract We discuss extensions of intensity based models for pricing credit risk and derivative securities to the simulation and valuation of portfolios. The stochasticity in interest rates, credit spreads (default intensities) and rating migrations are incorporated in a unified framework. Scenarios of future prices of all securities are calculated in a risk-neutral world. The calculated prices are consistent with observed prices and the term structure of default free and defaultable interest rates. Three applications are discussed: (i) study of the inter-temporal price sensitivity of credit bonds to changes in interest rates, default probabilities, recovery rates and rating migration, (ii) portfolio simulations with attribution of changes to credit events and interest rates and, (iii) tracking of corporate bond indices.
Current version as Hermes Paper #05-08
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Tracking Bond Indices in an Integrated Market and Credit Risk Environment
Norbert J. Jobst and Stavros A. Zenios, May 2001 (current version: August 2001
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Abstract The management of credit risky assets requires simulation models that integrate the disparate sources of credit and market risk, and suitable optimization models for scenario analysis. In this paper we integrated Monte Carlo simulation models with linear programming penalty models and apply them to the tracking of corporate bond indices. Results show that good tracking performance can be achieved by a strategic model, however extra value may be generated with a models that goes down to the tactical level with bond picking decisions. Extensive empirical results with the ex post performance of the model over an eighteen month recent period substantiate the conclusions of this paper.
Quantitative Finance, Volume 3, Issue 2, pp. 117-135, April 2003
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The Tail that Wags the Dog: Integrating Credit Risk in Asset Portfolios
Norbert J. Jobst and Stavros A. Zenios, July 2001 (Revised September 2001)
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Abstract Tails are of paramount importance in shaping the risk profile of portfolios with credit risk sensitive securities. In this context risk management tools require simulations that accurately capture the tails, and optimization models that limit tail effects. Ignoring the tails in the simulation or using inappropriate optimization metrics can have significant effects. The resulting portfolio risk profile can be grossly misrepresented when long run performance is optimized without consideration of the short term tail effects. This paper illustrates the pitfalls and suggests models for avoiding them.
Journal of Risk Finance, pp. 31-43, Fall 2001
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Parallelization, Optimization, and Performance Analysis of Portfolio Choice Models
Ahmed Abdelkhalek, Angelos Bilas, and Alexander Michaelides, 2001
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Abstract In this work we show how applications in computational economics can take advantage of modern parallel architectures to reduce the computation time in a wide array of models that have been, to date, computationally intractable. The specific application we use computes the optimal consumption and portfolio choice policy rules over the life-cycle of the individual.Our goal is two-fold: (i) to understand the behavior of a class of emerging applications and provide an efficient parallel implementation and (ii) to introduce a new benchmark for parallel computer architectures from an emerging and important class of applications. We start from an existing sequential algorithm for solving a portfolio choice model. We present a number of optimizations that result in highly optimized sequential code. We then present a parallel version of the application. We find that: (i) Emerging applications in this area of computational economics exhibit adequate parallelism to achieve, after a number of optimization steps, almost linear speedup for system sizes up to 64 processors. (ii) The main challenges in dealing with applications in this area are computational imbalances introduced by algorithmic dependencies and the parallelization method and granularity. (iii) We present preliminary results for a problem that has not been, to the best of our knowledge, solved in the financial economics literature to date.
In the Proceedings of the International Conference on Parallel Processing, Valencia, Spain, September 3-7, 2001.
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Real R&D Options with Endogenous and Exogenous Learning
Spiros H. Martzoukos, June 2001
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Abstract We demonstrate the valuation of real (investment) options in the presence of endogenous and exogenous learning. Endogenous learning is captured through optimally activated controls arising because of costly managerial actions (R&D, marketing research, advertisement, etc.) intended to enhance value and/or reveal information. The realization of the controls are jumps with a random size. The decision-maker solves an optimization problem by considering the trade-off between the benefits of the R&D actions and their cost. Exogenous learning is captured though random information arrival of rare events (jumps resulting from technological, competitive, regulatory or political risk shocks, etc.) that follow a Poisson process and have a size drawn from a mixed distribution. In addition, experiential learning is captured by a dynamic volatility similar to that observed in the financial options´ markets.
In Real R&D Options, Butterworth-Heinemann Quantitative Finance Series, pp. 111-129, 2003
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Portfolio Choice and Liquidity Constraints
Michael Haliassos and Alexander Michaelides, July 2001 (current version)
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Abstract We study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle for impatient consumers with access to riskless and risky assets. We consider a labour income process that allows us to decompose the consumption and portfolio effects of permanent and transitory shocks to labour income and show their interaction with liquidity constraints and their relative importance in producing precautionary effects and the portfolio specialization result. We show why the puzzle has proved robust for a number of model variations attempted in the literature, and argue that positive correlation between earnings shocks and stock returns is unlikely to provide a plausible resolution. We then offer an alternative explanation for observed stock holding patterns and the slow emergence of an equity culture. Specifically, we find that relatively small, fixed, stock market entry costs are sufficient to deter households from participating in the stock market. Such entry costs could arise, for example, from informational considerations, sign-up fees and investor inertia.
International Economic Review, Volume 44, Issue 1, pp. 143-178, February 2003
(Also published as CEPR Discussion Paper No. 2822.)
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Portfolio Choice, Liquidity Constraints and Stock Market Mean Reversion
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Abstract This Paper solves numerically for the optimal consumption and portfolio choice of an infinitely lived investor facing short sales and borrowing constraints, undiversifiable labour income risk and a predictable time varying equity premium. The investor aggressively times the market while positive correlation between permanent earnings shocks and stock return innovations generates a substantial hedging demand for the riskless asset. Moreover, a speculative increase in savings arises when stock returns are expected to be high and conversely when future returns are expected to be low. Small information/optimization costs can make it optimal for an investor to assume i.i.d excess stock returns, both because liquidity constraints can be frequently binding and because households can smooth idiosyncratic earnings shock using a small buffer stock of wealth.
CEPR Discussion Paper No. 2823
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Borrowing Constraints, Portfolio Choice and Precautionary Motives
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Abstract This paper studies effects of the type and tightness of borrowing constraints on wealth accumulation and on portfolios. We compare unconstrained and constrained behavior when borrowing limits are based on labor income or on asset holdings of the household, and we examine the effects of varying the tightness of such limits. Credit market conditions, as rejected in the tightness of borrowing constraints, can have serious effects on portfolio composition. Constraints can reduce or eliminate effects of earnings risk on wealth holdings. They can also reverse effects of risk aversion and of earnings risk on stockholding relative to those predicted by models that abstract from such constraints. As a result, samples contaminated with borrowing-constrained households will tend to underplay or even reverse the impact of risk aversion and of earnings risk expected on the basis of unconstrained models. Our analysis suggests caution in basing sample splits on observed asset holdings, and in interpreting the failure of empirical studies to uncover sizeable precautionary effects on wealth and on portfolios.
In Kontoghiorghes, E., N. Rustem and S. Siokos (eds.), Computational Methods in Decision Making, Economics and Finance, (Vol. 1: Optimization Models), Kluwer Publishers Applied Optimisation Series, Vol. 74, pp.183-210, 2002
(Also published as SCEF Working Paper No. 11.)
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Debt Revolvers for Self Control
Carol C. Bertaut and Michael Haliassos, May 2001 (Revised June 2001)
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Abstract By 1998, about two-thirds of U.S. households held a bank-type credit card. Despite high interest rates, most revolve credit card debt, and many do so despite having sufficient liquid assets to have paid it off. We propose an explanation for this puzzle based on self-control. In our model, the "accountant self" of the household can control the expenditures of the "shopper self" by limiting the purchases the shopper can make before encountering the credit limit. Since the card balance is used for control purposes, the accountant self may also find it optimal to save in lower-return riskless assets. Using data from the pooled 1995 and 1998 Surveys of Consumer Finances, we find that a number of factors make households less likely to hold a card but more likely to revolve debt once they have it, and to revolve less debt relative to their liquid assets. While this pattern is difficult to explain with reference to a need to borrow or to screening by banks, it is consistent with a significant role for self-control motives. Such motives tend to discourage households from applying for credit cards, and to encourage those who do get them to leave little room to their (other) selves to overspend.
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Equity Culture and Household Behavior
Michael Haliassos and Christis Hassapis, February 2000 (Revised February 2001)
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Abstract Equity culture has spread among households on both sides of the Atlantic. We analyze the likely changes in behavior of households that enter the stock market in response to arrival of information about how to invest in stocks. Without borrowing constraints, the improved prospects arising from the equity premium tend to dominate the increase in riskiness of future income streams. This encourages entrants to increase consumption and borrowing, and to reduce net financial wealth. At the same time, they tend to accumulate more precautionary wealth. By creating greater incentives to borrow, equity culture makes the young more susceptible to any borrowing constraints. Whether borrowing-constrained entrants increase consumption at all depends on risk aversion and on the tightness of the borrowing limits they face. Borrowing constraints can also reduce, eliminate, or reverse the tendency of entrants to hold larger precautionary wealth buffers.
Oxford Economic Papers, Vol. 54, Issue 4, pp. 719-745, October 2002
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Asset and Liability Modelling for Participating Policies with Guarantees
Andrea Consiglio, Flavio Cocco and Stavros A. Zenios, December 2000 (Revised July 2001)
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Abstract We develop a scenario based optimization model for asset and liability management of participating insurance policies with minimum guarantees. The model allows the analysis of the tradeoffs facing an insurance firm in structuring its policies as well as the choices in civering cost. The nonlinearly constrained optimization model can be leniarized through closed form solutions of the dynamic equations; hence large-scale problems are solved with standard methods. We report extensive empirical analysis of policies offered by Italian insurance firms. While the optimized model results are in general agreement with current industry practices, inefficiencies are still identified and potential improvements are highlighted.
European Journal of Operational Research, In press, 2007
(Also Wharton Financial Institution Paper 00-41-C)
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Resolving a Real Options Paradox with Incomplete Information: After All, Why Learn?
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Abstract In this paper we discuss a real options paradox of managerial intervention directed towards learning and information acquisition: since options are in general increasing functions of volatility whereas learning reduces uncertainty, why would we want to learn? Examining real options with (costly) learning and path-dependency, we show that conditioning of information and optimal timing of learning leads to superior decision-making and enhances real option value.
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Real Options with Incomplete Information and Multi-Dimensional Random Controls
Spiros H. Martzoukos, September 1999 (current version: August 2000; under revision)
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Abstract In this paper we provide a real (investment) options´ valuation method with controls that capture managerial intervention and learning (exploration, R&D, advertising, marketing research, etc.). In contrast to the standard wait-and-see approach of the real options literature, we assume that managers possess the ability to intervene either for value enhancement, or for information acquisition, and of course they wish to do so optimally. We assume the presence of multiple stochastic state-variables that follow Geometric Brownian motion (GBM), or jump-diffusion processes. Activated controls can affect several or all of the state-variables, and the outcome of control activation is random. For the case first of GBM processes, an analytic solution is provided to value the real claim in the presence of such multi-dimensional controls, and a Markov-chain numerical method is demonstrated for more complex applications. The method of random controls is similarly extended to the case where the state-variables follow jump-diffusion processes, with multiple classes of jumps. An analytic solution is provided, and again a Markov-chain numerical method is demonstrated. Neglecting the effect of such actions, causes a serious underestimate of the value of real options and leads to erroneous decision making.
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Household Portfolios: An International Comparison
Luigi Guiso, Michael Haliassos and Tullio Jappelli, October 2000
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Abstract This paper presents an overview of the main findings of an international project on Household Portfolios coordinated by the authors. Contributions to the project deal with the state of the art in analytical, computational, and econometric methods of analysis of household portfolio choice, identify stylized facts and trends observed in five major countries, and discuss issues relating to the portfolios of two important population groups, namely the elderly and the rich. In this paper, we integrate the main findings of the project, compare portfolio behavior across countries, and contrast theoretical predictions to empirical findings. This allows us to identify a number of stylized facts and portfolio puzzles that future theoretical and empirical research should attempt to analyze and resolve.
In Guiso, L., M. Haliassos, and T. Jappelli (Eds.), Household Portfolios, Cambridge, MA: MIT Press, 2002, pp. 1-24
(Also published as CSEF Working paper 48)
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Calibration and Computation of Household Portfolio Models
Michael Haliassos and Alexander Michaelides, September 2000
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Abstract This paper discusses calibration and numerical solution of a wide range of household portfolio models. We illustrate the main conceptual, technical, and computational issues that arise in the context of household portfolio choice, and explore the implications of alternative modeling choices. We consider both small- and large scale optimization models under finite and infinite horizons and under two types of earnings shocks, permanent and transitory. The role of alternative preference specifications, of borrowing constraints, and of predictability of excess returns on stocks is also discussed. In the process, we explore enduring portfolio puzzles and identify new ones to be resolved in future research. These include puzzles relating to participation in the stock market and to portfolio shares conditional on participation.
In Guiso, L., M. Haliassos, and T. Jappelli (Eds.), Household Portfolios, Cambridge, MA: MIT Press, 2002, pp. 55-102
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Enterprise-wide Asset and Liability Management: Issues, Institutions, and Models
Dan Rosen and Stavros A. Zenios, August 2001
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Abstract Enterprise risk management aligns a firm's business strategy with the risk factors of its environment in pursuit of business objectives. It is considered a well-grounded management strategy for corporations. The management of assets and liabilities is at the core of enterprise risk management for financial institutions. In this paper we discuss the general framework for enterprise risk management, and the role of asset and liability management within this broader strategy. From the general concepts we proceed to focus on specific financial institutions, and conclude with a discussion of modelling issues that arise in the enterprise-wide management of assets and liabilities.
In Handbook of Asset and Liability Management, Volume 1, North Holland Handbooks in Finance, Elsevier Science B.V., 2006
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Artificial Neural Networks for Valuation of Financial Derivatives and Customized Option Embedded Contracts
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Abstract In this paper we propose and test a valuation methodology for improving the efficiency of contingent claims pricing using Artificial Neural Networks (ANN). Contingent claims is by now a standard method for pricing under uncertainty non-linear (option embedded) contracts, for both financial options (standardized or customized) and real (investment) opportunities. In the presence of liquid option markets, implied volatility surfaces have aided considerably option pricing with and without the use of ANN. In the absence of such liquid markets, customized positions are much harder to evaluate. The method in this paper improves the efficiency of valuation and financial decision-making dramatically. The method can be used by financial institutions for real time pricing of customized options and investment contracts with guarantees, and valuation under uncertainty of new ventures and the related growth financing instruments. We compare the proposed (hybrid) method with the simple use of ANN for very hard option pricing problems and we demonstrate the method's superiority. The combination of accurate option pricing and the resulting efficiency are instrumental for the applications we discuss.
Current version as Hermes Paper #05-02
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Real (Investment) Option Games with Incomplete Information and Learning Spillovers
Spiros H. Martzoukos and Eleftherios Zacharias, May 2001 (current version: July 2001), Edited November 2001
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Abstract In this paper we discuss in a duopolistic game theoretic context managerial intervention directed towards value enhancement and information acquisition in the presence of uncertainty and spillover effects. Two entities have real investment options, embedded in which are (optional) learning actions. Due to learning spillovers, managers must optimize the learning behavior of their firms. The first decision is a strategic one: should they coordinate their efforts to a greater or lesser degree? The second is a tactical one: given their earlier decision, what is the optimal learning effort given the spillover effects and the cost of information acquisition? The resulting two classes of nonzero-sum games are solved for interdependently in a two-stage Nash-Cournot framework.
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www.Personal_Asset_Allocation
Andrea Consiglio, Flavio Cocco, and Stavros A. Zenios, November 2001 (Last version: January 2002)
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Abstract Today consumers are demanding anytime-anywhere delivery of financial services, while demonstrating a rapid evolution of their needs and desires. At the same time the World Wide Web provides a rich channel for the distribution of customized services to a range of clients. An internet-based system developed by Prometeia Calcolo S.r.l. for Italian banks---both traditional and e -banks --- provides consumers and financial advisors with support for personal financial planning. The system advises on personal asset allocation decisions to fund diverse needs of a consumer such as the purchase of a house, children's education, retirement, or other projects. State-of-the-art financial models --- based on scenario optimization --- develop plans that are consistent with the client's goals, his or her aptitude towards risk, and the prevailing views on market performance. It then assists the client in selecting off-the-shelf financial products, such as mutual funds, to create a customized portfolio. Finally, it analyzes the risk of the portfolio, in terms that are intuitive for a layperson, and monitors its performance in achieving the target goals. The system is currently in use by four major Banks supporting their networks of several thousand financial advisors, and reaching directly tens of thousands of clients.
Interfaces, Volume 34, Issue 4, pp. 287-302, July -August 2004
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Assets of Cyprus Households: Lessons from the First Cyprus Survey of Consumer Finances
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Abstract This paper describes participation of Cyprus households in financial and real assets using new data from the 1999 Cyprus Survey of Consumer Finances, and compares Cyprus to the United States and four major European countries. Almost 9 out of 10 Cyprus households own some financial asset. After checking accounts, the most popular financial asset is government savings bonds. One in two households participated in stocks directly or indirectly in 1999, a year of stock market frenzy, reaching participation levels comparable only to the United States. Despite the absence of mutual funds, almost one third of households invest in managed portfolios linked to life insurance, and this exceeds direct stockholding even in 1999. Participation in direct stockholding is higher than in other countries, overall and for households below 50 years, and unusually high for the very young. Potential sources of concern include the limited number of stocks held by direct stockholders, and the presence of a significant contingent with limited background. Diversification across risk categories of financial assets is limited, but the majority of those holding few assets do not hold stocks directly. Those who do hold stocks directly are poorly diversified across different stocks. More than one in two households have some form of life insurance, but participation in individual retirement accounts is very low. Participation in risky assets, financial or real, far exceeds that in other countries. Yet, a strong contingent of households concentrates on risky real assets and abstains from risky financial assets, even during 1999. Rates of ownership of real assets are exceptionally high compared to the other countries. Homeownership rates far exceed those in the United States, and the majority of homeowners own their home fully. One quarter of Cyprus households own business equity, more than double the rate in the United States.
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CVaR Models with Selective Hedging for International Asset Allocation
Nikolas Topaloglou, Hercules Vladimirou, and Stavros A. Zenios, December 2001
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Abstract We develop an integrated simulation and optimization framework for decision problems in multicurrency asset allocation. The simulation aspect concerns a procedure based on principal component analysis for generating representative scenario sets that depict discrete joint distributions for the uncertain asset returns and exchange rates. In the context of scenario analysis, we develop and implement models that optimize the conditional-value-at-risk (CVaR) metric. The scenario-based optimization models encompass alternative hedging strategies including a selective hedging policy that incorporates currency hedging decisions within the portfolio selection problem. Thus, the selective hedging model determines jointly the portfolio composition and the level of currency hedging for each market via forward exchanges. We examine empirically the benefits of international diversification and the impact of hedging policies on risk-return profiles of portfolios. We assess the effectiveness of the scenario generation procedure and the stability of the model's results by means of out-of-sample simulation tests. We compare and contrast the performance of the CVaR model against that of a model that employs the mean absolute deviation (MAD) risk measure. We investigate empirically the ex-post performance of the models on international portfolios of stock and bond indices using historical market data. In our empirical tests, selective hedging proves to be the superior hedging strategy that improves the risk-return profile of portfolios regardless of the risk measurement metric. Although in static tests the MAD and CVaR models often select portfolios that trace practically indistinguishable ex-ante risk-return efficient frontiers, in successive applications over several consecutive time periods the CVaR model attains superior ex-post results in terms of both higher returns and lower volatility.
Journal of Banking and Finance, Volume 26, Issue 7, pp.1535-1561, 2002
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Hysteresis Models of Investment with Multiple Uncertainties and Exchange Rate Risk
Spiros H. Martzoukos, 2001
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Abstract The hysteresis model of investment that was developed by Brennan and Schwartz, and Dixit we extend to capture the impact of interacting uncertainties for a firm with foreign operations. We develop a three-country four-factor model where both the continuous revenues and the continuous costs are stochastic and are generated in countries other than the home country of the investor. All four state-variables follow geometric Brownian motion processes. A critical assumption is made that the capital outlays for switching between the idle and the active states are constant fractions of the costs. An efficient numerical solution that we implement is used to demonstrate applications of the model for a multinational corporation that faces operating and exchange rate risks in a multi-stage investment setting with interacting investment and operating options.
Review of Quantitative Finance and Accounting, Volume 16, Issue 3, pp. 251-268, May 2001
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Integrated Simulation and Optimization Models for Tracking International Fixed Income Indices
Andrea Consiglio and Stavros A. Zenios, 2001
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Abstract Portfolio managers in the international fixed income markets must address jointly the interest rate risk in each market and the exchange rate volatility across markets. This paper develops integrated simulation and optimization models that address these issues in a common framework. Monte Carlo simulation procedures generate jointly scenarios of interest and exchange rates and, thereby, scenarios of holding period returns of the available securities. The portfolio manager's risk tolerance is incorporated either through a utility function or a (modified) mean absolute deviation function. The optimization models prescribe asset allocation weights among the different markets and also resolve bond-picking decisions. Therefore several interrelated decisions are cast in a common framework. Two models - an expected utility maximization and a mean absolute deviation minimization - are implemented and tested empirically in tracking a composite index of the international bond markets. Backtesting over the period January 1997 to July 1998 illustrate the efficacy of the optimization models in dealing with uncertainty and tracking effectively the volatile index. Of particular interest is the empirical demostration that the integrative models generate portfolios that dominate the portfolios obtained using classical disintegrated approaches.
Mathematical Programming, Series B, Volume 89, Issue 2, pp. 311-339, January 2001
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Real Options and Investment Under Uncertainty: An Overview
E. Schwartz and L. Trigeorgis, 2001
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Abstract Academic articles with the application of options pricing theory to valuating real assets have appeared in the finance literature for more than fifteen years. The practical application of these ideas has mainly been taking place in the last several years. Although the methodology was first applied to natural resource investments, more recently we started seeing applications in a range of other areas, including research and development, development of new technologies, company valuation and M&As, intellectual property rights/intangible assets, etc. We predict that the real options approach to valuation will have a significant impact in the practice of finance and strategy over the next 5-10 years.
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Flexibility and Commitment in Strategic Investments
Han T. J. Smit and Lenos Trigeorgis, 2001
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Abstract The paper deals with the tradeoffs between the option value of management flexibility and the strategic value of early commitment in a dynamic competitive environment. It departs from the standard real options optimisation problem (game against nature) to model strategic games against competition. It thus provides an integration of real options valuation with game-theoretic principles that enable the determination of different market structure equilibrium outcomes (e.g. Nash, Stackelberg leader/follower, or monopoly) in the various states of demand (nodes) within a binomial option valuation tree, as well proper accounting for the interdependencies among the early strategic commitment and subsequent investment decisions in a competitive interactive setting. The optimal investment strategy of a pioneer firm depends not only on its own stance vis-à-vis its competitor (tough or accommodation) and the type of investment (proprietary or shared), but also on the nature of competitive reaction (reciprocating or contrarian).
