A Stochastic Programming Framework for International PortfolioManagement
AbstractWe present a multi-stage stochastic programming model for managing portfolios of stock and bond indices denominated in multiple currencies. The portfolios are exposed to market risks and currency risks. Uncertainty in asset returns and exchange rates is represented by means of discrete distributions (scenario sets) in a way that captures empirically observed asymmetries and fat tails in the distributions of these random variables and their correlations. The stochastic programming model takes a holistic view of the problem and determines the optimal asset allocation as well as risk hedging decisions by means of forward contracts and options. The options are priced consistently with the postulated scenario sets for the underlying securities, while also satisfying fundamental non-arbitrage principles. The modeling framework provides a basis to investigate the performance of alternative risk management strategies. Through extensive computational experiments, both in static as well as in dynamic settings we demonstrate (a) the benefits of international diversification, (b) the impact of alternative hedging strategies â€“ including options â€“ to control the main risk exposures, (c) the relative performance of alternative risk hedging strategies and alternative model forms. We find that additional benefits are gained as a progressively integrated view towards total risk management is taken, i.e., as the constituent risks are jointly controlled through appropriate means.
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Bibliographic InfoPaper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 404.
Date of creation: 04 Jul 2006
Date of revision:
international portfolios; stochastic prorgamming; risk management;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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