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Stochastic Dedication: Designing Fixed Income Portfolios Using Massively Parallel Benders Decomposition

  • Randall S. Hiller

    (Delta Global Trading LP, 4 Cambridge Center, Cambridge, Massachusetts 02142)

  • Jonathan Eckstein

    (Mathematical Sciences Research Group, Thinking Machines Corporation, 245 First Street, Cambridge, Massachusetts 02142)

Registered author(s):

    Drawing on recent developments in discrete time fixed income options theory, we propose a stochastic programming procedure, which we call stochastic dedication, for managing asset/liability portfolios with interest rate contingent claims. The model uses scenario generation to combine deterministic dedication techniques with stochastic duration matching methods, and provides the portfolio manager with a risk/return Pareto optimal frontier from which a portfolio may be selected based on individual risk attitudes. We employ a fixed income risk metric that can be interpreted as the fair market value of a collection of interest rate options that eliminates bankruptcy risk from the asset/liability portfolio. We incorporate this metric into a risk/return stochastic optimization model, using a binomial lattice sampling procedure to construct interest rate paths and cash flow streams from an arbitrage-free term structure model. The resulting parametric linear program has a particularly simple subproblem structure, and we have been able to solve it using resource-directed decomposition on a massively parallel computer system, the Connection Machine CM-2. We take a novel approach that uses a standard serial simplex method to solve the master problem, but generates scenarios and Benders cuts in a massively parallel manner. We discuss the performance of this implementation and present the results for a simple pension fund immunization problem.

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    File URL: http://dx.doi.org/10.1287/mnsc.39.11.1422
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 39 (1993)
    Issue (Month): 11 (November)
    Pages: 1422-1438

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    Handle: RePEc:inm:ormnsc:v:39:y:1993:i:11:p:1422-1438
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