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Optimal Portfolios for Large Investors in Housing Markets Under Stress Scenarios: A Worst-Case Approach

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  • Bilgi Yilmaz

    (RPTU Kaiserslautern
    Kahramanmaras Sutcu Imam University)

Abstract

The study focuses on constructing a mathematical housing market threatened by a major catastrophic event or crash. It incorporates the worst-case scenario portfolio optimization problem as introduced in Korn and Wilmott (Int J Theor Appl Finance 5(02):171–187, 2002) into housing markets. The standard stochastic models for housing markets assume a geometric Brownian motion and neglect sudden housing price falls during crash times. However, the size, timing, and frequency of crashes have to be included in such models. By incorporating the worst-case portfolio optimization problem into housing markets, this study introduces a methodology to construct portfolios for large investors that are robust and resilient to extreme housing market conditions. The worst-case portfolio optimization approach can be used in housing markets to incorporate stress scenarios, minimize potential losses, utilize mathematical techniques, and manage housing investment risk effectively. This study provides valuable insights for large investors seeking to construct housing portfolios prioritizing downside protection and minimizing losses in extreme housing market conditions. Utilizing numerical illustrations, it provides insights into portfolio construction, demonstrating the effectiveness of adjusting portfolios to mitigate downside risks during housing market crises. The results highlight dynamic portfolio management’s significance in safeguarding wealth when housing prices undergo significant fluctuations.

Suggested Citation

  • Bilgi Yilmaz, 2025. "Optimal Portfolios for Large Investors in Housing Markets Under Stress Scenarios: A Worst-Case Approach," Computational Economics, Springer;Society for Computational Economics, vol. 65(5), pages 2853-2871, May.
    • Handle: RePEc:kap:compec:v:65:y:2025:i:5:d:10.1007_s10614-024-10660-y
    DOI: 10.1007/s10614-024-10660-y
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    References listed on IDEAS

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    1. Bilgi Yilmaz & A. Sevtap Selcuk-Kestel, 2019. "Computation of Hedging Coefficients for Mortgage Default and Prepayment Options: Malliavin Calculus Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 59(4), pages 673-697, November.
    2. Azevedo-Pereira, Jose A & Newton, David P & Paxson, Dean A, 2003. "Fixed-Rate Endowment Mortgage and Mortgage Indemnity Valuation," The Journal of Real Estate Finance and Economics, Springer, vol. 26(2-3), pages 197-221, March-May.
    3. Paulo Rotella Junior & Luiz Célio Souza Rocha & Rogério Santana Peruchi & Giancarlo Aquila & Edson de Oliveira Pamplona & Karel Janda & Arthur Leandro Guerra Pires, 2023. "Robust portfolio optimization: a stochastic evaluation of worst-case scenarios," Economic Research-Ekonomska Istraživanja, Taylor & Francis Journals, vol. 36(3), pages 2165525-216, December.
    4. Carole Bernard & Jit Seng Chen & Steven Vanduffel, 2014. "Optimal portfolios under worst-case scenarios," Quantitative Finance, Taylor & Francis Journals, vol. 14(4), pages 657-671, April.
    5. Krishan Mohan Nagpal, 2017. "Designing stress scenarios for portfolios," Risk Management, Palgrave Macmillan, vol. 19(4), pages 323-349, November.
    6. Ralf Korn & Olaf Menkens, 2005. "Worst-Case Scenario Portfolio Optimization: a New Stochastic Control Approach," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 62(1), pages 123-140, September.
    7. Gordon W. Crawford & Michael C. Fratantoni, 2003. "Assessing the Forecasting Performance of Regime‐Switching, ARIMA and GARCH Models of House Prices," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 31(2), pages 223-243, June.
    8. James Mills & Raven Molloy & Rebecca Zarutskie, 2019. "Large‐Scale Buy‐to‐Rent Investors in the Single‐Family Housing Market: The Emergence of a New Asset Class," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 47(2), pages 399-430, June.
    9. Rebonato,Riccardo & Denev,Alexander, 2014. "Portfolio Management under Stress," Cambridge Books, Cambridge University Press, number 9781107048119, June.
    10. Frank Thomas Seifried, 2010. "Optimal Investment for Worst-Case Crash Scenarios: A Martingale Approach," Mathematics of Operations Research, INFORMS, vol. 35(3), pages 559-579, August.
    11. Bilgi Yilmaz & Ralf Korn & A. Sevtap Selcuk-Kestel, 2023. "The Impact of Large Investors on the Portfolio Optimization of Single-Family Houses in Housing Markets," Computational Economics, Springer;Society for Computational Economics, vol. 61(2), pages 855-873, February.
    12. Marcus T. Allen & Jessica Rutherford & Ronald Rutherford & Abdullah Yavas, 2018. "Impact of Investors in Distressed Housing Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 56(4), pages 622-652, May.
    13. Ralf Korn & Paul Wilmott, 2002. "Optimal Portfolios Under The Threat Of A Crash," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 171-187.
    14. A. Fotheringham & Ricardo Crespo & Jing Yao, 2015. "Exploring, modelling and predicting spatiotemporal variations in house prices," The Annals of Regional Science, Springer;Western Regional Science Association, vol. 54(2), pages 417-436, March.
    15. Ralf Korn & Elisabeth Leoff, 2019. "Multi-Asset Worst-Case Optimal Portfolios," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-24, June.
    16. Nicholas Sharp & Paul Johnson & David Newton & Peter Duck, 2009. "A New Prepayment Model (with Default): An Occupation-time Derivative Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 39(2), pages 118-145, August.
    17. Kau, James B. & Keenan, Donald C. & Muller III, Walter J. & Epperson, James F., 1995. "The Valuation at Origination of Fixed-Rate Mortgages with Default and Prepayment," The Journal of Real Estate Finance and Economics, Springer, vol. 11(1), pages 5-36, July.
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