Asset classification under the IFRS 9 framework for the construction of a banking investment portfolio

Abstract

AbstractUnder the International Financial Reporting Standard 9 framework, we analyze the trade‐off of classifying a financial asset at amortized cost versus at fair value. Defining an impairment model and based on historical (2003–2019) data for the 10‐year Portuguese Government bonds, we analyze the annual performance (income/comprehensive income) of different investment allocations. Setting as objectives the maximization of the income and the minimization of the semivariance of the comprehensive income, we suggest a biobjective model in order to find efficient allocations. Given the nonsmoothness of the semivariance function, we compute the solution of the suggested model by means of a multiobjective derivative‐free algorithm. Assuming that the yields and funding rates follow a correlated mean‐reverting process and that the bonds' rating dynamics are described by an ordinal response model, we show a possible approach to mitigate the estimation error ingrained in the proposed biobjective stochastic model. Finally, we assess the out‐of‐sample performance of some of the suggested efficient allocations.