Risk management for international portfolios with basket options: A multi-stage stochastic programming approach

Abstract

The authors consider the problem of active international portfolio management with basket options to achieve optimal asset allocation and combined market risk and currency risk management via multi-stage stochastic programming (MSSP). The authors note particularly the novel consideration and significant benefit of basket options in the context of portfolio optimization and risk management. Extensive empirical tests strongly demonstrate that basket options consistently have more clearly improvement on portfolio performances than a portfolio of vanilla options written on the same underlying assets. The authors further show that the MSSP model provides as a supportive tool for asset allocation, and a suitable test bed to empirically investigate the performance of alternative strategies.