Portfolio Framework Research Articles

Calculating Systemic Risk Capital Requirements: A Factor Model Approach

Macro prudential regulation requires a rigorous process for calculating bank capital charges based on their systemic risk. Using data from the largest global financial institutions we document the existence of extreme event dependence between banks during the recent financial crisis. Subsequently, we extend existing approaches by proposing a model that employs a credit portfolio framework that accounts for such extreme event dependence, and we quantify the level of capital shortfall when this characteristic is ignored. Furthermore, regulatory and economic capital are aligned by introducing capital requirements through a mark to market valuation approach that more accurately accounts for the risk of credit downgrades.

Multi-objective genetic algorithms for solving portfolio optimization problems in the electricity market

The multi-objective portfolio optimization problem is not easy to solve because of (i) challenges from the complexity that arises due to conflicting objectives, (ii) high occurrence of non-dominance of solutions based on the dominance relation, and (iii) optimization solutions that often result in under-diversification. This paper experiments the use of multi-objective genetic algorithms (MOGAs), namely, the non-dominated sorting genetic algorithm II (NSGA-II), strength Pareto evolutionary algorithm II (SPEA-II) and newly proposed compressed objective genetic algorithm II (COGA-II) for solving the portfolio optimization problem for a power generation company (GenCo) faced with different trading choices. To avoid under-diversification, an additional objective to enhance the diversification benefit is proposed alongside with the three original objectives of the mean–variance–skewness (MVS) portfolio framework. The results show that MOGAs have made possible the inclusion of the fourth objective within the optimization framework that produces Pareto fronts that also cover those based on the traditional MVS framework, thereby offering better trade-off solutions while promoting investment diversification benefits for power generation companies.

A prolonged financial crisis: adjustments and prospects in Eurozone's southern markets

Purpose – The economic slump in the southern member states of the Eurozone has brought real estate market activity to a standstill and has raised questions about the future of these markets. Will they rebound and will they command a higher risk premium? This paper aims to assess the outlook for these markets as the crisis continues and analyses the conditions that are a prerequisite to restore investment activity and a healthy occupier market. Design/methodology/approach – Within a portfolio allocation framework, the paper examines the conditions for the revival of investor interest in these markets and the uncertainties that should be resolved. Through the analysis of selected data, the paper assesses the emerging state of these markets. Findings – The economic slump in peripheral Eurozone economies gives way to a period of slow growth and ongoing structural reforms. The latter are necessary to restore confidence in the respective economies and investment markets. Sentiment indicators contain the first signs of a rebound in business confidence. With confidence returning and mitigated macroeconomic risks investors will seek value in the markets of the southern region on a selective basis. Price corrections and yield differentials with core markets could prove attractive. It is, however, argued that a risk premium will remain to reflect progress with structural reforms that will make the economies more competitive and less prone to a similar crisis in the future. It is only when such reforms will firmly be put in place that pricing in the southern Eurozone markets will reflect cyclical risks and diversification contributions. Practical implications – The article provides a structured approach to assess the outlook for peripheral markets. It identifies the key risks affecting investor confidence. The analysis proceeds to stress conditions that should be satisfied for a rebound in the investment market. Signals from selected data series are extracted to assess sentiment and adjustment in the market and assist in the assessment of real estate market prospects in these economies. Originality/value – The paper examines conditions for investing in the hard hit markets of the Eurozone. It illustrates the path for the recovery in these markets and the conditions for the rebound in investment volumes. It contributes to the analysis of the growth potential and risk of these markets for investment purposes.

Reducing Rural Households' Annual Income Fluctuations Due to Rainfall Variation Through Diversification of Wildlife Use: Portfolio Theory in a Case Study of South Eastern Zimbabwe

Annual rural incomes in Southern Africa show large rainfall-induced fluctuations. Variable rainfall has serious implications for agro-pastoral activities (crop cultivation and livestock keeping), whereas wildlife and tourism are less affected. The aim of this paper is to investigate the role of wildlife income in reducing rainfall-induced fluctuations in households' annual incomes. We analyse costs and benefits from agro-pastoral systems in southeastern Zimbabwe by means of a two-tier longitudinal survey and wildlife benefits through analysis of wildlife revenues. We use the portfolio theory framework to investigate whether wildlife conservation has the potential for farmers to reduce risk associated with agricultural production. Results show that even though wildlife income is small, it tends to be less volatile than income from the agro-pastoral system. Furthermore, the addition of wildlife as an asset to the rural farmers' portfolio of assets showed that wildlife can be used as a hedge asset to offset risk from agricultural production without compromising on return. The potential of diversification using wildlife is, however, limited since agriculture and wildlife assets are positively correlated. We conclude that revenues from wildlife have some potential to reduce annual household income fluctuations, but only to a limited extent. We argue that if wildlife is organised on a more commercial basis, a more substantial role can be played by wildlife income in reducing variations in rural households' incomes.

Narrative leadership in a quality organization: a meaningful alternative to management by measurement

In the wake of teacher evaluation and performance pay legislation in the USA, an unprecedented cheating scandal in the Atlanta Public School System, and similar smaller testing scandals elsewhere, the effectiveness of school improvement models based on measuring standardized testing results is now a concern. This article addresses this concern by building on research that describes a successful accreditation approach using storytelling in a school-wide portfolio framework. The evaluation of this relational approach to accreditation laid the foundation for this examination of an organizational semiotic model of narrative leadership. In this study, I answer two overarching research questions: (1) how does a story construct narrative leadership? and (2) how does narrative leadership socially construct a quality organization through storytelling? This investigation validates narrative leadership as an effective alternative to the management-by-measurement approach to school improvement and as a way to construct quality organizations for the twenty-first century.

Competency-based assessment of academic interdisciplinary research and implication to university management

The objective of this study is to contribute to the development of a systematic management method for interdisciplinary research at an academic research institution level. Specifically, co-citation analysis that is a bibliometric approach focusing on citing-cited relation of publications was applied based on established publication and analytical databases in order to express research competence and interdisciplinary characteristics. By using this method, we conducted case studies of stem cell-related research at four universities and identified research competence as synthesized clusters of publications. Then, we demonstrated a research assessment by proposing and introducing key performance indicators and found that a certain degree of interdisciplinarity and internal collaboration may bring about high research productivity. Furthermore, we applied an established portfolio management framework in a business field and clarified differences in the status of research activities among these universities, suggesting the adequateness of applying the management method to academic research. These results suggest that the proposed research assessment and management approaches can provide strong support to facilitating strategic management for academic interdisciplinary research at academic research institutions. Copyright The Author 2012. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.

The Principles and the Specifics of Trading in Commodities

Abstract In the present period of instability on financial markets, investments in commodities are the solution for elimination of the consequences of inflation and ensure the yield. When investing in commodities, the use of specifics of commodities compared to other assets. The distribution of commodities we can interpret for agricultural commodities, commodities of energy, precious and other metals, and weather. Therefore, in the framework of the investment portfolio are the commodities. This is the reason why one of the most popular types of investment assets now become commodities. In the interpretation of particular commodities we talk about commodity futures. The reason is that the spot market with commodities is limited storage facilities. The growth of the popularity, which allows a wide range of commodities, has caused that in addition to from institutional investors and speculators for trade may involve even small investors. This development will be supplemented by interpretation of the charts and figers, which will be commented and used for generalization of knowledge. Finally, the article will be interpreted by the further development of the market for commodities as it by article assumes from the results of research.

Establishing a portfolio assessment framework for pre-service teachers: a multiple perspectives approach

In the field of initial teacher training, portfolios are widely used to assess pre-service teachers' performance as well as the outcomes of university-based teacher preparation programmes. However, little is known about the explicit design of portfolio assessment mechanisms in teacher preparation programmes. Issues related to the design and validation of portfolios for pre-service teacher assessment are a critical area of inquiry for the field of initial teacher training. In this study, perspectives were elicited from school trainee teachers and faculty from a secondary teacher preparation programme to examine the relationships identified among core competencies of a portfolio assessment framework and pre-service candidate learning outcomes. Comparative findings are presented about the relationships identified by the trainee teachers and faculty across the secondary education programme's portfolio core competencies and trainee learning outcomes. A discussion of the findings is presented with implications and future directions highlighted.

Valuing fuel diversification in power generation capacity planning

Deterministic capacity planning problems in electricity systems can be solved by comparing technology specific long-term and short-term marginal costs. In an uncertain market environment, Mean-Variance Portfolio (MVP) theory provides a consistent framework to balance risk and return in power generation portfolios. Focusing on fuel price risks, MVP theory can be adopted to determine the welfare efficient system generation technology mix.Existing literature on MVP applications in electricity generation markets uses predominantly numerical methods to characterize portfolio risks. In contrast, this article presents a novel analytical approach combining conceptual elements of classical capacity planning models and MVP theory to derive the efficient portfolio structure consisting of an arbitrary number of plant technologies given uncertain fuel prices. For this purpose, we provide a static optimization model which allows to fully capture fuel price risks in a mean variance portfolio framework. The analytically derived optimality conditions contribute to a better understanding of the optimal investment policy and its risk characteristics compared to existing numerical methods. Furthermore, we demonstrate an application of the proposed framework and provide results for the German electricity market which has been hardly treated in MVP literature on electricity markets.This article provides easily interpretable analytical optimality conditions for efficient generation portfolios from a societal point of view and therewith contributes to a better understanding of MVP in electricity applications.

Em-Powering Economics: Some Thoughts on Policy and Financial Markets

This paper addresses the discussion between economic power and the power of politics with particular focus on financial markets. After general reflections about the economic basis of power, the paper discusses in a general equilibrium framework how financial innovations can lead to risk creation and an inflation of financial products. This creates a fundamental disorder in the financial system which from an aggregate point of view can be described in a standard portfolio framework, in which higher rates of return go hand in hand with higher private risks but also with increasing externalized (social) risk and insurance illusion. Rate of return regulation is proposed as an appropriate regulatory measure. Alternatively the deficiency could be cured by admission regulations for financial products which put the burden of proof for no external (systemic) damages of a financial instrument to the issuer.

Optimal Commodity and Cross-Currency Heding: The Case of Asean-5-Based Grain and Soft Commodity Traders

The changes in commodity prices and exchange rates leave the representative ASEAN-5-based international commodity traders exposed with multiple risks. Foreign exchange hedging ratios are simultaneously estimated alongside commodity ratios in a time-varying portfolio framework. The comparisons of the minimum variance hedge ratios (MVHR) performance reveal that the model with the time-varying variance-covariance matrix provides greater risk reduction than the conventional model, illustrating importance of time-varying variance-covariance effect when modeling joint dynamic of spot and futures returns and hence estimating hedging strategies. When transaction costs are taken into account, incorporating Student’s t significantly enhances the performance of dynamic strategies in wheat and soybeans markets. However, the conventional OLS shows superior performance in the cotton market in terms of utility gain.

A network option portfolio management framework for adaptive transportation planning

A real option portfolio management framework is proposed to make use of an adaptive network design problem developed using stochastic dynamic programming methodologies. The framework is extended from Smit’s and Trigeorgis’ option portfolio framework to incorporate network synergies. The adaptive planning framework is defined and tested on a case study with time series origin–destination demand data. Historically, OD time series data is costly to obtain, and there has not been much need for it because most transportation models use a single time-invariant estimate based on deterministic forecasting of demand. Despite the high cost and institutional barriers of obtaining abundant OD time series data, we illustrate how having higher fidelity data along with an adaptive planning framework can result in a number of improved management strategies. An insertion heuristic is adopted to run the lower bound adaptive network design problem for a coarse Iran network with 834 nodes, 1121 links, and 10 years of time series data for 71,795 OD pairs.

A Scenario Generation Method with Heteroskedasticity and Moment Matching

We present a portfolio management framework composed of a new scenario generation algorithm and a stochastic programming (SP) model. The algorithm is built on heteroskedastic models and a moment matching approach to construct a scenario tree that is a calibrated representation of the randomness in risky asset returns. We also present a multistage SP model that maximizes the expected final wealth and controls the risk exposure through limiting conditional value-at-risk (CVaR) at each decision epoch over the scenario tree generated by the algorithm.

A Formalized Hybrid Portfolio Replication Technique Applied to Participating Life Insurance Portfolios

The practice of portfolio replication has proven its applicability to market risk management in complete markets through the appropriate modeling of a range of non-linear financial instruments. Replicating portfolios provide an intuitive and operational framework for explaining financial risks of life insurance companies as financial instruments with analytical formula encompassing instruments’ non-linearities, path dependency and specific sensitivities capture financial risks. Carrying out the market risk calculation for life insurance companies requires the replicating portfolio technique as the plan calculation referred to as ‘stochastic in stochastic’ requires immense computational power. For each of the real-world scenarios, the market-consistent values of assets and liabilities on the basis of the replicating portfolio technique are therefore determined. This article presents an enhanced replicating portfolio framework that is of utmost importance for the generation of market risk capital requirements applied to life insurance portfolios embedding options and guarantees. While the classic replication technique requires approximations and expert judgments as there is no clear-cut, easy answer for finding an optimal replicating portfolio providing a superior replication power (i.e. a portfolio composed of a finite number of financial vanilla instruments in an arbitrage-free context out of which the cash-flows best replicate the magnitude and timing of liabilities over the projection term), the proposed approach relies on a formalized framework that leads to build optimal replicating portfolios for participating life insurance business. This paper derives the principles behind the portfolio replication technique and provides explanations and justifications on the parameterization of replicating portfolios via a practical application case. The approach adopted is a hybrid model that combines a 'pure' portfolio replication technique and the curve fitting approach. As a result, the quality of replicating portfolios in extreme capital market environments is tested by means of a comparison with the results of a brute force revaluation incorporating a large range of sensitivities such as EEV, QIS 5 and extreme scenario (close to the economic capital driven scenario) sensitivities. In order to determine the weights of financial instruments, the ordinary least square technique is used to find the best possible portfolio composition that replicates liability cash flows in several market conditions at either the present or terminal value of the projection. Additional enhancement techniques such as a particular adjustment within the singular value decomposition and a scenario filter are introduced to better fit the weights of selected instruments with liability moves. An example of calibration strategy that leads to an optimal replicating portfolio is broadly described in this paper.

Risk Model and the Model Risk: Probabilistic DecisionTheory Applied to One Often Overlooked Risk

Traditional portfolio management theory suffers from several insurmountable shortcomings: unrealistic model of stock returns, the ill-posed matrix inversion problem, and difficulties with consistent incorporation of analysts’ and PM’s views. Despite some breakthroughs like the Black-Litterman approach, it is generally believed that the modern portfolio theory framework is not sufficiently rich and powerful to offer solutions to problems that modern investment practitioners face. The author suggests that the probabilistic decision theory provides the necessary toolset to develop the necessary analysis and optimization portfolio management framework. In this short article the author outlines the methodology and applies it to problems of increased complexity. The author shows that in the probabilistic decision theory the optimal composition of the portfolio is necessarily user-dependent: PM’s and analysts’ views are incorporated as the prior probability distributions, constraints and risk tolerances are intertwined with the optimization procedure and the model risk is consistently included in the consideration.

Marriage and other risky assets: A portfolio approach

We study the joint impact of gender and marital status on financial investments by testing the hypothesis that marriage represents – in a portfolio framework – a sort of safe asset and that this attribute may change over time. We show that married individuals have a higher propensity to invest in risky assets than single ones, that this marital status gap is stronger for women and that, for women only, it evolves and declines at the end of the sample period. Next we explore a number of possible explanations of the observed gender differences by controlling for background factors that capture the evolution of family and society. We find that both the higher female marital status gap and its time variability vanish for those women who are employed. Our empirical investigation is based on a dataset drawn from the 1993–2006 Bank of Italy Survey of Household Income and Wealth.

Supplier relationships in regulated industries: longitudinal study on energy distribution

The article attempts to analyse the transformation of procurement management with Finnish electricity distribution network operators regarding the maintenance and construction of distribution networks. We aim to provide insights into their portfolio frameworks the dynamics of which are illustrated using a longitudinal case-based study. The case study is based on archival analysis and interviews. The article demonstrates how the competitive changes through regulation, supply market evolution and supply decisions are interlinked. The appropriateness of Our findings suggest that supply management changes along with relationship management on high strategic value, comparative performance and the transaction costs of externalised activities. Indeed, the study shows that procurement management becomes less sensitive to portfolio attributes if specialised service providers are able to build attractive offerings.

The Intrinsic Logic of the Augmented Black-Litterman Model

Portfolio management is an art as well as science. We argue that portfolio managers eventually face two fundamental scientific challenges: (a) how to allocate; and (b) how to mimic. These require scientific answers. Other challenges in portfolio management are arts where different tastes, preferences, judgments and beliefs should be allowed. A general portfolio management framework should provide principles for solving the scientific problems, but remain neutral and facilitate interactions with the art part. The Augmented Black-Litterman (ABL) model rightly meets these requirements. This article reveals its intrinsic logic. It features: - An exploration of the motivation and general requirements of portfolio construction; - A dissection of the ABL allocation model; - Three ABL endogenous techniques and their efficiency evidences; - The intrinsic logic of the ABL model; and - Justifications of the model as a unified Bayesian allocation framework. Practitioners can consider this framework a unified allocation theory, which can be used to understand, evaluate and improve existing portfolio construction practices.

Liquidity preference in a portfolio framework and the monetary theory of Kahn

This paper examines the relation between variations in the propensity towards liquidity preference, price-adjustment and shifts in portfolio allocation by expanding Kahn's idea of marginal equilibrium under strong uncertainty in financial markets and contributes to recent post-Keynesian attempts to develop a liquidity preference theory of asset prices by providing an analysis of the price-adjustment mechanism. The notion of the own-rate of money interest is utilised to develop a multi-asset liquidity preference framework, which is consistent with uneven variations of liquidity-premia across assets in response to changes in the degree of strong uncertainty that is specific to different investors with variable allocation of assets in their portfolios. More specifically, in the context of this portfolio framework it is established that an increase in the state of strong uncertainty (state of bearishness) makes less liquid assets further less inconvenient than more liquid assets. In periods characterised by greater strong uncertainty, equilibrium is restored through a greater demand for more liquid assets including money relative to the demand for less liquid assets and, therefore, through a higher own-rate of money interest for less liquid assets than warranted, which shows the ineffectiveness of standard monetary policy.

Reviewing Korea's Strategic Plan of Adaptation and Mitigation for Sustainable Development and Climate Change

This article introduces Korea's Five Year Green Growth Plan (FYGGP) as the national policy portfolio framework, assesses the weakness of FYGGP using the Adaptation Policy Framework (APF)'s principals, and proposes three ideas to improve FYGGP. The first idea is setting up the Total Management System for Climate Changes (TMSCC) that consists of an effective integration process with existing authorities and plans; strong institutional support; monitoring and evaluation processes; and responsive adjusting mechanisms. The second idea is effectively applying the inventory of TMSCC to decide and modify the national policy. The TMSCC needs an independent agent under the Korean Presidential Committee which can coordinate and manage it, so that sustainability indicators and standards of judgment for mitigation can be developed and announced. The final idea is taking a systematic evaluation that can upgrade the TMSCC, linked with policy directions, as a suitability evaluation about TMSCC itself needs a process making the system; an efficiency evaluation needs a process modifying the system and a process applying policy scenarios; an accuracy evaluation needs a process forecasting policy effects and climate change impacts. This evaluation cycle can help achieve the national objectives.