Traditional Portfolio Theory Research Articles

Post Merger Changes in Riskiness of Bank Loan Portfolios

The recent problems in the financial sector suggest that various types of loans present different types of risk over and above the normal charge-offs. This paper examines the risk associated with post-merger variability in the charge-off rate and the non-performing loan rate, and the implications this variability has for the institution. It develops a new measure of risk to profitability in a bank's loan portfolio based on traditional portfolio theory. This measure is used to examine the risk levels in the loan portfolios of merging bank holding companies (BHCs) and the change in risk that occurs in the years following the merger.The paper finds that the combined loan portfolios of merging BHCs have higher than average levels of charge-offs and higher than average risk in their portfolios in the year prior to the merger. Using the new measure of risk, our research finds that the level of risk is increased after the merger as the surviving banks shift their portfolios toward loans with potentially higher risk and higher returns.

The Impact of Dynamic Correlations on Diversification within Long-Only and Hedge Fund Portfolios: Time To Rethink Portfolio Management

Correlation and Diversification: Strong (positive or negative) correlations make diversification that much harder to achieve, especially as correlations tend to increase with volatility. As greater occurrences of increasing volatility and more frequent ‘surprises’ have become the norm, it seems sensible to examine correlations in more depth, as these impact how asset‐classes and funds perform within the overall portfolio. To condense and assess vast quantities of data, a rudimentary scoring system was introduced. Counts were applied to rolling correlations across various time periods and the frequency of each score was recorded. We demonstrate that intra-day correlations vary from -1 to 1 across and intra-asset classes. This throws into question the relevance of Traditional Portfolio Theory and its attempt at diversification, as it assumes constant correlations and volatility. This paper demonstrates how asset correlations change significantly intra-day according to the different input/output time periods selected. From an investor's standpoint it should be clear that relying on monthly performance reports and monthly correlations mask an awful lot of information and in effect makes portfolio management ineffective.

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.

E-portfolio and Narrative Organization

This poster identifies core issues that learning designers need to consider when they plan to utilize an e-portfolio for learning purposes. These issues include questions as why should one use an e-portfolio? Another important question is of course what an e-portfolio is in the first place? Yet another question to be dealt with goes to how an e-portfolio is used? The poster starts by reviewing specific learning and sociological theories to identify two main reasons for using e-portfolios in today's educational institutions. Firstly, the e-portfolio is a tool for collecting learning products across classes, courses and programs and a tool for reflection with the aim to construct a meaningful whole out of all the smaller pieces of learning and/or learning products. Secondly, society needs the educational institutions to prepare students to construct a meaningful life in a world that's often experienced to be chaotic whether we regard it postmodern or not. The poster introduces theory beyond the traditional portfolio theory, that is theory on technology and media, to help bridging the theoretical gap between traditional paper based portfolios and e-portfolios based on interactive flexible hypermedia. The poster thus researches e-portfolios from one specific perspective: The student is seen as the architect and creator of his own portfolio and a narrator of his own learning and identity since the poster suggests that the structuring and re-structuring of an e-portfolio may be interpreted as creation of a narrative by the student.

Multi-Attribute Portfolio Selection with Genetic Optimization Algorithms

The traditional portfolio theory first proposed by Markowitz only provides a solution to capital allocation to a pre-determined set of assets, regardless of asset quality. To remedy this gap, a multi-attribute asset quality analysis, before asset allocation, is proposed. Thus a two-stage multi-attribute portfolio selection framework that considers asset quality, as well as asset allocation, is formulated. For solving the proposed portfolio selection problem, this study applies genetic algorithms for multi-attribute portfolio selection and analysis. In the first stage, i.e. asset quality evaluation, a genetic algorithm is used to identify good quality assets in terms of asset ranking. In the asset allocation stage, allocation of capital to individual high-quality assets is optimized using another genetic algorithm based on Markowitz's mean-variance theory. Through the two-stage asset evaluation and allocation process, an optimal portfolio can be determined in the context of considering both multiple asset return attributes and risk exposures. Experimental results reveal that the proposed multi-attribute portfolio selection framework provides a very feasible and useful tool to assist investors in planning their investment strategy and constructing their portfolios.

An empirical analysis of the risk of crude oil imports in China using improved portfolio approach

This paper quantifies the diversification index of China's crude oil imports during the period 1996–2004, and explores the relationship between the monthly prices and Brent crude oil cash prices. Accordingly, we calculate the systematic and specific risks using portfolio theory of China's crude oil import over the period 1996–2004. Because China's crude oil import increased rapidly since 1996, we improve upon the traditional portfolio theory and develop a risk index model of portfolio theory for crude oil imports in order to explore objectively the changes in China's crude oil import risks. The results show that China's crude oil import risk is affected extensively by the fluctuation of international oil prices. So the traditional portfolio theory is insufficient to measure China's crude oil import risk. The improved portfolio theory risks index model reflects the effect of international oil prices, diversification, imports, and geopolitics factors etc., on crude oil import risk, and changes in crude oil import risk. Therefore, the risk index model of portfolio theory provides greater theoretical and methodological robustness as an indicator of China's crude oil import security than that offered from the application of traditional measures of dependence.

Copulas and Coherence

Traditional portfolio theory assumes that risk factors are elliptically distributed, when most real-world risk factors do not satisfy this condition. The lack of ellipticality poses two problems: First, correlation-based approaches to statistical dependence become unreliable, and second, conventional risk measures such as the standard deviation and value at risk also become unreliable. These problems can be dealt with by using copulas to handle dependence and by using coherent risk measures. The advantages of using copulas are demonstrated in an example that shows that traditional portfolio theory can also be misleading in a non-elliptical context.

Portfolio selection under independent possibilistic information

This paper deals with a portfolio selection problem with independently estimated possibilistic return rates. Under such a circumstance, a distributive investment has been regarded as a good solution in the traditional portfolio theory. However, the conventional possibilistic approach yields a concentrated investment solution. Considering the reason why a distributive investment is advocated, a new approach to the possibilistic portfolio selection is proposed.

Portfolio Advice for a Multifactor World

Asset returns, it turns out, do not follow the Capital Asset Pricing Model, and are somewhat predictable over time. I survey and interpret the large body of recent work that adapts traditional portfolio theory to answer, what should an investor do about these new facts in finance? I survey the extension of the famous 2 - fund theorem to an N-fund theorem in which investors either hedge or assume the additional, non-market, sources of priced risk; I survey the burgeoning literature on time-varying portfolio rules and the Bayesian literature that advocates a great deal of caution. I emphasize the risk-sharing nature of asset markets, I note the likelihood that many supposed anomalies will not last, and I emphasize the fact that the average investor must hold the market so portfolio decisions must be driven by differences between an investor and the average investor.

A Brief History of Downside Risk Measures

Downside risk measures in portfolio analysis purport to be a major improvement over traditional portfolio theory. This article traces the development of the concept from the initial portfolio theory articles in 1952 to articles in the Journal of Investing in 1994. An understanding of the issues facing the researchers provides better knowledge of the concept.

Portfolio Advice for a Multifactor World

Asset returns, it turns out, do not follow the Capital Asset Pricing Model, and are somewhat predictable over time. I survey and interpret the large body of recent work that adapts traditional portfolio theory to answer, what should an investor do about these new facts in finance? I survey the extension of the famous 2 - fund' theorem to an N-fund'' theorem in which investors either hedge or assume the additional, non-market, sources of priced risk; I survey the burgeoning literature on time-varying portfolio rules and the Bayesian literature that advocates a great deal of caution. In a survey, I emphasize the risk-sharing nature of asset markets, I note the likelihood that many supposed anomalies will not last, and I emphasize the fact that the average investor must hold the market so portfolio decisions must be driven by differences between an investor and the average investor.

Optimality criteria for comparing efficient portfolios

A set of criteria for comparing efficient portfolios is critically reviewed here to show the inadequacy of the standard mean variance criterion used in traditional portfolio theory. These criteria emphasize, among other things, the following: (a) robustness, (b) multivariate distance as a measure of dissimilarity, and (c) diversity as an entropy measure related to information theory.

THE EFFECTS OF REGULATION ON BANK BALANCE SHEET DECISIONS

THERE ARE TWO IMPORTANT facets to the firm's balance sheet decisions: their contribution to profits and their effect on the firm's soundness or risk of insolvency. A sophisticated portfolio theory literature exists that deals with the pricing of assets and explicitly recognizes the relationship between risk and rate of return. However, the portfolio literature generally assumes the firm to have unlimited, riskless ability to borrow and leverage. For commercial banks, the liability side of the balance sheet must be given at least as much attention as the asset side, especially in view of banks' role as financial intermediaries. Furthermore, traditional portfolio theory typically depends on the assumption of perfect financial markets-a peculiar assumption in the analysis of any intermediary (see Pringle, 1974). Regulators, in their efforts to prevent bank failure, underscore the risk-return nature of both assets and liabilities. Whether regulators are effective in controlling risk in other than very general ways is debatable [see e.g. Mayne, Peltzman, and Mingo]. However, viewing a bank, analytically, in much the same way as a bank examiner, can prove instructive, especially since this orientation is not reflected in the theoretical banking literature. Existent analytical approaches to commercial banking can be generally divided into two categories. There are a group of models that examine the relationship, if any, between asset mix and liability management (see e.g. Klein, and Pringle). These micro models provide a useful framework for analyzing the interrelationships inherent in commercial banking with particular emphasis on maturity structure and asset choice. Another focus has been on how factors external to the bank influence its behavior. In particular, emphasis has been on how monetary policy influences credit availability (see e.g. Jaffee and Modigliani, and Kane and Malkiel). But, by largely ignoring the soundness requirements regulators attempt to impose, the literature has passed up a potentially useful way of viewing a banking firm; that is as a firm attempting to maximize profit while recognizing limitations imposed by regulatory standards of bank soundness. Only Dudley Luckett's (1970) model of bank behavior explicitly incorporates the regulator's soundness constraint. In this paper we present a model with strong neoclassical microeconomic roots. Profit maximization is assumed to be management's goal with the primary external