1,721,035 research outputs found
A parsimonious model for generating arbitrage-free scenario trees
Full text linkSimulation models of economic, financial and business risk factors are widely used to assess risks and support decision-making. Extensive literature on scenario generation methods aims at describing some underlying stochastic processes with the least number of scenarios to overcome the ‘curse of dimensionality’. There is, however, an important requirement that is usually overlooked when one departs from the application domain of security pricing: the no-arbitrage condition. We formulate a moment matching model to generate multi-factor scenario trees for stochastic optimization satisfying no-arbitrage restrictions with a minimal number of scenarios and without any distributional assumptions. The resulting global optimization problem is quite general. However, it is non-convex and can grow significantly with the number of risk factors, and we develop convex lower bounding techniques for its solution exploiting the special structure of the problem. Applications to some standard problems from the literature show that this is a robust approach for tree generation. We use it to price a European basket option in complete and incomplete markets
Scenario modelling for selective hedging strategies
No full textThe model considers hedging exchange rate risk in the context of an optimal portfolio model with historical scenario
Stochastic debt sustainability analysis for sovereigns and the scope for optimization modeling
Full text linkWe argue that sovereign debt sustainability analysis must be augmented
by stochastic correlated risk factors and a risk measure to capture tail effects. Crisis
situations can thus be adequately specified and analyzed with sufficient accuracy to
warrant the relevance of policy decisions. In this context there is significant scope
for optimization modeling for both strategic planning and operational management.
We discuss diverse aspects of the problem of debt sustainability and highlight
modeling approaches that can be brought to bear on the problem. Results with the
fictitious, but nor unrealistic, Kingdom of Atlantis, which is sinking under excessive
debt, illustrate the proposed models
Risk Management Optimization for Sovereign Debt Restructuring
No full textDebt restructuring is one of the policy tools available for resolving sovereign debt crises and, while unorthodox, it is not uncommon. We propose a scenario analysis for debt sustainability and integrate it with scenario optimization for risk management in restructuring sovereign debt. The scenario dynamics of debt-to-GDP ratio are used to define a tail risk measure, termed conditional Debt-at-Risk. A multi-period stochastic programming model minimizes the expected cost of debt financing subject to risk limits. It provides an operational model to handle significant aspects of debt restructuring: it collects all debt issues in a common framework, and can include contingent claims, multiple currencies and step-up or linked contractual features. Alternative debt profiles – obtained by maturity rescheduling, interest payment concessions or nominal value haircuts – are analyzed for their expected cost-risk tradeoffs. With a suitable re-calculation of the efficient frontier, the risk of debt un-sustainability of alternative risk profiles can be ascertained with a given confidence level. The model is applied to Greece sovereign debt crisis analyzing the suitability of various proposals to restore debt sustainability
Designing and pricing guarantee options in defined contribution pension plans
Full text linkThe shift from defined benefit (DB) to defined contribution (DC) is pervasive among pension funds, due to demographic changes and macroeconomic pressures. In DB all risks are borne by the provider, while in plain vanilla DC all risks are borne by the beneficiary. However, for DC to provide income security some kind of guarantee is required. A minimum guarantee clause can be modeled as a put option written on some underlying reference portfolio and we develop a discrete model that selects the reference portfolio to minimise the cost of a guarantee. While the relation DB-DC is typically viewed as a binary one, the model shows how to price a wide range of guarantees creating a continuum between DB and DC. Integrating guarantee pricing with asset allocation decision is useful to both pension fund managers and regulators. The former are given a yardstick to assess if a given asset portfolio is fit-for-purpose; the latter can assess differences of specific reference funds with respect to the optimal one, signalling possible cases of moral hazard. We develop the model and report numerical results to illustrate its uses
Asset and Liability Modelling for Participating Policies with Guarantee
Full text linkWe study the problem of asset and liability management of participating insurance policies with guarantees. We develop
a scenario optimization model for integrative asset and liability management, analyse the tradeoffs in structuring such policies,
and study alternative choices in funding them. The nonlinearly constrained optimization model can be linearised
through closed form solutions of the dynamic equations. Thus large-scale problems are solved with standard methods.
We report on an empirical analysis of policies offered by Italian insurers. The optimized model results are in general agreement
with current industry practices. However, some inefficiencies are identified and potential improvements are
highlighted
Insurance league: Italy vs. U.K
No full textInsurers are competing by adopting product innovations that provide the insured with integrated coverage for actuarial and financial risks. This article compares the contract structures of blended life policies between the insurance markets in Italy and the United Kingdom within the context of asset-liability management and welfare analysis. © Emerald Backfiles 2007
Risk profiles for re-profiling the sovereign debt of crisis countries
No full textPurpose - This paper aims to use a risk management approach for re-profiling of sovereign debt. It develops profiles that trade off expected cost of financing alternative debt structures against their risk. The risk profiles are particularly informative for countries facing sovereign debt crisis, as they allow us to identify, with high probability, debt unsustainability. Risk profiles for two eurozone countries with excessive debt, Cyprus and Italy, were developed. In addition, risk profiles were developed for a proposal to impose debt sanctions in the Ukrainian crisis and it was shown that the financial impact could be substantial.Design/methodology/approach - Using scenario analysis, a risk measure of the sovereign's debt Conditional Debt-at-Risk -was developed, and an optimization model was then used to trade off expected cost of debt financing against the Conditional Debt-at-Risk. The model is applied to three diverse settings from current crises.Findings - The methodology traces informative risk profiles to identify sustainable debt structures. Interesting, although tentative, conclusions are drawn for the countries where the methodology was applied. Cyprus's debt sustainability hinges on current International Monetary Fund (IMF) projections about gross domestic product growth and small deviations can push debt into unsustainable territory. For Italy, our analysis provides evidence of debt unsustainability. Common assumption of debt by eurozone member states could restore sustainability for Italy. Finally, it is shown how a proposal to impose debt sanctions against Russia for the Ukrainian crisis could have significant financial impact for Ukraine.Research limitations/implications - Additional work is needed to calibrate the simulation models for each country separately. Nevertheless, the direction of the results is such that more careful calibration will most likely not alter the conclusions but make them stronger instead.Practical implications - The results provide significant insights for the management of sovereign debt for Cyprus and Italy. They also show the significant positive impact on Ukrainian public finances from debt sanctions. However, the most important practical implication is to show how the proposed methodology provided a decision support tool for restructuring and rescheduling sovereign debt for crisis countries.Social implications - There is widespread acceptance that debt restructuring has been too little and too late in recent crises failing to re-establish market access in a durable way. How to develop risk profiles for alternative debt structures has been illustrated. Debt profiles that are unsustainable can be identified, with high probability, and alternative structures proposed that restore sustainability. The methodology proposed in this paper is providing a useful tool of analysis. The topic of debt relief is currently debated widely at policy circles by the IMF and the United Nations, and the analysis of this paper provides some insightful input to the debate.Originality/value - The use of scenario analysis for sovereign debt modeling and the use of an optimization model developed by the authors in previous research provide empirical analysis for three current problems in sovereign debt management. Useful insights are obtained for three important real-world cases for Cyprus, Italy and Ukraine
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