http://repub.eur.nl/res/aut/237/ List of Publications en http://repub.eur.nl/static-eur/img/logo.png http://repub.eur.nl http://repub.eur.nl/res/pub/7020/ 2005-11-04T00:00:00Z When delegating an investment decisions to a professional manager, investors often anchor their mandate to a specific benchmark. The manager’s exposure to risk is controlled by means of a tracking error volatility constraint. It depends on market conditions whether this constraint is easily met or violated. Moreover, the performance of the portfolio depends on market conditions. In this paper we argue that these mandated portfolios should not only be evaluated relative to their benchmarks in order to appraise their performance. They should also be evaluated relative to the opportunity set of all portfolios that can be formed under the same mandate – the portfolio opportunity set. The distribution of performance values over the portfolio opportunity set depends on contemporary market dynamics. To correct for this, we suggest a normalized version of the information ratio that is invariant to these market conditions. http://repub.eur.nl/res/pub/1472/ 2004-08-11T00:00:00Z We derive an estimator for Black-Scholes-Merton implied volatility that, when compared to the familiar Corrado & Miller [JBaF, 1996] estimator, has substantially higher approximation accuracy and extends over a wider region of moneyness. http://repub.eur.nl/res/pub/10686/ 2004-03-01T00:00:00Z In this paper we present and illustrate using real-life data a framework for managing an investment portfolio in which the investment opportunities are described in terms of a set of attributes and part of this set is intended to capture the effects on society. Here we link with the emerging literature on SRI: socially responsible investment. Given the multi-attribute descriptions of the individual investment opportunities we show how these can be combined into portfolios with the same attributes at the portfolio level. Also we show how a manager can systematically be supported in the choice between different portfolio profiles. As part of the framework we use multi-criteria decision tools. http://repub.eur.nl/res/pub/1220/ 2004-02-20T00:00:00Z Aside from the aggregated information provided by price and quantity indexes, there is growing interest in index decompositions that reveal the contribution of each index component to overall index change. In this paper, we derive a “natural” decomposition of the Fisher price index that is directly implied by its linear homogeneity in price relatives. The proposed “Euler” weights not only indicate the total contribution of each component to total index change but also reveal which component had the highest or lowest marginal impact. Our results can readily be generalized to any index that satisfies the linear homogeneity property. http://repub.eur.nl/res/pub/927/ 2003-09-25T00:00:00Z In this paper we explore the theoretical and empirical problems of estimating average (excess) return and risk of US equities over various holding periods and sample periods. Our findings are relevant for performance evaluation, for estimating the historical equity risk premium, and for investment simulation. Using a unique set of US equity data series, comprising monthly prices and dividends based on consistent definitions over the 132 year period 1871-2002, we investigate the complex effect of temporal return aggregation and sample estimation error. Our major finding is that holding period risk and return statistics show an extraordinary sensitivity to the choice of the starting point in calendar time. For example, over the period 1926-2002 there is a difference of almost 140 basis points between the average annual total return starting in January compared to starting in July, and a difference of almost 7 (!) percentage points in estimated annual volatility. This is yet another way in which stock price seasonality manifests itself, but this ambiguity in the underlying estimation process seems completely neglected in the current literature. http://repub.eur.nl/res/pub/928/ 2003-09-25T00:00:00Z In this paper we explore the relevance of dividends in the total equity return over longer time horizons. In addition, we investigate the effects of different reinvestment assumptions of dividends. We use a unique set of revised and corrected US equity data series, comprising monthly prices and dividends based on consistent definitions over the period 1871-2002 (132 years). Our findings are relevant for performance evaluation, for estimating the historical equity risk premium, and for investment simulation. http://repub.eur.nl/res/pub/426/ 2003-06-04T00:00:00Z Large institutional investors allocate their funds over a number of classes (e.g. equity, fixed income and real estate), various geographical regions and different industries. In practice, these allocation decisions are usually made in a hierarchical (top-down), consecutive way. At the higher decision level, the allocation is made on basis of benchmark portfolios (indexes). Such indexes are then set as targets for the lower levels. For example, at the top level the allocation decision is made on the basis of asset class benchmark indexes, on the second level the decisions are made on the basis of sector benchmark indexes, etc. Obviously, the lower levels have considerable flexibility to deviate from these targets. That is the reason why targets often come with limits on the maximally allowed deviation (or "tracking error") from these targets. The potential consequences of deviations from the benchmark portfolios have received very little attention in the literature. In this paper, we discuss and illustrate this influence. The lower level tracking errors with respect to the benchmark indexes propagate to the top level. As a result the risk-return characteristics of the actual aggregate portfolio will be different from those of the initial benchmark-based portfolio. We illustrate this effect for a two level process to allocate funds over individual US stocks and sectors. We show that the benchmark allocation approaches used in practice yield inferior solutions when compared to a non-hierarchical approach where full information about individual lower level investment opportunities is available. Our results reveal that even small deviations from the benchmark portfolios can cause large shifts in the top-level risk-return space. This implies that the incorporation of lower level information in the initial top-level decision process will lead to a different (possibly better) allocation. http://repub.eur.nl/res/pub/321/ 2003-04-29T00:00:00Z Most financial-economic decisions are made consciously, with a clear and constant drive to ???good???, ???better??? or even ???optimal??? decisions. Nevertheless, many decisions in practice do not earn these qualifications, despite the availability of financial economic theory, decision sciences and ample resources. We plea for the development of a multidimensional framework to support financial economic decision processes. Our aim is to achieve a better integration of available theory and decision technologies. We sketch (a) what the framework should look like, (b) what elements of the framework already exist and which not, and (c) how the MCDA community can co-operate in its development. http://repub.eur.nl/res/pub/234/ 2002-10-08T00:00:00Z We present an analysis of the performance of the DAX, German's major stock market index, over the last two years. Our analysis is broader than conventional benchmark approaches because we study the properties of all feasible portfolios, i.e. portfolios composed given the same investment opportunity set and also given the same constraints as implied by the definition of the DAX. We estimate the distribution of performance values of all feasible portfolios according to different performance measures and evaluate the position of the DAX with respect to this feasible set. As in existing approaches, our analysis describes the 'average' development of the market over time. In addition, our analysis provides an insight into the development of the dynamics of the market over time by following the dispersion of the performance distributions over time. http://repub.eur.nl/res/pub/6140/ 2002-10-01T00:00:00Z For people working in finance, either in academia or in practice or in both, the combination of finance and multiple criteria is not obvious. However, we believe that many of the tools developed in the field of MCDM can contribute both to the quality of the financial economic decision making process and to the quality of the resulting decisions. In this paper we answer the question why financial decision problems should be considered as multiple criteria decision problems and should be treated accordingly. http://repub.eur.nl/res/pub/223/ 2002-09-09T00:00:00Z For people working in finance, either in academia or in practice or in both, the combination of ?finance? and ?multiple criteria? is not obvious. However, we believe that many of the tools developed in the field of MCDM can contribute both to the quality of the financial economic decision making process and to the quality of the resulting decisions. In this paper we answer the question why financial decision problems should be considered as multiple criteria decision problems and should be treated accordingly. http://repub.eur.nl/res/pub/205/ 2002-06-04T00:00:00Z In this paper we present and illustrate using real-life data a framework for managing an investment portfolio in which the investment opportunities are described in terms of a set of attributes and part of this set is intended to capture the effects on society. Here we link with the emerging literature on SRI: Socially Responsible Investment. Given the multifarious descriptions of the individual investment opportunities we show how these can be combined into portfolios with the same attributes at the portfolio level. Also we show how a manager can systematically be supported in the choice between different portfolio profiles. As part of the framework we use multi-criteria decision tools. http://repub.eur.nl/res/pub/6145/ 2002-06-01T00:00:00Z Most financial-economic decisions are made consciously, with a clear and constant drive to good, better or even optimal decisions. Nevertheless, many decisions in practice do not earn these qualifications, despite the availability of financial economic theory, decision sciences and ample resources. We plea for the development of a multidimensional framework to support financial economic decision processes. Our aim is to achieve a better integration of available theory and decision technologies. We sketch (a) what the framework should look like, (b) what elements of the framework already exist and which not, and (c) how the MCDA community can co-operate in its development. http://repub.eur.nl/res/pub/6948/ 2000-07-05T00:00:00Z Most of the available monthly interest data series consist of monthly averages of daily observations. It is well- known that this averaging introduces spurious autocorrelation effects in the first differences of the series. It is exactly this differenced series we are interested in when estimating interest rate risk exposures e.g. This paper presents a method to filter this autocorrelation component from the averaged series. In addition we investigate the potential effect of averaging on duration analysis, viz. when estimating the relationship between interest rates and financial market variables like equity or bond prices. In contrast to interest rates the latter price series are readily available in ultimo month form. We find that combining monthly returns on market variables with changes in averaged interest rates leads to serious biases in estimated correlations (R2s), regression coefficients (durations) and their significance (t-statistics). Our theoretical findings are confirmed by an empirical investigation of US interest rates and their relationship with US equities (S&P 500 Index). http://repub.eur.nl/res/pub/6137/ 2000-01-01T00:00:00Z http://repub.eur.nl/res/pub/7721/ 1999-06-11T00:00:00Z In fixed income analysis, duration plays a central role as a proxy for interest rate risk exposure. Although this role relies on the interpretation of duration as (minus) the yield elasticity of the bond price, duration is measured as a bond's present value weighted average time to maturity and expressed in terms of years. Hence duration is regarded as an elasticity with a time dimension. In this note we resolve this apparent duration paradox and show that duration is a pure number. http://repub.eur.nl/res/pub/7723/ 1999-05-10T00:00:00Z An intensive and still growing body of research focuses on estimating a portfolio’s Value-at-Risk. Depending on both the degree of non-linearity of the instruments comprised in the portfolio and the willingness to make restrictive assumptions on the underlying statistical distributions, a variety of analytical methods and simulation-based methods are available. Aside from the total portfolio’s VaR, there is a growing need for information about (i) the marginal contribution of the individual portfolio components to the diversified portfolio VaR, (ii) the proportion of the diversified portfolio VaR that can be attributed to each of the individual components consituting the portfolio, and (iii) the incremental effect on VaR of adding a new instrument to the existing portfolio. Expressions for these marginal, component and incremental VaR metrics have been derived by Garman [1996a, 1997a] under the assumption that returns are drawn from a multivariate normal distribution. For many portfolios, however, the assumption of normally distributed returns is too stringent. Whenever these deviations from normality are expected to cause serious distortions in VaR calculations, one has to resort to either alternative distribution specifications or historical and Monte Carlo simulation methods. Although these approaches to overall VaR estimation have received substantial interest in the literature, there exist to the best of our knowledge no procedures for estimating marginal VaR, component VaR and incremental VaR in either a non-normal analytical setting or a Monte Carlo / historical simulation context. This paper tries to fill this gap by investigating these VaR concepts in a general distribution-free setting. We derive a general expression for the marginal contribution of an instrument to the diversified portfolio VaR ? whether this instrument is already included in the portfolio or not. We show how in a most general way, the total portfolio VaR can be decomposed in partial VaRs that can be attributed to the individual instruments comprised in the portfolio. These component VaRs have the appealing property that they aggregate linearly into the diversified portfolio VaR. We not only show how the standard results under normality can be generalized to non-normal analytical VaR approaches but also present an explicit procedure for estimating marginal VaRs in a simulation framework. Given the marginal VaR estimate, component VaR and incremental VaR readily follow. The proposed estimation approach pairs intuitive appeal with computational efficiency. We evaluate various alternative estimation methods in an application example and conclude that the proposed approach displays an astounding accuracy and a promising outperformance. http://repub.eur.nl/res/pub/7726/ 1999-05-03T00:00:00Z In recent years the Value at Risk (VaR) concept for measuring downside risk has been widely studied. VaR basically is a summary statistic that quantifies the exposure of an asset or portfolio to market risk, or the risk that a position declines in value with adverse market price changes. Three parties have been particularly interested: financial institutions, regulators and corporates. In this paper, we focus on VaR use for corporates. This field is relatively unexplored. We show how VaR can be helpful to study market value risk -- proxied by share price risk. We develop a methodology to decompose the overall VaR into components that are attributable to underlying external risk factors and a residual idiosyncratic component. Apart from developing theoretical results, we study the airline industry to show what practical results our 'Component VaR framework' can yield. Like any multinational company, an airline faces significant exposures to external risk factors, e.g. commodity prices, interest rates and exchange rates. In our opinion, Component VaR analysis can enrich discussions in the company on financial risk management and shareholder value. http://repub.eur.nl/res/pub/6008/ 1997-05-16T00:00:00Z The definition of Financial Modelling chosen by the EURO working group on financial modelling is ‘the development and implementation of tools supporting firms, investors, intermediaries, governments and others in their financial-economic decision making, including the validation of the premises behind these tools and the measurement of the effectivity of the use of these tools’. Clearly, in this definition, the decision and its solution is central. Unlike financial modelling in our definition, the theory of finance is not so much concerned with individual decisions, but rather with the effects of the decisions and actions of many individuals on the formation of prices in financial markets. It is therefore no wonder that the assumptions underlying financial theory, which at best describe ‘average individuals’ and ‘average decision situations’, are not suited to describe specific individual decision problems. In our view it is the role of financial modelling to support individual decision making, taking account of the peculiarities of the actual case, where possible taking benefit from the results of the financial theory. This philosophy towards financial modelling is illustrated by a framework for portfolio management. http://repub.eur.nl/res/pub/6000/ 1997-01-01T00:00:00Z http://repub.eur.nl/res/pub/8220/ 1994-11-11T00:00:00Z http://repub.eur.nl/res/pub/5997/ 1992-01-01T00:00:00Z