Asymmetric Correlation in IT Project Portfolio Management

Real Option Analysis (ROA) has been a focus of the MIS literature for the last ten years. Much of this literature has focused on (1) the suitability of using ROA in IS/IT; (2) case studies examining single projects; (3) real options embedded in projects; (4) the Black Scholes or Binomial option models; and (5) developing models to account for sources of variability. In this paper we investigate (5) above by taking a portfolio view of an organization’s IT/IS projects. We assume that both costs and revenues behave stochastically. We use the concept of an IT Project Portfolio Map to divide the portfolio into different sections by the relative size of project costs and revenues. Finally, we introduce the idea of asymmetric correlation in these different areas of the portfolio. The importance of asymmetric correlation and the dependence structure of a portfolio in general stems from the idea that projects that have uncorrelated costs and revenues are more valuable then projects with highly correlated costs and revenues

Comparing univariate and multivariate models to forecast portfolio value-at-risk

This article addresses the problem of forecasting portfolio value-at-risk (VaR) with multivariate GARCH models vis-à-vis univariate models. Existing literature has tried to answer this question by analyzing only small portfolios and using a testing framework not appropriate for ranking VaR models. In this work we provide a more comprehensive look at the problem of portfolio VaR forecasting by using more appropriate statistical tests of comparative predictive ability. Moreover, we compare univariate vs. multivariate VaR models in the context of diversified portfolios containing a large number of assets and also provide evidence based on Monte Carlo experiments. We conclude that, if the sample size is moderately large, multivariate models outperform univariate counterparts on an out-of-sample basis.Market risk, Backtesting, Conditional predictive ability, GARCH, Volatility, Capital requirements, Basel II

Concurrent Credit Portfolio Losses

We consider the problem of concurrent portfolio losses in two non-overlapping credit portfolios. In order to explore the full statistical dependence structure of such portfolio losses, we estimate their empirical pairwise copulas. Instead of a Gaussian dependence, we typically find a strong asymmetry in the copulas. Concurrent large portfolio losses are much more likely than small ones. Studying the dependences of these losses as a function of portfolio size, we moreover reveal that not only large portfolios of thousands of contracts, but also medium-sized and small ones with only a few dozens of contracts exhibit notable portfolio loss correlations. Anticipated idiosyncratic effects turn out to be negligible. These are troublesome insights not only for investors in structured fixed-income products, but particularly for the stability of the financial sector

The Bank's Choice of Financing and the Correlation Structure of Loan Returns

This paper examines how the correlation structure of loan returns within a bank s loan portfolio a.ects its choice of .nancing when the bank faces binding capital constraints and there is asymmetric information about the quality of its loans.The paper uses an asymmetric information model similar to Myers and Majluf (1984), where a bank must raise its equity-toassets ratio either by issuing equity or by selling loans in the secondary market.The results suggest that the correlation structure of loan returns can have signi.cant in.uence on the cost of issuing equity since it a.ects the variance of a banks loan portfolio. However, it is shown that a bank will always prefer to sell loans instead of equity if it has favorable inside information for some of its loans and unfavorable information for some of its other loans.banks;financing;correlation;loans;capital;information

European Securitisation : a GARCH model of CDO, MBS and Pfandbrief spreads

Asset-backed securitisation (ABS) is an asset funding technique that involves the issuance of structured claims on the cash flow performance of a designated pool of underlying receivables. Efficient risk management and asset allocation in this growing segment of fixed income markets requires both investors and issuers to thoroughly understand the longitudinal properties of spread prices. We present a multi-factor GARCH process in order to model the heteroskedasticity of secondary market spreads for valuation and forecasting purposes. In particular, accounting for the variance of errors is instrumental in deriving more accurate estimators of time-varying forecast confidence intervals. On the basis of CDO, MBS and Pfandbrief transactions as the most important asset classes of off-balance sheet and on-balance sheet securitisation in Europe we find that expected spread changes for these asset classes tends to be level stationary with model estimates indicating asymmetric mean reversion. Furthermore, spread volatility (conditional variance) is found to follow an asymmetric stochastic process contingent on the value of past residuals. This ABS spread behaviour implies negative investor sentiment during cyclical downturns, which is likely to escape stationary approximation the longer this market situation lasts

Asset securitisation as a risk management and funding tool : what does it hold in store for SMES?

The following chapter critically surveys the attendant benefits and drawbacks of asset securitisation on both financial institutions and firms. It also elicits salient lessons to be learned about the securitisation of SME-related obligations from a cursory review of SME securitisation in Germany as a foray of asset securitisation in a bank-centred financial system paired with a strong presence of SMEs in industrial production. JEL Classification: D81, G15, M2

Regularizing Portfolio Optimization

The optimization of large portfolios displays an inherent instability to estimation error. This poses a fundamental problem, because solutions that are not stable under sample fluctuations may look optimal for a given sample, but are, in effect, very far from optimal with respect to the average risk. In this paper, we approach the problem from the point of view of statistical learning theory. The occurrence of the instability is intimately related to over-fitting which can be avoided using known regularization methods. We show how regularized portfolio optimization with the expected shortfall as a risk measure is related to support vector regression. The budget constraint dictates a modification. We present the resulting optimization problem and discuss the solution. The L2 norm of the weight vector is used as a regularizer, which corresponds to a diversification "pressure". This means that diversification, besides counteracting downward fluctuations in some assets by upward fluctuations in others, is also crucial because it improves the stability of the solution. The approach we provide here allows for the simultaneous treatment of optimization and diversification in one framework that enables the investor to trade-off between the two, depending on the size of the available data set

Where do we stand in the theory of finance? : a selective overview with reference to Erich Gutenberg

For the past 20 years, financial markets research has concerned itself with issues related to the evaluation and management of financial securities in efficient capital markets and with issues of management control in incomplete markets. The following selective overview focuses on key aspects of the theory and empirical experience of management control under conditions of asymmetric information. The objective is examine the validity of the recently advanced hypothesis on the myths of corporate control. The present overview is based on Gutenberg's position that there exists a discrete corporate interest, as distinct from and separate from the interests of the shareholders or other stakeholders. In the third volume of Grundlagen der BWL: Die Finanzen, published in 1969, this position of Gutenberg's is coupled with an appeal for a so-called financial equilibrium to be maintained. Not until recently have models grounded in capital market theory been developed which also allow for a firm's management to exercise autonomy vis-à-vis its stakeholder. This paper was prepared for the Erich Gutenberg centenary conference on December 12 and 13, 1997 in Cologne