Ranking, risk-taking and effort: an analysis of the ECB's foreign reserves management

The investment of the ECB reserves in US dollars and yen, delegated to a network of portfolio managers in the Eurosystem’s national central banks, involves a periodic assessment of performance against a common benchmark, controlled by the ECB and subject to revision on a monthly basis. Monetary reward for the best performers is almost entirely absent, and compensation comes mainly as reputational credit following the transmission of the annual report to the Governing Council. Employing a new data set on individual portfolio variables during 2002-2009, we study this peculiar tournament and show the existence of risk-shifting behaviour by reserve managers related to their year-to-date ranking: interim losers increase relative risk in the second half of the year, in the same way as mutual fund managers. In the dollar case, risk-shifting is asymmetric: the adjustment to ranking is generally reduced or entirely offset if reserve managers have achieved a positive interim performance against the benchmark. Yen reserve managers that rank low show a tendency to increase effort, as proxied by portfolio turnover. We also find that reserve managers who ranked low in the previous year tend to reduce risk significantly. Our evidence is consistent with a reserve managers’ anecdote, according to which they obtain a concave reputational reward within their national central banks, which induces risk aversion and explains the observed low usage of the risk budget. Since reserve managers should have a comparative advantage over the tactical benchmark within a monthly horizon, possible enhancements to the design of the tournament are discussed. These might involve an increased reward for effort and performance by means of a convex scoring system linked to monthly, rather than annual, performance. JEL Classification: G11, E58, D81Delegated portfolio management, effort, Foreign reserves, incentives, tournament

Ranking, risk-taking and effort: an analysis of the ECB's foreign reserves management

The investment of the ECB reserves in US dollars and yen involves an annual performance assessment of portfolio managers, located in the Eurosystem’s national central banks. Employing new data on individual portfolios during 2002-2009, we study this peculiar tournament and show the existence of risk-shifting behaviour by reserve managers related to their year-to-date ranking: interim losers increase relative risk in the second half of the year, in the same way as mutual fund managers. In the dollar case the adjustment to ranking is reduced or offset if reserve managers have achieved a positive interim performance against the benchmark. Yen reserve managers that rank low show a tendency to increase effort, as proxied by portfolio turnover. Those who ranked low in the previous year tend to reduce risk significantly. Since reserve managers should have a comparative advantage over the benchmark within a monthly horizon, possible enhancements to the design of the tournament might involve an increased reward for effort and performance by means of a convex scoring system linked to monthly, rather than annual, performance.foreign exchange reserves, tournament, incentives, effort, portfolio management

Analysis of the sensitivity to discrete dividends : A new approach for pricing vanillas

The incorporation of a dividend yield in the classical option pricing model of Black- Scholes results in a minor modification of the Black-Scholes formula, since the lognormal dynamic of the underlying asset is preserved. However, market makers prefer to work with cash dividends with fixed value instead of a dividend yield. Since there is no closed-form solution for the price of a European Call in this case, many methods have been proposed in the literature to approximate it. Here, we present a new approach. We derive an exact analytic formula for the sensitivity to dividends of an European option. We use this result to elaborate a proxy which possesses the same Taylor expansion around 0 with respect to the dividends as the exact price. The obtained approximation is very fast to compute (the same complexity than the usual Black-Scholes formula) and numerical tests show the extreme accuracy of the method for all practical cases.Equity options;discrete dividends

Network service chaining with efficient network function mapping based on service decompositions

Network Service Chaining (NSC) is a service concept which promises increased flexibility and cost-efficiency for future carrier networks. The two recent developments, Network Function Virtualization (NFV) and Software-Defined Networking (SDN), are opportunities for service providers to simplify the service chaining and provisioning process and reduce the cost (in CAPEX and OPEX) while introducing new services as well. One of the challenging tasks regarding NFV-based services is to efficiently map them to the components of a physical network based on the services specifications/constraints. In this paper, we propose an efficient cost-effective algorithm to map NSCs composed of Network Functions (NF) to the network infrastructure while taking possible decompositions of NFs into account. NF decomposition refers to converting an abstract NF to more refined NFs interconnected in form of a graph with the same external interfaces as the higher-level NF. The proposed algorithm tries to minimize the cost of the mapping based on the NSCs requirements and infrastructure capabilities by making a reasonable selection of the NFs decompositions. Our experimental evaluations show that the proposed scheme increases the acceptance ratio significantly while decreasing the mapping cost in the long run, compared to schemes in which NF decompositions are selected randomly