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#02-01  The PROMETEIA Model for Managing Insurance Policies with Guarantees
#02-02  A Dynamic Stochastic Programming Model for International Portfolio Management
#02-03  Life-Cycle Asset Allocation: A Model with Borrowing Constraints, Uninsurable Labor Income Risk, and Stock-Market Participation Costs
#02-04  Critical Assessment of Option Pricing Methods Using Artificial Neural Networks and Implied Volatility
#02-05  The Risks of the Cyprus and Athens Stock Exchanges
#02-06  Insurance League: Italy vs. UK
#02-07  Equity Risk of the CDB Portfolio
#02-08  Stockholding: Recent Lessons from Theory and Computations
#02-09  Stockholding in Europe: Where Do We Stand and Where Do We Go?
#02-10  Scenario Optimization Asset and Liability Modeling for Individual Investors
#02-11  Measuring Portfolio Credit Risk Application for a Cypriot Commercial Bank
#02-12  Delivering E-Banking Services: An Emerging Internet Business Model and a Case Study
#02-13  Real (Investment) Options with Multiple Sources of Rare Events
#02-14  On the Propagation of the Fluctuations of Stock Returns on Growth: is the Global Effect Important?
#02-15  International Evidence on the Transmission of Stock Market Fluctuations to Output
#02-16 Investigating the Links Between and Stock Price Changes with Empirical Evidence From the G7 Economies
#02-17  Stockholding: A European Comparison

 

Abstracts and downloadables

 

 

HERMES Working Paper #02-01

 

The PROMETEIA Model for Managing Insurance Policies with Guarantees

 

Andrea Consiglio, Flavio Cocco and Stavros A. Zenios, January 2002

 

 

Abstract Insurance products become increasingly more innovative in order to face competitive pressures. Insurance policies today come with guarantees on the minimum rate of return, bonus provisions, and surrender options. These features make them attractive for investors who seek not only insurance but also investment vehicles. However, the new policies are much more complex to price and fund than traditional insurance products. In this chapter we discuss the development of a scenario-based optimization model for asset and liability management for the participating policies with guarantees and bonus provisions offered by Italian insurers. The changing landscape of the financial services in Italy sets the backdrop for the development of this system which was the result of a multi-year collaborative effort between academic researchers, the research staff at Prometeia in Bologna, and end-users from diverse Italian insurers. The model is presented, its key features are discussed in detail, and several extensions are briefly introduced. The resulting system allows the analysis of the tradeoffs facing an insurance firm in structuring its policies as well as the choices in covering their cost. It is applied to the analysis of policies offered by Italian insurance firms. While the optimized model results are in general agreement with current industry practices, inefficiencies are still identified and potential improvements are suggested. Extensive numerical experiments provide significant insights on features of the participating guaranteed policies.

In Handbook of Asset and Liability Management, Volume 1, North-Holland Handbooks in Finance, 2007
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HERMES Working Paper #02-02

 

A Dynamic Stochastic Programming Model for International Portfolio Management

 

Nikolas Topaloglou, Hercules Vladimirou, and Stavros A. Zenios, January 2002

 

 

Abstract We develop a multi-stage stochastic programming model for international portfolio management in a dynamic setting. We model uncertainty in asset prices and exchange rates in terms of scenario trees that closely approximate the empirical distributions implied by market data. The model takes a holistic view of the problem. It considers portfolio rebalancing decisions over multiple periods in accordance with the contingencies of the scenario tree. The solution jointly determines capital allocations to international markets, the selection of assets within each market, and appropriate currency hedging levels. We investigate the performance of alternative hedging strategies through extensive numerical tests with real market data. We show that appropriate selection of currency forward contracts materially reduces risk in international portfolios. We further find that multi-stage models consistently outperform single-stage models. Our results demonstrate that the stochastic programming framework provides a flexible and effective decision support tool for international portfolio management.

European Journal of Operational Research, In press, 2006
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HERMES Working Paper #02-03

 

Life-Cycle Asset Allocation: A Model with Borrowing Constraints, Uninsurable Labor Income Risk, and Stock-Market Participation Costs


Francisco Gomes and Alexander Michaelides, January 2002

 

 

Abstract We study life-cycle asset allocation in the presence of liquidity constraints and undiversifiable labor income risk. We find that small stock-market entry costs can explain the zero-median stockholding puzzle. Households start saving in the riskless asset and enter the stock market later in life. Moreover, the presence of human capital rationalizes the asset allocation puzzle of Canner, Mankiw and Weil (1997). Nevertheless, conditional on participation, the portfolio allocation remains heavily skewed towards equities. Extensions that generate a larger co-existence of cash and stocks imply a counterfactually high stock market participation rate. These results suggest that simultaneously matching stock market participation and asset allocation remains a challenge.

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HERMES Working Paper #02-04

 

Critical Assessment of Option Pricing Methods Using Artificial Neural Networks and Implied Volatility

 

Panayiotis Ch. Andreou, Chris Charalambous, and Spiros H. Martzoukos, January 2002

 

 

Abstract In this paper we compare the predictive ability of the Black-Scholes-Merton Formula (BSMF) and Artificial Neural Networks (ANNs) to price call options including in our information set both historical and implied volatility measures. The practically standard backpropagation training algorithm in financial application literature was replaced with a modified Levenberg-Marquardt optimisation algorithm. We used daily data for the S&P 500 European call options and the underlying asset and furthermore, we employed nonlinearly interpolated risk-free interest rate from the Federal Reserve board for the period 1998 to 2000. Our final dataset was formed after we did extensive work for cleaning and filtering. In order to select the best ANN configurations and models, we did extensive research using different variants and transformations of input variables and optimising the number of hidden neurons in the hidden layer. Mean-variance scaling transformations for the data and transformed (maturity adjusted) volatilities improve performance.

Using the best models in each sub-period tested, our preliminary results demonstrate the following: a) by using historical measures of volatility, ANNs outperform the BSMF; b) by using the appropriate implied volatility per contract for the BSMF, we show that BSMF outperforms the ANNs; and c) a hybrid ANN model that also incorporates a unique transformed implied volatility per contract, often outperforms the BSMF even if BSMF utilizes implied volatility. Our results are significant and differ from previous literature (i.e. Hutchison et al., 1994, etc). Finally, we are currently extending the research in order to investigate the applicability of the models using trading strategies with various levels of transaction costs.

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HERMES Working Paper #02-05

 

The Risks of the Cyprus and Athens Stock Exchanges

 

Marios Nerouppos, David Saunders, Costas Xiouros, and Stavros A. Zenios, 2002

 

 

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HERMES Working Paper #02-06

 

Insurance League: Italy vs. UK

 

Andrea Consiglio, David Saunders, and Stavros A. Zenios, 2002

 

 

Abstract Insurance companies have been turning to innovative products in order to attract clients who are seeking, today, integration of their actuarial risks with financial risks. Products with guaranteed rates of return and bonus provisions play a particularly prominent role in this respect. These products come in many distinct flavors, and in this paper we compared two general models that prevail among the UK and Italian insurers. The differences in the policies offered by these two players in the insurance league derive from the characteristics of the bonus policies. Using an integrative asset and liability management model we examine the impact of these bonus policies from the points of view of the company's shareholders, the policyholders, and the management. In particular, we find that the greater flexibility afforded UK insurers is reflected in increased benefit for shareholders at the expense of policyholders. Recent events in the UK have shown how dramatic the impact of this bias can be.

Journal of Risk Finance, Volume 4, Issue 4, pp. 47-54, Summer 2003
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HERMES Working Paper #02-07

 

Equity Risk of the CDB Portfolio

 

Marios Nerouppos, David Saunders and Stavros A. Zenios, 2002

 

 

Abstract In this report we analyze different methodologies for assessing the risk of the traded equity component of the portfolio of the Cyprus Development Bank. The approach takes it to fit the Capital Asset Pricing Model (CAPM) to each of the securities. We consider specification of the CAPM with the CSE General Index as the market index, as well as teh use of teh relevant sector indexes for each equity. The quality of the fit of the CAPM to the securities is assessed in detail. Once the CAPM has been fit, we examine different methodologies for scenario generation and risk measurement for the CDB portfolio. Detailed results are presented on the effectiveness of using each method for estimating the industry standard risk measure Value-at-Risk (VaR). Methods for dealing with the lack of data and liquidity of the local market are also discussed.

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HERMES Working Paper #02-08

 

Stockholding: Recent Lessons from Theory and Computations

 

Michael Haliassos, 2002

 

 

Abstract Household-level portfolio data show a tendency of the majority of households in each country to hold no stocks despite a historical expected-return premium on equity relative to riskless assets. This paper first explains why such a tendency constitutes a puzzle in economic theory (the "stockholding puzzle"). It discusses why simple popular notions regarding the source of non-participation (risk aversion, risky labor income, and borrowing constraints) are not confirmed by careful analysis of portfolio models and presents recent conclusions on what causes non-participation. Based on this, it revisits the popular view on non-participation and shows how it can be qualified to be consistent with lessons from economic theory. It also explains how this view can be extended to account for exits from the stock market and for limited diversification. Then, the paper describes three unsolved empirical puzzles concerning the share of stocks in portfolios of households that do participate in the stock market. It points to basic underlying mechanisms producing these theoretical results and discusses briefly possible future directions for research that may help resolve the puzzles. Finally, the paper draws lessons for practitioners interested in expanding the stockholder base.

In Guiso, L., M. Haliassos, and T. Jappelli (Eds), Stockholding in Europe, Palgrave Macmillan Publishers, pp. 30-51, 2002
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HERMES Working Paper #02-09

 

Stockholding in Europe: Where Do We Stand and Where Do We Go?

 

Luigi Guiso, Michael Haliassos, and Tullio Jappelli, 2002

 

 

Abstract We discuss the current state of stockownership among households in major European countries (France, Germany, Italy, the Netherlands, Sweden, and the UK), drawing parallels and contrasts with the US experience. We use detailed microeconomic datasets and explore the extent to which observed international differences in stockholding can be attributed to differences in household characteristics. Statistical analysis finds (1) an increase in stock market participation in all countries; (2) persistent differences across countries, with the US, the UK and Sweden having considerable more participation than France, Germany, Italy; (3) a robust correlation between the participation decision on the one hand, and wealth and education on the other; (4) a relatively small effect of education and wealth on the asset share invested in stocks, conditional on participation. Interestingly, international differences in stock market participation remain large even when we control for household characteristics. As our empirical results point to the relevance of participation costs, we probe into a number of indicators of such costs, and we find that these are consistent with the observed pattern of participation across countries. Since the lowering of such costs brings into the market households with different characteristics than incumbents, we discuss their likely impact, policy concerns, and types of policies that could mitigate their adverse impact on the future workings of the market.

Economic Policy, Volume 18, Issue 36, pp. 123-170, 2003
(Also available as CSEF Working Paper 88)
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HERMES Working Paper #02-10

 

Scenario Optimization Asset and Liability Modeling for Individual Investors


Andrea Consiglio, Flavio Cocco and Stavros A. Zenios, 2002

 

 

Abstract We develop a scenario optimization model for asset and liability management of individual investors. The individual has a given level of initial wealth and a target goal to be reached within some time horizon. The individual must determine and asset allocation strategy so that the portfolio growth rate will be sufficient to reach the target. A scenario optimization model is formulated which maximizes the upside potential of the portfolio, with limits on the downside risk. Both upside and downside are measured vis-a-vis the goal. The stochastic behavior of asset returns is captured through bootstrap simulation, and the the simulation is embedded in the model to determine the optimal portfolio. Post-optimality analysis using out-of-sample scenarios measures the probability of success of a given portfolio. It also allows us to estimate the required increase in the initial endowment so that the probability of success is improved.

Annals of Operations Research, Volume 152, Issue 1, pp. 167-191, 2007
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HERMES Working Paper #02-11

 

Measuring Portofolio Credit Risk Application for a Cypriot Commercial Bank

 

David Saunders, Costas Xiouros, and Stavros A. Zenios, 2002

 

 

Abstract In this paper we present a framework for measuring and managing the default risk of a loan portofolio. Through the dependency of the counterparty defaults on a systematic factor we explore the conditional indepedence of the individual defaults in analyzing and quantifying the credit risk. Monte carlo simulations and asymptotic analysis are employed to approximate the loss distribution as well as estimate the various risk measures. The analysis performed shows that the asymptotic analysis is a fast way for generating relatively accurate results. Also, the senitivity analysis highlights the need for enough credit related data in order to accurately estimate the model parameters as small fluctuation in these parameters can alter the results significanlty.

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HERMES Working Paper #02-12

 

Delivering E-banking Services: An Emerging Internet Business Model and a Case Study

 

Andreas Soteriou and Stavros A. Zenios, 2002

 

 

Abstract Over the last few years a number of internet business models have appeared in the literature, addressing various aspects of e-commerce. With very few exceptions, these do not target the idiosyncrasies of e-banking. This chapter builds upon the previous literature and presents an internet business model that focuses on e-banking and can provide the foundation for successful e-banking strategies. More specifically, we first review some of the changes of the world of financial services in the internet era that are relevant for the proliferation of e-banking services. We examine both supply and demand forces that shape the drive for internet-based financial services, paying particular attention to Italy —the country on which we later on base our case study. Based on the above, we next present a general business model specific to e-banking. Finally, we present as a case study a system for personal financial planning which has been deployed by some Italian banks and analyse some of its components from the point of view of the general business model.

In Handbook of Quantitative Supply Chain Analysis: Modeling in the E-Business Era, International Series in Operations Research and Management Science, Kluwer Academic Publishers, pp. 783-803, 2004
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HERMES Working Paper #02-13

 

Real (Investment) Options with Multiple Sources of Rare Events

 

Spiros H. Martzoukos and Lenos Trigeorgis, 2002

 

 

Abstract We value real (investment) options when the underlying asset follows a mixed jump-diffusion process involving various types (sources) of rare events (jumps). These jumps are assumed independent of each other, with each type having a log-normally distributed jump size and a random (Poisson-distributed) arrival time. They may represent uncertainties about the arrival and impact (on the underlying investment) of new information concerning technological innovation, competition, political risk, regulatory effects, and other sources. An analytic solution is presented for European claims (call or put options) with multiple sources of jumps. A discrete-time (Markov-chain) methodology (implemented within a finite-difference scheme) is proposed for the valuation of American as well as European options. The approach is also applicable to financial options with multiple types of rare events. The approach is illustrated through valuing complex real options with compound features involving interactions between optimal investment and subsequent operating decisions. Specifically we value a growth option and an extension option.

European Journal of Operational Research, Volume 136, Issue 3, pp. 696-706, 2002
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HERMES Working Paper #02-14

 

On the Propagation of the Fluctuations of Stock Returns on Growth: Is the Global Effect Important?

 

Christis Hassapis and Sarantis Kalyvitis, 2002

 

 

Abstract Increasing capitalization in developed economies has attracted the attention of policymakers and economists with respect to the effects of unanticipated changes in stock returns on growth. This paper attempts to examine empirically the response of output growth to shocks in real stock returns. Evidence from OECD countries by use of Vector Autoregressions shows that output growth does not respond significantly to shocks in domestic real stock returns. The picture, however, changes when a shock in foreign (United States) real stock returns is considered. A portion of excess output volatility in these countries can be explained by innovations in foreign real returns, which indicates that in the global economic environment growth is more exposed to financial instability originating from abroad.

Journal of Policy Modeling, Number 24, Issue 5, pp.487-502, 2002
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HERMES Working Paper #02-15

 

International Evidence on the Transmission of Stock Market Fluctuations to Output

 

Christis Hassapis and Sarantis Kalyvitis, 2002

 

 

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HERMES Working Paper #02-16

 

Investigating the Links Between Growth and Stock Price Changes with Empirical Evidence from the G7 Economies

 

Christis Hassapis and Sarantis Kalyvitis, 2002

 

 

Abstract This paper investigates the link between real stock price changes and economic growth. We develop a simple growth model, which presents the relationship between real stock prices and output. Evidence from the G-7 economies by use of the Vector Autoregression (VAR) methodology shows that real stock price changes and output growth are strongly related, as predicted by the theoretical model. The bivariate framework also provides useful information for understanding the response of economic growth and real stock prices to external shocks.

The Quarterly Review of Economics and Finance, Volume 42, Issue 3, pp. 543-575, Autumn 2002
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HERMES Working Paper #02-17

 

Stockholding: A European Comparison

 

Luigi Guiso, Michael Haliassos and Tullio Jappelli, 2002

 

 

In Guiso, L., M. Haliassos, and T. Jappelli (Eds), Stockholding in Europe, Palgrave Macmillan Publishers, pp. 3-29, 2002
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