Cambridge University Press 978-0-521-86170-0 - Optimization Methods in Finance Gerard Cornuejols and Reha Tutuncu Table of Contents More

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Contents

Foreword page xi Introduction 1 1.1 Optimization problems 1 1.2 Optimization with data uncertainty 5 1.3 Financial mathematics 8 Linear programming: theory and algorithms 15 2.1 The linear programming problem 15 2.2 Duality 17 2.3 Optimality conditions 21 2.4 The simplex method 23 LP models: asset/liability cash-ow matching 41 3.1 Short-term nancing 41 3.2 Dedication 50 3.3 Sensitivity analysis for linear programming 53 3.4 Case study: constructing a dedicated portfolio 60 LP models: asset pricing and arbitrage 62 4.1 Derivative securities and the fundamental theorem of asset pricing 62 4.2 Arbitrage detection using linear programming 69 4.3 Additional exercises 71 4.4 Case study: tax clientele effects in bond portfolio management 76 Nonlinear programming: theory and algorithms 80 5.1 Introduction 80 5.2 Software 82 5.3 Univariate optimization 82 5.4 Unconstrained optimization 92 5.5 Constrained optimization 100 5.6 Nonsmooth optimization: subgradient methods 110

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Cambridge University Press 978-0-521-86170-0 - Optimization Methods in Finance Gerard Cornuejols and Reha Tutuncu Table of Contents More information

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Contents

6 NLP models: volatility estimation 6.1 Volatility estimation with GARCH models 6.2 Estimating a volatility surface 7 Quadratic programming: theory and algorithms 7.1 The quadratic programming problem 7.2 Optimality conditions 7.3 Interior-point methods 7.4 QP software 7.5 Additional exercises 8 QP models: portfolio optimization 8.1 Mean-variance optimization 8.2 Maximizing the Sharpe ratio 8.3 Returns-based style analysis 8.4 Recovering risk-neutral probabilities from options prices 8.5 Additional exercises 8.6 Case study: constructing an efcient portfolio 9 Conic optimization tools 9.1 Introduction 9.2 Second-order cone programming 9.3 Semidenite programming 9.4 Algorithms and software 10 Conic optimization models in nance 10.1 Tracking error and volatility constraints 10.2 Approximating covariance matrices 10.3 Recovering risk-neutral probabilities from options prices 10.4 Arbitrage bounds for forward start options 11 Integer programming: theory and algorithms 11.1 Introduction 11.2 Modeling logical conditions 11.3 Solving mixed integer linear programs 12 Integer programming models: constructing an index fund 12.1 Combinatorial auctions 12.2 The lockbox problem 12.3 Constructing an index fund 12.4 Portfolio optimization with minimum transaction levels 12.5 Additional exercises 12.6 Case study: constructing an index fund

112 112 116 121 121 122 124 135 136 138 138 155 158 161 165 167 168 168 169 173 177 178 178 181 185 187 192 192 193 196 212 212 213 216 222 223 224

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Cambridge University Press 978-0-521-86170-0 - Optimization Methods in Finance Gerard Cornuejols and Reha Tutuncu Table of Contents More information

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13 Dynamic programming methods 13.1 Introduction 13.2 Abstraction of the dynamic programming approach 13.3 The knapsack problem 13.4 Stochastic dynamic programming 14 DP models: option pricing 14.1 A model for American options 14.2 Binomial lattice 15 DP models: structuring asset-backed securities 15.1 Data 15.2 Enumerating possible tranches 15.3 A dynamic programming approach 15.4 Case study: structuring CMOs 16 Stochastic programming: theory and algorithms 16.1 Introduction 16.2 Two-stage problems with recourse 16.3 Multi-stage problems 16.4 Decomposition 16.5 Scenario generation 17 Stochastic programming models: Value-at-Risk and Conditional Value-at-Risk 17.1 Risk measures 17.2 Minimizing CVaR 17.3 Example: bond portfolio optimization 18 Stochastic programming models: asset/liability management 18.1 Asset/liability management 18.2 Synthetic options 18.3 Case study: option pricing with transaction costs 19 Robust optimization: theory and tools 19.1 Introduction to robust optimization 19.2 Uncertainty sets 19.3 Different avors of robustness 19.4 Tools and strategies for robust optimization 20 Robust optimization models in nance 20.1 Robust multi-period portfolio selection 20.2 Robust prot opportunities in risky portfolios 20.3 Robust portfolio selection 20.4 Relative robustness in portfolio selection 20.5 Moment bounds for option prices 20.6 Additional exercises

225 225 233 236 238 240 240 242 248 250 252 253 254 255 255 256 258 260 263 271 271 274 276 279 279 285 288 292 292 293 295 302 306 306 311 313 315 317 318

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Cambridge University Press 978-0-521-86170-0 - Optimization Methods in Finance Gerard Cornuejols and Reha Tutuncu Table of Contents More information

Contents

Appendix A Convexity Appendix B Cones Appendix C A probability primer Appendix D The revised simplex method References Index

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