Decision Making under Uncertainty in Financial Markets
Decision Making under Uncertainty in Financial Markets

Author: Jonas Ekblom

Publisher: Linköping University Electronic Press

Published: 2018-09-13

Total Pages: 36

ISBN-13: 9176852024

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This thesis addresses the topic of decision making under uncertainty, with particular focus on financial markets. The aim of this research is to support improved decisions in practice, and related to this, to advance our understanding of financial markets. Stochastic optimization provides the tools to determine optimal decisions in uncertain environments, and the optimality conditions of these models produce insights into how financial markets work. To be more concrete, a great deal of financial theory is based on optimality conditions derived from stochastic optimization models. Therefore, an important part of the development of financial theory is to study stochastic optimization models that step-by-step better capture the essence of reality. This is the motivation behind the focus of this thesis, which is to study methods that in relation to prevailing models that underlie financial theory allow additional real-world complexities to be properly modeled. The overall purpose of this thesis is to develop and evaluate stochastic optimization models that support improved decisions under uncertainty on financial markets. The research into stochastic optimization in financial literature has traditionally focused on problem formulations that allow closed-form or `exact' numerical solutions; typically through the application of dynamic programming or optimal control. The focus in this thesis is on two other optimization methods, namely stochastic programming and approximate dynamic programming, which open up opportunities to study new classes of financial problems. More specifically, these optimization methods allow additional and important aspects of many real-world problems to be captured. This thesis contributes with several insights that are relevant for both financial and stochastic optimization literature. First, we show that the modeling of several real-world aspects traditionally not considered in the literature are important components in a model which supports corporate hedging decisions. Specifically, we document the importance of modeling term premia, a rich asset universe and transaction costs. Secondly, we provide two methodological contributions to the stochastic programming literature by: (i) highlighting the challenges of realizing improved decisions through more stages in stochastic programming models; and (ii) developing an importance sampling method that can be used to produce high solution quality with few scenarios. Finally, we design an approximate dynamic programming model that gives close to optimal solutions to the classic, and thus far unsolved, portfolio choice problem with constant relative risk aversion preferences and transaction costs, given many risky assets and a large number of time periods.

Decision Making Under Uncertainty in Electricity Markets
Decision Making Under Uncertainty in Electricity Markets

Author: Antonio J. Conejo

Publisher: Springer Science & Business Media

Published: 2010-09-08

Total Pages: 549

ISBN-13: 1441974210

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Decision Making Under Uncertainty in Electricity Markets provides models and procedures to be used by electricity market agents to make informed decisions under uncertainty. These procedures rely on well established stochastic programming models, which make them efficient and robust. Particularly, these techniques allow electricity producers to derive offering strategies for the pool and contracting decisions in the futures market. Retailers use these techniques to derive selling prices to clients and energy procurement strategies through the pool, the futures market and bilateral contracting. Using the proposed models, consumers can derive the best energy procurement strategies using the available trading floors. The market operator can use the techniques proposed in this book to clear simultaneously energy and reserve markets promoting efficiency and equity. The techniques described in this book are of interest for professionals working on energy markets, and for graduate students in power engineering, applied mathematics, applied economics, and operations research.

Investment under Uncertainty
Investment under Uncertainty

Author: Robert K. Dixit

Publisher: Princeton University Press

Published: 2012-07-14

Total Pages: 484

ISBN-13: 1400830176

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How should firms decide whether and when to invest in new capital equipment, additions to their workforce, or the development of new products? Why have traditional economic models of investment failed to explain the behavior of investment spending in the United States and other countries? In this book, Avinash Dixit and Robert Pindyck provide the first detailed exposition of a new theoretical approach to the capital investment decisions of firms, stressing the irreversibility of most investment decisions, and the ongoing uncertainty of the economic environment in which these decisions are made. In so doing, they answer important questions about investment decisions and the behavior of investment spending. This new approach to investment recognizes the option value of waiting for better (but never complete) information. It exploits an analogy with the theory of options in financial markets, which permits a much richer dynamic framework than was possible with the traditional theory of investment. The authors present the new theory in a clear and systematic way, and consolidate, synthesize, and extend the various strands of research that have come out of the theory. Their book shows the importance of the theory for understanding investment behavior of firms; develops the implications of this theory for industry dynamics and for government policy concerning investment; and shows how the theory can be applied to specific industries and to a wide variety of business problems.

Handbook of the Fundamentals of Financial Decision Making
Handbook of the Fundamentals of Financial Decision Making

Author: Leonard C. MacLean

Publisher: World Scientific

Published: 2013

Total Pages: 941

ISBN-13: 9814417351

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This handbook in two parts covers key topics of the theory of financial decision making. Some of the papers discuss real applications or case studies as well. There are a number of new papers that have never been published before especially in Part II.Part I is concerned with Decision Making Under Uncertainty. This includes subsections on Arbitrage, Utility Theory, Risk Aversion and Static Portfolio Theory, and Stochastic Dominance. Part II is concerned with Dynamic Modeling that is the transition for static decision making to multiperiod decision making. The analysis starts with Risk Measures and then discusses Dynamic Portfolio Theory, Tactical Asset Allocation and Asset-Liability Management Using Utility and Goal Based Consumption-Investment Decision Models.A comprehensive set of problems both computational and review and mind expanding with many unsolved problems are in an accompanying problems book. The handbook plus the book of problems form a very strong set of materials for PhD and Masters courses both as the main or as supplementary text in finance theory, financial decision making and portfolio theory. For researchers, it is a valuable resource being an up to date treatment of topics in the classic books on these topics by Johnathan Ingersoll in 1988, and William Ziemba and Raymond Vickson in 1975 (updated 2 nd edition published in 2006).

Managing Uncertainty, Mitigating Risk
Managing Uncertainty, Mitigating Risk

Author: Nick Firoozye

Publisher: Springer

Published: 2016-04-20

Total Pages: 281

ISBN-13: 1137334541

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Managing Uncertainty, Mitigating Risk proposes that financial risk management broaden its approach, maintaining quantification where possible, but incorporating uncertainty. The author shows that by using broad quantification techniques, and using reason as the guiding principle, practitioners can see a more holistic and complete picture.

Decision Making under Deep Uncertainty
Decision Making under Deep Uncertainty

Author: Vincent A. W. J. Marchau

Publisher: Springer

Published: 2019-04-04

Total Pages: 408

ISBN-13: 3030052524

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This open access book focuses on both the theory and practice associated with the tools and approaches for decisionmaking in the face of deep uncertainty. It explores approaches and tools supporting the design of strategic plans under deep uncertainty, and their testing in the real world, including barriers and enablers for their use in practice. The book broadens traditional approaches and tools to include the analysis of actors and networks related to the problem at hand. It also shows how lessons learned in the application process can be used to improve the approaches and tools used in the design process. The book offers guidance in identifying and applying appropriate approaches and tools to design plans, as well as advice on implementing these plans in the real world. For decisionmakers and practitioners, the book includes realistic examples and practical guidelines that should help them understand what decisionmaking under deep uncertainty is and how it may be of assistance to them. Decision Making under Deep Uncertainty: From Theory to Practice is divided into four parts. Part I presents five approaches for designing strategic plans under deep uncertainty: Robust Decision Making, Dynamic Adaptive Planning, Dynamic Adaptive Policy Pathways, Info-Gap Decision Theory, and Engineering Options Analysis. Each approach is worked out in terms of its theoretical foundations, methodological steps to follow when using the approach, latest methodological insights, and challenges for improvement. In Part II, applications of each of these approaches are presented. Based on recent case studies, the practical implications of applying each approach are discussed in depth. Part III focuses on using the approaches and tools in real-world contexts, based on insights from real-world cases. Part IV contains conclusions and a synthesis of the lessons that can be drawn for designing, applying, and implementing strategic plans under deep uncertainty, as well as recommendations for future work. The publication of this book has been funded by the Radboud University, the RAND Corporation, Delft University of Technology, and Deltares.

Corporate Decision-Making with Macroeconomic Uncertainty
Corporate Decision-Making with Macroeconomic Uncertainty

Author: Lars Oxelheim

Publisher: Oxford University Press

Published: 2008-09-26

Total Pages: 256

ISBN-13: 0190450576

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Macroeconomic turbulence and volatility in financial markets can fatally affect firm's performance. Very few firms make serious attempts to inform market participants and other outsider stakeholders about the impact of macroeconomic fluctuations--manifested as changes in exchange rates, interest rates, inflation rates and stock market returns-- on performance. These stakeholders, as well as financial analysts, must make their own assessments but they generally lack both the required tools and the information to do so. Worse, top management in most firms do not themselves possess the tools to identify whether a change in performance represents a change in the firm's intrinsic competitiveness or a reflection of macroeconomic conditions outside their influence. Corporate Decision-Making with Macroeconomic Uncertainty: Performance and Risk Management develops and presents in an easily comprehensible way the essential elements of a corporate strategy for managing uncertainty in the macroeconomic environment. This Macroeconomic Uncertainty Strategy, or MUST, enhances firm value by allowing management and external stakeholders to become better informed about the development of corporate competitiveness in a turbulent macroeconomic environment. The MUST also provides guidelines for how to develop a successful risk management program. This research based book includes methods to identify the impact of macroeconomic fluctuations on cash flows and value, to develop strategies for macroeconomic risk management, to provide informative reports to external stakeholders, to evaluate the relative performance of subsidiaries and business units in multinational companies, and to evaluate performance for purposes of setting executive compensation and of fulfilling the due diligence requirements in an M & A context. The authors' use of value-based management, various performance measurements, the concept of real options, and risk management from the perspective of shareholder wealth maximization, makes the book rich and compelling. They address researchers and students in the field of international business, finance and corporate governance. On the business side, executives with strategic responsibilities, chief financial officers, and bankers who analyze corporate performance and give advice on risk management will benefit from reading this book.

Market and Professional Decision-making Under Risk and Uncertainty
Market and Professional Decision-making Under Risk and Uncertainty

Author: Erick Davidson

Publisher:

Published: 2007

Total Pages: 107

ISBN-13:

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Abstract: This dissertation explores decision making under risk and uncertainty by professionals and markets composed of professionals. Both essays use empirical data from some of the most competitive economic environments imaginable. The first essay looks at market prices resulting from the sum of both professional and lay choices while the second analyzes the individual choices of professional gamblers. Both essays propose a theoretical framework to not just positively identify what professionals do, but also prescribe normatively what they should do. In both cases, the two are found to be different. The first essay, Market Response to Risk and Uncertainty, 2004 Hurricane Forecasts, develops a simple function to explain insurance losses from hurricanes as a function of short-term forecasts. After demonstrating the accuracy of the function in explaining 2004 insurance claims, the remainder of the essay looks at the stock market's use of these forecasts in pricing insurer and US economy risk. Despite causing billions in damages, both hurricanes and hurricane forecasts are found to have only marginal impacts on financial markets. Surprisingly, markets fail to make efficient use of hurricane forecasts in pricing both insurer and general market exposure to hurricane risk. A potential explanation for market inefficiency around hurricane information is that, like researchers, financial actors may be confounding uncertainty for unpredictability. The second essay, Know When to Hold'em, examines a specific decision within a highly popular, high-stakes version of poker. Like financial markets analyzed in the first essay, professional gamblers must make risky decisions with uncertain probabilities of success. Gamblers are found to be both overly conservative in their choices and overly confident in their abilities to predict uncertain outcomes. A simple statistical model that generalizes across situations to form a naïve probability of having the best cards, is found to be as effective in decision making as players' true expectations of winning. Additionally, a dynamic theoretical model is presented in order to show professional divergence from risk-neutral expected profit maximization in the credit constrained world of tournament poker. Interestingly the value function, derived from this model, is equivalent to an optimal stock price of a poker player.