Time: 9.15am - 4.30pm
Venue: LSE
Tutor: Dr William T. Ziemba (University of British Columbia)
Course outline

This masterclass covers static and dynamic portfolio theory with applications. This is in discrete and continuous time. We begin with the fundamentals of stochastic dominance and risk aversion. The assumptions necessary to show the equivalence of second order stochastic dominance and mean-variance analysis are shown. The mean is the most important parameter in any portfolio decision problem and its importance is risk aversion dependent. The little-known Rubenstein risk aversion measure is shown to be optimal but not easily interpretable or estimable.  However, the average Arrow-Pratt risk aversion index serves as a very good approximation to show the effect of risk aversion on portfolio choice. The Enron pension disaster is used as an example to illustrate the effect of risk aversion and getting mean right. Investors tend to over bet on their own company stock with possibly disastrous results.

The afternoon session deals with multiperiod models.  The stochastic programming approach to asset liability and wealth management is well suited for very good large scale models for various types of financial institutions. Scenarios describe the possible evolution of the future.  These are optimized subject to the constraints of using a convex risk measure concave utility function. The approach using scenario dependent correlation matrices is applied to the Vienna pension fund of Siemens in the model InnoALM.

The rest of the afternoon has continuous time portfolio models. The Merton model is extended to liabilities and four fund separation. This is applied with continuous distribution as well as assets with jumps. We close the class with a study of the effects of incentives and managers stake in the fund on risk taking behavior and the value of the call option on other peoples’ money. A modification of the Sharpe ratio is used to evaluate the greatest investors such as the Renaissance Medallion Hedge Fund. The downside symmetric Sharpe ration can detect frauds as well as superior funds.

The SRC masterclass Series is taught at a level appropriate to postgraduate research students and is free of charge.

Timetable: View the timetable here.