Financial Engineering and Portfolio Design Problem: State of the Art

Financial Engineering and Portfolio Design Problem: State of the Art

DOI: 10.4018/978-1-7998-1882-3.ch001

Abstract

Any financial institution is in charge of assigning to a client's portfolio a set of assets in a reliable way by minimizing the risk of loss and maximizing gain. All portfolios should share in an equitable way risky assets and safe assets with respect to a financial structured product such as CDO2 (collateralized debt obligation squared). Realizing a balanced portfolio requires a good level of diversification on the chosen assets. Many works have made proposals for modeling and solving the (OPD) problem, but each one has taken into account specific types of risks and cases. However, in this chapter, the authors introduce the problem in a general way by using the CDO2 structure. The authors focus in this chapter on the basic and useful notions of financial engineering, followed by a description of the financial portfolio structure CDO2, the most used and structured financial product. The chapter introduces the financial portfolio optimization problem through the CDO2 structure, the effect of the diversification on the efficiency of the financial portfolio.
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Background

Financial structures such as CDO (Collateralized Debt Obligation), CPDO (Constant Proportion Debt Obligations), CDO squared, CDO cubed, etc. were developed to address the issues resulted from human decisions.

We deduce through different finance documents (Clauss, Roncalli & Weisang, 2009; Black & Myron, 1973; Papst, 2011; Black & Scholes, 1973; Dufour & Orhangazi, 2014; Robinson, 2014; Wong, 2012; Numora, 2006; Graham & Dodd,1951; Barnett-Hart, 2009), that analysts' opinions on the origins of the economic disaster which appeared in 2007-2008, are divided into three classes:

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