Portfolio Management Framework for Derivative Instruments
9 Pages Posted: 25 Sep 2022
Date Written: September 14, 2022
The investment industry lacks an unified framework for handling derivative instruments in general portfolio management. With the increased use of derivatives, there is a need for a framework that aligns fundamental terminology and concepts. The main challenges with the current practices seem to be caused by not properly separating exposure / notional and market value / price. This tendency is also seen in the academic literature where exposure and market value are usually treated as identical quantities, e.g., in portfolio optimization. This article proposes a simple framework that can be used for all purposes of portfolio management and has intuitive properties that align with current conventions related to portfolio return. This feature allows us to perform portfolio optimization, risk decomposition, and performance evaluation in a familiar way.
Keywords: Portfolio management, derivative instruments, leverage, portfolio optimization, performance evaluation, CVaR, tail risks, market views, stress-testing, Entropy Pooling, Kullback-Leibler divergence.
JEL Classification: B16, B26, C02, C61, C63, C65, C88, G00, G10, G11, G13, G17
Suggested Citation: Suggested Citation