Annals of Operations Research

, Volume 59, Issue 1, pp 77–97 | Cite as

Asset/liability management under uncertainty for fixed-income securities

  • Stavros A. Zenios


Short-sighted asset/liability strategies of the seventies left financial intermediaries — banks, insurance and pension fund companies, and government agencies — facing a severe mismatch between the two sides of their balance sheet. A more holistic view was introduced with a generation ofportfolio immunization techniques. These techniques have served the financial services community well over the last decade. However, increased interest rate volatilities, and the introduction of complex interest rate contingencies and asset-backed securities during the same period, brought to light the shortcomings of the immunization approach. This paper describes a series of (optimization) models that take a global view of the asset/liability management problem using interest rate contingencies. Portfolios containingmortgage-backed securities provide the typical example of the complexities faced by asset/liability managers in a volatile financial world. We use this class of instruments as examples for introducing the models. Empirical results are used to illustrate the effectiveness of the models, which become increasingly more complex but also afford the manager increasing flexibility.


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. [1]
    D.F. Babbel and S.A. Zenios, Pitfalls in the analysis of option-adjusted spreads, Fin. Anal. J. (July/August, 1992) 65–69.Google Scholar
  2. [2]
    F. Black, E. Derman and W. Troy, A one-factor model of interest rates and its application to treasury bond options, Fin. Anal. J. (Jan./Feb. 1990) 33–39.Google Scholar
  3. [3]
    P. Boyle, Options: A Monte Carlo approach, J. Fin. Econ. 4(1977)323–338.CrossRefGoogle Scholar
  4. [4]
    S.P. Bradley and D.B. Crane, A dynamic model for bond portfolio management, Manag. Sci. 19(1972)139–151.Google Scholar
  5. [5]
    P.E. Christensen and F.J. Fabozzi, Bond immunization: An asset liability optimization strategy, in:The Handbook of Fixed Income Securities, ed. F.J. Fabozzi and I.M. Pollack (Dow Jones Irwin, 1987).Google Scholar
  6. [6]
    J.C. Cox, Jr., E. Ingersoll and S.A. Ross, A theory of the term structure of interest rates, Econometrica 53(1985)385–407.MathSciNetGoogle Scholar
  7. [7]
    C. Vassiadou-Zeniou and S.A. Zenios, Robust optimization models for managing callable bond portfolios, Euro. J. Oper. Res. (1995).Google Scholar
  8. [8]
    H. Dahl, A. Meeraus and S.A. Zenios, Some financial optimization models: I. Risk management, in:Financial Optimization, ed. S.A. Zenios (Cambridge University Press, 1993) pp. 3–36.Google Scholar
  9. [9]
    G.B. Dantzig, Linear programming under uncertainty, Manag. Sci. 1(1955)197–206.Google Scholar
  10. [10]
    B. Golub, M. Holmer, R. McKendall, L. Pohlman and S.A. Zenios, Stochastic programming models for money management, Euro. J. Oper. Res. (1995).Google Scholar
  11. [11]
    R.R. Grauer and N.H. Hakansson, Returns on levered actively managed long-run portfolios of stocks, bonds and bills, Fin. Anal. J. (Sept. 1985) 24–43.Google Scholar
  12. [12]
    R.S. Hiller and J. Eckstein, Stochastic dedication: Designing fixed income portfolios using massively parallel Benders decomposition, Manag. Sci. 39(1994)1422–1438.CrossRefGoogle Scholar
  13. [13]
    M.R. Holmer, The asset/liability management system at Fannie Mae, Interfaces 24(1994)3–21.Google Scholar
  14. [14]
    J.M. Hutchinson and S.A. Zenios, Financial simulations on a massively parallel Connection Machine, Int. J. Supercomp. Appl. 5(1991)27–45.Google Scholar
  15. [15]
    J.E. Ingersoll, Jr.,Theory of Financial Decision Making, Studies in Financial Economics (Rowman and Littlefield, Totowa, NJ, 1987).Google Scholar
  16. [16]
    H. Konno and H. Yamazaki, Mean-absolute deviation portfolio optimization model and its applications to Tokyo stock market, Manag. Sci. 37(1991)519–531.Google Scholar
  17. [17]
    H. Markowitz, Portfolio selection, J. Fin. 7(1952)77–91.Google Scholar
  18. [18]
    H. Markowitz,Mean-Variance Analysis in Portfolio Choice and Capital Markets (Basil Blackwell, Oxford, 1987).Google Scholar
  19. [19]
    J.M. Mulvey and H. Vladimirou, Stochastic network optimization models for investment planning, Ann. Oper. Res. 20(1989)187–217.MathSciNetGoogle Scholar
  20. [20]
    J.M. Mulvey and S.A. Zenios, Capturing the correlations of fixed-income instruments, Manag. Sci. 40(1994)1329–1342.CrossRefGoogle Scholar
  21. [21]
    R.B. Platt (ed.),Controlling Interest Rate Risk, Wiley Professional Series in Banking and Finance (Wiley, New York, 1986).Google Scholar
  22. [22]
    R.J-B Wets, Stochastic programs with fixed resources: The equivalent deterministic problem, SIAM Rev. 16(1974)309–339.CrossRefGoogle Scholar
  23. [23]
    K.J. Worzel, C. Vassiadou-Zeniou and S.A. Zenios, Integrated simulation and optimization models for tracking fixed-income indices, Oper. Res. 42(1994)223–233.Google Scholar
  24. [24]
    S.A. Zenios, Massively parallel computations for financial modeling under uncertainty, in:Very Large Scale Computing in the 21st Century, ed. J. Mesirov (SIAM, Philadelphia, PA, 1991) pp. 273–294.Google Scholar

Copyright information

© J.C. Baltzer AG, Science Publishers 1995

Authors and Affiliations

  • Stavros A. Zenios
    • 1
  1. 1.HERMES Laboratory for Financial Modeling and Simulation, Decision Sciences Department, The Wharton SchoolUniversity of PennsylvaniaPhiladelphiaUSA

Personalised recommendations