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«Essays on Robust Portfolio Selection and Pension Finance Thesis submitted in partial fulfilment of the requirements for the degree of Doctor of ...»

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Henley Business School

ICMA Centre

Essays on Robust Portfolio Selection and

Pension Finance

Thesis submitted in partial fulfilment of the requirements for

the degree of Doctor of Philosophy

by

Emmanouil Platanakis

Reading, October 2015

i

To my parents, George and Kalliopi

"μὴ μου τοὺς κύκλους τάραττε!" - Αρχιμήδης

ii

Declaration

I confirm that this is my own work and the use of all

material from other sources has been properly and fully

acknowledged.

____________________ Date:_______________

Emmanouil Platanakis iii Acknowledgements First and foremost, I would like to express my deepest gratitude to my supervisor, Charles Sutcliffe (ICMA Centre – University of Reading) for his guidance, support and faith that he showed to me. Charles has been very encouraging, helpful and thoughtful, while his comments and feedback have been direct and insightful. Also, Charles has made me think harder about the motivations, potential contributions, importance and positioning of my work.

Furthermore, I would like to thank the ICMA Centre for the doctoral scholarship that it has granted me during my doctoral studies as well as their generous additional funding in order to cover my travel expenses for various conference presentations. Many faculty members of the ICMA Centre have also assisted me in a number of ways. In particular, discussions with Ioannis Oikonomou, Chris Brooks, Sotiris Tsolacos, Nicholas Chen and Alfonso Dufour have been very inspiring.

I would also like to express my appreciation for my fellow doctoral candidates Andrei Stancu and Chris Godfrey for helping me towards the data collection process. In addition, I must thank the participants of the 4 th International Conference of the Financial Engineering and Banking Society (Surrey, UK), 8th Portuguese Finance Network International Conference (Vilamoura, Portugal), 12th Annual International Conference on Finance (Athens, Greece) and the Annual Workshop of the Dauphine-Amundi Chair in Asset Management (Paris, France) for their comments on the paper presented in Chapter 3, as well as two anonymous referees for the European Journal of Finance where the study presented in Chapter iv 3 has been published after 3 rounds of revision. Furthermore, I must thank the participants of the 5th International Conference of the Financial Engineering and Banking Society (Nantes, France), 4th European Business Research Conference (London, UK) and the ICMA Centre Internal Research Seminar (Reading, UK) for their valuable comments on the study presented in Chapter 4. Finally, I must also thank the participants of the ICMA Centre Internal Research Seminar (Reading, UK)

for their comments as well as an anonymous referee for the Insurance:

Mathematics and Economics journal where the study presented in Chapter 5 has been accepted for revise and resubmit.

Finally, my special gratitude goes to my parents, George and Kalliopi, and to my brother, Konstantinos, who have always incentivized me to pursue education and achieve my targets. They have always been a source of inspiration and I think that I would not be able to pursue this doctoral degree without their support and motivation.

–  –  –

This thesis examines three different, but related problems in the broad area of portfolio management for long-term institutional investors, and focuses mainly on the case of pension funds. The first idea (Chapter 3) is the application of a novel numerical technique – robust optimization – to a real-world pension scheme (the Universities Superannuation Scheme, USS) for first time. The corresponding empirical results are supported by many robustness checks and several benchmarks such as the Bayes-Stein and Black-Litterman models that are also applied for first time in a pension ALM framework, the Sharpe and Tint model and the actual USS asset allocations. The second idea presented in Chapter 4 is the investigation of whether the selection of the portfolio construction strategy matters in the SRI industry, an issue of great importance for long term investors.

This study applies a variety of optimal and naïve portfolio diversification techniques to the same SRI-screened universe, and gives some answers to the question of which portfolio strategies tend to create superior SRI portfolios.

Finally, the third idea (Chapter 5) compares the performance of a real-world pension scheme (USS) before and after the recent major changes in the pension rules under different dynamic asset allocation strategies and the fixed-mix portfolio approach and quantifies the redistributive effects between various stakeholders. Although this study deals with a specific pension scheme, the methodology can be applied by other major pension schemes in countries such as the UK and USA that have changed their rules.

vi Table of Contents Acknowledgements

Abstract

List of Figures

List of Tables

1 Introduction and Overview

2 Literature Review

2.1 Introduction

2.2 Markowitz Portfolio Theory

2.3 Modern Portfolio Theory Criticisms

2.4 Portfolio Approaches Dealing with Estimation Risk

2.4.1 Bayes’ Estimators





2.4.2 Constraints on Portfolio Weights

2.4.3 ‘Resampled Efficiency’

2.4.4 Optimal Mixture Portfolios

2.4.5 Portfolios with Moments Restrictions

2.4.6 Robust (Worst-Case) Optimization

2.5 Performance Measures and Portfolio Evaluation

2.5.1 Performance Measures based on Lower Partial Moments

2.5.2 Performance Measures based on Drawdown

2.5.3 Performance Measures based on Value-at-Risk

2.6 Asset Liability Management (ALM)

2.7 Operational Research and ALM Techniques

2.7.1 Stochastic Programming ALM Models

2.7.2 Single Period ALM Models (Portfolio Theory)

2.7.3 Stochastic Simulation ALM Models

2.7.4 Dynamic Programming and Stochastic Control ALM Models

2.8 Techniques for Generating Scenarios

2.8.1 Sampling Approach

2.8.2 Statistical Approach

2.8.3 Alternative Techniques

2.9 Pension Schemes Design and Intergenerational Transfers

2.9.1 Defined Benefit (DB) Pension Schemes

vii 2.9.2 Defined Contribution (DC) Schemes

2.9.3 Intergenerational Effects

2.10 Conclusions

3 Asset Liability Modelling and Pension Schemes: The Application of Robust Optimization to USS

3.1 Introduction

3.2 Robust Optimization ALM Model

3.3 Application to USS

3.4 Data and Analysis

3.5 Results

3.6 Robustness Checks

3.7 Conclusions

Appendix 3.A – Projected Contribution Rate

Appendix 3.B - Uncertainty Sets

Appendix 3.C – Conversion to a Second Order Cone Problem

Appendix 3.D - Actuarial Liability Models

4 Socially Responsible Investment Portfolios: Does the Optimization Process Matter?..... 99

4.1 Introduction

4.2 Related literature and motivation of the study

4.3 Model and dataset

4.3.1 Portfolio evaluation metrics

4.3.2 Dataset

4.4 Results

4.4.1 Main results

4.4.2 Robustness tests

4.4.3 Additional analyses

4.5 Conclusions

Appendix 4.A: Mathematical definition of implemented optimization approaches..... 147

4.A.1 Markowitz portfolio optimization

4.A.2 Robust estimation approach

4.A.3 Black-Litterman approach

4.A.4 Risk-parity portfolio construction

4.A.5 Reward-to-risk timing portfolios

viii Appendix B: Indicators for each CSP dimension

Chapter 5

5 Pension Scheme Redesign and Wealth Redistribution Between the Members and Sponsor: The USS Rule Change in October 2011

5.1 USS

5.2 Methodology

5.3 Literature Review

5.4 Forecasting Asset Returns, Inflation and Salaries

5.5 Forecasting the Size of the Age Cohorts

5.6 Forecasting the Liabilities

5.7 Generating the Cohort Cash Flows

5.8 Redistribution

5.9 Results

5.10 Robustness Checks

5.11 Conclusions

Appendix 5.A - USS Rules Pre and Post-October 2011

Appendix 5.B.1 Final Salary (FS) Scheme

Appendix 5.B.2 Career Revalued Benefit (CRB) Scheme

Appendix 5.C Time Varying Price of Risk

Chapter 6

6 Conclusions and Future Research

6.1 Summary and Conclusions

6.2 Suggestions for Future Research

References

–  –  –

Figure 4.1………………………………………………………………………………………………….

.………128 Figure 4.2……………………………………………………………………………………………………..……130 Figure 4.3………………………………………………………………………………………………………..…133 Figure 5.1…………………………………………………………………………………………………………..197 Figure 5.2………………………………………………………………………………………………………..…197 Figure 5.3……………………………………………………………………………………………………..……198 Figure 5.4………………………………………………………………………………………………………..…198 Figure 5.5……………………………………………………………………………………………………..……199 Figure 5.6………………………………………………………………………………………………………..…199 Figure 5.7……………………………………………………………………………………………..……………200 Figure 5.8………………………………………………………………………………………………..…………200 Figure 5.9…………………………………………………………………………………………………..………201 Figure 5.10…………………………………………………………………………………………………..…… 201 Figure 5.11………………………………………………………………………………………………..……….202 Figure 5.12…………………………………………………………………………………………………..…….202 Figure 5.13…………………………………………………………………………………………………..…….203 x List of Tables Table 2.1………………………………………………………………………………………………………………37 Table 3.1………………………………………………………………………………………………………………65 Table 3.2………………………………………………………………………………………………………………68 Table 3.3………………………………………………………………………………………………………………69 Table 3.4………………………………………………………………………………………………………………70 Table 3.5………………………………………………………………………………………………………………75 Table 3.6………………………………………………………………………………………………………………77 Table 3.7………………………………………………………………………………………………………………80 Table 3.8………………………………………………………………………………………………………………86 Table 4.1…………………………………………………………………………………………………………….122 Table 4.2…………………………………………………………………………………………………………….122 Table 4.3…………………………………………………………………………………………………………….124 Table 4.4…………………………………………………………………………………………………………….132 Table 4.5…………………………………………………………………………………………………………….137 Table 4.6…………………………………………………………………………………………………………….139 Table 4.7…………………………………………………………………………………………………………….139 Table 4.8………………………………………………………………………………………………….…………139 Table 4.9…………………………………………………………………………………………………………….143 Table 5.1…………………………………………………………………………………………………………….204 Table 5.2…………………………………………………………………………………………………………….183

–  –  –

This thesis examines three different, but related problems in the broad area of portfolio management for long-term institutional investors, and focuses mainly on the case of pension funds. In what follows, we provide a comprehensive overview of the following chapters.



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