Controlling the complexity of investment decisions using qualitative reasoning techniques

Abstract

Assembling financial instruments such as equities, bonds, options, and other derivatives into a portfolio requires a thorough understanding of how the portfolio will behave in response to changes of specific economic variables and parameters of the instruments. With more information about a more diverse set of instruments becoming available to traders, it is becoming important to limit the complexity of the analysis involved. We show how this complexity can be limited by using qualitative analysis, where the objective is to construct a few good vehicles which can then be analyzed quantitatively. We illustrate how two qualitative reasoning techniques — qualitative simulation and qualitative synthesis — are used to design investment vehicles for risk management purposes. These techniques are currently employed by a prototype expert system that aims at assisting traders solving a risk management problem called hedging.