Unit-0: Syllabus for Optimization methods in Finance(MA61061,3-0-0)

Course Coordinator:
Prof. Geetanjali Panda,
Room No N319, Department of Mathematics Mail id:
[email protected]
IIT Kharagpur

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Unit-0: Syllabus for Optimization methods in Finance(MA61061,3-0-0)

Course Coordinator:
Prof. Geetanjali Panda,
Room No N319, Department of Mathematics Mail id:
[email protected]
IIT Kharagpur

Quadratic Programming and application in Finance(Markowitz models)

Fractional Programming and application in Finance(Capital Asset Pricing
models)
Multiobjective programming application in finance(Sharpe ratio model)
Linear programming application in finance(MAD and Min-max models)
Integer programming and application in finance(auction and index fund)
Stochastic programming and application in finance(Value-at-Risk and
Conditional Value-at-Risk)

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Books

1 Optimization Methods in Finance by Gerad Cornuejols and Reha T ,

Cambridge University Press.
2 Numerical Methods and Optimization in Finance by Manfred Gilli,
Dietmar Maringer, Enrico Schumann. Academic Press.
3 Mean Variance Analysis in Portfolio Choice and Capital Markets by
Harry M. Markowitz, Wiley.

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Books

1 Optimization Methods in Finance by Gerad Cornuejols and Reha T ,

Cambridge University Press.
2 Numerical Methods and Optimization in Finance by Manfred Gilli,
Dietmar Maringer, Enrico Schumann. Academic Press.
3 Mean Variance Analysis in Portfolio Choice and Capital Markets by
Harry M. Markowitz, Wiley.

Evaluation Process
PROJECT+ Attendance 20 Marks,Test 80 Marks

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Books

1 Optimization Methods in Finance by Gerad Cornuejols and Reha T ,

Cambridge University Press.
2 Numerical Methods and Optimization in Finance by Manfred Gilli,
Dietmar Maringer, Enrico Schumann. Academic Press.
3 Mean Variance Analysis in Portfolio Choice and Capital Markets by
Harry M. Markowitz, Wiley.

Evaluation Process
PROJECT+ Attendance 20 Marks,Test 80 Marks
In project you will be provided a research paper and you will implement the
methodology of the paper in Indian financial market.

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Self study

Linear Programming: Simplex method, Revised simplex method,

Artificial variable technique, Dual simplex method.

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Self study

Linear Programming: Simplex method, Revised simplex method,

Artificial variable technique, Dual simplex method.
Integer programming: All integer and mixed integer programming
technique.

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Self study

Linear Programming: Simplex method, Revised simplex method,

Artificial variable technique, Dual simplex method.
Integer programming: All integer and mixed integer programming
technique.
Explore financial webpages: BSE(www.bseindia.com),NSE , Global
markets(www.bloomberg.com).

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Do yourself(Optimization Part)

1 Solve the following linear programming problems first by manually by

suitable linear programming technique and then verify your answer using
Python.
1 Maximize 3x1 + 2x2 + 5x3 subject to
x1 + 2x2 + x3 ≤ 430, 3x1 + 2x3 ≤ 460, x1 + 4x2 ≤ 420, x, x2 , x3 ≥ 0.
2 Maximize 2x1 + 3x2 + 10x3 subject to
x1 + 2x3 = 0, x2 + x3 = 1, x, x2 , x3 ≥ 0.
2 Use a suitable integer programming technique to solve the following
integer programming problem. Then verify your answer using Python
Maximize 3x1 + 3x2 + 13x3 subject to
−3x1 + 6x2 + 7x3 ≤ 8, 6x1 − 3x2 + 7x3 ≤ 8, 0 ≤ x, x2 , x3 ≤ 5,
and integers.

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Do yourself (Finance part)

Explain the following financial terms(Hint: see www.investopedia.com):

1 Financial Market, Stock Market, Bond Market, Money Market, Derivative
Market, Forex Market.
2 Asset, Share, equity, bond, mutual fund, portfolio, return of an
asset/portfolio, risk of an asset/portfolio, short selling, Different market
indices.
3 Explore the webpages like www.bseindia.com, www.nseindia.com
4 Try to find the historical data of the any index and any asset from
www.bseindia.com or www.nseindia.com .

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How to download data from BSE

To find all stocks from different sectors, explore the webpage

https : //www.bseindia.com/corporates/List− Scrips.aspx

In this page you will see options GROUP(A,B,C,...) and Industry(......).

Select one group and one industry say Group A+BANKS. You will see
different banks. Each one has security code, security id and security
name. Select one bank say IDBI. click its code.

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How to download data from BSE contd..

In this page go to Archives. Provide From date and To date and search.
You will get a list of stocks containing opening price ,closing price etc.
Save this as excel sheet through save option. Then select only one
column either opening price or closing price. save in one excel file. save
this excel file as your roll number.
Save data of 20 stocks from different sectors(oil sector, aviation sector,
IT sector, Banking sector, Infrastructure sector, SAIL, etc...) , and from
different groups. Save this file of 20 assets. Throughout this course you
will use this file to solve assignments, tests and project.

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General Optimization Techniques

1 Linear Programming
2 Integer Programming
3 General Nonlinear Programming
4 Quadratic Programming
5 Fractional Programming
6 Stochastic Programming
7 Multi-Objective Programming

USE PYTHON PLATFORM: scipy.optimize

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Linear Programming

A general Linear Programming problem may be stated as

M aximize/M inimize c1 x1 + c2 x2 + ... + cn xn

Subject to a11 x1 + a12 x2 + .... + a1n xn ≤, =, ≥ b1
a21 x1 + a22 x2 + .... + a2n xn ≤, =, ≥ b2
.....
am1 x1 + am2 x2 + .... + amn xn ≤, =, ≥ bm
xj ≥ 0, j = 1, 2, ..., n

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Linear Programming

A general Linear Programming problem may be stated as

M aximize/M inimize c1 x1 + c2 x2 + ... + cn xn

Subject to a11 x1 + a12 x2 + .... + a1n xn ≤, =, ≥ b1
a21 x1 + a22 x2 + .... + a2n xn ≤, =, ≥ b2
.....
am1 x1 + am2 x2 + .... + amn xn ≤, =, ≥ bm
xj ≥ 0, j = 1, 2, ..., n

In matrix form LPP can be represented as

M aximize/M inimize cT x s.to Ax ≤, =, ≥ b, x ≥ 0,

x, c ∈ Rn , b ∈ Rm , A = (aij )m×n

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Optimization Techniques used to solve this problem:
Simplex method
Two Phase Method
Artificial Variable Technique
Interior point methods: Karmakar Algorithm

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Linear Integer Programming:

M aximize/M inimize c1 x1 + c2 x2 + ... + cn xn

Subject to a11 x1 + a12 x2 + .... + a1n xn ≤, =, ≥ b1
a21 x1 + a22 x2 + .... + a2n xn ≤, =, ≥ b2
.....
am1 x1 + am2 x2 + .... + amn xn ≤, =, ≥ bm
xj ∈ Z, j = 1, 2, ..., n,

Z is the set of integers.

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Example:

A manger has four assignments (A,B,C,D) to complete a project and he has

four officers (P,Q,R,S), who can be assigned these duties according to their
efficiency in terms of time to complete the work. Following table provides
number of hours to complete an assignment by an officer. Determine the
suitable policy to assign each work to an officer to complete the project in
minimum time.

A B C D
P 2 1 1 2
Q 1 2 1 3
R 3 1 2 1
S 2 3 3 2

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Model Formulation:

xij = 1 if ith job is assigned to j th person otherwise xij = 0, i, j = 1, 2, 3, 4.

M inimize 2x11 + x12 + x13 + 2x14

+x21 + 2x22 + x23 + 3x24
+3x31 + x32 + 2x33 + 1x34
+2x41 + 3x42 + 3x43 + 2x44

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subject to x11 + x12 + x13 + x14 = 1
x21 + x22 + x23 + x24 = 1
x31 + x32 + x33 + x34 = 1
x21 + x22 + x23 + x24 = 1
x11 + x21 + x31 + x41 = 1
x12 + x22 + x32 + x42 = 1
x13 + x23 + x33 + x43 = 1
x14 + x24 + x34 + x44 = 1
xij = 1 or 0

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This is linear integer(binary) programming problem.

Optimization Technique: Cutting plane method

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Nonlinear Programming:

Nonlinear Programming problems are of two categories:

Un-Constrained Optimization Problem

min f (x)
x∈Rn

Constrained Optimization Problem

min f (x)
subject to gi (x) ≤ 0, i = 1, 2, ..., m
hj (x) = 0, j = 1, 2, ...., p, x ∈ Rn

where f : Rn → R, gi : Rn → R, hj : Rn → R.

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Numerical optimization algorithms

Newton like methods

Conjugate gradient methods
Penalty function methods
Derivative free methods like Nelder Mead simplex method
Coordinate search methods

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