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DecisionTools Suite® Blooms among the Bloomberg Set

9 July 2007, Ithaca, NY - In its early years, the DecisionTools Suite served as decision support for the specialists on Wall Street and in the commodities markets who had quantitative know-how. Today demand for the suite to assess securities transactions comes from a broader cross-section of the folks who read Bloomberg. These business people face not only straightforward questions about equities, but complex, time constrained decisions about hedging and derivatives, and they are finding success coordinating the tools bundled with @RISK—in particular PrecisionTree and RISKOptimizer--to support any given course of action.

@RISK for Derivatives Analysis
@RISK is widely used in the analysis of “derivatives”: financial instruments such as options, futures, forwards, and interest-rate swaps. According to a May 25, 2007 piece in HPCWire.com:

“Derivatives analysis is a critical on-going activity for financial institutions, allowing them to manage pricing, risk hedging, and the identification of arbitrage opportunities. The worldwide derivatives market has tripled in size in the last five years.

“The numerical method for derivatives analysis uses Monte Carlo simulations in a Black-Scholes world. The algorithm makes heavy usage of floating-point math operations such as logarithm, exponent, square-root, and division. In addition, these computations must be repeated over millions of iterations. The numerical Black-Scholes solution is typically used within a Monte Carlo simulation, where the value of a derivative is estimated by computing the expected value, or average, of the values from a large number different scenarios, each represent a different market condition.”

Not Just @RISK—Enter PrecisionTree
More broadly, decision trees like those found in PrecisionTree are being used for a variety of securities applications. In the March 26, 2007 issue of BusinessWeek, decision trees are touted as must-haves for all investments. Clark Winter, Global Chief Strategist for Citigroup Global Wealth Management, is quoted as saying, “The smartest executives and the most successful investors have a unique ability to process an enormous amount of information and boil it down into binaries—'yes or no' is a binary—that simplify decision-making.”

In foreign exchange, fluctuating currencies mean there is a need to consider hedging foreign currency receivables and payables. According to a May 3, 2007 Business Standard article, systematic assessment requires thinking through a decision tree process: To hedge or not?

Stock price targets are yet another application of decision trees. A May 24, 2007 StreetInsider.com piece quoted a Citigroup analyst discussing the price target of Dow Jones: “Our price target is $55 (previously $37) and is based on a decision-tree analysis of potential outcomes.”

Even Berkshire Hathaway billionaire Charlie Munger has said, “One of the advantages of a fellow like Buffett is that he automatically thinks in terms of decision trees.”

DecisionTools Suite: An Example with CDOs
Projecting the return for a single equity, or even for a mutual fund, is a simple task for @RISK used on its own. But take, for a particularly thorny example of how DecisionTools can be used, the decision to invest in a CDO—collateralized debt obligation. A CDO is a portfolio of bonds, loans, and other fixed income securities that are repackaged to create a new set of fixed income securities. The duration of the bonds, the life of the loans, and the constraints of the other securities and physical assets vary individually, and losses from the portfolio are typically reclassified as successive levels of debt. @RISK can project potential gains and losses throughout the portfolio, PrecisionTree is invaluable for anticipating the scheduled steps in maturation, repayment, and reinvestment, and RISKOptimizer targets ideal results at each stage in the investment scenario.

NeuralTools Rounds Out the List
Many traders are using neural networks software like Palisade’s NeuralTools to predict the future direction of equity, commodity, or FX markets. Available separately from the DecisionTools Suite, NeuralTools adds-in to Excel and integrates well with the other Tools, particularly RISKOptimizer. Traders use genetic algorithm-based optimization (similar to those used in RISKOptimizer) to develop optimal trading strategies based on the neural network predictions of future prices.

"Not Surprising"
“I’m not surprised at the rate of adoption in the financial markets because the assessment of financial instruments and aggregations of financial instruments is an ideal task for DecisionTools,” said Wayne Winston, professor of operations and decision technologies at Indiana University’s Kelley School of Business. “The markets generate tons of data, and the intuitive interface of Palisade's software provides the decision maker an efficient path through all that information to a smart decision. I also wouldn’t be surprised to see a further increase in this group of users when the new 5.0 version of @RISK and the DecisionTools Suite comes out.”

» Read Case Studies from finance
» Read paper on Monte Carlo simulation and CDOs: “Fast and Robust Monte Carlo CDO Sensitivities and their Efficient Object Oriented Implementation”



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