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The building blocks of complexity: a unified criterion and selected applications in risk management

Author

Listed:
  • D. Seese

    (Institute AIFB, University Karlsruhe (TH), D-76128 Karlsruhe, Germany)

  • F. Schlottmann

    (Institute AIFB, University Karlsruhe (TH), D-76128 Karlsruhe, Germany)

Abstract

The analysis of many complex problems and complex dynamic systems suggests that there are dependencies between high complexity and properties of the underlying structures, as the existence of large grids, non-regularities and inhomogeneous structures and irregular flows of information. These observations indicate the existence of a unified criterion that defines structural elements of complex entities. We present the idea of such a criterion basing on concepts from computational and parametric complexity theory and analyse its impact in financial risk management. It is shown that selected real-world problems in risk managements are complex in the sense of NP-completeness. Here the criterion is used to analyse the structural reasons for the proved complexity. We show how selected risk management methods fit into the picture of our complexity criterion and derive some implications for the future generation of risk management methods from the viewpoint of complexity.

Suggested Citation

  • D. Seese & F. Schlottmann, "undated". "The building blocks of complexity: a unified criterion and selected applications in risk management," Modeling, Computing, and Mastering Complexity 2003 14, Society for Computational Economics.
    • Handle: RePEc:sce:cplx03:14
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    References listed on IDEAS

    as
    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    2. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Gordy, Michael B., 2002. "Saddlepoint approximation of CreditRisk+," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1335-1353, July.
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    Cited by:

    1. Schlottmann, Frank & Seese, Detlef, 2004. "A hybrid heuristic approach to discrete multi-objective optimization of credit portfolios," Computational Statistics & Data Analysis, Elsevier, vol. 47(2), pages 373-399, September.

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    More about this item

    Keywords

    complexity; risk management; credit risk; operational risk; NP-hard; tree width; local structure; information flow;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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