CS 5354/CS 4365 Advanced Computational Methods in Economics and Finance
Fall 2018, Test 3

Name: ____________________________

General comments:

Good luck!

1. Use Lagrange multiplier method to solve the following constraint optimization problem: find the point of the line 2x1 − x2 = 1 which is the closest to 0, i.e., in precise terms, minimize the sum x12 + x22 under the above constraint.

2-3.

2. Suppose that we have two investments, one with expected return 10 and variance 20, another with expected return 20 and variance 10, and we want to have a return of 13. Assuming that these two investments are independent, use the general formulas that we had in class to find the optimal portfolio.

3. Same as in Problem 2, but this time, the two investments are not independent: the covariance is -0.5. Describe the optimal portfolio for this case.

4-7. Assume that we have ten estimates for the a company's worth: three estimate of 2 Billion dollars, five estimates of 3 Billions, and two outliers: an over-pessimistic estimate of 0 Billion, and an over-optimistic estimate of 10 Billions.

4. What will be the combined estimate if we use the standard least squares methods (i.e., l2).

5. What will be the combined estimate if we use the l1 method? Explain in what sense this method is more robust.

6. What is the general class of robust techniques that includes both l2 and l1 as particular cases? What is the justification for using methods from this class?

7. Describe the first few steps of an algorithm for providing the lp-estimate for p = 1.5. (No need to actually perform the computations).

8-10. An investor placed her money into two hedge funds. The first one led to annual returns of 10%, 5%, 5%, 5%, and 10%. The second one lead to annual returns of 9%, 0%, 9%, 9%, and 9%.

8. Which of the two investments leads to better end results?

9. Which of the two investments will the investor prefer if he/she follows the peak-end rule?

10. What is the justification for the peak-end rule?