A knowledge-based approach to solving hedge design problems

Problems such as the explosive number of hedging alternatives that is constantly growing, the quick decisions risk managers need to make in response to the speed in which information flows, and the lack of appropriate computerized support in the early phases of the hedge design process, suggest that there is ample scope for risk managers to make suboptimal decisions. The authors formulate hedge design as a multi-objective optimization problem. This optimization problem involves several complexities with which existing quantitative solution techniques cannot deal. They also present a knowledge-based system called INTELLIGENT-HEDGER, developed to solve the hedge design problem. This system uses an object-centered representation that captures risk managers' deep domain knowledge, and facilitates emulation of first-principles reasoning processes risk managers use to make decisions and explain them.<>