Decision Support Systems

AuthorConstantin Zopounidis, Michael Doumpos, Laurie Hillstrom

Page 170

Decision support systems (DSS) are computer information systems that perform complex data analysis in order to help users make informed decisions. In general, a DSS retrieves information from a large data warehouse, analyzes it in accordance with user specifications, then publishes the results in a format that users can readily understand and use. DSS find application in a wide range of business settings, including investment portfolio management.

Portfolio management is one of the most essential problems in modern financial theory. It involves the construction of a portfolio of securities (stocks, bonds, treasury bills, etc.) that maximizes the investor's utility. The process leading to the construction of such a portfolio consists of two major steps. In the first step the decision-maker (investor, portfolio manager) has to evaluate the securities that are available as investment instruments. The vast number of available securities, especially in the case of stocks, makes this step necessary, in order to focus the analysis on a limited number of the best investment choices. Thus, on the basis of this evaluation stage the decision-maker selects a small number of securities that constitute the best investment opportunities. In the second step of the process the decision maker must decide on the amount of the available capital that should be invested in each security, thus constructing a portfolio of the selected securities. The portfolio should be constructed in accordance with the decision-maker's investment policy and risk tolerance.

The portfolio theory assumes that the decision-maker's judgment and investment policy can be represented by a utility function that is implicitly used by the decision-maker in making his investment decisions. Thus, the maximization of this utility function will result in the construction of a portfolio that is as consistent as possible with the decision-maker's expectations and investment policy. However, it is quite difficult to determine the specific form of this utility function.

The founder of portfolio theory, Nobelist Harry Markowitz, has developed a framework according to which the decision-maker's utility is a function of two variables, the expected return of the portfolio and its risk. Thus, he formulated the maximization of the decision-maker's utility as a two-objective problem: maximizing the expected return of the portfolio and minimizing the corresponding risk. To consider the return and the risk, Markowitz used two well-known statistical measures, the mean of all possible returns to estimate the return of the portfolio, and the variance to measure its risk. On the basis of this mean-variance framework, Markowitz has developed a mathematical framework to identify the efficient set of portfolios that maximizes returns at any given level of allowable risk. Given the risk aversion policy of the investor, it is possible to select the most appropriate portfolio from the efficient set.

This pioneering work of Markowitz motivated financial researchers to develop new portfolio management techniques, and significant contributions have been made over the last decades. The most significant of the approaches that have been proposed for portfolio management include the capital asset pricing model (CAPM), the arbitrage pricing theory (APT), single and multi index models, as well as several optimization techniques. Elton and Gruber's 1995 book Modern Portfolio Theory and Investment Analysis provides a comprehensive discussion of the various approaches.


The concept of decision support systems (DSS) was introduced, from a theoretical point of view, in the late 1960s. DSS can be defined as computer information systems that provide information in a specific problem domain using analytical decision models and techniques, as well as access to databases, in order to support a decision maker in making decisions effectively in...

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