Portfolio Management Framework for Derivative Instruments

The investment industry lacks an unified framework for handling derivative instruments in general portfolio management. With the increased use of derivatives, there is a need for a framework that aligns fundamental terminology and concepts. The main challenges with the current practices are caused by an improper separation of exposure / notional and market value / price. This tendency is also seen in the academic literature where exposures and prices are usually treated as identical quantities, e.g., in portfolio optimization. This article proposes a simple framework that can be used for all aspects of portfolio management and has intuitive properties that align with current conventions related to portfolio return. This feature allows us to perform portfolio optimization, risk decomposition, and performance evaluation in a familiar way