Application of Portfolio Theory to Support Resource Allocation Decisions for Biosecurity

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1 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze Ecoomst 11 September 2013 CES/BIOSECURITY FLAGSHIP

2 Presetato outle The resource allocato problem What ca ecoomcs cotrbute? Portfolo theory Bosecurty applcatos Emprcal model: Hypothetcal survellace problem Prelmary results: portfolo optmsato Cocluso ad ext steps... 2 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

3 How much to sped o dfferet threats? Mexca Feather Grass 1% Potato Cyst Nematode $60M 2% Salva 1% Allgator Weed 1% Athrax Cotrol 0% Chestut Blght 2% Eque Iflueza Maagemet 25% Locust Cotrol 48% Hawkweed 1% Frut Fly 19% Source: DPI (2012). Bosecurty cdets Vctora Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

4 What ca ecoomcs cotrbute? Ecoomcs s about the scarcty of resources ad how to allocate the avalable resources the best possble way to maxmse objectves set by the decso maker. A umber of tools avalable from ecoomcs ad decso scece (Rch et al., 2005); Cost-beeft aalyss (Boardma et al. 2006) Portfolo theory (Markowtz, 1952) Lear programmg ad optmsato Search theory/ecoomcs for optmum survellace Bo-ecoomc models etc 4 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

5 Portfolo Theory (Markowtz, 1952) Portfolo theory emerged to address the problem of fdg the portfolos that maxmse expected retur o vestmet whle mmsg rsk (Markowtz, 1952). Key varables are expected mea retur ad rsk, the latter s measured usg stadard devato. Wdely used the facal dustry to select combatos of facal strumets (stocks, bods, treasury blls etc). Cocepts of portfolo theory are applcable to other projects (Prattley et al., 2007) 5 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

6 Applcato to other projects Gaydo et al. (2012). (Agrcultural Water Maagemet). Comparg water optos for rrgato farmers usg portfolo theory. Prattley et al. (2007). (Prevetve Veterary Medce). Applcato of portfolo theory to rsk-based allocato of survellace resources amal populatos New Zealad. Brdges J (2004). (Health, Rsk & Socety). Uderstadg the rsks assocated wth resource allocato decsos health: A llustrato of the mportace of portfolo theory. Gallga D.T, Marsh W.E. (1988). (prevetve veterary medce). Applcato of portfolo theory for the optmal choce of dary veterary maagemet programs. 6 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

7 The Effcet Froter (Markowtz, 1991) A portfolo lyg o the effcet froter shows the combato offerg the best Possble expected retur for a gve level of rsk. 7 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

8 Portfolo Characterstcs: Expected retur ad rsk (stadard devato) E( R p p p ) 1 1 w E( R 2 2 ( w ) 1 1 j1 j1 ) ( w w j j ( w w j) 1/ 2 j j j) 1/ 2 (1) (2) (3) R p s expected retur o the portfolo, R s expected retur o asset, w s the weght or share of asset, ρ j s the covarace betwee returs o asset ad asset j 8 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

9 The Portfolo Choce Theorem Max f ( w) subject f ( w) p 1 to w A w p A 1 1 j1 w w j j (4) = umber of assets, w =proporto of portfolo vested asset, α=expected retur of asset, α p =expected retur of portfolo, σ p = stadard devato of portfolo ρ= covarace of asset wth asset j, A=coeffcet of relatve rsk averso 9 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

10 Example: Hypothetcal survellace problem Ivestmet areas Aual rate of retur Lower boud Upper boud Pest A 3.0% $0 $50,000 Pest B 5.0% $10,000 $25,000 Dsease C 7.0% $0 $80,000 Dsease D 11.0% $10,000 $100,000 A decso maker s faced wth a problem to allocate a survellace budget of $100,000 to 4 bosecurty areas. The aual returs for each project ad the mmum ad maxmum amouts the decso maker s comfortable allocatg to each project are lsted above. What s the best allocato strategy that results the hghest mea total expected retur? 10 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

11 Portfolo optmsato The source of ucertaty ths problem s the expected aual retur of each vestmet. So we eed to create probablty dstrbutos that descrbe the ucertaty surroudg specfc put varables? The decso problem: To determe how much to vest each asset to maxmse total expected returs whle keepg the rsk at a acceptable level ad stayg wth the costrats ad requremets. Objectve fucto: Maxmse the mea total expected retur subject to a budget costrat. Costrat: Lear budget costrat Requremets: Lower boud ad upper boud lmts for decso varables. Method: Stochastc optmsato model (wth Mote Carlo smulato) 11 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

12 Model assumptos/probablty dstrbutos Ivestmet areas Pest A 3.0% Pest B 5.0% Dsease C 7.0% Aual rate of retur Dsease D 11.0% 12 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

13 Portfolo optmsato (results) Ivestmet areas Amout vested ($) Dsease C $41,200 41% Dsease D $48,400 46% Pest A $400 1% Pest B $12,000 12% Share (%) 13 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

14 Cocluso ad ext steps "Behold, the fool sath, "Put ot all the eggs the oe basket" - whch s but a matter of sayg, "Scatter your moey ad your atteto"; but the wse ma sath, "Put all your eggs the oe basket ad - WATCH THAT BASKET." Mark Twa, Pudd'head Wlso's Caledar, 1894" Addtoal modellg work GAMS Correlatos Rsk averso parameter Develop 2 detaled case studes 14 Applcato of Portfolo Theory to Support Resource Allocato Decsos for Bosecurty Paul Mwebaze

15 Thak you CES/Bosecurty Flagshp Paul Mwebaze Research Scetst t e Paul.Mwebaze@csro.au w ADD BUSINESS UNIT/FLAGSHIP NAME