A Multidimensional Knapsack Model for Asset-Backed Securitization

Author(s): R. Mansini and M. G. Speranza

Source: The Journal of the Operational Research Society, Vol. 53, No. 8 (Aug., 2002), pp. 822-
832
Published by: Palgrave Macmillan Journals on behalf of the Operational Research Society
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A multidimensionalknapsackmodel for asset-backed

securitization
R Mansini* and MG Speranza
University of Brescia, Brescia, Italy

Securitizationis a financial operationwhich allows a financial institutionto transformfinancial assets, for instance
mortgage assets or lease contracts,into marketablesecurities. We focus the analysis on a real case of a bank for the
leasing. Once the securitizationcharacteristics,such as size and times of the operation,have been defined,the profitfor
the financialinstitution-Italease Bank for the Leasing in our case-depends on how the financialassets to use in the
securitizationare selected. We show thatthe selectionproblemcan be modelled as a multidimensionalknapsackproblem
(MDKP). Some formalargumentssuggest thattheremay exist a prevailingconstraintin the MDKP.Such an idea is used
in the design of some simple heuristicswhich turn out to be very effective.
Journal of the Operational Research Society (2002) 53, 822-832. doi: 10. 1057/palgravejors.2601401

Keywords: asset-backedsecuritization;leasing; multidimensionalknapsack;heuristics

Introduction evaluation and pricing of mortgage-backedsecurities as

Securitizationis a financialoperationwhich allows a financial
institutionto transformunmarketablefinancialassets, such as
mortgageassets or lease contracts,into marketablesecurities
(asset-backedsecurities).The latterare usually highly rated
due to the presence of severaldifferentbanks and insurance
companieswhich guaranteethe credit quality of the whole
operation.Differentreasonsmotivatethe interestin securiti-
zation. Among the main advantagesentailedto the financial
institutionwe note the replacementof illiquid assets in the
balance sheet with improvementof returnon equity (ROE)
and the diversificationof its fund sources. Although several
actorstake partin securitization,we are mainly interestedin
the problemsfacedby the financialinstitutionwhich owns the
assetsandwhichis mainlyinvolvedwiththe selectionofthose
assets to be transformedinto securities.
An impressive growth in the number of securitizations
has been recently observed in practice. While in the past
only banks were interestedin this financialtool, nowadays
insurance companies and even national institutions (eg
INPS, which manages the Italian social security system)
are attractedby the advantagesofferedby this new financial
operation. The economic significance of securitizationis
also broadlydiscussed in the literature.In the last few years
securitizationhas been studiedespeciallywith respectto the
final step of the securitiesissuance. Simulationand optimi-
zationmodels are known for a portfolioof mortgage-backed
securities,1 while a wide literature has investigated the
*Correspondence: R Mansini, Department of Electronics for Automation,
University of Brescia, via Branze 38, 25123 Brescia, Italy.
E-mail: rmansini@ing.unibs.it
well as the prepaymentof the underlying assets.2'3For a
deeper investigation about securitizationwe refer to the
specialized literature.47 No references are known about
the problem of deciding how to select the financial assets
to transforminto securities.
In this paper we focus the discussion on the problem of
optimallyselecting the assets in the real case of a largebank
for leasing, ItaleaseBank for the Leasing, and we show how
the problem can be modelled as a multidimensionalknap-
sack problem(MDKP). While a vast literatureexists for the
classical knapsack problem, relatively few studies have
analysed the multidimensionalversion. One of the early
referencesto this problem is due to Gilmore and Gomory8
who presenteda dynamicprogrammingalgorithm.In 1984,
Magazine and Chern9showed that the problemof finding a
fully polynomialapproximationalgorithmfor the MDKP is
NP-hard,while, successively,Lee and Guignardl?presented
an approximatealgorithm for the multidimensionalknap-
sack. One of the most effective heuristics for MDKP was
proposedby Toyodal1in 1975. More recently,Beasley and
Chu12 have proposed a genetic algorithm, but also other
heuristic approaches13-16 are known for the problem. The
famous book by Martello and Toth17 remains the main
referencefor knapsackproblems.
If all the assets share the same amortizationinternalrate
and the same number of instalments(term), the analysed
problemis equivalentto a 0-1 knapsackproblem, since all
but one constraintsof the MDKP turn out to be redundant.
We use this resultto design some simple heuristicsbased on
the idea that, althoughthe above assumptionsare in general
not satisfied, one of the constraintsmay be considered as
 RMansini
'prevailing'. The computational results, carried out on
instances taken from the real case of Italease have shown
that the proposed heuristics substantiallyimprovethe solu-
tion typically adopted by the bank allowing it a relevant
gain. In orderto achieve a higherdegree of confidencein the
heuristics performance, we have simulated a number of
instances based on the real case parameters.The computa-
tional resultsobtainedon these instanceshave confirmedthe
good performancesof the heuristics.
The paperis organizedas follows. In the next section the
problemis describedand the typical securitizationprocess is
analysed.In the following section the mathematicalformu-
lation of the problemis introducedand its reductionto a 0-1
knapsackproblemis analysed.Then a section is devoted to
the heuristicalgorithms.In the subsequentsections the real
case is dealt with, followed by a section on the computa-
tional results on randomlygeneratedinstances obtainedby
simulating real-case scenarios. Concluding remarks and
ideas for futureresearchare drawnin the final section.
A real case-problem: Italease Bank for the Leasing
ItaleaseBank for the Leasing (from now on simply Italease)
is one of the main Italianbanks operatingas leaser for plant,
machineryand real estate contracts.In the last few years the
bank has taken part into differentsecuritizationsinvolving
internationaloperators.
Before presenting a detailed description of the Italease
problem and in order to make the paper self-contained,we
briefly describethe general characteristicsof the securitiza-
tion process relatedto this case study.
The kernel of thatpartof the securitizationprocess which
deals with the transformationof the financial assets into
securities consists of two main steps: the selection of the
financialassets and the issuance of the correspondingsecu-
rities on the market.Each of these phases is handled by a
specialized company.The special purpose vehicle (SPV) is
the company in charge of the securities issuance on the
market. The proceeds obtained by the final investors who
purchasethe securitiesare used by the SPV to issue a long-
term loan to the financialinstitution(called the originator)
whichownsthe financialassets.Theoriginatorpaysbacksuch
a loan with the periodicinflowsof its financialassets. In other
words, the securities issued are strictly connected with the
underlyingassets they fund and expire in tandemwith them.
Two flows characterizethe kernel of the securitization
process as describedin Figure 1, where the two directionsof
such flows are emphasized.A flow of money goes from the
final investorswho underwritethe securitiesin the marketto
the originator,through the SPV Then a flow of financial
assets is sent from the originator to the intermediate
company which uses the periodic instalments(interestand
principal)of such assets to pay the periodic interests or to
globally refundthe final investors,owners of the securities.
Notice that, due to their high rating, these securities are
andMG
Speranza-A
multidimensional
knapsack
model
forasset-backed
securitization
823
loan securities
Special Purpose issuance
Vehicle (SPV)
financial
assets
financial
Special Purpose interests
Vehicle (SPV)
Figure 1 The securitizationprocess.
highly reliable investments and thus, pay low interest rates
to their holders. For the sake of simplicity, let us define the
yearly rate paid to the final investors as y.
We analyse the problem of selecting the financial assets
(or simply assets) which will finance, with their inflows, the
payment of the interests of the securities to the final
investors. The problem can be simply described as follows:
the originator receives the long-term loan and reimburses it
in terms of its assets. The originator's goal is the minimiza-
tion of the gap between the outstanding principal of the loan
and the sum of the outstanding principals of the assets
handed over to be transformed into securities. This allows
the financial institution to optimize the profit deriving by the
spread among the positive interests received from the
financial assets holders and the negative interests that have
to be paid to securities holders. The problem of optimally
selecting the assets finds an interesting combinatorial formu-
lation thanks to the shape of the outstanding principals
of the main loan and of the assets. Figure 2 shows the
typical stepwise shape of the outstanding principal, coming
up from the reimbursement of the principal instalments,
of a general loan. After the reimbursement of each instal-
ment the outstanding principal decreases correspondingly. In
Figure 2 the set {t,, t2, t3, t4} represents the dates of the loan
reimbursement: the loan starts at t1 and expires after three
reimbursement dates. The assets used by the originator to
pay back this loan have a similar non-increasing shape of the
outstanding principal. Figure 3a shows the stepwise shape of
the outstanding principal of two assets. From this point of
view, the problem of optimally selecting the assets becomes
that of choosing the assets which better fit, at each time, into
the loan, as shown in Figure 3b. The assetholders pay to the
bank periodic principal instalments as well as interest
instalments at a given yearly rate, say oc.
824 Journal
oftheOperational
Research Vol.53,No.8
Society

do

(a)
rr2
t10r ~1
t=0 t2 t3 t4

Figure 2 The stepwise shape of the outstandingprincipal.

If the sum of the outstanding principals of the assets has a

steep decreasing shape with respect to that of the main loan,
then the principal instalments of the selected assets become
available to the institution in advance with respect to the time )K ~ (b
at which the main loan principal reimbursement has to be
done. In these cases, the institution is forced to reinvest them
in pre-defined secure types of investment indicated in the
securitization agreement, at a yearly rate / < oc.The objec-
tive of the problem is to reduce as much as possible the
'distance' over time between the outstanding principal of the
loan and the sum of the outstanding principals of the selected
assets. Such a gap is a measure of the amount of money that
the financial institution is forced to reinvest at the low rate /B
instead of x yielding a spread rate B- y instead of a higher
rate x - y. This implies that the larger the gap, the larger the
amount of money to be reinvested at the low rate f and, as a Figure 3 Outstandingprincipalsof two assets and their compo-
consequence, the higher the reduction in profit measured by sition into the outstandingprincipalof the loan.
the spread between the two rates a and / applied to such
money. Figure 3b shows the solution obtained by handing this type of constraint is the risk diversification and a higher
over the assets I and 2 at time 0. credit quality of the handed over assets.
It is worth noticing that the problem formulation is also Now, let us focus on the case study of Italease Bank for
dependent upon the type of amortization used for the under- the Leasing. In all the financial operations entailed, Italease
lying assets. Based on the practice observed in the case study, has played the role of the originator, ie the seller of assets
in this paper we make the assumption that the general (here, lease contracts).
instalment is constant, ie the French amortization is applied. The core structure of a typical lease-backed securitization
Moreover, composition constraints may be imposed on the is slightly different from that shown in Figure 1. In this case,
selected assets. This is the case of conditions which simply the transformation of lease contracts into securities (here
exclude sets of assets. Other conditions (class conditions) notes) requires an intermediate step and a specialized
may establish that the assets belonging to a certain class company (a factor) which operates between the seller and
(eg the underlying goods are motor vehicles, plant and the special purpose company (SPV) which issues the notes.
machinery or real estate if the assets are lease contracts, as The factor receives the proceeds of the notes issuance from
in our case) cannot exceed a maximal percentage of the total the SPV and uses them to issue a long-term loan to the seller.
amount of selected assets. The main financial justification for Due to the presence of the factor, the SPV is no longer

responsiblefor the reliabilityof the lease contracts.Italease
has to decide which lease contractsto handover to the factor
with the objective of minimizing the gap between the
outstandingprincipal of the loan and the amounts trans-
ferred under its lease contracts. Such amounts are the
periodic payments of interest and principal instalments
that the leasees pay to the leaser, as owner of property,for
using machineries,plantsand so on. In the following section
a complete descriptionof the problem is given.
Problem formulation
Let T = {O,1,2, .. . n} be the discretized time period
betweenthe assets selection date (time 0, also called closing
date) and the end of the loan (time n). The outstanding
principal of the loan at time t E T is denoted by dt. Let
TL c T be the set of reimbursementdates of the loan. The
value of each reimbursementinstalmentof the loan is the
differencebetween the values of dt at two consecutive dates
in TL. We assume thatthe firstreimbursementdate is 0 and
that the instalmentof the loan at time 0 is equal to 0. The
last reimbursementdate is n.
We denote by C the set of assets availablefor selection at
time 0 (ie residuesof old assets or new assets) which expire
before time n. We define by rjt the outstandingprincipalof
the asset j E C at time t. We set rjt= 0 for any t after the
expiring date of the asset j. In Figure 3a the outstanding
principalof two assets is shown. We denote by 3t the gap
between dt and the cumulative sum, at time t, of the
outstandingprincipalsof the assets to hand over.
The objectivefunctionof the problemis the minimization
of the averagegap between the outstandingprincipalof the
loan and the sum of the outstandingprincipalsof the assets
to hand over, ie min Etn bt/(n + 1). However,since
n n n n
E bt= E t- E rjtxj =E dt -
t=O t=O jEC t=O jEC
the objective function of the problem can be expressed as
Et=
min Et=- t = max EjEC Et=O rjtxj
n+ 1 n+ 1 n+ 1
By defining v; = Etn rjt/(n + 1), Vj, the problemof opti-
mally selecting a portfolio of assets at time 0 is
ProblemP
max E VjXj
jEC
LrjtXj dt tETL
JEC
XjE{O,1} jEC
RMansini
andMG
Speranza-A
multidimensional
knapsack
model
forasset-backed
securitization
825
where TL = TL\{n). The constraintsof the problem state
that the sum of the outstanding principals of the assets
which are handed over at time 0 cannot exceed at any time
t > 0 the outstandingprincipald, (ie each constraintdefines
the non-negativegap 6t, V t E TL). Notice that, althoughthis
type of constrainthas to be satisfied at any time t E T, due
to the non-increasingshape of the outstandingprincipalsof
the assets, only the constraintsat times t E TL are explicitly
needed. The constraintat time n is not necessaryas the set C
only includes assets which expire before time n.
ProblemP is a multidimensional0-1 knapsackproblem
(MDKP) with a numberof constraintsequal to the number
of the dates of reimbursementof the loan, includingtime 0
and with the exclusion of the end of the loan. The binary
variablexi takes value 1 if assetj is handedover and value 0
otherwise.In the case when the only date of reimbursement
aftertime 0 is the end of the loan, only the constraintat time
O is necessary and problem P simply becomes a 0-1
knapsack problem (KP). Note that, by definition of the
rjt rjt > rj,t+?, V], t, ie for any asset its 'weight' in a
constraintis always greaterthan or equal to its 'weight' in
the next constraint.
In some cases, the selection of assets to hand over may be
done not only at the closing date but also at some pre-
defined dates, betweentime 0 and time n, called subsequent
dates. It is straightforwardto adapt the above described
model to this situation.
Finally,the class conditionscan be addedto the model by
introducing,for each class u, the following constraint
E rjoxj< pudo (4)
jEPu
wherepu and Pu representthe maximalpercentageof assets
of class u which is possible to handover and the set of assets
availablefor class u at time 0, respectively.Each constraint
E rjtxj states that the total sum of the outstandingprincipalsof the
t=O
assets of a class handedover at time 0 cannotexceed a given
percentageof the outstandingprincipalof the loan at time 0.
We will refer to a set of constraintsof this type as class
constraints.
The describedMDKP correctlymodels Italease'sproblem
of selecting lease contractsat a given date.
If all the assets share the same amortizationinternalrate
and the same numberof instalments,problemP is equiva-
lent to a 0-1 KP.
Each asset available to be selected is characterizedby
periodic inflows (asset instalments). We assume that, for
(1) each asset, the instalmentsare identicalover time according
to the rules of French amortization.Let n1 and i, be the
numberof instalments(term) and the amortizationinternal
(2) rate for assetj, respectively.The periodic instalmentRj for
the assetj E C is expressed as Rj = Cj, + Ij, where
Cj, and
Ijj representthe principaland the interestinstalmentat time
(3) s for the assetj, respectively.
 oftheOperational
826 Journal Research Vol.
Society 53,No.8
Given the geometric progressionof the principal instal-
ments in Frenchamortizationand the conditionestablishing
that the outstandingprincipalis equal to the sum of all the
successive principal instalments, by assuming ij = i and
nj = h, Vj, we can express rjt, for all t, as a function of
C1oas follows (a detailedproof is available18):
rit = h(t)Cjo, Vt > 0
where h(t) is the quantity (qlh - qt+l)/(q - 1), with
q = 1 + i.
Then, if ij = i, and nj = n, Vj, problem P can be
rewrittenas
Max EvLx;
jEC
oi <dttEc
jEC h(t) t (5)
XjE{0,1} jEC (6)
Since all the inequalities(5) have the same left-handside,
all the constraintsbut the one with the minimumright-hand
side are redundant,and the MDKP reduces to a 0-1 KP.
This result is the basis for the design of the simple
heuristics presented in the next section, which explicitly
considerone constraintonly andjustifies theireffectiveness.
Heuristic procedures
In this section we presentsome heuristicsfor the solution of
the problem.Forthe sake of simplicity,the coefficientof the
objective function tj is defined as the profit of assetj while
the outstandingprincipalrjtof assetj at time t is the weight
of assetj in the constraintassociatedwith time t.
The algorithms are inspired by the result which states
that,if all the assets have the same internalrateand the same
term,only one constraintneeds to be considered.Obviously,
such assumptions are not fully satisfied in real problems.
Nevertheless,we may say thatat least the assumptionon the
internalratesis rathercommon in practice.Ourbasic idea is
to identify a prevailing constraintby means of an estimation
of the various (for differentt) right-handsides of inequality
(5) and the selection of the constraintfor which the right-
hand side estimation is minimum. dt being a parameter
independentof the assumptions,the problem of finding an
estimationof dt/h(t) reducesto thatof finding an estimation
h(t) for h(t). This is obtainedby taking the averageover all
the assetsj E C of the hq(t)= _- q+)(q 1), with
qj = 1 + ij, ie h(t) = EjEC hj(t)/ICI. Then the prevailing
constraintis the constraintfor which h(t) is minimum.
For each of the heuristics we will present two versions,
one for the basic problemand one for the problemwith the
additionof the class constraints.
The Greedyheuristic
The simplest heuristic is a basic Greedy heuristic for the
knapsackproblem. The assets are orderedaccordingto the
non-increasingratio between the profit vj and the weight rjt
in the prevailing constraint. Then the assets are selected
if they satisfy, togetherwith the previously selected assets,
all the problem constraints. In the case where the class
constraintsare introduced,a new asset is selected only if it
satisfies both the constraintsof the MDKP and the class
constraints.
Exchange-basedalgorithms
The exchange-based algorithms (EBA) we present in this
section have two characteristicsin common. The first one is
the assignmentof a priorityto each asset equal to the ratio
between the profit and the weight of the asset in the
prevailing constraint.Let L be the resulting orderedset of
the assets. The second common characteristicis the fact that
the heuristicstry to substituteone or more of the assets in a
partialsolution with one or more assets with lower priority.
More precisely,given a set of assets X which satisfies all
the constraintsand representsa partialsolution,we define as
criticalfor X with respect to the size the asset q , X which
does not satisfy together with X all the constraintsof the
MDKP.The asset q belonging to class u is said to be critical
for X with respect to the compositionif it does not satisfy,
togetherwith X, the class constraints.After sorting,in each
of the EBA, the assets are selected until a critical asset is
identified. When this happens, the critical asset is not
necessarily discarded,but it may replace, possibly together
with other assets, one or more of the previously selected
assets. The computationalcomplexity of each of the heur-
istics is O(ICIlog ICI).
Composite procedure Greedy-co(kM,e). The procedure
Greedy-co(kM,e) is a composite procedurebased upon the
applicationof the same scheme kMtimes and keeping the
best solution among all the solutions found. The parameter
k = 1, . . ., kM gives the position in the partialsolution set X
of the asset which may be replaced by the currentcritical
asset. When the algorithm identifies a critical asset, it
compares such asset with the last, or the last but one, or
the last but two..., and so on, asset previously insertedin
the solution set X, depending on k = 1, k = 2, or k = 3 ....
The asset identified in this way is called the candidatefor
leaving. The comparisonbetween the critical asset, say i,
and the candidatefor leaving, sayj, is based on the profits.If
e = 0, asset i will replaceassetj if vi > Vjeven if, according
to L, j is more promisingthan i. If e 0 0, then the replace-
ment will take place only if vi > vj and the prioritiesof the
two assets do not differ for more than e, ie (vj/rj1) -
(vi/rit) < ?, in the prevailingconstraint.
For the case with class constraintsthe algorithmmakes
the possible replacementby going back k positions in the

partialsolution set, where a position is counted if the asset
belongs to the same class of the criticalasset. Obviously,the
exchange is made only if it allows the satisfaction of all,
includingthe class, constraints.
Composite procedure Greedy-est(kM, e, m). The procedure
Greedy-est(km,e, m) is again based on the solution of the
same scheme kMtimes. The value assigned to the parameter had an initial
k, k = 1, . . ., km, identifies the position of the candidate will decrease to 110
for leaving in the partialsolution set X. As in the Greedy-
co(kM,e), the replacementtakes place if the critical asset i
has a profit vi greater than the profit of the candidatefor
leavingj and, when E 4 0, also if the ratios between profit
and weight are closer than e. The differenceis that if such a
condition is not satisfiedthe asset i is not cancelled,but the
procedurechecks if it is possible to replace assetj with the
union of asset i with the asset following it, or the union of
asset i with the two assets following it and so on, up to a
maximum of m assets {i, i + 1, i + 2, . .., i + ml, provided
that vi + vi+1 + . + vi+m > vj holds. For the case with
class constraints,the assets j, i and the possible m assets
{i, i + 1,. , i + m} belong to the same class.
We also tested a non-compositeprocedure(Greedy-int(k,
e)) where the parameterk representsthe numberof the last
inserted assets which are compared with the candidate
for leaving. Since such procedure never outperformsthe
above EBA algorithmswe do not report its results in the
computationalsection.
Other tested heuristics
We have added,in the computationalexperiments,the heur-
istic used by the decision makersin the describedreal case
study, in order to evaluatethe effectiveness of this method
with respect to the heuristics introducedherein. This heur-
istic, referred to as Seller, selects the assets according to the and 0.1. Similarly,the results suggested to test the Greedy-
non-increasingorderof theiroutstandingprincipalat time 0.
If an asset satisfiesthe constraintstogetherwith thepreviously
selected assets, it is acceptedotherwiseit is rejected.
We also tested the heuristicproposedby Toyoda" for the
solution of MDKPs.
Computational results on the real case study
In this section the greedy heuristicsand the EBA are tested
on the real data from two differentsecuritizationsto which
Italease has taken part. In both cases we consider the
selection of contracts at the 1st of October 1996 (called
here as settlementdate), which is subsequentto the closing
date in both the securitizations.The first securitizationhas
571 contracts available to be handed over on the 1st of
October 1996. The securitization,which will expire on the
5th of May 1999, has startedbefore October 1996 with an
outstandingprincipalof 100 billion which decreasedto 80
billion on the 5th of May 1997 (first principalreimburse- Notice that there are no contractsbelonging to pool 3: in
RMansini
andMG
Speranza-A
multidimensional
knapsack
model
forasset-backed
securitization
827
ment date) and, finally, to 60 billion at the same date in
1998. The difference between the outstandingprincipalof
the loan and the sum of the outstandingprincipals of the
contractshanded over before the 1st of October 1996 were
equal to about 23 662 million Italianliras, at the settlement
date, and equal to 21 931 and to 43 065 million on the two
following reimbursementdates. The second securitization
outstandingprincipal of 420 billion, which
billion on the 1st of November 1999
and finally to 45 billion on the 1st of November2000 until
the end of the securitization,the 1st of July 2001. The
numberof contractsavailableis 2385. The gap between the
sum of outstanding principals of the contracts already
handed over before the settlementdate and the outstanding
principalof the loan is equal to 62 734 million Italianliras
on the 1st of October 1996, equal to 76277 and 39749
million liras at the two following reimbursementdates,
respectively. The computationalresults for securitizations
1 and 2 are shown in Tables 2 and 3, respectively.
The classesdescribedin the sectionon problemformulation
are now called pools and refer to the underlying assets
shown in the first line of Table 1 where (1) means that the
lease contracthas a purchasingprice lower than 150 million
Italianliras, while (2) means the price is over 150 million.
We have tested the effectiveness of the heuristics by
comparing the value of their solutions with the value of
the linear programming(LP) relaxation, since no integer
solution has been found by CPLEXwithin the tree memory
space thresholdof 50 Mb.
Since the EBA depend on the value assigned to the
parameters kM and ?, we have carried out a group of
preliminaryexperimentswith 100 assets, in order to find
some desirablevalues for the parametersto use in the final
experiments.According to the results we have decided to
test the algorithmGreedy-co(km,e) for kM = 1 and 2, E = 0
est(kM, e, m) with kM = 1 and 2, e = 0 and 0.1, and m = 2.
In the following experimentalanalysis, we only show the
resultsfound for kM = 2. On average,in fact, the difference
between the average errors found for kM = 1 and those
found for kM = 2 has an orderof magnitudeof 0.1. All the
experimentshave been carried out on a PC Intel Pentium
with 133 MHz and 64 Mb of RAM.
A detailed description of these and other results is
available for interestedreaders,19while Mansini and Sper-
anza20 describe the results obtained by using different
heuristicstested on slightly differentreal instances.
Both cases of portfolio selection, with and without class
constraintson the composition in pools, have been consid-
ered. The dataavailableare divided into five differentpools,
for each of which the maximum percentage allowed in a
portfolioand the averageterm for the contractsbelonging to
the pool are as shown in Table5. Table 1 shows the number
of contracts per pool available for each securitization.
 oftheOperational
828 Journal Research
Society 53,No.8
Vol.
Table 1 Number of contractsfor each pool
Securitization P1, vehicles (1) P2, plant/machinery(1)
Sec. 1 77 220
Sec. 2 239 1480
Table 2 Securitization1 (571 contracts)-cases without and with pools
Withoutpools
Algorithms Numberof contracts
Seller 195
Greedy 339
Toyoda 340
Greedy-co(kM=2, c=0) 339
Greedy-co(kM=2, E=0.1) 339
the analysed real case all the real estate contractsmust be
completely handed out in the portfolio selected at the
closing date.
The following tables (Tables2 and 3) show the solutions
found by the heuristics. The Greedy-est errors are not
shown, being in most of the cases equal to those of
Greedy-co. Each table is divided into two parts according
to the cases without and with pool constraints.In each part
the first column gives the number of contracts selected,
while the second one shows the percentageerrorscomputed
with respect to the optimal solution of the LP relaxation
(overestimationof the real errors).The comparisonof the
two parts of each table allows the evaluation of the class
constraintseffect on the solutions found. The presence of
pools increases, on average, the number of contracts
selected by the procedures.In both the securitizationsthe
pool 2 counts, with respect to the other ones, the largest
numberof contracts(see Table 1).
The computationalresults for the first securitizationare
shown in Table 2. Notice that, in this securitization,only
three contractsbelong to pool 5: this influences the effec-
tiveness of the solutionsfoundwhen the class constraintsare
taken into account. In the instances without class
constraints, the most part of contracts selected in the
solutions comes from the pool with the largest availability
of contracts.This is not the case when, due to the introduc-
tion of the class constraints,the contractsfrompool 2 cannot
exceed the 35%of the total value of the portfolio.In Table4,
as an example, we show the composition in pools of the
portfolio (195 contracts) selected by the procedure Seller
when no class constraintsare introducedand that of the
portfolio (373 contracts)handed over when the same heur-
istic is applied with such constraintsin securitization1.
By comparingthe errorsfound in the instanceswith and
without class constraintsfound by the differentheuristicsin
the first securitization,we observe that while procedures
Greedy, EBA and Toyoda do not change their good
P3, real estate P4, vehicles (2) P5, plant/machinery(1) Total
0 271 3 571
0 613 53 2385
Withpools
Percent errors Numberof contracts Percent errors
5.10 373 6.979
0.009 443 0.009
0.0086 444 0.0184
0.0087 444 0.0098
0.0047 444 0.0098
performances,the procedureSeller, even if the number of
contracts selected has increased, shows an increase of the
percentageerrorfrom 5.10% (case withoutpools) to 6.979%
(case with pools).
HeuristicsEBA and Toyoda,in all the tested instanceson
both securitizations,with and without class constraints,give
rise to a percentage error never greater than 0.01%.
However, while algorithmsEBA never require more than
one minute of runningtime, algorithmToyodamay require
almost half an hour in the instances with class constraints.
The procedureSeller finds, on average,errorsmuch greater
than the other procedures.
Since the sum of the gaps between the outstanding
principal of the loan and the total sum of the outstanding
principals of the contracts handed over, computed for all
t > 0, t E T, has the meaning,for Italease,of liquidityto be
reinvestedat a low rate,Bwith respectto the high rateo paid
by assets holders, we can normalize such a figure by the
number of days in a year and apply to it the spread rate
oc- , and obtain an immediatefinancial evaluationof the
results. Since oc- , representsthe cost for less profitable
investments of the liquidity the objective function of the
problemis in this way transformedinto loss of profit.At the
time these problemshad to be solved by Italease,the spread
rate was 0.4% per year (given by the financialmanagerof
Italease).Withthis rateand a currencyexchangerate,at that
time, of 1560 Italian liras for 1 US dollar the profit loss
generatedby the procedureSeller in securitization1 is about
60027 US dollars (93.642 million Italian liras), while the
most effective heuristic(Greedy-co)has a solution equal to
about 57692 US dollars (about 90.0 million Italian liras).
The differenceis more impressivewhen pools are taken into
account (and they had to be taken into accountby Italease):
about 128 158 dollars for the Seller and 73 684 dollars for
Greedy-co. This means that the use of the Greedy-co
generates a gain for the company equal to 54474 US
dollars.
 RMansini
andMG multidimensional
Speranza-A model
knapsack forasset-backed 829
securitization

Table 3 Securitization2 (2385 contracts)-cases without and with pools

Withoutpools Withpools

Algorithms Numberof contracts Percent errors Numberof contracts Percent errors

Seller 55 18.18 599 14.87
Greedy 397 0.00243 763 0.0036
Toyoda 399 0.00234 764 0.00843
Greedy-co(kM=2, E=0) 393 0.00148 764 0.0048
Greedy-co(kM=2, E= 0.1) 394 0.0027 764 0.0048

Table 4 Portfolio composition in pools. Procedure Seller with and Then, we have simulatedthe instanceson the basis of these
without pools-securitization 1 parameters.
Pools Withoutpools Withpools Let 1be the maximumnumberof instalmentsallowed for
all the assets. We define as H := {-l + 1, -l + 2, . . ., 0}
P1 33 38 the set of deadlines at which the simulator generates the
P2 46 153
P3 0 0
assets so that the first deadline occurs 1 - 1 units of time
P4 116 179 before the date of the assets selection. If, for instance, the
P5 0 3 instalments have monthly periodicity and the maximum
term for an asset is 1 = 100, then the assets may come up
each month for the 99 monthsprecedingthe startingdate of
the loan. In this way, at the selection date a set of new assets
Table 5 Characteristics of the classes
is availableas well as residues of assets startedin the past
Maximum Average term but not expired yet. At each deadline h E H the simulator
Classes percentagep5 (months) [sin,nsax] [SmnSm=J generates l-hs assets for each class s, with Ph, uniformly
C1 20% 35 [25-45] [10,150] distributedin the interval[as, bS]. For each assetj, belonging
C2 35% 54 [44-64] [150,3000] to class s, the number of instalmentsnjs (term), the initial
C3 32% 95 [85-105] [150,4500] outstandingprincipalSjSand the amortizationinternalrateij
C4 32% 48 [38-58] [10,150] are random values uniformly distributed in the ranges
C5 15% 47 [37-57] [150,3000]
m nmax] [Smin,Smax] and [imin,imax]' respectively. Mini-
mum and maximum values for each of these intervals have
been chosen according to the real data. For all the assets
In the second securitizationfor the case withoutpools the generated at time h, (ie lhl periods before the date of assets
profit loss of the Seller is equal to 375 468 USA dollars selection) which have a total length njs > lhl and
while that of Greedy-cois equal to 328 382 US dollars.The ns - Ih < n, with n the duration of the securitization, the
same figures for the instances with pools are 456813 and simulator generates the corresponding amortization plan
400 433 US dollars.Thus, for the second securitizationwith according to a given financial rule (we have chosen
pools, the gain for Italeaseobtainedwith the use of Greedy- French amortization).
co is equal to 56 380 US dollars. We have considered the selection of assets with and
As a final remarkon the Italeasecase we point out that,as without class constraints at the starting date of the secur-
a consequence of the analysis and results describedin this itization and at a subsequent date (49 months later). For each
section, Italease has decided to implement the Greedy date we have generated 50 instances (25 without classes and
heuristic, for the following reasons: it is simple, very easy 25 with classes). We have taken five different numbers of
to implement (they implementedit themselves) and had a assets available to be handed over: 100, 500, 1000, 2000 and
performancevery close to that of the Greedy-co. 3000. For each of them, 10 different instances have been
tested, five for the case with class constraints and five for the
case without them.
Computational results on simulated instances In each tested instance the number of assets per class is
identical. Table 5 gives the main characteristics per class. The
In this section we describethe resultsobtainedby testing the first column shows the maximum percentage in the portfolio,
algorithmson largerinstancesgeneratedby simulatingreal- while the second colunm gives the average term in months.
case scenarios.Fromthe real case describedin the previous The last two columns show the ranges for the term and the size
section we have derivedthe relevantparametersto use in the of each asset, respectively. Finally, the monthly internal rates
generationof simulateddata,such as rangeon the size of the used to generate the amortization plan for all the assets are
outstandingprincipalof the assets, terms and interestrates. fixed and uniformly distributed in the interval [0.01, 0.015].
 oftheOperational
830 Journal Research Vol.53,No.8
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As in the real case describedin the previous section, the
securitization lasts 8 years (n = 96 months) with loan
reimbursementdates after 5 and 7 years from the closing
date and with the outstandingprincipaloutlines reportedin
the Table 6 for instances with 100, 500, 1000, 2000 and
3000 assets (Loanl, Loan2, Loan3). The second column of
Table6 shows the rangeof the numberof assets generatedat
each monthly deadline per class. For example, when the
numberof availableassets is 500, the outstandingprincipal
of the loan is 20 billion Italian liras at the closing date, it
decreasesto 11 billion at the first date of reimbursement5
years later, reaching the 4.5 billion at the beginning of
the seventh year. Moreover,the number of assets for each
h E H is generatedin the range [7-13]. As soon as the 500
assets are createdthe generationis interrupted.
Tables 7 and 9 show the average errors found by the
heuristicsfor the case without class constraintsfor an initial
and a subsequentportfolio selection, respectively.Tables 8
and 10 show the same results for the case when class
constraints are taken into account. Each table shows the
averageerrorswhen the numberof assets availableis equal
to 100, 500, 1000, 2000 and 3000, respectively.In all the
tables the last column shows the number of instances in
which each heuristic obtains the best performanceamong
the tested heuristics.
The errors generatedby each heuristic have been eval-
uatedwith respectto the optimum,for the case in which this
was availableby using the MILProutineof CPLEXwithin a
memory limit of 50 Mb for the branch-and-boundsolution
tree (approximately30 min). When this was not possible, the
errorsof the heuristicshave been evaluatedwith respect to
the optimal solution of the relaxedproblem,overestimating,
in this case, the real errors. In each table the symbol '*'
identifies the errors computed with respect to the relaxed
optimal solution.
In the initial portfolio selection without class constraints
(ie Table 7), the Greedy gets the best performancein two
cases only, but generates errorson the 25 tested instances
never larger than 1.908%. On the other hand, Toyoda's
algorithm shows a bad performance, with errors never
lower than 12.842%, as well as the procedureSeller which
never turns out to be the best procedurewith an average
error always greaterthan 8.167%. The EBA are the most
effective heuristics (lower average errors and best perfor-
Table 6 Levels of the outstandingprincipalof the loan (in million
Italianliras) and ranges used to generatethe numberof assets at
each deadline
Assets [as, bs] Loan] Loan2 Loan3
100 [2-8] 10 000 5500 2250
500 [7-13] 20000 11000 4500
1000 [12-18] 40000 22000 9000
80000 44000 18000
2000 [17-23]
3000 [22-28] 120 000 66 000 27 000
mance), especially when the size of the problem increases.
In particular,the Greedy-co(kM= 2, e = 0) is the best
procedure 17 times out of 25, while it gets the optimum
only 8 times out of 25 for kM = 1 and e = 0.
The composite procedures never require, for the case
without classes, more than 5 s in the instances with 100
assets and take a maximumtime of 2 min and few seconds
for the instanceswith 3000 assets. The computationaltimes
required for the solution of the instances with classes
increase on average by 50%. With respect to the initial
portfolio selection with classes the errorsfound confirmthe
behaviour of the heuristics observed in the case without
classes. The performanceof the Greedy heuristicimproves
in the case with classes with respect to the case without
classes, becoming closer to the performanceof the best
heuristic.On the contrary,the performanceof the procedure
Seller worsens.
In the subsequentportfolio selection (see Tables 9 and
10), the algorithm Greedy-co(kM= 2, e = 0) is the most
effective heuristic finding the best solution the highest
numberof times: 13 times out of 25 in the instanceswithout
classes and 16 out of 25 in the instanceswith classes. As the
computational time required by the heuristic Greedy-
co(kM= 2, e = 0) is never greaterthan a few minutes, we
can conclude that this method is the most effective in both
the initial and the subsequentportfolio selection.
Conclusions and future research
In this paperwe have shown how the problemof selecting
the assets in a securitizationcan be formulatedas a 0-1
MDKP.We have also given some formalargumentsto show
that, in general, one of the constraintsin MDKP can be
considered as prevailing while the others can be substan-
tially ignored. On the basis of this idea, we have designed
some simple greedy-typeheuristicswhich turnedout to be
satisfactoryboth in terms of errors and of computational
time. All the proposedheuristicshave been tested on the real
instances of the bank Italease and on simulated instances.
The computationalresults show that the proposedheuristics
largelyoutperformthe proceduretypicallyused by the bank,
generatinga relevantgain for the bank itself.
Finally,some ideas are drawnfor futureresearch.The first
idea is strictly related to the work presentedin this paper:
differentassumptionscan be made on the type of amortiza-
tion used for the assets and give rise to differentoptimiza-
tion models. Two differentproblems of interest for future
researchwere raised duringthis study. The first problem is
that of finding an outline of the outstandingprincipalof the
loan into which those of the assets fit as well as possible.
The second problem is the managementof the interaction
among different securitizations,for instance the choice of
which assets to use for which securitizationand the evalua-
tion of whetherthe assets availableare sufficientto starta
new securitization.
 RMansini
andMG multidimensional
Speranza-A model
knapsack forasset-backed
securitization
831

Table 7 Averageerrors.Initialportfolio selection without classes

Withoutclasses

Numberof assets 100 500 1000 2000 3000 Average

Algorithms
Seller 13.70% 8.845% 8.259% 8.167% 8.769% 9.548% 0
Greedy 0.874% 0.172% 0.615% 0.020% 0.091% 0.354% 2
Toyoda 16.069% 16.254% 15.950% 15.368% 14.148% 15.558% 0
Greedy-co(kM=2, ?=0) 0.266% 0.095% 0.056% 0.005% 0.01% 0.0864% 17
Greedy-co(kM=2, E=0.1) 0.527% 0.0904% 0.063% 0.00% 0.019% 0.139% 18
Greedy-est(kM=2, =0, m =2) 0.288% 0.178% 0.0546% 0.008% 0.024% 0.110% 13
Greedy-est(kM=2, =0.1, m=2) 0.297% 0.184% 0.0546% 0.011% 0.019% 0.113% 13

Table 8 Averageerrors.Initialportfolio selection with classes

Withclasses

Numberof assets 100 500 1000 2000 3000 Average

Algorithms
Seller 10.26*% 12.223*% 13.00*% 14.330*% 12.096*% 12.382*% 0
Greedy 1.07*% 0.783*% 3.473*% 0.141*% 0.293*% 1.152*% 14
Toyoda 6.92*% 3.705*% 4.477*% 6.697*% 6.90*% 5.739% 0
Greedy-co(kM=2, E= 0) 0.520*% 0.771*% 0.378*% 0.186*% 0.116*% 0.394*% 7
Greedy-co(kM=2, =0.1) 0.401*% 0.721*% 0.333*% 0.141*% 0.074*% 0.334*% 13
Greedy-est(kM=2, ?=0, m=2) 0.412*% 0.744*% 0.344*% 0.141*% 0.272*% 0.383*% 6
= 2, E= 0.1, m = 2)
Greedy-est(kM 0.415*% 0.673*% 0.344*% 0.294*% 0.202*% 0.385*% 4

Table 9 Averageerrors.Subsequentportfolio selection without classes

Withoutclasses

Numberof assets 100 500 1000 2000 3000 Average

Algorithms
Seller 7.145% 9.068% 8.248% 8.683% 9.524% 8.534% 0
Greedy 1.079% 0.269% 0.062% 0.068% 0.029% 0.301% 5
Toyoda 5.707% 6.679% 7.264% 8.466% 8.293% 7.282% 0
Greedy-co(kM=2, =0) 0.175% 0.051% 0.077% 0.018% 0.0201% 0.068% 13
Greedy-co(kM=2, =0.1) 1.077% 0.260% 0.032% 0.017% 0.022% 0.282% 9
Greedy-est(kM=2, ?-=0, m=2) 0.393% 0.218% 0.046% 0.018% 0.028% 0.141% 6
Greedy-est(kM=2, =0.1, m=2) 1.132% 0.186% 0.0319% 0.022% 0.028% 0.279% 8

Table 10 Averageerrors.Subsequentportfolio selection with classes

Withclasses
Numberof assets 100 500 1000 2000 3000 Average
Algorithms
Seller 5.604*% 6.896*% 10.503*% 11.715*% 14.82*% 9.907*% 0
Greedy 2.365*% 4.388*% 4.474*% 4.303*% 4.179*% 3.942*% 3
Toyoda 5.760*% 8.311*% 6.609*% 7.884*% 8.122*% 7.337*% 0
Greedy-co(kM=2, =0) 2.083*% 3.514*% 4.222*% 4.079*% 4.104*% 3.600*% 16
Greedy-co(kM=2, ?=0.1) 2.158*% 4.296*% 4.233*% 4.258*% 4.159*% 3.821*% 7
Greedy-est(kM=2,s=0, m=2) 2.214*% 4.137*% 4.319*% 4.254*% 4.139*% 3.849*% 7
Greedy-est(kM=2, ?-0.1, m=2) 2.200*% 4.208*% 4.207*% 4.222*% 4.150*% 3.797*% 6
 oftheOperational
832 Journal Research Vol.53,No.8
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Received January 2001;
accepted March 2002 after two revisions