The effect of regulation on optimal corporate pension risk

We study firms' pension prefunding and portfolio allocation choices in a model in which firms trade off the need to compensate workers for the financial risk in their pension benefit against the cost advantage that may be gained by exploiting underpriced pension insurance. In the absence of pension insurance, the firm minimizes costs by rendering promised benefits free of risk to workers, who are assumed to be unable to hedge firm-specific risk. Various forms of government intervention, such as benefit guarantees, can alter this outcome dramatically by providing the firm with an incentive to shift risk to other parties. In this case, we find that the firm's decisions depend on, among other influences, the degree of insurance mispricing, the amount of guaranteed benefits, the stringency of minimum funding requirements, and the costs of financial distress.     

The size of venture capital and private equity fund portfolios

We propose a model that examines the optimal size of venture capital and private equity fund portfolios. The relationship between a VC and entrepreneurs is characterized by double-sided moral hazard, which causes the VC to trade off larger portfolios against lower values of portfolio companies. We analyze the structural relations between the VC's optimal portfolio structure and entrepreneurs' and VC's productivities, their disutilities of effort, the value of a successful project, and the required initial investment in a venture. We also test the model's predictions using a small proprietary dataset collected through a survey targeted to VC and private equity funds worldwide.     

The effect of downside risk reduction on UK equity portfolios included with Managed Futures Funds

The concept of asymmetric risk estimation has become more widely applied in risk management in recent years with the increased use of Value-at-risk (VaR) methodologies. This paper uses the n-degree lower partial moment (LPM) models, of which VaR is a special case, to empirically analyse the effect of downside risk reduction on UK portfolio diversification and returns. Data on Managed Futures Funds are used to replicate the increasingly popular preference of investors for including hedge funds and fund-of-funds type investments in the UK equity portfolios. The result indicates, however that the potential benefits of fund diversification may deteriorate following reductions in downside risk tolerance levels. These results appear to reinforce the importance of risk (tolerance) perception, particularly downside risk, when making decisions to include Managed Futures Funds in UK equity portfolios as the empirical analysis suggests that this could negatively affect portfolio returns.     

The role of information asymmetries and inflation hedging in international equity portfolios

We investigate the role of information asymmetries and inflation hedging in shaping international equity portfolios. We confirm, in a multinational setting, Cooper and Kaplanis [Cooper, I.A., Kaplanis, E., 1994. Home bias in equity portfolios, inflation hedging and international capital market equilibrium. Review of Financial Studies 7 (1), 45–60] result of no inflation hedging motive driving investors’ behavior and find evidence of a crucial role for financial market development and trade linkages.     

Art as an investment: risk, return and portfolio diversification in major painting markets

The present paper examines risk, return and the prospects for portfolio diversification among major painting and financial markets over the period 1976–2001. The art markets examined are Contemporary Masters, French Impressionists, Modern European, 19th Century European, Old Masters, Surrealists, 20th Century English and Modern US paintings. The financial markets comprise US Treasury bills, corporate and government bonds and small and large company stocks. In common with the published literature in this area, the present study finds that the returns on paintings are much lower and the risks much higher than conventional investment markets. Moreover, while low correlations of returns suggest that opportunities for portfolio diversification in art works alone and in conjunction with equity markets exist, the construction of Markowitz mean‐variance efficient portfolios indicates that no diversification gains are provided by art in financial asset portfolios. However, diversification benefits in portfolios comprised solely of art works are possible, with Contemporary Masters, 19th Century European, Old Masters and 20th Century English paintings dominating the efficient frontier during the period in question.     

A model of optimal portfolio selection under liquidity risk and price impact

We study a financial model with one risk-free and one risky asset subject to liquidity risk and price impact. In this market, an investor may transfer funds between the two assets at any discrete time. Each purchase or sale policy decision affects the rice of the risky asset and incurs some fixed transaction cost. The objective is to maximize the expected utility from terminal liquidation value over a finite horizon and subject to a solvency constraint. This is formulated as an impulse control problem under state constraints and we characterize the value function as the unique constrained viscosity solution to the associated quasi-variational Hamilton–Jacobi–Bellman inequality. We would like to thank Mihail Zervos for useful discussions.     

The role of no-arbitrage on forecasting: Lessons from a parametric term structure model

Parametric term structure models have been successfully applied to numerous problems in fixed income markets, including pricing, hedging, managing risk, as well as to the study of monetary policy implications. In turn, dynamic term structure models, equipped with stronger economic structure, have been mainly adopted to price derivatives and explain empirical stylized facts. In this paper, we combine flavors of those two classes of models to test whether no-arbitrage affects forecasting. We construct cross-sectional (allowing arbitrages) and arbitrage-free versions of a parametric polynomial model to analyze how well they predict out-of-sample interest rates. Based on US Treasury yield data, we find that no-arbitrage restrictions significantly improve forecasts. Arbitrage-free versions achieve overall smaller biases and root mean square errors for most maturities and forecasting horizons. Furthermore, a decomposition of forecasts into forward-rates and holding return premia indicates that the superior performance of no-arbitrage versions is due to a better identification of bond risk premium.     

An empirical examination of jump risk in asset pricing and volatility forecasting in China's equity and bond markets

Understanding jump risk is important in risk management and option pricing. This study examines the characteristics of jump risk and the volatility forecasting power of the jump component in a panel of high-frequency intraday stock returns and four index returns from Shanghai Stock Exchange. Across portfolio indexes, jump returns on average account for 45% to 64% of total returns when jumps occur. Market systematic jump risk is an important pricing factor for daily returns. The average jump beta is 62% of the average continuous beta for individual stocks. However, the contribution of jump risk to total risk is limited, indicating that statistically significant jumps in the stochastic process of asset price are rare events but have tremendous impacts on the prices of common stocks in China. We further document that accounting for jump components improves the performance of volatility forecasting for some equity and bond portfolios in China, which is confirmed by in-the-sample and out-of-sample forecasting performance analysis.     

打破“刚性兑付”困局 促进信托业发展的观察与思考

“刚性兑付”的信托业潜规则促进了信托业的爆发式增长。然而,随着行业规模不断扩大,兑付风险事件陆续出现,“刚性兑付”日渐成为信托业发展的桎梏。尽管拥有诸多打破“刚性兑付”的理由,但受各方利益既得者打破动力不足的影响,行动十分迟缓。在压力与动力并存之下,打破“刚性兑付”势在必行。     

The role of expertise in risk communication: laypeople's and expert's perception of the millennium bug risk in The Netherlands

This paper focuses on the discussion of the role of expertise in risk communication. It describes empirical data on the risks posed by the Millennium bug in 1999 in the Netherlands. The study systematically examined the risk perception of both general public and computer experts with respect to the Millennium bug, assessing a potential discrepancy between the layman's and the expert's judgement, as has been observed in other risk areas. Two surveys were fielded, the first aimed at a random sample of the Dutch population ( n = 253), the second at a sample of computer experts ( n = 91). Results indicated that respondents did not perceive the Millennium bug to be a major threat. However, laypeople worried more, did see the issue as more personally risky, and did think the level of public awareness was higher than experts did. Computer experts felt more capable of taking mitigating actions than laypeople, and were more convinced that these actions were adequate. The implications of these findings for the role of expertise in risk communication are discussed.     

The going public decision and the structure of equity markets

The industries in which listed firms are concentrated in less developed equity markets are not random, nor entirely explained by the underlying composition of production. Listed firms and market capitalization are disproportionately concentrated in industries with low beta (measured with their beta with the market portfolio in the U.S.). We document a strong positive relationship between the industry-weighted country beta and the degree of market development across countries. Recent IPO activity confirms the result since new listings have higher betas than the average firm already in the market.     

The cost of equity of internet stocks: a downside risk approach

Beta as a measure of risk has been under fire for many years. Although practitioners still widely use the CAPM to estimate the cost of equity of companies, they are aware of its problems and are looking for alternatives. A possible alternative is to estimate the cost of equity based on the semideviation, a well-known and intuitively plausible measure of downside risk. Complementing evidence reported elsewhere about the ability of the semideviation to explain the cross-section of returns in emerging markets and that of industries in emerging markets, this article reports results showing that the semideviation also explains the cross-section of Internet stock returns.     

打开内部评级法的黑箱:假设、模拟与监管实践

内部评级法的风险权重模型实质上是建立在单一系统性风险因子假设基础上的条件违约概率。内部评级法有两个主要特点:一是单一风险因子假设,假设信用风险的系统风险由单个共同因子控制;二是组合不变性,组合具有良好的分散性以使所有特殊风险充分多样化。这些假设在促成内部评级法成为简单易行、具有一定的可比性资本监管工具的同时,也对监管当局自身形成了挑战:一是如何针对不同银行的组合粒度补提"剩余"的监管资本,二是如何选择与本经济体相称的资产相关系数。在中国,由于政府主导经济,体制相关性较高,后一个问题尤显重要。     

Enterprise risk management and firm performance: The Italian case

This paper investigates whether a relationship exists between the extent of implementation of enterprise risk management (ERM) systems and the performance of Italian listed companies. While many contributions in the literature focus on the determinants of ERM adoption and use one-dimensional feature to proxy for ERM implementation, we detect the consequences of ERM implementation and capture a variety of features to measure the sophistication of the ERM system. The results show that firms with advanced levels of ERM implementation present higher performance, both as financial performance and market evaluation. Additional tests also corroborate the expectation that effective ERM systems lead to higher performance by reducing risk exposure and that reverse causality between ERM and performance is not present in the short term. The study provides a twofold contribution to the ERM literature. First, it introduces new and more complete measures for ERM implementation, concerning not only corporate governance bodies dedicated to risk management, but also the characteristics of the risk assessment process. Moreover, it provides evidence of a positive relationship between ERM implementation and firm performance in an under-investigated context such as Italy.     

Assessing business risk: The case of Premier Punch, Inc

The recently issued Statement on Auditing Standards No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, emphasizes the need for auditors to understand the client’s business and environment, particularly the client’s business risk [American Institute of Certified Public Accountants (AICPA) (2006a), understanding the entity and its environment and assessing the risks of material misstatement, Statement on Auditing Standards No. 109. New York, NY: AICPA]. However, the manner in which auditors obtain such an understanding, especially an auditor’s assessment of a client’s business risk, is often challenging for students because they lack the business experience necessary to perform such an assessment. This case provides students with an opportunity to assess business risk in a realistic context that includes evidence beyond the content of the financial statements. Company information is provided via a webpage (www.premierpunch.com) with content similar to that of an actual investor relations site. Students must evaluate the information presented in the company’s annual report, press releases and other sources, and consider the impact of that information on several facets of business risk. Students also perform an analytical review of the company’s financial statements and synthesize the case information into a professional memo containing their assessment of business risk.     

The plausibility of risk estimates and implied costs to international equity investments

We reconsider the costs to international equity investments implied by standard portfolio theory (Cooper and Kaplanis, 1994; Sercu and Vanpée, 2008). Estimated costs are mostly driven by risk estimates, not by asset holdings. For OECD markets, risks are fairly stable and relatively easy to estimate, but for emerging markets this is not the case. Many required expected returns implied by unconditional risk estimates defy credibility, both a priori and empirically. More sophisticated volatility estimates based on a dynamic risk model a la Bekaert and Harvey (1997) lead to implicit costs that are far more credible, but the results remain fragile.     

The joint influence of financial risk perception and risk tolerance on individual investment decision‐making

The increasing complexity of the investment environment has accelerated the need for better quality financial advice services. Central to quality advice is advisers’ accurate assessment of their clients’ risk characteristics. Typically a client's risk characteristic is assessed by measuring the client's risk tolerance but not risk perception. To assess whether this practice fails to fully capture the client's risk profile, we explore both risk tolerance and risk perception in the investment decision‐making context. Using Australian online survey data of financial adviser clients (n = 364), our results reveal that risk tolerance influences risky‐asset allocation directly and indirectly through risk perception. These results thus clarify the joint role of both risk constructs in the investment making decision and highlight the importance of assessing both in the provision of client financial advice services. Importantly, our results validate a new comprehensive risk perception measure applicable in the financial advice context.     

The Private Finance Initiative: risk, uncertainty and the state

This paper analyses the UK's Private Finance Initiative (PFI) at a conceptual level by focusing on the management of risk, which is central to the justification for the policy and its application across the public services, and uncertainty, which underlies the role of the state. The paper argues that the rhetorical support for PFI rests on a conflation of risk and uncertainty and that PFI leads to contractual arrangements that are inappropriate for the provision of public services over the medium term.     

The rise of risk: risk related bills submitted to the Swedish parliament in 1964-65 and 1993-95

Bills submitted to the Swedish parliament in 1964-65 and in 1993-95 were scored according to their major concern: risk, resource allocation or resource growth. It was found that risk related bills had increased strongly, from 11% to 28%, implying that currently almost a third of all bills in the Swedish parliament are related to risk issues. The absolute number of risk bills increased by a factor of four. Resource allocation bills, on the other hand, decreased strongly, and resource growth bills, a minority of bills, remained at a relatively low level. All parties except the Conservatives showed a strong trend towards increased risk concern, especially the Social Democrats. The most frequently encountered type of risks in the 60s were health related, while environmental risks predominated in the 90s. These changes are discussed in relation to the hypothesis that risks become more important during periods of slower economic growth. It is concluded that risk is currently a very important issue on the Swedish political agenda.     

Performance differentiation: cutting losses and maximizing profits of private equity and venture capital investments

Recent research has pointed out the need to differentiate between good versus poor performance of venture capital and private equity investments and to analyze the factors that determine the ‘winners’ and ‘losers’ of a fund. This study examines the different contractual and behavioral characteristics and their influence on the positive and negative performances of private equity investments. Specifically, we analyze how fund managers apply tools and investment behavior to mitigate risks and maximize returns. The empirical investigation of these questions is based on a merged dataset, which combines the Venture Economics and CEPRES databases. It includes a total of 1,011 investments made by 137 different funds that belong to 54 private equity and venture capital firms worldwide over the period from 1979 to 2003. Our results confirm that the reduction of losses and the maximization of investment profits have different antecedents. Although losses are minimized by the use of convertibles and by increasing the venture capital firms’ accumulated experience, profits are increased by the potential of the fund’s management to allocate resources to portfolio companies. Our findings contribute to the understanding of the determinants of venture capital and private equity returns by differentiating between the mitigation of risks and the maximization of profits.