Should smart investors buy funds with high past returns?

We fully characterize the equilibria in a gme between a fundmanager of unknown ability who control the riskiness of hisportfolio and investors who only observe realized returns. Wederive two types of equilibria. The first one is such that (i)investors invest in the fund if the realized return falls withinsome interval, i.e., is neither too low nor too high, (ii) agood manager picks a portfolio of minimal riskiness and (iii)a bad manager picks a portfolio with higher risk, "gambling"on a lucky outcome. The second type of equilibrium is more traditional:(i) investors invest in the fund if the observed return is largerthan some threshold, and (ii) good and bad managers choose thesame risk level.     

Should this team be saved?

As far as anyone could tell, Vigor Skin Care's star was rising, mostly on the strength of Ageless Vigor, its new line of enriched skin cleansers and cosmetics. In fact, this evening, the three employees responsible for developing the product line were slated to receive the parent company's highest award for performance. But CEO Peter Markles knew that despite the accolades, the business unit--and its "fearsome threesome"--had hit a rough patch in recent months. When Peter took the reins four years ago, Vigor Skin Care was the sleeping dog of the health-and-beauty industry; his challenge was to rejuvenate the maturing business. He knew a turnaround would require equal parts discipline, politics, and creativity--so he pulled together a team that could address those needs. Peter relied on Sandy Fryda, Vigor's longtime marketing director, to help him navigate the tricky political waters at headquarters. And he tapped 30-year-old Josh Bartola, a maverick contributor to Vigor Skin Care's research group, for his independent spirit and new product ideas. Their all-consuming, intensely collaborative efforts resulted in the successful Ageless Vigor line. Then reality set in. The team found the day-to-day operations of manufacturing Ageless Vigor, for all their necessity and urgency, a bit tedious. Peter felt relegated to troubleshooting distribution problems. Josh was having meetings with executives from another division who were actively recruiting the wunderkind. And Sandy was simply on the verge of burnout. Tonight, at the award ceremony, there would be speeches and applause and toasts. But tomorrow, Peter would have to face the question: Should he try to salvage the Ageless Vigor team? Four commentators offer their advice in this fictional case study.     

Should individual investors avoid the stock market outside of January?

Recent studies suggest that there is no reward for bearing risk outside of January, implying that individuals should invest in common stocks only in January. The purpose of this study is to demonstrate that this conclusion is far too strong given existing empirical evidence. Our results suggest that inferences drawn from the evidence can be altered greatly through small changes in the way the empirical question is addressed. There is sufficient evidence to doubt the conclusion that individuals are not compensated for the risk of participating in the stock market outside of January.     

Should investors include commodities in their portfolios after all? New evidence

This paper investigates whether an investor is made better off by including commodities in a portfolio that consists of traditional asset classes. First, we revisit the posed question within an in-sample setting by employing mean-variance and non-mean-variance spanning tests. Then, we form optimal portfolios by taking into account the higher order moments of the portfolio returns distribution and evaluate their out-of-sample performance. Under the in-sample setting, we find that commodities are beneficial only to non-mean-variance investors. However, these benefits are not preserved out-of-sample. Our findings challenge the alleged diversification benefits of commodities and are robust across a number of performance evaluation measures, utility functions and datasets. The results hold even when transaction costs are considered and across various sub-periods. Not surprisingly, the only exception appears over the 2005-2008 unprecedented commodity boom period.     

Should remittances be taxed or subsidized?

This paper analyzes the optimal nonlinear schedule of taxes and subsidies on remittances from emigrants. The analysis identifies conditions under which emigrants remitting small amounts of income face positive average and marginal subsidies on their remittances, whereas emigrants remitting relatively large amounts of income face positive marginal taxes. In this way, the tax system improves the distribution of income by indirectly taxing the “brain drain,” while simultaneously encouraging remittances that tend to go to low-income residents.     

Should investors include Bitcoin in their portfolios? A portfolio theory approach

Many papers in recent years have examined the benefits of adding alternative assets to traditional portfolios containing stocks and bonds. Bitcoin has emerged as a new alternative investment for investors which has attracted much attention from the media and investors alike. However relatively little is known about the investment benefits of Bitcoin and therefore this paper examines the benefit of including Bitcoin in a traditional benchmark portfolio of stocks and bonds. Specially, we employ data up to June 2018 and analyse the potential out-of-sample portfolio benefits resulting from including Bitcoin in a stock-bond portfolio for a range of eight popular asset allocation strategies. The out-of-sample analysis shows that, across all different asset allocation strategies and risk aversions, the benefits of Bitcoin are quite considerable with substantially higher risk-adjusted returns. Our results are robust to rolling estimation windows, the incorporation of transaction costs, the inclusion of a commodity portfolio, alternative indices, short-selling as well as two additional optimization techniques including higher moments with (and without) variance-based constraints (VBCs). Therefore, our results suggest that investors should include Bitcoin in their portfolio as it generates substantial higher risk-adjusted returns.     

Should the government be running job centres?

Most people find their jobs by means other than job centres. Since they are not a monopoly, what reason is there for government to run them? Can it even tell whether they are being run efficiently?     

Should bank capital regulation be risk sensitive?

We present a screening model of the risk sensitivity of bank capital regulation. A banker funds a project with uninsured deposits and costly capital. Capital resolves a moral hazard problem in the choice of the probability of default (PD). The project’s loss given default (LGD) is the banker’s private information. The regulator receives a noisy signal about the LGD and imposes a minimum capital requirement. We show that the optimal sensitivity of capital regulation is non-monotonic in the accuracy of risk assessment. If the signal is inaccurate, the regulator should use risk-insensitive capital requirements. Given sufficient accuracy, the regulator should separate types via risk-sensitive capital requirements, reducing the risk-sensitivity of bank capital as accuracy improves.     

Should the forensic accounting profession be regulated?

Adopting Huber’s (2012) argument that forensic accounting has become a profession, this paper examines whether the forensic accounting profession and the forensic accounting certification industry should be regulated. Several recent studies have uncovered significant problems within the forensic accounting profession and the forensic accounting certification industry. The failure of forensic accounting corporations to disclose either their legal status or the qualifications of their officers and directors, their failure to publish financial statements, and their failure to adopt or enforce a Code of Ethics or Standards of Practice, were among the most significant problems uncovered. The failures of the corporations were exacerbated by forensic accountants’ failure to investigate diligently the corporations that issued their certifications prior to obtaining their certifications. This resulted in a significant number of forensic accountants holding certifications from corporations that were inconsistent with their beliefs that a forensic accounting corporation should be not-for-profit, and their officers and directors should be qualified.Those studies suggested three alternatives for addressing the problems: voluntary action by the corporations, establishing an independent agency for accrediting the corporations and certifications, and regulatory intervention. However, the feasibility of the recommended alternatives was not sufficiently evaluated to be able to arrive at a conclusion for recommending which alternative should be implemented.This paper evaluates the feasibility of alternative solutions. It concludes that the most realistic alternative is for government regulation of forensic accounting in the form of legislation at the state level.     

Should short-term speculators be taxed,or subsidised?

Summary This paper explores the welfare implications of a securities transaction tax when long-term information contained in stock prices can improve resource allocation but speculators have short horizon objectives. Speculators can trade on information of differing time horizons and profit maximizing firms can use long-term information contained in stock prices to improve their investment decisions. The model takes full account of the effect of a tax on market liquidity and welfare for all market participants. Surprisingly, a subsidy on short-term speculation can increase the amount of equilibrium trade on long-horizon information. This is because short-term informed trade exerts a positive externality over long-term informed trade when speculators have a short planning horizon. The cost of paying the subsidy may be smaller than the gain in firm value, while no trader is made worse off.This paper is a revised version of chapter 4 of my Ph.D. dissertation written at the European University Institute. I wish to thank Paolo Battigalli, James Dow, Thierry Foucault, Rainer Kiefer, Matt Spiegel, Erik Theissen, the co-editor and two anonymous referees for helpful comments. I would also like to thank audiences at the workshop of the ESSFM Gerzensee and EFA Annual Meetings 2000.     

Should hedge funds be cautious reporting high returns?

In a recent article, Schuster and Auer (2012) show that fund managers with a certain positive performance need to be aware of the fact that too high prospective excess returns can lower the empirical Sharpe ratio of their funds. In this note, we investigate the empirical relevance of this effect. We analyse whether hedge funds being evaluated on the basis of the Sharpe ratio negatively influence their performance by reporting too high returns. Our results show that a economically significant number of hedge funds listed in the CISDM hedge fund database has at least once reported a high return causing this effect.     

Should investors include green bonds in their portfolios? Evidence for the USA and Europe

The green bond market has seen a rapid growth world widely in recent years. This paper explores the role of green bonds in asset allocation using the dynamic R-vine copula-based mean-CVaR approach. We compare the performance of portfolios including green bonds with that of portfolios including conventional bonds in the U.S. and European markets. Empirical results show that portfolios with green bonds outperform portfolios with conventional bonds in terms of risk-adjusted returns in the majority of cases in both markets. The benefit of green bonds comes from both the increase in the return and the decrease in the volatility for most of the cases. Overall, our findings suggest that green bonds are beneficial to investors.     

Should investors invest in hedge fund-like mutual funds? Evidence from the 2007 financial crisis

This study empirically examines the value added for investors during the 2007–2009 financial crisis from hedge fund-like equity mutual funds, including 130/30, market neutral, and long/short equity funds. We find that based on the information ratio, all market neutral funds, top 90% of long/short funds, and top 25% of 130/30 funds outperform a long-only passive index fund over the crisis period. However, we find little evidence of abnormal performance by the average and median funds in our sample, based on either unconditional or conditional four-factor alphas. The reason for the overall under-performance in the crisis period is that while short positions taken by these funds do generate alpha, the gain from their short positions is not sufficiently large to offset the loss from their long positions. Finally, the abnormal performance of short positions is found to be attributable to managers’ characteristic-adjusted and industry-adjusted stock selection skills. One implication of this study is that even though market neutral and long/short funds on average may not generate alpha, investors can benefit from holding these funds, especially the former, that can provide a hedge against down markets due to their low betas and that can be useful for asset allocation.     

Supervisor and Market Analysts: What Should Research be Seeking?

This article is primarily directed towards examining the desirability of incorporating market signals in the process of supervision of commercial banks by regulators and insurers. But the ideas developed here can also be applied to the general problem of using market information to assess the solvency and safety of any financial or non-financial institution.Market prices and yields of securities anticipate actions by regulators, central banks, and other players due to the fact that such actions may materially influence the risk and the expected return associated with investment decisions pertaining to those securities. It is well known that the yield curve of government securities such as T-bills, T-notes and T-bonds reflect the market's consensus regarding the actions that the Federal reserve may take as they pertain to the valuation of such securities. The extent to which the market has already discounted the future actions of the central bank will no doubt play a role in the way in which the central bank may think about its actions, its actual effect and how it relates to its intended effects.The extent to which market prices can provide useful guides depends on the underlying market structure and the practices in the industry.While markets may do lot of the hard work in aggregating and incorporating future actions, the task of supervision and regulation can never be put on automatic pilot. Ideally, supervisory policies should effectively combine the market signals with initiatives that serve to maintain the safety and the soundness of the underlying markets. I will begin by exploring the extent to which equity prices may be used as a signal of bank credit risk. I will then explore the advantages and disadvantages of using subordinated debt securities to derive a market signal.     

Should earnings thresholds be used as delisting criteria in stock market?

In Chinese stock market, firms reporting two consecutive annual losses are subject to special treatment (ST), with further losses causing the firms’ stocks to be suspended from trading or to be delisted. We argue that these earnings-based delisting requirements are misconstrued. Such policies drive financially healthy firms out of stock market, and induce listed firms to engage in rampant earnings manipulation in order to avoid delisting. The results carry important public policy implications for securities market regulation.     

Should the insurance industry be banking on risk escalation for solvency II?

Basel II introduced a three pillar approach which concentrated upon new capital ratios (Pillar I), new supervisory procedures (Pillar II) and demanded better overall disclosure to ensure effective market discipline and transparency. Importantly, it introduced operational risk as a standalone area of the bank which for the first time was required to be measured, managed and capital allocated to calculated operational risks. Concurrently, Solvency II regulation in the insurance industry was also re-imagining regulations within the insurance industry and also developing operational risk measures. Given that Basel II was first published in 2004 and Solvency II was set to go live in January 2014. This paper analyses the strategic challenges of Basel II in the UK banking sector and then uses the results to inform a survey of a major UK insurance provider. We report that the effectiveness of Basel II was based around: the reliance upon people for effective decision making; the importance of good training for empowerment of staff; the importance of Board level engagement; and an individual's own world view and perceptions influenced the adoption of an organizational risk culture. We then take the findings to inform a survey utilizing structural equation modelling to analyze risk reporting and escalation in a large UK insurance company. The results indicate that attitude and uncertainty significantly affect individual's intention to escalate operational risk and that if not recognized by insurance companies and regulators will hinder the effectiveness of Solvency II implementation.     

Should banks be geographically diversified? Empirical evidence from cross-country diversification of European banks

Using a sample of European bank, this paper investigates the impact of banks' geographic diversification on their cost of equity capital. Examining the geographic diversification of European banks gives an insight on the value of cross-border banking. To measure diversification between major geographic areas in which the bank operates, the Herfindahl–Hirschman Index, based on revenues generated at home and abroad is constructed for each bank. To address the problem of endogeneity, system generalized method of moments estimator is used. The main finding of the analysis is that, other things equal, more geographic diversified banks have higher cost of equity capital than geographically focused ones. This result implies that the adverse market valuation effect of geographic diversification (increase in agency problem) dominates the positive ones (increase in efficiency and reduction in risk).     

Should SME exposures be treated as retail or corporate exposures? A comparative analysis of default probabilities and asset correlations in French and German SMEs

We use a one-factor credit risk model to provide new estimates of stationary default probabilities and asset correlations in two large samples of French and German Small and Medium-sized Enterprises. Results show that, on average, SMEs are riskier than large businesses; and the asset correlations in the SME population are very weak (1–3% on average) and decrease with size. On average, the relationship between PDs and asset correlations is not negative, as assumed by Basel II, but positive, especially at the industry level, in the two countries. It is also possible to distinguish different segments inside the SMEs’ population: at least between very small and small SMEs and large SMEs.