A mean/variance approach to long-term fixed-income portfolio allocation

Abstract

Long-term investments in bonds offer known returns, but with risks corresponding to defaults of the underwriters. The excess return for a risky bond is measured by the spread between the expected yield and the risk-free rate. Similarly, the risk can be expressed in the form of a default spread, measuring the difference between the yield when no default occurs and the expected yield. For zero-coupon bonds and for actual market data, the default spread is proportional to the probability of default per year. The analysis of market data shows that the yield spread scales as the square root of the default spread. This relation expresses the risk premium over the risk-free rate that the bond market offers, similarly to the risk premium for equities. With these measures for risk and return, an optimal bond allocation scheme can be built following a mean/variance utility function. Straightforward computations allow us to obtain the optimal portfolio, depending on a pre-set risk-aversion level. As for equities, the optimal portfolio is a linear combination of one risk-free bond and a risky portfolio. Using the scaling law for the default spread allows us to obtain simple expressions for the value, yield and risk of the optimal portfolio.     

A global approach to mutual funds market timing ability

In this paper, we globally investigate market timing abilities of mutual fund managers from the three perspectives: market return, market-wide volatility and aggregate liquidity. We propose a new specification to study market timing. Instead of considering an average market exposure for mutual funds, we allow mutual fund market betas to follow a random walk in the absence of market timing ability. As a consequence, we capture market exposure dynamics which is really due to manager market timing skills while allowing dynamics to come from other sources than market timing. We find that on average 6% of mutual funds display return market timing abilities while this percentage amounts to respectively 13% and 14% for volatility and liquidity market timing. We also analyze market timing by investment strategies and for surviving and dead funds. Dead funds exhibit lower volatility and liquidity timing skills than live funds.     

A note on the geometry of Shanken's CSR T2 test for mean/variance efficiency

Shanken (1985) derives a test for the zero-beta capital asset pricing model (CAPM) which, as he points out, is equivalent to a test of the mean/variance efficiency of the market portfolio. This note illustrates the geometry of Shanken's test in the mean/variance space.     

The Causal Effect of Limits to Arbitrage on Asset Pricing Anomalies

We examine the causal effect of limits to arbitrage on 11 well-known asset pricing anomalies using the pilot program of Regulation SHO, which relaxed short-sale constraints for a quasi-random set of pilot stocks, as a natural experiment. We find that the anomalies became weaker on portfolios constructed with pilot stocks during the pilot period. The pilot program reduced the combined anomaly long–short portfolio returns by 72 basis points per month, a difference that survives risk adjustment with standard factor models. The effect comes only from the short legs of the anomaly portfolios.     

External auditors' willingness to rely on the work of internal auditors: The influence of work style and barriers to cooperation

The extent to which external auditors rely on the work of internal auditors is an important judgment. Recently, the Public Company Accounting Oversight Board has recommended that external auditors “rely (more) on the work of others” to reduce the greater-than-expected costs associated with compliance with Section 404 of the Sarbanes–Oxley Act. Reliance decisions, however, are complex decision tasks that require professional judgment and may be influenced by a number of factors, both external (environmental) and internal (cognitive and affective), including the auditors' working style and pervious experiences related to barriers to external/internal auditor cooperation (e.g., previously experienced low versus high internal auditor objectivity and/or competence). We experimentally examine these influences in our research reported herein. Consistent with expectations, external auditors' work styles significantly influenced the extent of planned audit testing, internal auditor reliance judgments, and interpretation of analytical procedures results. Auditors' perceptions about internal auditors' competence and objectivity, developed over years of interaction, also influenced these judgments, and interacted with work styles. Inconsistent with expectations, auditor rank (senior versus manager) did not influence judgments.     

An examination of the influence of mutual CFO/audit firm tenure on audit quality

This study examines whether the extent of professional relationships between an audit firm and their client’s CFO influences audit quality. If regulators’ concerns that the relationship that develops over time between an audit firm and their client’s CFO impairs auditor judgment are justified, then we should observe a negative relationship between the length of audit firm’s tenure with their client’s CFO and audit quality. The results suggest that mutual audit firm-CFO tenure is associated with lower audit quality measured by the magnitude of discretionary accruals, the reduced incidence of issuance of going-concern audit opinions for distressed companies, and an increased likelihood of the receipt of an Accounting and Auditing Enforcement Release (AAER) from the US. Securities and Exchange Commission (SEC). These affects are concentrated in a subsample of firms with higher levels of corporate governance concerns. These findings have implications for policies related to audit firm rotation. Specifically, the results suggest that regulators need to consider other relationships underlying audit firm tenure, such as the relationships that form between audit firm and client personnel, when evaluating audit firm rotation policies.     

支付工具的支付范围研究——基于成本结构关系的视角

在信息技术的推动下,新兴支付工具的快速发展替代了传统支付工具,提高了社会支付效率。多种支付工具共存情况下,支付工具的使用表现为用于不同的支付范围。从成本结构角度出发,分析了各支付工具成本结构关系与支付金额范围的关系,并对荷兰银行2002年支付工具成本调研结果进行了案例分析,这有助于了解新支付工具及支付工具市场的发展,并为深入分析支付工具市场现象起到一个抛砖引玉的作用。     

The effect of discretionary actions on small firms' ability to survive Chapter 11 bankruptcy

This paper analyzes whether judges' actions within Chapter 11 bankruptcy affect debtor firms' ability to reorganize (e.g., debt restructurings and mergers) as opposed to being liquidated in Chapter 7 bankruptcy. Our main finding is that debtor firms' control of the process, e.g., the exclusivity period, affects their ability to restructure debt. A reduction in the exclusivity period decreases the likelihood of reorganization, but increases the likelihood of deviation from absolute priority when plans of reorganization are agreed upon. An extension of the exclusivity period, however, does not increase the likelihood of either reorganization or deviation from absolute priority.     

The effect of SFAS 142 on the ability of goodwill to predict future cash flows

This study examines the effect of Statement of Financial Accounting Standards No. 142 (SFAS 142) on the ability of goodwill to predict future cash flows. SFAS 142 allows substantial managerial discretion and leads to a significant magnitude of economic impact on financial statements, resulting in critical debates over the consequence of its adoption. I find that the ability of goodwill to predict future cash flows has improved since the Financial Accounting Standards Board (FASB) adopted SFAS 142. Furthermore, sub-sample analyses fail to reveal compelling evidence that reporting discretion induced by SFAS 142 is used opportunistically or informatively, contrasting with the pervasive view based on the opportunistic reporting hypothesis. Overall, contrary to the position of critics of SFAS 142, the results support the view taken by the FASB and proponents of SFAS 142: eliminating systematic amortization and adopting fair value estimates improve representational faithfulness of goodwill reporting.     

Testing for mean reversion in heteroskedastic data II: Autoregression tests based on Gibbs-sampling-augmented randomization

A decade ago Fama and French [Fama, E.G., French, K.R., 1988. Permanent and temporary components of stock prices. J. Political Econ. 96 (2) 246–273] estimated that 40% of variation in stock returns was predictable over horizons of 3–5 yr, which they attributed to a mean reverting stationary component in prices. While it has been clear that the Depression and war years exert a strong influence on these estimates, it has not been clear whether the large returns of that period contribute to the information in the data or rather are a source of noise to be discounted in estimation. This paper uses the Gibbs-sampling-augmented randomization methodology to address the problem of heteroskedasticity in estimation of multi-period return autoregressions. Extending the sample period to 1995, we find little evidence of mean reversion. Examining subsamples, only 1926–1946 provides any evidence of mean reversion, while the post war period is characterized by mean aversion. A test of structural change suggests that this difference between pre and post war periods is significant.     

Reflections on Milton Friedman's contributions to open economy money/macro

Friedman's central contributions to open economy macroeconomics are contained in his essay “The Case for Flexible Exchange Rates.” The paper describes equilibrium in an open economy in terms of the flow market for domestic currency, and so presents the basic elements of The Monetary Approach to the Balance of Payments, which Mundell and Johnson developed later in the decade. An application of the argument includes the first definitive statement of the criteria which one finds in the literature on Optimum Currency Areas. The essay's model, in a better specified, more modern form, reappears in A Monetary History (with Anna Schwartz), where it serves as a basis for detailed analysis of particular episodes and as a framework for empirical work which continues to this day.     

The effect of SFAS 131 on the stock market’s ability to predict industry‐wide and firm‐specific components of future earnings

This study examines the impact of SFAS 131 on the extent to which stock prices incorporate industry‐wide and firm‐specific components of future earnings. By decomposing earnings into industry‐wide and firm‐specific components, this paper finds that the firms that aggregated segments under the old rule experience significant acceleration in the incorporation of future earnings into current stock prices upon adoption of SFAS 131. However, the acceleration of future earnings is mostly driven by the improved incorporation of industry‐wide components of future earnings, which indicates the market’s ability to predict firm‐specific components is not significantly changed. Supplemental analysis suggests that the reduced geographic earnings information is one possible reason for lack of improvement in incorporating firm‐specific earnings into price.