Searching hedging instruments against diverse global risks and uncertainties

We evaluate the influence of five major risk and uncertainty factors on four asset classes. Our time-varying findings suggest that each asset hedges only a particular uncertainty factor, whereas gold does more than one factor, especially during COVID-19. Our frequency-based quantile regression (QR) results show that in the raw frequency, gold and Islamic stock can better hedge various uncertainty factors than Bitcoin and crude oil, depending on the market conditions. Additionally, using the frequency bands (e.g., short, medium, and long term) data, we further notice that, depending on the market circumstances and investment horizons, gold and Islamic stock returns are still better hedges for the various risks and uncertainties than Bitcoin and crude oil returns. Our findings have crucial risk and portfolio management implications for investors, portfolio managers, and policymakers.     

The costs of suboptimal dynamic asset allocation: General results and applications to interest rate risk, stock volatility risk, and growth/value tilts

The recent theoretical asset allocation literature has derived optimal dynamic investment strategies in various advanced models of asset returns. But how sensitive is investor welfare to deviations from the theoretically optimal strategy? Will unsophisticated investors do almost as well as sophisticated investors? This paper develops a general theoretical framework for answering such questions and applies it to three specific models of interest rate risk, stochastic stock volatility, and mean reversion and growth/value tilts of stock portfolios. Among other things, we find that growth/value tilts are highly valuable, but the hedging of time-varying stock risk premia is less important.     

Dependent relationships between Chinese commodity markets and the international financial market: Evidence from quantile time-frequency analysis

In this article, the quantile time–frequency method is utilized to study the dependence of Chinese commodities on the international financial market. The impacts of risk management and diversification benefits of different portfolios are examined by calculating the reduction in downside risk. Moreover, we estimate and compare Sharpe Ratios (SRs) and Generalized Sharpe Ratios (GSRs) based on the frequencies of the investigated portfolios. Our empirical results reveal a strong asymmetric response from Chinese commodity markets. Specifically, we find that gold is a safe-haven asset, and due to negative correlations found at lower quantiles in medium and long term, an increase in the USD index damages bull commodity markets but boosts bear conditions under long-term investments, and negative (positive) tail correlations with interest rates (IRs) in bull (bear) markets are observed. It is proven that WTI can decrease short-run risks while USD and GOLD are more efficient in the diversification of downside risk. Adding international commodities may not improve the returns of Chinese commodities at given risk levels in the short and medium term through SRs and GSRs. In brief, investors should consider these dependence structures and modes of risk management in terms of time and frequency.     

A Rational Expectations Consistent Measure of Risk: Using Financial Market Data from a Middle Income Context*

Although economic theory assumes that risk is of central importance in financial decision making, it is difficult to measure the uncertainty faced by investors. Commonly used empirical proxies for risk (such as the moving standard deviation of the returns on an asset) are not firmly grounded in economic theory. Risk measures have been developed by other studies, but these are often based on subjective weights attaching to a range of objective component indicators, are difficult to replicate and are not strictly consistent with underlying theory. The contribution of this article is to develop a methodology to construct rational expectations consistent empirical risk measures. It has the advantages of being explicitly consistent with economic theory and easily replicable. We illustrate this methodology by specific application to the South African context. The time‐varying risk measure developed in this article is consistent with a rational expectations application of the expectations hypothesis. The constructed measure is a broad one (it includes political risk and peso problems for instance) and reflects investors’ perceptions of systematic risk.     

CAPM模型在上海股票市场的有效性检验

根据资本资产定价模型(CAPM),从上海A股市场随机抽取100支股票,计算它们的收益率,选择上证综合指数为市场组合的市场指数,并利用双层回归分析方法对2007年1月1日至2011年12月31日这段时间的100支股票进行实证检验。虽然很多国外研究表明,CAPM模型在一定程度上能够解释市场收益,并在资产估价、资本预算、投资风险分析方面已经得到了广泛应用,同时也有利于投资者构建最优的证券投资组合,但本文实证研究结果发现,CAPM模型并不适合中国的股票市场,股票预期收益率和系统风险之间不仅不存在正相关的关系,而且也不存在线性关系,除了系统风险外,非系统风险在解释股票收益上也具有一定的作用。     

Over-investment in corporate R&D,risk, and stock returns

Large-size firms which significantly increase their R&D expenditures experience subsequently three-year-long negative abnormal stock returns on the magnitude of 56 basis-points per month. We find no robust evidence of significant event-induced abnormal returns for small-size sample firms or any systematic risk changes for the small- and large- size firms. We also find that the large-size sample firms generate relatively much larger cash flows (i.e., have significantly greater over-investment discretion) and have significantly larger (over-) valuation multiples than the small-size firms. Moreover, some of their operating performance measures show signs of deterioration instead of improvement following these R&D programs. These findings are consistent with the view that investors initially underestimate the over-investment in R&D by some large-size firms that appear to be overvalued and have high cash flows at the time of the investment, only to be disappointed later.     

Direct and indirect oil shocks and their impacts upon energy related stocks

We attempt to consolidate (at least in part) the vast literature on oil shocks and stock returns by decomposing the influence of oil shocks into two channels of effect: ‘direct’ and ‘indirect’. Using a simple empirical asset pricing model, it is shown that oil shocks can affect stocks not only directly, but also indirectly through general market risk (which is shown to be due in part to oil shocks), or put another way that additional oil price risk exposure is embedded in the traditional market beta. As far as is known this is the first paper explicitly quantifying both effects together. By doing so we offer a more complete picture of when and how oil shocks impact stock returns, thus allowing investors to make more informed responses to oil shocks. The results are illustrated using daily data from all (active) listed energy related stock portfolios in the Asia Pacific Region, and are robust to structural instability and the specification of oil shock used.     

The impact of individual and institutional investor sentiment on the market price of risk

We examine the effect of individual and institutional investor sentiment on the market price of risk derived from DJIA and S&P500 index returns. Consistent with behavioral asset pricing models, we find significant positive response of rational sentiment suggesting greater incentive for rational investors to engage in arbitrage when the compensation for taking risk is greater. Further, an increase in irrational optimism leads to a significant downward movement, but an increase in rational sentiment does not lead to a significant change market price of risk. These results are robust for both market indexes, DJIA and S&P500 and for both individual and institutional investor sentiment.     

Homeownership and mixed-asset portfolio allocations

Homeownership represents both a consumption and an investment decision for individuals. Considering the investment benefits of the home, we estimate the total returns and risk associated with the investment in single-family homes. Then, using a mean–variance utility function, we consider the impact of homeownership and mortgage loan financing on the optimal asset allocation decisions of individuals and contrast this with advice that does not include the home as part of the portfolio. While optimal portfolio weights are dependant upon both the degree of risk aversion of the individual investor and the relative importance of the home in the overall net worth picture, we show that, in general, the higher the home-to-net worth ratio, the higher the optimal portfolio allocation to stock. For most investors, including the home in the optimization decision leads to higher allocations to risky stock than suggested by traditional advice that ignores the home.     

Variance swaps,non-normality and macroeconomic and financial risks

This paper studies the determinants of the variance risk premium and discusses the hedging possibilities offered by variance swaps. We start by showing that the variance risk premium responds to changes in higher order moments of the distribution of market returns. But the uncertainty that determines the variance risk premium – the fear by investors to deviations from normality in returns – is also strongly related to a variety of macroeconomic and financial risks associated with default, employment growth, consumption growth, stock market and market illiquidity risks. We conclude that the variance risk premium reflects the market willingness to pay for hedging against these financial and macroeconomic sources of risk. An out-of-sample asset allocation exercise shows that the inclusion of the variance swap reduces the modified value-at-risk with respect to a portfolio holding exclusively the equity market portfolio.     

Wavelet coherence analysis of returns,volatility and interdependence of the US and the EU money markets: Pre & post crisis

This research analyse the US and the EU money markets interdependence from 2004 to 2018. The study explains to what extent the volatility of the chosen money markets instruments in two regions is inter-correlated before, during and after the financial crisis of 2008. We apply the econometric analysis and estimate time-series models of class GARCH to study the historical dynamics of interbank rates and bond returns. The study demonstrates that correlation between returns of analogous money market instruments in the EU and US is not stable over time. We find that correlation rises in periods when countries are exposed to the same external shocks as global financial crisis. Wavelet coherence analysis suggests that investors do not get any advantages of portfolio diversification investing only in US treasuries with different maturities for more than 256 days and do not get any advantages at all investing only in European bonds.     

Risk decomposition,estimation error,and naïve diversification

How to achieve adequate diversification is important in portfolio construction. Efficient markets should not reward an investor for taking on risk that can be diversified away. Hence, when minimizing risk exposure, investors need to measure what part of total portfolio risk is systematic and what part can be diversified away. I examine several methods for decomposing total portfolio risk into systematic and diversifiable components and then carry out simulations to compare cross-sectional distributions of estimated and true risk as number of stocks increases in portfolios constructed using naïve diversification. Ordinary least squares estimators of diversifiable risk are relatively robust, and their cross-sectional distributions closely track the cross-sectional distributions of the corresponding true diversifiable risk. Other proposed estimators of diversifiable risk as well as all estimators of systematic risk have cross-sectional dispersion much greater than the corresponding true risk although, with one exception, bias is small. Results are relatively robust to the choice of method for generating market returns and to the underlying asset pricing model but not to random security betas. The simulation analysis also shows that risk and magnitude of shocks due to diversifiable risk are not negligible, even for 300-stock portfolios.     

Lessons from naïve diversification about the risk-reward trade-off

Studies of naïve diversification show that average total portfolio risk declines asymptotically as number of stocks increases. Recent work shows that a significant amount of idiosyncratic risk remains, even for portfolios with large numbers of stocks. The corresponding shocks are non-trivial. For example, more than half of all equal-weighted portfolios with 100 stocks have better than a 16 percent chance of an annual shock at least as large as about half of the annualized mean excess return on the U.S. total stock market index over July 1963–June 2018. I perform a simulation analysis of portfolio reward-to-risk as well as the components of total portfolio risk. On average, investors do not appear to be rewarded for exposure to non-systematic risk. The cross-sectional distribution of the true Sharpe ratio rises and its dispersion shrinks significantly as the number of stocks in the portfolio increases, whereas the cross-sectional distribution of the true non-systematic risk falls and its dispersion shrinks significantly as the number of stocks in the portfolio increases. This pattern appears regardless of the true asset pricing model for generating security returns, the portfolio weighting method, or specification of security alphas.     

Cross-sectional implications of dynamic asset pricing with stochastic volatility and ambiguity aversion

Building on recent research that highlights the importance of macroeconomic volatility and ambiguity aversion in explaining the dynamics of stock returns, in this paper we propose a dynamic asset pricing model that simultaneously accounts for stochastic macroeconomic volatility and ambiguity, assuming that investors deal with uncertainty about the mechanics of macroeconomic fluctuations using first-release consumption and revisions to aggregate consumption on vintage data. Our results show that the proposed model captures a large fraction of the cross-sectional variation of excess returns for a wide range of market anomaly portfolios. Furthermore, while the price of risk for ambiguity is positive and significant for the vast majority of assets under study, macroeconomic volatility yields ambiguous outcomes, although it significantly increases the explanatory power of the model for specific assets. Our results suggest that macroeconomic volatility and ambiguity complement each other in explaining the cross-sectional behavior of stock returns.     

Tail risk and investors’ concerns: Evidence from Brazil

I estimate tail risk for Brazil from January 2001 to July 2020 and investigate the origins of tail risk variation. The tail risk measure peaks at stock market crashes, financial crises, political shocks and disaster events such as the coronavirus pandemic. Moreover, I find that tail risk is countercyclical, has strong predictive power for market returns and negatively predicts real economic activity. In order to identify the investors’ concerns associated with tail risk, I extract daily news from the largest financial newspaper in Brazil. The co-movement between news and tail risk indicates that tail risk variation is mainly driven by disaster concerns, followed by economic and government uncertainty. While economic uncertainty explains the countercyclical property of tail risk, investors only require compensation for bearing tail risk implied by disaster concerns. Similarly, tail risk negatively impacts real outcomes because of the disaster concerns that it identifies. These findings support recent models explaining asset pricing puzzles with time-varying disaster risk.     

Real estate portfolio allocation: The European consumers’ perspective

Owner occupied housing facilitates household wealth accumulation and the stability of consumption in developed countries. It also contributes to other social goals. But owner-occupied housing is also a risky investment. This paper synthesizes existing knowledge about the riskiness of housing investment in European economies during the past quarter century. It also presents estimates of the potential gains to European consumers from investments in derivatives which may reduce risk at the individual level. We find that futures markets in house price indexes may increase portfolio returns for European investors by several percentage points at the same level of risk. We also consider practical steps to develop markets for these investments.     

Asymmetric positive feedback trading and stock pricing in China

Defining asymmetry of feedback trading (AFC) as the difference between buying-winners and selling-losers intensities, the paper investigates if AFC impacts stock pricing. We show that buying stocks with low AFC and selling stocks with high AFC makes significant positive returns after controlling traditional pricing factors. The return mainly comes from the long leg and cannot be simply attributed to either mispricing, liquidity, or risk premium. Further study shows that the negative impact of AFC on future stock return is reinforced with an increase in past returns, maximum daily return, relative valuation level, asset growth rate, or operating profit rate. As AFC represents retail trading intensity, the results imply that the inactiveness of retail investors may make price relative underreaction to good news and thus lead to positive expected stock return.     

A THEORETICAL AND PRACTICAL PERSPECTIVE ON THE EQUITY RISK PREMIUM*

Abstract In historical perspective, equity returns have been higher than interest rates but have also varied a good deal more. However, the average excess return has been larger than what could be expected based on classical equilibrium theory: the equity risk premium (ERP) puzzle. This paper has two objectives. First, the paper presents a comprehensive overview of the vast literature developed aimed at adjusting theory and testing the robustness of the puzzle. Here we will show that the failure of theory to link asset prices to economics is mostly quantitative by nature and not qualitative (anymore). Second, beyond providing a survey of theory, we aim for a relevant practical angle as well. Our main contribution is that we spend time on why returns have been higher than investors reasonably could have expected. We present evidence that forecasts of equity returns can be enhanced by valuation models: low valuation levels (low price‐to‐earnings ratios) portend high subsequent returns. While conventional wisdom (several years ago) was to use historical returns to forecast future returns, a growing consensus now recognizes that the predictive power of valuation ratios is preferred. Finally we provide some practical implications based on this predictability. While the ERP is essentially a long‐term issue, the likelihood of a lower risk premium increases risk for many and means that short‐term volatility might not be neglected.     

Performance evaluation with portfolio holdings information

This paper surveys recent academic research that uses portfolio holdings to evaluate the performance of an asset manager. These approaches mitigate the benchmark-choice problem of Roll (1978), as well as providing a much more precise attribution of the sources of manager returns. Although originally developed with U.S. data, recent papers have applied these approaches to European, Asian, and Australian equity managers. All surveyed approaches can be integrated into the Brinson, Hood, and Beebower (1986) attribution method, if we allow the composition of the benchmark portfolio to evolve through time according to the observed portfolio holdings of an asset manager.     

Idiosyncratic risk,market risk and correlation dynamics in the US real estate investment trusts

This study examines total, market and idiosyncratic risk and correlation dynamics using weekly return data on two US REIT firm samples from 1988 to 2008. We find that both market and idiosyncratic variance are time-varying and that idiosyncratic variance represents a dominant component of a REIT firm’s total variance. We find a decline in idiosyncratic risk as well as a rise in average REIT correlation during the new REIT era, from 1993 to 2008. This recent downward trend of idiosyncratic risk among REITs is different to the stylized upward trend of idiosyncratic risk among stocks. There is bi-lateral Granger causality between the market and idiosyncratic risks. Finally, we detect a positive relationship between the idiosyncratic risk and expected returns, implying that the risk premium of REITs is positively related to the idiosyncratic risk during the period new REIT era, 1993–2008. Our results have important asset-pricing implications for under-diversified investors.