The duration of option portfolios

Duration is a value-weighted measure of average maturity which is commonly associated with portfolios of fixed-income securities. However, the concept finds application in option pricing theory also. This article shows that if options are valued by the Black (1976) formula and a comparative-statics methodology is employed, then the interest rate sensitivity of a portfolio of European options is equal to its duration. If the options are instead valued through the Black-Scholes (1973) formula, then the interest rate sensitivity is equal to only the ‘bond-equivalent duration’ inherent in a dynamic replication strategy for the option portfolio.     

Optimal fiscal and monetary policy in an economy without capital

This paper is concerned with the structure and time-consistency of optimal fiscal and monetary policy in an economy without capital. In a dynamic context, optimal taxation means distributing tax distortions over time in a welfare-maximizing way. For a barter economy, our main finding is that with debt commitments of sufficiently rich maturity structure, an optimal policy, if one exists, is time-consistent. In a monetary economy, the idea of optimal taxation must be broadened to include an ‘inflation tax’, and we find that time-consistency does not carry over. An optimal ‘inflation tax’ requires commitment by ‘rules’ in a sense that has no counterpart in the dynamic theory of ordinary excise taxes. The reason time-consistency fails in a monetary economy is that nominal assets should, from a welfare-maximizing point of view, always be taxed away via an immediate inflation in a kind of ‘capital levy’. This emerges as a new possibility when money is introduced into an economy without capital.     

‘Slow-burn’ spillover and ‘fast and furious’ contagion: a study of international stock markets

‘Fast and furious’ contagion across capital markets is an important phenomenon in an increasingly integrated financial world. Different from ‘slow-burn’ spillover or interdependence among these markets, ‘fast and furious’ contagion can occur instantly. To investigate this kind of contagion from the US, Japan and Hong Kong to other Asian economies, we design a research strategy to capture fundamental interdependence, or ‘slow-burn’ spillover, among these stock markets as well as short-term departures from this interdependence. Based on these departures, we propose a new contagion measure which reveals how one market responds over time to a shock in another market. We also propose international portfolio analysis for contagion via variance decomposition from the portfolio manager’s perspective. Using this research strategy, we find that the US stock market was cointegrated with the Asian stock markets during four specific periods from 3 July 1997 to 30 April 2014. Beyond this fundamental interdependence, the shocks from both Japan and Hong Kong have significant ‘fast and furious’ contagion effects on other Asian stock markets during the US subprime crisis, but the shocks from the US have no such effects.     

The value of convexity: a theoretical and empirical investigation

We explore from a theoretical and an empirical perspective the value of convexity in the US Treasury market. We present a quasi-model-agnostic approach that is rooted in the existence of some affine model capable of recovering with good accuracy the market yield curve and covariance matrix. As we show, at least one such model exists, and this is all we require for our results to hold. We show that, as a consequence, the theoretical ‘value of convexity’ purely depends on observable features of the yield curve, and on statistically determinable yield volatilities. We then address the question of whether the theoretical convexity is indeed correctly reflected in the shape of the yield curve. We present empirical results about the predictive power of a strategy based on the discrepancies between the theoretical and the predicted value of convexity. By looking at 30 years of data, we find that neither the strategy of being systematically long or short convexity (and immunized against ‘level’ and ‘slope’ risk) would have been profitable. However, a conditional strategy that looks at the difference between the ‘implied’ and the statistically estimated value of convexity would have identified extended periods during which the proposed approach would have delivered attractive Sharpe Ratios.     

Individualization revisited: global family developments,uncertainty and risk

Abstract

As part of our special issue appreciating the work of Ulrich Beck, this article introduces and rearticulates his concept of individualization for an audience beyond those engaged with sociological theory. It is argued to be the ‘forgotten half’ of Beck’s approach that is in particular need of both restatement and reaffirmation of its contemporary relevance. It does so by firstly contextualizing and explaining its comparatively limited impact before elaborating the stages of the individualizing process and how his key notion of ‘disembedding without re-embedding’ is distinct from traditional sociological understanding of the individualizing dynamic within modernity. Its relevance and utility is then indicated through surveying developments in family and affective relations in China and America, two of Beck’s ideal types of individualization pattern. Both demonstrate a pattern of radical ‘disembedding’, and a conscious and partial ‘re-embedding’ in the case of the ‘neo-traditional’ American middle-class family. Following this, the article suggests a stronger potential connection between the risk and individualization dimensions of his approach than was drawn out by Beck himself, through focusing upon the uncertainty created by disembedding. The uncertainty that follows from individualization suggests precautionary retreat into security and the construction of risk as a means of embodying and managing uncertainty. Recognition of this social dynamic is potentially more useful in understanding risk than the better-known but very general theory of reflexive modernization that is the other half of Beck’s contribution to risk research.     

A duscrete-time model of high-frequency stock returns

A model of intraday financial time series is developed. The model is a dynamic factor model consisting of two equations. First, a rate of return of a ‘stock’ in a single day is assumed to be generated by serveral common factors plus some additive erros (‘intraday equation’). Secondly, the joint distribution of those common factors is assumed to depend on the hidden state of the day, which fluctuates according to a Markov chain (‘day-by-day equation’). Together the equations compose a hidden Markov model.

We investigate properties of the model. Among them is a central limit theorem for cumulative returns, which agrees with the well-known empirical phenomenon in the stock markets that the distributions of longer-horizon returns are closer to the normal. We propose a two-step procedure consisting of the method of principal components and the EM algorithm to estimate the model parameters as well as the unboservable states. In addition, we propose a procedure for predicting intraday returns. Finally, the model is fitted to empirical data, the Standard&Poors 500 Index 5 min return data, to see if the model is capable of describing intraday movements of the index.     

Optimal investment of an insurer with regime-switching and risk constraint

We investigate an optimal investment problem of an insurance company in the presence of risk constraint and regime-switching using a game theoretic approach. A dynamic risk constraint is considered where we constrain the uncertainty aversion to the ‘true’ model for financial risk at a given level. We describe the surplus of an insurance company using a general jump process, namely, a Markov-modulated random measure. The insurance company invests the surplus in a risky financial asset whose dynamics are modeled by a regime-switching geometric Brownian motion. To incorporate model uncertainty, we consider a robust approach, where a family of probability measures is cosidered and the insurance company maximizes the expected utility of terminal wealth in the ‘worst-case’ probability scenario. The optimal investment problem is then formulated as a constrained two-player, zero-sum, stochastic differential game between the insurance company and the market. Different from the other works in the literature, our technique is to transform the problem into a deterministic differential game first, in order to obtain the optimal strategy of the game problem explicitly.     

Does obfuscating excessive CEO pay work? The influence of remuneration report readability on say-on-pay votes

This paper assesses whether reducing ‘readability’ is an effective obfuscation strategy for influencing the level of shareholder say-on-pay voting dissent in firms with excessive CEO pay. Based on a sample of UK-listed firms, our results indicate that in cases of excessive CEO pay, a less readable remuneration report is associated with reduced say-on-pay voting dissent. However, the effect of the obfuscation strategy diminishes as institutional ownership increases. Using obscurely written remuneration reports may even backfire (i.e. associated with increased voting dissent) when a firm’s majority shares are held by institutional investors. Our results are robust to controlling for compensation contract complexity as well as other alternative explanations. The results are also robust to various controls for endogeneity including a two-stage instrumental variable approach and propensity-score matching. Our findings offer regulatory implications that regulators could minimize the use of ‘obfuscation’ in pay-related disclosures by prescribing how information is to be presented.     

Setting Public Service Outcome Targets: Lessons from Local Public Service Agreements

Public agencies in the UK and elsewhere are increasingly required to set outcome targets as a strategy for improving their services. A crucial element of this ‘results orientation’ is a clear definition of the desired outcomes and a specification of appropriate performance indicators. A recent example of this policy in the UK—Local Public Service Agreements (LPSAs)—is examined in this article. The authors’ analysis of the first generation of LPSAs shows that just under half of the indicators used were measures of outcome. The authors explain the ‘wicked’ issues in outcome measurement that emerged from the research.     

Framing the UK’s counter-terrorism policy within the context of a wicked problem

Terrorist attacks can be seen as the ultimate wicked problem. After 9/11, terrorists moved from so-called ‘spectacular’ events to relatively low-intensity attacks against individuals and groups. The emergence of what has become known as the ‘home-grown’ terrorist has added a further dimension to the ‘wicked’ nature of the problem. This paper considers the UK’s CONTEST and PREVENT strategies as a policy response to the threats from terrorism and the impact that the policies themselves can have on the radicalization of individuals. The author highlights some of the limitations of the PREVENT strand of the overall strategy and the constraints that are imposed on government policies by failing to take a holistic perspective on the nature of the problem.     

Strategy implementation as fantasising – becoming the leading bank

In this empirical case study we explore the fantasy nature of strategy work and propose fantasising as a framework contributing to the nascent literature dealing with the previously overlooked fantasy nature of strategy. More specifically, our interest is on examining how the meaning of official strategy gets constructed as it is being implemented, as well as and how and why the perceptions may evolve during implementation. Our data consists of official strategy documents and interviews from Finland's largest financial services group and its largest unit. The interviews cover all organisational levels, enabling us to reveal the variations of perceptions of strategy as it is being implemented. The data analysis is carried out by means of qualitative interpretation. According to our findings, the main goal of becoming the leading bank, as outlined in the official strategy, had been adopted throughout the organisation hierarchically. However, conceptions of what would constitute ‘a leading bank’ varied, especially horizontally. The plausibility of the official strategy is constructed through rational techniques (e.g. numerical ‘objective’ accounting information) intertwined with storytelling. As a result we propose that strategy implementation may best be understood as fantasising involving two forms: functional (explicit, short-term-oriented) and symbolic (metaphorical, long-term-oriented). We offer fantasising in these two forms as an addition to fantasy-oriented strategy literature for further exploration to better understand the nature of strategy work.     

Macroeconomic factors and yield curve for the emerging Indian economy

This article investigates the dynamic linkages between the estimated parameters of a zero coupon yield curve and macroeconomic variables like inflation, gross domestic product growth in the presence of a monetary policy indicator in India for the period July 1997 to February 2004. The study finds that there exists strong causality from financial factors, defined by three parameters of the yield curves (‘Level’, ‘Slope’, ‘Curvature’) to macroeconomic factors; growth, inflation and monetary policy indicators (changes in the call money rate). However, the causality in the opposite direction is found to be weaker. It is found that theyield and macro factors do not cause each other before the launch of a liquidity adjustment facility, so the evidence of causality from financial to macroeconomic factors can be attributed to the introduction of a liquidity adjustment facility in June 2000. The causality from yield factors to macro factors is primarily driven by the fact that the ‘changes in level’ of yield curve brings an impact on inflation through the changes in monetary policy. This finding suggests that monetary policy plays a key role in driving the causality. This also implies that the indirect instrument of monetary policy mechanism is becoming increasingly important to influence the aggregate demand in the economy.     

Evaluation of psychosocial and organizational factors in offshore safety: a comparative study

This study compares UK and Norwegian offshore workers' evaluations of social and organizational factors that can have an impact upon safety on offshore installations. A total of 1138 Norwegian (87% response rate) and 622 UK workers (40% response rate) responded to a self-completion questionnaire, which was distributed to 18 installations in February/March 1994. The questionnaire contained six scales that were suitable and relevant for the purposes of comparison. These scales measured ‘risk perception’, ‘satisfaction with safety measures’, ‘perceptions of the job situation’, ‘attitudes to safety’, ‘perceptions of others' commitment to safety’ and ‘perceptions of social support’. The data show clear differences in how UK and Norwegian workers evaluate various social and organizational factors that can have an impact upon safety, however, eta² analysis indicated that for most of the scales ‘installation’ explained a greater percentage of the variance than sector. The exceptions to this were scales measuring ‘safety attitudes’ where both sector and installation contributed equally to the effects. Although the results from the ‘safety attitudes’ scales should be interpreted with caution (due to low internal reliability), it is possible that they are tapping into more deeply held beliefs about the nature of safety, e.g. ‘fatalism’ and the ‘causes of accidents’. In contrast, the other scales are measuring factors directly related to the working environment such as perceptions of risk and satisfaction with safety measures on the installation. These may reflect the prevailing ‘safety climate’ or ‘atmosphere’ on the installations surveyed, whereas constructs such as ‘fatalism’, etc. may be reflections of underlying ‘cultural’ values. Recognizing the existence of different ‘safety cultures’ and understanding the processes which lie behind them could have implications for safety management in an industry which is highly international in nature and in which workers' are often required to work in foreign countries for varying periods of time.     

How trading activity scales with company size in the FTSE 100

This paper investigates the scaling dependencies between measures of ‘activity’ and of ‘size’ for companies included in the FTSE 100. The ‘size’ of companies is measured by the total market capitalization. The ‘activity’ is measured with several quantities related to trades (transaction value per trade, transaction value per hour, tick rate), to the order queue (total number of orders, total value), and to the price dynamic (spread, volatility). The outcome is that systematic scaling relations are observed: (1) the value exchanged by hour and value in the order queue have exponents of less than 1, respectively 0.90 and 0.75; (2) the tick rate and the value per transaction scale with the exponents 0.39 and 0.44; (3) the annualized volatility is independent of the size, and the tick-by-tick volatility decreases with the market capitalization with an exponent of ?0.23; (4) the spread increases with the volatility with an exponent of 0.94. A theoretical random walk argument is given that relates the volatility exponents to the exponents in points 1 and 2.     

Auditor–client management relationships and roles in negotiating financial reporting

We carry out an interview based field study of chief financial officer (CFO)–audit partner dyads to examine the assumption that the roles played by each side and the nature of the relationships are similar across negotiations. These dyads freely discussed with us their relationship, a specific issue negotiated and it’s resolution process. Employing the lens of social positioning negotiation research, we find these negotiations are ‘fluid’, with continual redefinition not only of the substantive issues under negotiation, but also of the negotiation roles and relationships (i.e. ‘shadow’ negotiations). The CFO’s actions and expectations in these ‘shadow’ negotiations appear to define the auditor’s role and the relationship’s parameters, but both can evolve over time. The audit partners express a desire to be in the “ideal” relationship where they assume the role of the ‘expert advisor’ (as opposed to a ‘police officer’) but they seemingly have no explicit strategy to move the relationship toward a ‘proactive’ (rather than ‘reactive’) state. Furthermore, the audit partner is always the ‘relationship manager’ whose job it is to see that client management remains “happy”. These roles and relationships negotiated in the ‘shadows’ also affect how the negotiation process unfolds, including the set of alternative accounting treatments considered during negotiations. Finally, audit firms appear to manage the assignment of partners to engagements based on CFO preferences and remove those partners who are in “poor” relationships, irrespective of why the relationship is considered by the CFO to be “poor”. Implications for the broader research program on auditor–client management negotiations are discussed.     

Improving retirement adequacy through asset class prioritization

Highly risk-averse retirees are generally advised to adopt a fixed spending strategy such as the 4% withdrawal rule. To prevent the premature depletion of a retirement portfolio, the rule attempts to proxy as the ‘safe withdrawal rate’. But a constant withdrawal rate means that retirees accumulate unspent surpluses when markets outperform and face spending shortfalls when markets underperform. While a safe withdrawal rate can prevent spending shortfalls, the opportunity cost of unspent surpluses associated with this strategy can be extreme. We apply a range of basic investment decision rules to a retirement portfolio applying various withdrawal rates and examine the probability of shortfalls over a retirement horizon. Using a block bootstrap simulation technique, we examine decision rules relating to stock and bond investments. Our results show that retirement portfolios with a bias towards stocks coupled with a decision rule that sources withdrawals from bonds and cash before stocks significantly outperforms alternative withdrawal strategies, despite the inherent increase in volatility. This finding is in direct contrast to the safe withdrawal rate conventions used in contemporary financial advice models.     

Budgetary incrementalism in a Christian bureaucracy

This paper presents the second stage of a field based case study focussed upon the planning and control concepts and processes employed by the central offices of the Victorian Synod of the Uniting Church in Australia. Its analysis is informed by grounded theory methodology and develops a micro-theoretical framework of that organization’s planning and control process. A reactive style of planning produces an incremental budgetary mélange that ultimately results in a form of control by compromise. The emergent findings are compared with a selection of relevant prior strategy and not-for-profit organization research. The study presents contextualized insights into the potential limits of ‘rational’ management system operation in such organizations, and the role of budgetary systems in organizational approaches to coping with a complex and dynamic environment.     

An experimental study on real-options strategies

We conduct a laboratory experiment to study whether people intuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make production decisions in response to a simulated mean-reverting oil price. Using cluster analysis, participants can be classified into four groups, which we label ‘mean-reverting’, ‘Brownian motion real-option’, ‘Brownian motion myopic real-option’, and ‘ambiguous’. We find two behavioral biases in the strategies of our participants: ignoring the mean-reverting process, and myopic behavior. Both lead to too frequent switches when compared with the theoretical benchmark. We also find that the last group behaved as if they have learned to incorporate the true underlying process into their decisions, and improved their decisions during the later stage.     

A bootstrap-based comparison of portfolio insurance strategies

This study presents a systematic comparison of portfolio insurance strategies. We implement a bootstrap-based hypothesis test to assess statistical significance of the differences in a variety of downside-oriented risk and performance measures for pairs of portfolio insurance strategies. Our comparison of different strategies considers the following distinguishing characteristics: static versus dynamic protection; initial wealth versus cumulated wealth protection; model-based versus model-free protection; and strong floor compliance versus probabilistic floor compliance. Our results indicate that the classical portfolio insurance strategies synthetic put and constant proportion portfolio insurance (CPPI) provide superior downside protection compared to a simple stop-loss trading rule and also exhibit a higher risk-adjusted performance in many cases (dependent on the applied performance measure). Analyzing recently developed strategies, neither the TIPP strategy (as an ‘improved’ CPPI strategy) nor the dynamic VaR-strategy provides significant improvements over the more traditional portfolio insurance strategies.     

For fraud,look under ‘serious and organized crime’

ABSTRACT

The UK government’s response to fraud cannot be disentangled from its broader ‘serious and organized crime’ (SOC) strategy. In order to explore whether fraud should—in public policy, criminal justice and law enforcement terms—be seen primarily as an SOC issue, there is a need to consider questions about whether or not ‘SOC’ is a sensible object of policy-making in the first place. Several arguments in favour of an SOC policy are identified in the paper. However, the notion of an overarching SOC policy is problematic for three reasons. First, SOC is a fundamental misrepresentation of reality, which does not correspond to a real social problem. Second, SOC policy can limit the development of more problem-specific crime strategies, Third, the ‘SOC’ label can negatively transform how social problems are perceived over the long term. If fraud is to be better understood and dealt with, it may therefore be necessary to extract it from its current inclusion within wider SOC strategy.