Currency hedging for single-currency equity portfolios: Does cross-asset risk matter?

Foreign investors who are fully invested in a single-currency domestic equity portfolio are exposed to domestic equity risk, but also to currency risk. The standard approach to hedging the currency risk optimally is to estimate a single optimal hedge ratio, but this approach hedges only exchange rate risk, not cross-asset risk. We provide an alternative approach that estimates two optimal hedge ratios to adjust the currency exposures—one associated with the domestic currency and one associated with the foreign currency—and hedges both exchange rate risk and cross-asset risk. This alternative approach can significantly reduce risk.     

Climate transition risk in U.S. loan portfolios: Are all banks the same?

We examine banks' exposure to climate transition risk using a bottom-up, loan-level methodology incorporating climate stress test based on the Merton probability of default model and transition pathways from the Intergovernmental Panel on Climate Change (IPCC). Specifically, we match machine learning predictions of corporate carbon footprints to syndicated loans initiated in 2010–2018 and aggregate these to loan portfolios of the twenty largest banks in the United States. Banks vary in their climate transition risk not only due to their exposure to the energy sectors but also due to borrowers' carbon emission profiles from other sectors. Banks generally lend a minimal amount to coal (0.4%) but hold a considerable exposure in oil and gas (8.6%) and electricity firms (4.6%) and thus have a large exposure to the energy sectors (13.5%). We observe that climate transition risk profile was stable over time, save for a temporary (in some cases) and permanent (in others), reduction in their fossil-fuel exposure after the Paris Agreement. From the stress testing, the median loss is 0.5% of US syndicated loans, representing a decrease in CET1 capital of 4.1% when extrapolated to the whole balance sheet. The loss is twice as large in the 1.5°C scenarios (1.4%–2.1% of loan value, 12%–16% of CET1 capital) compared to the 2°C target (0.6%–1.1% of loan value, 5%–9% of CET1 capital) with significant tail-end risk (7.7% of loan value, 62% of CET1 capital). Banks' vulnerabilities are also driven by the ex-ante financial risk of their borrowers more generally, highlighting that climate risk is not independent from conventional risks.     

The Prestige disaster: risk or danger?

The sinking of the Prestige off the coast of Galicia in north-west Spain in November 2002 was an enormous environmental disaster and it had an immense media impact both nationally and internationally, lasting weeks as a social and political phenomenon. Five days before the ship sank, the captain had reported to the maritime authorities that the old tanker was damaged and in trouble. During these five days leading up to the shipwreck, a crucial decision had to be made: what should be done with this dangerous oil tanker? Temporality is a property of the hazardous events which, after being noticed, are evaluated as imminent or deferred. This temporality makes a clear difference between a risk and a danger. Whereas the risk has time to anticipate the events, danger has just a very short time or even has no time. At this point, the Prestige disaster turns to be paradigmatic. To tow away this damaged oil tanker was a risk decision which estimated that there was still a time to prevent its running aground what meant to follow the story repeatedly told by the narrative context of risk. However, the Prestige had been spilling out oil all the time and the damage was not a probability but a fait accompli. This accident has not a risk temporality; in fact, it had not temporality at all because it demanded an immediate intervention. My conclusion here is that this crisis was managed in terms of risk when it should have been treated as a danger situation.     

Financial systemic risk: Taxation or regulation?

This paper describes financial systemic risk as a pollution issue. Free riding leads to excess risk production. This problem may be solved, at least partially, either by financial regulation or by taxation. From a normative viewpoint, taxation is superior in many respects. However, reality shows that financial regulation is adopted more frequently. This paper makes a positive, politico-economic argument. If the majority chooses regulation, the level is likely to be too harsh. If it chooses taxation, then the level is likely to be too low. Due to regressive effects, a tax on financial transactions receives low support from a majority of low polluting portfolio owners. The same kind of majority may strategically choose regulation in order to burden the minority with a larger share of the cost of reducing systemic risk.     

Asset pricing anomalies: Liquidity risk hedgers or liquidity risk spreaders?

We capture two distinct investing preferences – hedging against aggregate liquidity risk or betting on it – in the cross-section of stock returns. A three-factor model underpinned by exposures to changes in market liquidity, isolating two alternating patterns, is developed. Our results can be summarized in the following ways: one, the improved performance of recent asset-pricing models is driven by factors that mimic liquidity risk hedging and are linked to cross-sectional mispricing. Two, our model outperforms competing models in explaining time-series return variation across market states. Three, our parsimonious model enables an understanding of diverging return premia in the cross-section. Four, the estimated risk premiums in our model correspond to theoretical, economic, and statistical restrictions holistically across varied and complex anomaly structures. In this respect, the performance of the proposed model is even better than the risk premiums on factors in the model that have the largest cross-sectional r-squared values.     

Re-examining the risk–return relationship in Europe: Linear or non-linear trade-off?

This paper analyzes the risk–return trade-off in Europe using recent data from 11 European stock markets. After relaxing the linear assumptions in the risk–return relationship by introducing a new approach that considers the current state of the market, we obtain significant evidence for a positive risk–return trade-off for low volatility states. However, this finding is reduced or even non-significant during periods of high volatility. Maintaining the linear assumption over the risk–return trade-off leads to non-significant estimations for all cases. These results are robust across countries despite the conditional volatility model used. These results also demonstrate that the inconclusive results in previous studies may be due to strong linear assumptions when modeling the risk–return trade-off. This previous research fails to uncover the global behavior of the relationship between return and risk.     

White matter hyperintensities: age appropriate or risk indicator?

White matter hypertensity (WMH) is a term frequently seen in the MRI reports of insurance applicants. Its significance is often uncertain. There are different patterns and extent of WMH of variable clinical significance can be identified. Pathological correlates are varied with most pointing toward WMH as a reflection of small vessel ischemic burden. The predominant clinical associations are with stroke, cognitive impairment, dementia, general disability and death. This review examines the relationship of white matter hyperintensities to client morbidity, disability and mortality from an insurance medicine perspective.     

Australian – USA Federal Government Accounting: Convergence or Divergence?

Despite moves toward international harmonisation of accounting standards, there is evidence that standards regulating government accounting in various countries are diverging. This paper argues that, despite their similar federal systems and ostensibly similar objectives for federal government reporting, the accounting standards of the USA and Australia differ significantly in detail. A comparison of their objectives and standards reveals that the standards particularly differ in relation to accounting for assets, and in determining the performance of a reporting entity. Although these divergences emanate from differing philosophies underlying the standards of the two countries, they have implications for international harmonisation of accounting standards, and for reciprocity agreements.     

Changes to mutual fund risk: Intentional or mean reverting?

An empirical issue is whether a mutual fund’s change in intertemporal risk is intentional or arises from risk mean reversion. Our methodology uses actual fund trades to identify funds that actively change risk. Funds that are statistically identified as trading to change return variance or tracking error variance do not exhibit risk mean reversion. Mostly, funds trade to reduce risk and, in particular, tracking error variance. This is most evident for funds that previously attained a low tracking error variance. We find no evidence of a relation between past performance and intended changes to return variance or tracking error variance.     

Post-truth or agnogenesis? Theorizing risk and uncertainty in a neoliberal nature

In the aftermath of the great recession, many have investigated the characteristics of life in a ‘neoliberal nature’. In more recent months, we have also seen an apparent erosion of truth, the ‘post-truth’ moment. This paper argues that there are important and undertheorized links between the risk centrality of life in neoliberal nature and the post-truth moment. We begin by reviewing some treatments of risk from different fields, coming to the general conclusion that neoliberal nature is a place characterized primarily by its heightened risk(s). We then undertake a Foucauldian interpretation of neoliberal governmentality to demonstrate that the strategy of recasting society as atomized agents of risk is the source of a great deal of alienation and discontent, manifesting in an apparently post-truth citizen/society relationship. Next, we relate each of these concepts to the study of culturally induced ignorance, or ‘agnotology,’ to demonstrate that neoliberal governmentality in fact requires the systemic production of ignorance. We then propose an extension of agnotology to argue that a seemingly innocuous post-truth moment is better understood as an outgrowth of the deliberate production of targeted ignorance, especially in the context of environmental injustices. Finally, to provide an illustration of the trends described in this paper, we conclude with a section on the historic use of leaded gasoline in the U.S.     

Commodity returns co-movements: Fundamentals or “style” effect?

This paper investigates dynamic correlations both across commodities and between commodities and traditional assets, such as equities and government bonds, using the Regime Switching Dynamic Correlation (RSDC) model. There are three major findings. First, results from correlations both across commodities and between them and equities and bonds are in line with the “style” effect theoretical findings. Before the recent financial crisis, while correlations across In-index commodities started to increase from mid-2005, correlations between them and equities and bonds remained at low level. Second, all correlations increased markedly with a regime change which coincides exactly with the demise of the Lehman Brothers on September 15, 2008. We therefore suggest that the low correlation between In-index commodities and equities and bonds detected before the financial crisis should not be interpreted as a weak integration between commodity and financial markets. Integration was actually high, as revealed by the financial crisis, but was masked by the “style” effect. Finally, the new and original finding here is the temporary nature detected of the financial crisis effect on correlations which reverted to their pre-crisis level from April 2013. This highlights the impact of the financial-based factors on commodity price movements.     

Learning to organise risk management in organisations: what future for enterprise risk management?

This paper identifies recurring issues in the regulation of new technologies through an historical review of the risk management of automobiles in the 1800s. Parallels are drawn between the regulation of early automobiles and that of the regulation of Unmanned Aircraft Systems (UASs) today. It is found that many of the regulatory challenges facing UASs are analogous to those which faced the automobile industry more than a century and half ago and that the need for informed and objective decision making in policy development is reinforced. A systems engineering approach, based on general systems theory and decision‐based design principles, is then proposed as a means for improving the objectivity, transparency and rationality in the risk management decision making process. An example risk management decision making scenario is given within the context of a small UAS operating over a populated area. The results obtained from this case study illustrate how even simple analysis can support the decision making process and highlights some of the potential challenges in the regulatory approach currently applied to UASs.     

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.     

Covenants in convertible bonds: Boon or boilerplate?

This paper examines the role of restrictive covenants in convertible bonds. After controlling for standard covenant intensity determinants, an average convertible bond offering has 3.21 fewer covenants than an average straight bond offering. While covenants negatively affect straight bond yields, there is no negative association between covenants and convertible bond yields. Moreover, contrary to straight bond covenants, convertible bond covenants are set largely independently of issuer characteristics. Overall, our findings suggest that the conversion option and certain covenants are substitutes for addressing debt-related financing costs. The few covenants included in convertibles represent irrelevant boilerplate clauses.     

Socially responsible investment portfolios: Does the optimization process matter?

This study investigates the impact of the choice of optimization technique when constructing Socially Responsible Investment (SRI) portfolios. Corporate Social Performance (CSP) scores are price sensitive information that is subject to considerable estimation risk. Therefore, uncertainty in the input parameters is greater for SRI portfolios than conventional portfolios, and this affects the selection of the appropriate optimization method. We form SRI portfolios based on six different approaches and compare their performance along the dimensions of risk, risk-return trade-off, diversification and stability. Our results for SRI portfolios contradict those of the conventional portfolio optimization literature. We find that the more “formal” optimization approaches (Black-Litterman, Markowitz and robust estimation) lead to SRI portfolios that are both less risky and have superior risk-return trade-offs than do more simplistic approaches; although they also have more unstable asset allocations and lower diversification. Our conclusions are robust to a series of tests, including the use of different estimation windows and stricter screening criteria.     

Are return seasonalities due to risk or mispricing?

Stocks tend to earn high or low returns relative to other stocks every year in the same month (Heston and Sadka, 2008). We show these seasonalities are balanced out by seasonal reversals: a stock that has a high expected return relative to other stocks in one month has a low expected return relative to other stocks in the other months. The seasonalities and seasonal reversals add up to zero over the calendar year, which is consistent with seasonalities being driven by temporary mispricing. Seasonal reversals are economically large and statistically highly significant, and they resemble, but are distinct from, long-term reversals.     

Closed circuit television systems: a failure in risk communication?

This article discusses the growth in the UK of the use of public space closed circuit television (CCTV) systems as a means of controlling risk. The evidence as to the efficacy of CCTV is equivocal, but despite this successive UK governments have extolled the virtues of the technology, and have made money available to fund a large number of systems. There has been little debate outside the academic literature on the use of CCTV, therefore there is an apparent paradox between CCTV's use as a medium for communication and the paucity of risk communication from government to the public. Due to apparent public acquiescence to the use of CCTV, government appears to have felt that informed debate is not required. Using a multimethod case study of the largest residential-area CCTV system in Scotland, it is concluded that there is a strong desire amongst the public for CCTV, suggesting that at present they have been unconcerned at the lack of policy debate and hard empirical evidence.     

Systemic risk in non financial companies: Does governance matter?

The paper investigates the impact of four key corporate governance mechanisms - board, audit, compensation and ownership, and anti-takeover provisions - on the exposure and contribution to systemic risk of >400 US non-financial companies (NFCs) listed in S&P500 from 2005 to 2020. Our results show that in NFCs, unlike in banks, good corporate governance practices constrain both systemic risk exposure and contribution. We find a complementary effect between internal corporate governance mechanisms in reducing both the contribution and the exposure to systemic risk, and a substitution effect between internal and external governance practices in constraining the exposure of NFCs to systemic risk. Moreover, strong corporate governance practices are shown to constrain systemic risk both in steady-state conditions and in times of distress.     

Factor exposures and diversification: Are sustainably screened portfolios any different?

Financial Markets and Portfolio Management - We analyze the performance, risk, and diversification characteristics of global screened and best-in-class equity portfolios constructed according to...     

Sinus bradycardia: normal phenomenon or risk factor? Evaluation based on recent evidence

Although sinus bradycardia is a common abnormality seen in medical reports, the proper evaluation of sinus bradycardia is poorly understood by physicians. Recent data from heart rate epidemiologic and cohort studies has emerged regarding the risk stratification of sinus bradycardia, which may help insurers better underwrite this abnormality. In this review, an operational age-related heart rate reference based on recent advances is provided along with a suggested approach to the risk stratification and assessment of prognosis for inappropriate sinus bradycardia.