Optimal human capital policies

We analyze optimal income taxes and optimal schooling subsidies in a dynamic private information economy with observable human capital accumulation. We show that under plausible conditions the marginal schooling subsidies are positive and that they are zero at both endpoints of the skill distribution.We compute the optimal policies and evaluate their impact over the transition and at the steady state. We find that the optimal schooling policies are significantly smaller than the optimal marginal income taxes. If optimal schooling policies are introduced jointly with optimal income taxes then their welfare and aggregate effects are small. However, if income taxes are not set optimally then the optimal schooling policies have significant welfare and aggregate effects.     

General convex order on risk aggregation

Using a general notion of convex order, we derive general lower bounds for risk measures of aggregated positions under dependence uncertainty, and this in arbitrary dimensions and for heterogeneous models. We also prove sharpness of the bounds obtained when each marginal distribution has a decreasing density. The main result answers a long-standing open question and yields an insight in optimal dependence structures. A numerical algorithm provides bounds for quantities of interest in risk management. Furthermore, our numerical results suggest that the bounds obtained in this paper are generally sharp for a broader class of models.     

Optimal investments for risk- and ambiguity-averse preferences: a duality approach

Ambiguity, also called Knightian or model uncertainty, is a key feature in financial modeling. A recent paper by Maccheroni et al. (preprint, 2004) characterizes investor preferences under aversion against both risk and ambiguity. Their result shows that these preferences can be numerically represented in terms of convex risk measures. In this paper we study the corresponding problem of optimal investment over a given time horizon, using a duality approach and building upon the results by Kramkov and Schachermayer (Ann. Appl. Probab. 9, 904–950, 1999; Ann. Appl. Probab. 13, 1504–1516, 2003). Supported by Deutsche Forschungsgemeinschaft through the SFB 649 “Economic Risk”.     

发挥资本导向整合银行风险管理体制

近年来,资本管理在商业银行中的地位越来越重要,这是监管部门强调资本约束原则的效果,也是商业银行自身控制风险的重要手段。文章指出,作为商业银行风险管理工作的重要抓手,资本管理的核心是计量能力的提升,对于资本分配应掌握总量控制的原则。中国银行业应以资本管理为导向,逐步完善自身的风险管理体系。     

Investment timing and optimal capital structure under liquidity risk

Deterioration in debt market liquidity reduces debt values and affects firms' decisions. Considering such risk, we develop an investment timing model and obtain analytic solutions. We carry out a comprehensive analysis in optimal financing, default, and investment strategies, and stockholder–bondholder conflicts. Our model explains stylized facts and replicates empirical findings in credit spreads. We obtain six new insights for decision makers. We propose a ‘new trade-off theory’ for optimal capital structure, a new tax effect, and new explanations of ‘debt conservatism puzzle’ and ‘zero-leverage puzzle’. Failure in recognizing liquidity risk results in substantially over-leveraging, early bankruptcy or investment, overpriced options, and undervalued coupons and credit spreads. In addition, agency costs are surprisingly small for a high liquidity risk or a low project risk. Interestingly, the risk shifting incentive and debt overhang problem decrease with liquidity risk under moderate tax rates while they increase under high tax rates.     

Information dissemination on intellectual capital in mergers and acquisitions: purchase price allocations,press releases and business press

In order to reduce information asymmetries in relation to a firm's current decisions and long-term strategy, firms must consistently provide information to stakeholders. This paper investigates intellectual capital (IC) information disclosed in mergers and acquisitions (M&A) provided through three different disclosure channels (voluntary press releases, related newspaper articles and subsequent mandatory corporate disclosures in the notes to the financial statements). For a sample of 215 randomly selected US and European M&As, we analyse 215 press releases, 1025 newspaper articles and 215 purchase price allocations. Our findings suggest that IC disclosure in press releases is not perceived as informative and qualitative forward-looking IC information in voluntary corporate disclosures appears to lack credibility. Moreover, we empirically demonstrate interdependencies across the three disclosure channels. The business press seems to filter IC information provided in press releases. The amount of IC disclosure in the notes to the financial statements is positively associated with prior IC disclosure in newspaper articles, but negatively associated with IC disclosure in press releases. The managements of acquirer firms appear to pay attention to news coverage and public opinion. However, both voluntary and mandatory corporate disclosures appear to substitute rather than complement each other.     

Optimal reinsurance under general law-invariant risk measures

In recent years, general risk measures play an important role in risk management in both finance and insurance industry. As a consequence, there is an increasing number of research on optimal reinsurance decision problems using risk measures beyond the classical expected utility framework. In this paper, we first show that the stop-loss reinsurance is an optimal contract under law-invariant convex risk measures via a new simple geometric argument. A similar approach is then used to tackle the same optimal reinsurance problem under Value at Risk and Conditional Tail Expectation; it is interesting to note that, instead of stop-loss reinsurances, insurance layers serve as the optimal solution. These two results highlight that law-invariant convex risk measure is better and more robust, in the sense that the corresponding optimal reinsurance still provides the protection coverage against extreme loss irrespective to the potential increment of its probability of occurrence, to expected larger claim than Value at Risk and Conditional Tail Expectation which are more commonly used. Several illustrative examples will be provided.     

Dynamic risk measures: Time consistency and risk measures from BMO martingales

Time consistency is a crucial property for dynamic risk measures. Making use of the dual representation for conditional risk measures, we characterize the time consistency by a cocycle condition for the minimal penalty function. Taking advantage of this cocycle condition, we introduce a new methodology for the construction of time-consistent dynamic risk measures. Starting with BMO martingales, we provide new classes of time-consistent dynamic risk measures. These families generalize those obtained from backward stochastic differential equations. Quite importantly, starting with right-continuous BMO martingales, this construction naturally leads to paths with jumps.      

Optimal execution strategies in limit order books with general shape functions

We consider optimal execution strategies for block market orders placed in a limit order book (LOB). We build on the resilience model proposed by Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]) but allow for a general shape of the LOB defined via a given density function. Thus, we can allow for empirically observed LOB shapes and obtain a nonlinear price impact of market orders. We distinguish two possibilities for modelling the resilience of the LOB after a large market order: the exponential recovery of the number of limit orders, i.e. of the volume of the LOB, or the exponential recovery of the bid–ask spread. We consider both of these resilience modes and, in each case, derive explicit optimal execution strategies in discrete time. Applying our results to a block-shaped LOB, we obtain a new closed-form representation for the optimal strategy of a risk-neutral investor, which explicitly solves the recursive scheme given in Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]). We also provide some evidence for the robustness of optimal strategies with respect to the choice of the shape function and the resilience-type.     

Uncertainty on survival probabilities and solvency capital requirement: application to long-term care insurance

In this paper, we focus on uncertainty issues on disabled lives survival probabilities of LTC insurance policyholders and its consequences on solvency capital requirement. Among the risks affecting long-term care portfolios, special attention is addressed to the table risk, i.e. the risk of unanticipated aggregate mortality, arising from the uncertainty in modeling LTC claimants survival law. The table risk can be thought as the risk of systematic deviations referring not only to a parameter risk but, as well, to any other sources leading to a misinterpretation of the life table resulting for example from an evolution of medical techniques or a change in rules of acceptance. In fine, the idea is to introduce the risk of systematic deviations arising from the uncertainty on the disabled lives death probabilities directly. We analyze the consequences of an error of appreciation on the disabled lives survival probabilities in terms of level of reserves and describe a framework in an Own Risk and Solvency Assessment perspective to measure the gap between the risk profile from the standard formula to the risk analysis specific to the organism.     

A structural framework for modelling contingent capital

This paper develops a structural model of contingent capital. In contrast to existing approaches we explicitly link the firm’s total payout to its cost of debt, leading to a total payout that is linear in—as opposed to proportional to—asset value. In the special case that asset value evolves as affine geometric Brownian motion we derive closed-form expressions for limiting (i.e. perpetual) bond values. The proposed model is flexible, so that it can be used to gauge the relative merits of different variations of contingent capital, and parsimonious, so that it is relatively easy to implement in practice. An empirical example using data from the Canadian banking sector is provided that illustrates how the model can generate insights into problems that are of interest to both regulators and issuers of contingent capital (e.g. what range of conversion prices would be consistent with regulatory guidelines, and how expensive is contingent debt over this range).     

Dividend policy under conditions of capital market and signaling equilibria

This article develops a generalized capital asset pricing model with dividend signaling under the assumption of asymmetric information between corporate insiders and outside investors. The generalized capital asset pricing model is derived under reasonably plausible conditions that are sufficient for the existence of dividends. The model provides a theoretical framework for testing the effect of dividends on equity price and returns. Further, if dividends serve as a credible signal and the cost of signaling is positive, paying higher dividends results in higher systematic risk.     

The fragile capital structure of hedge funds and the limits to arbitrage

During a financial crisis, when investors are most in need of liquidity and accurate prices, hedge funds cut their arbitrage positions and hoard cash. The paper explains this phenomenon. We argue that the fragile nature of the capital structure of hedge funds, combined with low market liquidity, creates a risk of coordination in redemptions among hedge fund investors that severely limits hedge funds' arbitrage capabilities. We present a model of hedge funds' optimal asset allocation in the presence of coordination risk among investors. We show that hedge fund managers behave conservatively and even abstain from participating in the market once coordination risk is factored into their investment decisions. The model suggests a new source of limits to arbitrage.     

Accounting for decarbonisation and reducing capital at risk in the S&P500

This article accounts for carbon emissions in the S&P 500 and explores the extent to which capital is at risk from decarbonising value chains. At a global level it is proving difficult to decouple carbon emissions from GDP growth. Top-down legal and regulatory arrangements envisaged by the Kyoto Protocol are practically redundant given inconsistent political commitment to mitigating global climate change and promoting sustainability. The United Nations Environment Programme (UNEP) and European Commission (EC) are promoting the role of financial markets and financial institutions as drivers of behavioural change mobilising capital allocations to decarbonise corporate activity.     

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.     

The role of regulatory capital in international bank mergers and acquisitions

When investigating the role of regulatory capital in bank mergers and acquisitions (M&As) we finds that US targets are better capitalized than their acquirers and non-acquired peers and that US banks maintain higher capital levels than European banks. Thus, US banks strategically raise their capital levels to avoid regulatory scrutiny. Furthermore, more value is created for targets with high excess capital and in M&As involving targets with considerably higher excess-capital ratios than their acquirers. Thus, the excess regulatory capital hypothesis is supported. Finally, market prices reflect the influence that capital has on the probability of the merger's regulatory approval.     

Optimal credit risk transfer, monitored finance, and banks

We examine the implications of optimal credit risk transfer (CRT) for bank-loan monitoring, and the incentives for banks to engage in optimal CRT. In our model, properly designed CRT instruments allow banks to insure themselves against loan losses precisely in those states that signal monitoring. We find that optimal CRT enhances loan monitoring and expands financial intermediation, in contrast to the findings of the previous literature. Optimal CRT instruments are based on loan portfolios rather than individual loans and have credit-enhancement guarantees, pretty much as banks do in practice. But the extent of credit enhancement needs to be precisely delimited. Above that exact level, monitoring incentives are undermined (loan quality deteriorates) and wealth is transferred from the bank's financiers to the bank. Properly designed risk-based capital requirements are shown to prevent such a wealth transfer and to provide banks with the incentive to engage in optimal CRT.