Hedging Housing Risk*

An unusually rich source of data on housing prices in Stockholm is used to analyze the investment implications of housing choices. This empirical analysis derives market-wide price and return series for housing investment during a 13-year period, and it also provides estimates of the individual-specific, idiosyncratic, variation in housing returns. Because the idiosyncratic component follows an autocorrelated process, the analysis of portfolio choice is dependent upon the holding period. We analyze the composition of household investment portfolios containing housing, common stocks, stocks in real estate holding companies, bonds, and t-bills. For short holding periods, the efficient portfolio contains essentially no housing. For longer periods, low-risk portfolios contain 15 to 50 percent housing. These results suggest that there are large potential gains from policies or institutions that would permit households to hedge their lumpy investments in housing. We estimate the potential value of hedges in reducing risk to households, yet yielding the same investment returns. The value is surprisingly large, especially to poorer homeowners.     

A precautionary tale:

In the wake of the minimal disruption to computer systems arising from the Y2K Millennium Bug, there has been a notable lack of discussion about whether the huge expenditures devoted to solving the problem were justified. The most common response was that they were worth it ‘just to be on the safe side’. Furthermore, there were many related benefits in upgraded infrastructure and improved systems. We argue that in fact Y2K activity is an important if unexpected example of the ‘precautionary principle’ at work, i.e. acting in advance to ward off potential danger despite a lack of full scientific certainty about the extent of danger. It was unexpected because it was championed by corporations and governments who routinely oppose precautionary policies directed at environmental issues such as global warming. The paper outlines several reasons why Y2K was acted upon so swiftly while environmental issues are not, and explores what lessons may be learnt from the Y2K episode in terms of future strategies for dealing with environmental danger.     

Experimental Economics and the Theory of Decision Making Under Risk and Uncertainty

Following a brief review of the main experimental work into the economics of risk and uncertainty, both static and dynamic, this paper reports the results of an experiment testing one of the key assumptions of the theory of dynamic economic behaviour—that people have a plan and implement it. Using a unique design which enables the plan (if one exists) to be revealed by the first move, the experiment was implemented via the Internet on a subset of the University of Tilburg's ongoing family expenditure survey panel. The advantages of using such a set of subjects for the experiment are twofold: the demographic characteristics of the set are known and therefore demographic inferences can be made; the representativeness of the set is known and therefore inferences about populations can be made. The results suggest that at least 36% of the subjects had behaviour inconsistent with the hypothesis under test: that people formulate plans and then implement them. Interestingly demographic variables are unable to explain the consistency or inconsistency of individuals. One conclusion is that subjects simply make errors. An alternative conclusion, consistent with previous experimental research, is that people are unable to predict their own future decisions. The implications for dynamic theory (particularly relating to savings and pensions decisions) are important.     

The Volatility and Price Sensitivities of Managerial Stock Option Portfolios and Corporate Hedging

We use estimates of the Black–Scholes sensitivity of managers' stock option portfolios to stock return volatility and the sensitivity of managers' stock and stock option portfolios to stock price to test the relationship between managers' risk preferences and hedging activities. We find that as the sensitivity of managers' stock and stock option portfolios to stock price increases, firms tend to hedge more. However, as the sensitivity of managers' stock option portfolios to stock return volatility increases, firms tend to hedge less.     

Do share prices matter?

This paper examines whether the cross sectional variation in Australian share prices is partially explained by measures of firm size and ownership characteristics in a manner that is consistent with firms behaving in accordance with Merton's (1987) model of capital market equilibrium with incomplete information. Based on a sample of firms whose shares were traded on the ASX during 1995, we show that firms largely owned by less wealthy shareholders tend to have low stock prices, although this relation is not linear. In addition, larger, better–known, firms tend to have higher stock prices. These findings are consistent with prior evidence from US markets, and suggest the existence of a shareholder clientele effect in Australia that is related to the share price of the underlying firm.     

Pricing U.S. Dollar Index Futures Options: An Empirical Investigation

This paper develops a pricing model and empirically tests the pricing efficiency of options on the U.S. Dollar Index (USDX) futures contract. Empirical tests of the model indicate that the market consistently overprices these options relative to the derived model. This overpricing is more pronounced for out‐of‐the‐money options than for in‐the‐money options and more pronounced for put options than for call options. To validate the above results, delta neutral portfolios are created for one‐ and two‐day holding periods and consistently generate positive arbitrage profits, indicating that on average the market overprices the options on the USDX futures contracts.     

A Semiparametric Method for Valuing Residential Locations: Application to Automated Valuation

This paper is motivated by automated valuation systems, which would benefit from an ability to estimate spatial variation in location value. It develops theory for the local regression model (LRM), a semiparametric approach to estimating a location value surface. There are two parts to the LRM: (1) an ordinary least square (OLS) model to hold constant for interior square footage, land area, bathrooms, and other structural characteristics; and (2) a non-parametric smoother (local polynomial regression, LPR) which calculates location value as a function of latitude and longitude. Several methods are used to consistently estimate both parts of the model. The LRM was fit to geocoded hedonic sales data for six towns in the suburbs of Boston, MA. The estimates yield substantial, significant and plausible spatial patterns in location values. Using the LRM as an exploratory tool, local peaks and valleys in location value identified by the model are close to points identified by the tax assessor, and they are shown to add to the explanatory power of an OLS model. Out-of-sample MSE shows that the LRM with a first-degree polynomial (local linear smoothing) is somewhat better than polynomials of degree zero or degree two. Future applications might use degree zero (the well-known NW estimator) because this is available in popular commercial software. The optimized LRM reduces MSE from the OLS model by between 5 percent and 11 percent while adding information on statistically significant variations in location value.     

Ethical Unit Trust Financial Performance: Small Company Effects and Fund Size Effects

Recent papers which have examined unit trusts have controlled either for a 'fund size effect' or for the 'small firms effect' in the investment portfolio. The contribution of this paper is an analysis of the 'small firms effect' whilst simultaneously controlling for the 'fund size effect'. We show that the ethical unit trusts have significantly greater exposure than general unit trusts to the 'small firms effect', and that net of this there is no significant evidence of over or under performance by ethical trusts using an adjusted Jensen measure. Using two cross-sectional approaches, we demonstrate that whilst a 'small firms effect' has a role to play in explaining unit trust performance, fund size is not correlated with the financial performance of unit trusts. This cross-sectional analysis also provides some evidence that ethical unit trusts may perform less well than general unit trusts.     

A taxonomy of internationally dispersed technology units and its application to management issues

Internationally dispersed technology units are classified using a system based upon three clearly defined dimensions: Type of technical work (research, development or support); functional areas with which the technology unit collaborates in its work (marketing, manufacturing, marketing and manufacturing, or none); and geographic area of collaboration (local, international). The resulting eight category taxonomy is shown to provide an improved platform for organizing and integrating the literature on the management of internationally dispersed technology units and for articulating theoretical issues in ongoing programs of empirical research.