In Search of the Optimal Saving Strategy for Pan-European Pension Products

Searching for the optimal saving strategy is often tied with the life-cycle strategies where only the age of a saver is considered for setting the allocation profile between equities and bonds. Our article contributes to the debate by looking at the performance and adequacy risks arising from applying age-based saving strategies for savers in funded pension schemes. As many studies have proven the shift of the risk onto savers in defined contribution pension schemes under various saving strategies, we contribute to the debate by providing simulations of expected accumulated savings via funded pension scheme under the various life-cycle income profiles and existence of unemployment risk. Using the resampling simulation technique, we compare the fixed and age-based strategies of three different agents with various life-cycle income paths and different unemployment risk. We compare the expected amount of savings and calculate relative indicators comparing the expected monthly benefits, income replacement rate. We look closely on the impact of unemployment on the value of savings and calculate the unemployment factor explaining the value of savings lost due to the periods of unemployment. By combining life-cycle income functions of individuals with different education level and unemployment risk, we show that decisions of implementing low risk saving strategies are suboptimal and lead to a substantial decrease in replacement ratios not only for higher income cohorts but especially for the lowest ones. At the same time, we prove that employing low risk saving strategy leads to the increase of adequacy risk especially driven by the unemployment risk that is higher for lower education individuals. We conclude that age-based life-cycle saving strategies, where the remaining saving horizon is the only factor defining the allocation profile is not the optimal saving strategy and other factors should be considered as well when searching for optimal saving strategy.

The Low Downside Risk Effect - Lower Risk and Higher Returns with Low Downside Risk

It is part of managerial wisdom that managers need to take risks in order to succeed. This is in stark contrast to the prominent agent-based theories of experiential learning and competitive selection that are known to be biased against risky alternatives in the long run. How can the positive managerial view on risk taking prevail given these results? Qualitative surveys of managers suggest risks to be acceptable if their outcome distribution meets certain criteria. We argue in this paper that these criteria are widely congruent with low downside risk. Using a novel simulation design, we analyze the effects of experiential learning and competitive selection on downside risk preferences in an ecology of agents. In the long run, experiential learning implies weak downside risk seeking, whereas competitive selection leads to strong downside risk aversion. Furthermore, competitive selection leads to the prevalence of outcome distributions with low downside risk in an ecology, even if they have a significantly higher level of total risk than comparable distributions with more downside risk. We draw implications for empirical studies on managerial behavior.The online appendix is available at https://doi.org/10.1287/orsc.2017.1149 .

Governance mechanisms and downside risk

Private ESG Shareholder Engagement and Risk: Clinical Study of the Extractive Industry

The phaseout of Methyl Bromide (MBr) required by the Montreal Protocol on Substances that Deplete the Ozone Layer has decreased its use in soil fumigation in the United States (U.S.). Reduced supplies also increased the price of MBr and affected producers net revenues and its cost effectiveness as a soil fumigant. The phaseout encouraged some producers to switch to available alternatives. Previous studies using partial budget analysis show that some alternatives are more cost effective with higher yields. Nevertheless, the share of crop acreage treated with MBr remains high, especially for tomatoes and strawberries. This study analyzes producers’ risk and risk aversion to construct a more comprehensive yield and economic analysis of the MBr use decision. The data are collected from fresh tomatoes production trials with MBr and alternatives conducted at the Plant Science Research and Education Unit, University of Florida in Citra, FL. The results show that alternative fumigants (especially carbonated Telone C35 with totally impermeable films) are often cost effective and provide higher yields. However, a risk analysis indicates that MBr has lower downside risk and is still preferred by risk averse producers.

PurposeMultinational structure has been linked to operational flexibilities that can improve corporate adaptability and a knowledge‐based view suggests that multinational resource diversity can facilitate responsive opportunities. The enhanced maneuverability from this can reduce earnings volatility and hence the corporate performance risk. But, the internationalization process may also require irreversible investments that increase corporate exposures and leave the risk implications of multinational enterprize somewhat ambiguous. Hence, the purpose of the paper is to present an empirical study of the implied relationships between the degree of multinationality and various risk measures including downside risk, upside potential, and performance risk.Design/methodology/approachThe paper provides a brief literature review, develops hypotheses, and tests them in two‐stage least square regressions on archival data to control for pre‐selection biases.FindingsThe analyses indicate that multinationality is associated with lower downside risk as well as higher upside potential and leads to reduced performance risk. The study finds no trace of diminishing effects from higher degrees of multinationality.Research limitations/implicationsThe empirical study uses a sample of large US‐based corporations, which could affect the generalizability of results. However, this is consistent with other studies and eases comparability of findings.Practical implicationsThe findings add to the ongoing debate about the risk effects of a multinational corporate structure and confirms that a diverse multinational presence is associated with positive risk outcomes.Originality/valueThe paper complements a limited number of studies with equivocal results and adopts alternative risk outcome measures. The study extends the industry scope by introducing a comprehensive sample of firms operating in different manufacturing and service businesses.

Online portfolio selection, as a research hotspot in financial signal processing, has been widely studied with machine learning perspective in recent years. Online Newton Step (ONS), which generates portfolio with low-complexity online convex optimization and achieves the same asymptotic wealth as the Best Constant-Rebalanced Portfolio in hindsight, is one promising algorithm among various portfolio selection strategies. However, ONS does not consider the downside risk, which leads to large investment loss in some market environments. To overcome this limitation, this paper proposes a novel portfolio selection method, namely ONS with Side Information (ONS-SI), which incorporates ONS with the side information derived from the market, to reduce the investment risk. The performance of ONS-SI is evaluated on the Chinese A-share market. Experiment results show that the proposed ONS-SI achieves higher wealth and lower downside risk than ONS.

In this paper, we investigate whether U.S. bank holding companies (BHCs) with strong and independent risk management functions have lower enterprise-wide risk. We hand-collect information on the organizational structure of the risk management function at the 74 largest publicly-listed BHCs, and use this information to construct a Risk Management Index (RMI) that measures the strength of organizational risk controls at these institutions. We find that BHCs with a high RMI in the year 2006 (i.e., before the onset of the financial crisis) had lower exposure to private-label mortgage-backed securities, were less active in trading off-balance sheet derivatives, had a smaller fraction of non-performing loans, and had lower downside risk during the crisis years (2007 and 2008). In a panel spanning the 9 year period 2000--2008, we find that BHCs with higher RMIs have lower enterprise-wide risk, after controlling for size, profitability, a variety of risk characteristics, corporate governance, CEO's pay-performance sensitivity, and BHC fixed effects. This result holds even after controlling for any dynamic endogeneity between risk and internal risk controls. Overall, these results suggest that strong internal risk controls are effective in restraining risk-taking behavior at banking institutions.

Studies on downside risk timing in asset management utilize both parametric and non-parametric methodology for calculation of Value at Risk (VaR) as a measure of downside risk timing skill. We utilize parametric methodology for calculation of VaR on a robust sample of 36 large cap open-ended equity mutual funds over a ten-year horizon. We sort funds on the basis of 3-year and 5-year ranking and conduct panel data analysis on variables shortlisted to gauge the impact of VaR. Since, Covid 19 pandemic presented an economic shock to the world economy, we break the time period of study into Non-Covid (2011–2019) and During Covid (Dec 2019 onwards). To the best of our knowledge, our study is the first ever study in Indian context to utilize VaR estimates in assessing the ability of fund managers to capitalize on macroeconomic information & generate superior returns by shifting funds between high and low downside risk assets.. Our study leads us to three valuable inferences – One, fund managers have limited array of mechanisms available for timing downside risk – shifting funds between cash & other assets and making transmission between high beta to low beta stocks with equity holdings within constrained interplay as per regulations. Second, funds skilled in downside risk timing attract high fund flows and carry out swift transmission between small-cap and large cap stocks in response to macro-economic information, hence generating superior returns during market uptrends (13–25% on an average) & at least two-times the alpha generated by unskilled downtimers Third, most skilled fund managers’ exhibit persistence in downside risk timing skill across 3-year and 5-year ranking periods, and this continues even during Covid-19 pandemic, an economic shock

Predicting future promotion information on markdowns, customers can maximize their utilities by deciding when to buy. With this strategic behavior, this paper investigates a downside-risk-averse retailer’s integrated stock and pricing problem using a single case study method. Analyzing effects of the downside risk aversion and strategic customers is our purpose. By exploring a two-phase newsvendor model with a retailer selling to strategic customers, our work determines the downside-risk-averse retailer’s equilibrium ordering level and selling price. On this basis, effects of the downside risk aversion and the strategic behavior on the retailer’s optimum decisions and profit are analyzed. We find that the reverse effect of the strategic behavior can be mitigated by the retailer’s downside risk constraint. We also extend the model to a decentralized supply chain case. It is found that a low (high) downside risk aversion would mean that the supply chain profit in the decentralized case can (cannot) dominate the centralized under some (any) wholesale price contracts when customers are strategic. In addition, for different risk aversions, we also construct contracts to optimize the supply chain profit. Our results will provide reference evidence of making operational management decisions for the downside-risk-averse retailer in the case of strategic customers.

Should Investors Join the Index Revolution? Evidence from Around the World

Over the past 15 years, passive investing has seen 1.5 trillion dollars of fund inflows while active investing has seen 500 billion of outflows. These numbers are in line with the tenets of passive investing, which assert it is close to impossible to consistently outperform the market. We therefore ask in this paper whether there are truly no viable alternatives to indexing and passive investing. We devise a simple actively managed strategy based on a new version of the minimum variance portfolio that outperforms comparable stock indices around the world with on average 20.2% higher raw returns, 46.7% higher risk-adjusted returns, and 28.4% smaller drawdowns. Furthermore, it exhibits 32.4% lower portfolio turnover than the 1/N strategy of DeMiguel et al. (Rev Financ Stud 22(5):1915–1953, 2009) around the world. Not only does this actively managed portfolio have higher returns at lower risk (the well-known risk-return puzzle), it also displays higher returns at higher skewness levels (i.e., lower downside risk) and thus presents a novel skewness-return puzzle. Moreover, the portfolio also has lower recession risk. Our evidence thus suggests that the principles of passive investing should be questioned and that more effort in the actively managed fund industry should be devoted to the exploration and application of similar strategies to overcome the industry’s decades-long underperformance.

The outbreak of the 2008 international financial crisis underlines banking system instability, and the improper CEO compensation incentive plans are generally regarded as a deep cause. Hence, US, UK, EU etc, all issued schemes to reform bank CEO compensation, among which the debt-based incentives, such as deferred compensation and bonus recovery, are the important measure. In February of 2010, China Banking Regulatory Commission （CBRC） also released Guidelines for Robust Compensation Supervision of Commercial Banks”, clearly requiring commercial banks to enact the alike debt-based incentives. This practice has linked risk costs and risk deduction directly with CEO compensation, and as a result, compensation mechanism can fully play the constraint role in risk prevention. Existing literature on effects of debt-based incentives centers around the risk taking at individual banking level, and proves that debt-based incentives are helpful to the achievement of benefit consistency between CEOs and creditors, and the alleviation of benefit conflicts between stake-holders and creditors, thus decreasing banks’ downside risk, from perspectives of hedging decisions, payment policies, earnings management, credit allocation and so on. However, a key limitation lies in that these studies do not further explore the impact of CEO debt-based incentives on bank systemic risks. Then, whether or not debt-based incentives can lower bank systemic risks is still not known, and moreover, if so, what on earth are the influencing channels? Answers to those problems are of great practical significance to the implementation of compensation reform scheme and the forestalling of systemic risks. By collecting a sample data of Chinese listed banks from 2008 to 2015, this paper firstly applies CoVaR approach to measure each bank’s systemic risks, then builds up the unobserved effects panel model to analyze the direct effect of debt-based incentives on bank systemic risks, and finally constructs a pair of channel-effect system equations to further elaborate the indirect effect. Measurement results tell us that, no matter in crisis times or during stationary periods, banks show steady differences in systemic risks. Generally speaking, systemic risks are high in large-scaled state-owned banks or joint-stock banks, such as the Industrial and Commercial Bank of China, Pudong Development Bank, China Merchants Bank, China Construction Bank and China Industrial Bank, while those are low in small-scaled city commercial banks, such as Bank of Ningbo and Bank of Nanjing. In addition, volatility analysis of systemic risks discloses remarkable heterogeneity among banks, namely systemic risk of China Merchants Bank is the most volatile and that of Bank of Nanjing the least volatile. As to the empirical results, the main points are as follows. Firstly, CEO debt-based incentives can significantly deter banks’ systemic risks after controlling elements such as bank characteristics, corporate governance features and economic conditions. By implementing inside debt-based incentives in the form of deferred compensation, it helps to strengthen CEOs’ precautionary consciousness on bank risks. The logic behind this is that debt-based incentives can effectively mitigate the principal-agent conflict, thus reducing CEOs’ excessive risk taking activities and bank risk transfer possibility. Secondly, debt-based incentives lower bank systemic risks mainly through the decrease in maturity mismatch between banks’ assets and liabilities and the increase in banks’ non-interest income, especially commission and fees. On the one hand, a reduction in maturity mismatch would inhibit liquidity risk and default risk, thereby weakening inter-bank correlation and risk contagion. On the other hand, the enhancement of non-interest income would raise income stability, thereby alleviating the impact of systemic shocks. Lastly, the channel effects of financial derivatives are not significant, possibly because China’s financial derivative market started too late and the banking institutions are too cautious to intervene in it too much. This paper contributes to the existing literature in two aspects. In the first place, it fills the gap in disclosing the relationship between CEO debt-based incentives and bank systemic risks, and thus provides direct support for the optimization of compensation mechanism design. In the second place, it comprehensively studies the influencing channels of CEO debt-based incentives on bank systemic risks from perspectives of maturity mismatch, non-interest income and financial derivatives, and thus expands horizons for prudential regulation.

Using survey-based measures of mutual fund manager loss aversion, we study the effects of institutional investor preferences on their investment decisions, performance, and career outcomes. We find that managers with higher aversion to losses choose portfolios with lower downside risk, increase their risk-taking more in response to poor past performance, and display a stronger disposition effect. Further, we provide evidence that managers who are more loss-averse have lower performance and are more likely to have their contracts terminated.Received December 3, 2014; editorial decision May 25, 2016 by Editor Andrew Karolyi.