Exposure Of Assets Research Articles

Optimal currency hedging in- and out-of-sample

The optimal currency hedging policy for portfolios with foreign asset exposure is easily determined by mean-variance analysis, yet many investors choose inefficient hedging policies. Some investors reject the mean-variance approach because they believe the required inputs are not sufficiently stable to generate satisfactory out-of-sample results, whereas other investors blindly choose a 50 per cent uniform hedging policy in order to minimise ‘regret risk’. We present results that are relevant both to foreign equity managers and to plan sponsors with liability obligations, and these results demonstrate that naively determined inputs to mean-variance analysis are sufficiently stable to reduce out-of-sample portfolio risk. We then challenge the minimum regret solution for three reasons: it implies an implausible utility function; its empirical validity is confounded by errors in means and even if investors have such an implausible utility function, a variant of mean-variance analysis yields a solution that is superior to a constant 50 per cent hedge ratio. Finally, we investigate the economic rationale that gives rise to varying optimal hedging polices across countries.

Assessing climate change impacts, sea level rise and storm surge risk in port cities: A case study on Copenhagen

This study illustrates a methodology to assess economic impacts of climate change at city scale, focusing on sea level rise and storm surge. It is based on a statistical analysis of past storm surges in the studied city, matched to a geographical-information analysis of the population and asset exposure in the city, for various sea levels and storm surge characteristics. An assessment of direct losses in case of storm surge (i.e. of the damages to buildings and building content) can then be computed and the corresponding indirect losses – in the form of production and job losses, reconstruction duration, amongst other loses – deduced, allowing a risk analysis of the effectiveness of coastal flood protections, including risk changes due to climate change and sea level rise. This methodology is applied in the city of Copenhagen, capital of Denmark, which is potentially vulnerable to the effects of variability in sea level, as a low lying city....

Time-varying Integration and International diversification strategies

This paper investigates the impact of globalization and integration on the relative benefits of country and industry diversification. Unlike previous models, our factor model allows asset exposures and volatilities to vary with both structural changes and temporary fluctuations in the economic and financial environment. First, we find that globalization and integration have lead to a gradual convergence of country to industry betas, especially in Europe. Second, the structurally-driven increase in market betas is accompanied by a gradual decrease in country-specific risk. Third, even though the edge has structurally decreased, geographical diversification continues being superior to industry diversification.

An explicit solution for an optimal stopping/optimal control problem which models an asset sale

In this article we study an optimal stopping/optimal control problem which models the decision facing a risk-averse agent over when to sell an asset. The market is incomplete so that the asset exposure cannot be hedged. In addition to the decision over when to sell, the agent has to choose a control strategy which corresponds to a feasible wealth process. We formulate this problem as one involving the choice of a stopping time and a martingale. We conjecture the form of the solution and verify that the candidate solution is equal to the value function. The interesting features of the solution are that it is available in a very explicit form, that for some parameter values the optimal strategy is more sophisticated than might originally be expected, and that although the setup is based on continuous diffusions, the optimal martingale may involve a jump process. One interpretation of the solution is that it is optimal for the risk-averse agent to gamble.

Effectiveness of CPPI strategies under discrete-time trading

The paper analyzes the effectiveness of the constant proportion portfolio insurance (CPPI) method under trading restrictions. If the CPPI method is applied in continuous time, the CPPI strategies provide a value above a floor level unless the price dynamics of the risky asset permit jumps. The risk of violating the floor protection is called gap risk. In practice, it is caused by liquidity constraints and price jumps. Both can be modelled in a setup where the price dynamics of the risky asset are described by a continuous-time stochastic process but trading is restricted to discrete time. We propose a discrete-time version of the continuous-time CPPI strategies which satisfies three conditions. The resulting strategies are self-financing, the asset exposure is non-negative and the value process converges. We determine risk measures such as the shortfall probability and the expected shortfall and discuss criteria which ensure that the gap risk does not increase to a level which contradicts the original intention of portfolio insurance. In addition, we introduce proportional transaction costs and analyze their effects on the risk profile.

Time-Varying Integration and International Diversification Strategies

This paper investigates the impact of globalization and integration on the relative benefits of country and industry diversification. Unlike previous models, our factor model allows asset exposures to vary with both structural changes and temporary fluctuations in the economic and financial environment. First, we find that globalization and integration have lead to a gradual convergence of country to industry betas, especially in Europe. Second, not accounting for time-varying factor exposures leads to substantial biases in measures of country and industry risk. Third, even after correcting for the TMT bubble, geographical and industry diversification now yield roughly the same diversification benefits.

A primer on structured finance

On the heels of last year's downgrades of General Motors Corp. and Ford Motor Co. to noninvestment grade status, the haircut unwinding of exposed collateralised debt obligations reverberated in mounting regulatory unease about current risk measurement standards of derivatives and their impact on financial stability. Probable knock-on effects of the recent bankruptcies of US auto parts supplier Delphi and two major airlines have fuelled groundswell concern about complex structured finance techniques, such as customised single-tranche and hybrid collateralised debt obligations with overlay structures, against the background of tightening credit spreads and greater dislocation in the correlation market. Subsequent warnings about the resilience of credit risk transfer to systemic crisis, however, hardly extended beyond indistinct assessments of how derivatives might propagate asset shocks across different capital market segments. This brief paper defines structured finance in order to inform a more specific debate about the regulatory challenges posed by the assembly of asset exposures and credit risk transfer in complex structured finance transactions that marry considerations of profitability and diversification alike.

Time-Varying Exposure to Long-Run Consumption Risk

This paper develops a model of time-varying expected returns and shows that, when investors care about the long-run consumption risk, they also care about the persistence of an asset's exposure to this risk, and demand substantially higher compensation for more persistent exposure. The model also implies a negative sensitivity of price-dividend ratios to expected excess returns, and the magnitude of the sensitivity is substantially larger for more persistent exposure. In an application of the model, I specify individual stocks' dividend growth as containing two time-varying components of exposure to the long-run consumption risk - a fast mean-reverting component whose shocks are positively correlated with the independent dividend growth shocks, and a slow mean-reverting component whose shocks are negatively correlated with the independent dividend growth shocks. Firm level simulations from this model produce short-run momentum and long-run reversal quantitatively comparable to empirically documented patterns in the cross section as well as along the time dimension. The simulations also show that the value premium across price-dividend ratio sorted portfolios is driven by a spread in the slow mean-reverting risk exposure. Together, these results propose potential interpretations of the value and momentum factors as representing time-varying loadings of different persistence on the long-run consumption risk factor.

Comparisons of the Incentive for Insolvency under Different Legal Regimes

This paper compares the effects of joint and several liability on capital and production decisions with the effects of several‐only liability in the context of hazardous‐waste generation. Our main result shows that increased potential liability causes firms to decrease asset exposure but may also lead firms to create less waste. First, we find that both several‐only and joint and several liability induce firms to go bankrupt more often and create more waste than is socially optimal. Then we find that, for a given level of funds, joint and several liability induces firms to go bankrupt more often and to create more waste than does several‐only liability. This implies that society will be responsible for a larger share of cleanup under joint and several liability than under several‐only liability. Finally, we show that firms with potentially higher liabilities for cleanup will raise fewer funds, creating “smaller” firms and thus the possibility of less waste generated overall.

European Securitization

Asset-backed securitization is a highly flexible yet complex refinancing technique that involves the issuance of contingent claims with varying seniority on the cash flow performance of a designated pool of asset exposures. Efficient risk management of ABS obligations requires both investors and issuers to thoroughly understand the inherent spread dynamics in this growing segment of fixed income markets. We model the heteroskedasticity of weekly secondary market spreads of European CDO, MBS, and Pfandbrief transactions in a multi-factor GARCH process for valuation and forecasting purposes. We find that expected spread changes follow a positive trend with asymmetric mean reversion depending on the direction of past spread changes. A statistically and economically stronger contribution by negative first moments of past spreads on mean spread changes indicates stronger difference stationarity when spreads are tightning. However, we observe a random stochastic process if spreads widen over several consecutive period. Also most of the conditional spread volatility is informed by negative past innovations, which constitute most of the economic significance of a positive general GARCH effect. These spread dynamics over our sample period imply that a higher risk premium from a sudden contraction of spreads seems to induce higher spread volatility at times when widening spread levels testify to negative investor sentiment.

Effectiveness of CPPI Strategies under Discrete-Time Trading

The paper analyzes the effectiveness of the constant proportion portfolio insurance (CPPI) method under trading restrictions. If the CPPI method is applied in continuous time, the CPPI strategies provide a value above a floor level unless the price dynamic of the risky asset permits jumps. The risk of violating the floor protection is called gap risk. In practice, it is caused by liquidity constraints and price jumps. Both can be modelled in a setup where the price dynamic of the risky asset is described by a continuous-time stochastic process but trading is restricted to discrete time. We propose a discrete-time version of the continuous-time CPPI strategies which satisfies three conditions. The resulting strategies are self-financing, the asset exposure is non-negative and the value process converges. We determine risk measures such as the shortfall probability and the expected shortfall and discuss criteria which ensure that the gap risk does not increase to a level which contradicts the original intention of portfolio insurance.

The Future of Investment Management

Looking at the present and at 35 years in the investment management field has produced the six observations and conjectures in this article: The correct portfolio for any investor is global (with a distinction between currency exposure and asset exposure), and global asset trading will eventually be continuous, 24 hours; “momentum investing” is an oxymoron; the model inputs reflecting our fundamental expectations are often irrational; investment management fees must drop significantly; the lumpiness and discontinuities in the market provide opportunities but frighten most investors; and past investment results are largely random noise with no predictive value.

Security Issuance and Investor Information

Although the commoditisation of illiquid asset exposures through securitisation facilitates the disciplining effect of capital markets on the risk management, private information about securitised debt as well as complex transaction structures could possibly impair the fair market valuation. In a simple issue design model without intermediaries we maximise issuer proceeds over a positive measure of issue quality, where a direct revelation mechanism (DRM) by profitable informed investors engages endogenous price discovery through auction-style allocation preference as a continuous function of perceived issue quality. We derive an optimal allocation schedule for maximum issuer payoffs under different pricing regimes if asymmetric information requires underpricing. In particular, we study how the incidence of uninformed investors at varying levels of valuation uncertainty and their function of clearing the market effects profitable informed investment. We find that the issuer optimises own payoffs at each valuation irrespective of the applicable pricing mechanism by awarding informed investors the lowest possible allocation (and attendant underpricing) that still guarantees profitable informed investment. Under uniform pricing the composition of the investor pool ensures that informed investors appropriate higher profit than uninformed types. Any reservation utility by issuers lowers the probability of information disclosure by informed investors and the scope of issuers to curtail profitable informed investment.

Risk Management by Multinational Corporations: A Test of the
 Underinvestment Hypothesis

This study analyzes foreign currency hedging activity of U.S. multinational firms to determine if these firms hedge exchange rate risk to overcome an underinvestment problem. Previous research on this problem shows that firms' investment opportunities help to explain exchange rate risk hedging. This study uses more detailed, geographically segmented, firm-level data on hedging activity to test further implications of the underinvestment problem model. Evidence from this sample supports the conclusion that multinational firms with asset exposure to exchange rates hedge more and firms coordinate hedging and investment decisions.

Managing demand uncertainty in supply chain planning

In this work, we provide an overview of our previously published works on incorporating demand uncertainty in midterm planning of multisite supply chains. A stochastic programming based approach is described to model the planning process as it reacts to demand realizations unfolding over time. In the proposed bilevel-framework, the manufacturing decisions are modeled as ‘here-and-now’ decisions, which are made before demand realization. Subsequently, the logistics decisions are postponed in a ‘wait-and-see’ mode to optimize in the face of uncertainty. In addition, the trade-off between customer satisfaction level and production costs is also captured in the model. The proposed model provides an effective tool for evaluating and actively managing the exposure of an enterprises assets (such as inventory levels and profit margins) to market uncertainties. The key features of the proposed framework are highlighted through a supply chain planning case study.

Portuguese coastal zones and the new coastal management plans

Abstract Coastal zones in Portugal, as interface areas between land and sea, have problems related to the growing human pressure in terms of changes in land use associated with urban and industrial occupation, new accessibility (ports, motorways) and traffic flows, intensification of recreational use (beaches, water sports) and excessive fishing. Impacts include deterioration of water quality and sediments; alteration and degradation of natural habitats; new hydrodynamic situations; major landscape changes; and rapid changes in habits and way of life of the local populations and increased exposure of populations and assets to natural and induced risks (storms, accidents, spills, explosions). Plans for the Management of the Coastal Zone (POOC) have been developed and seven of them have been approved, while two similar plans are at a final stage of preparation. Together they cover the entire coast of Portugal. Their implementation and assessment could be a first step towards an integrated management of the ...

Managing Business Risk: An Organization-Wide Approach to Risk Management

An introduction to the subject of risk mamagement risk assessment risk control asset exposure to risk liability exposures to risk risk financing principles insurance risk management program administration.

Equilibrium with divergence of opinion

AbstractSince the less informed incorrectly estimate asset returns, they anticipate higher returns from their risky investments. They thus over‐invest in risky securities. They are rewarded by higher total portfolio returns. Too high a proportion of less‐informed investors lowers the return on risky assets. Equilibrium requires that the less informed's rate of return equal the informed's. The less informed control a stable equilibrium percentage of total wealth. Since an individual's recent investment experience correlates with his terminal wealth, learning need not reduce the less informed's risky asset exposure. Implications exist for the slope of the return versus systematic risk curve.

Optimal Risk Management Using Options

This article provides an analytical solution to the problem of an institution optimally managing the market risk of a given exposure by minimizing its Value‐at‐Risk using options. The optimal hedge consists of a position in a single option whose strike price is independent of the level of expense the institution is willing to incur for its hedging program. This optimal strike price depends on the distribution of the asset exposure, the horizon of the hedge, and the level of protection desired by the institution. Moreover, the costs associated with a suboptimal choice of exercise price are economically significant.

Overview: Alternative Investing

Alternative investment strategies have come to play an increasing role in investment portfolios, partly because of a promise of high returns and partly as a way to find refuge from the swings in fortune of the more traditional markets. Alternative investing has come to mean a great deal of things to many people, and the term has been used to cover everything from innovative investment strategies to special investment situations that did not work out. In some cases, alternative investing means any private investment, and in others, it means a potentially new type of asset exposure that lends substantial diversification to an existing portfolio. Alternative investing can also mean an entirely different way of structuring asset exposures so as to create a new distribution of expected performance outcomes. To some extent, alternative assets are in the eye of the beholder and simply represent a departure from a traditional way of investing. Fifteen years ago, real estate and international equities were alternative assets for most portfolios. The seminar from which this proceedings was developed was intended to give participants an understanding of the broad asset category termed alternative-an asset class of growing importance given concerns about u.s. equity market returns reverting to historical long-term levels. Various authors from this proceedings draw on their extensive experience to help investors understand this asset class and assess whether alternatives are appropriate given the investor's objectives and constraints. The authors' insights also help investors select among available alternative investment vehicles and strategies, implement an alternative investment program, and evaluate the success of such a program.