Fixed Income Assets Research Articles

Testing Consumption-Based CAPM: Evidence from Alternative Models

Despite its intuitive appeal, empirical evidence on the consumption-based CAPM remains unclear at best. Model restrictions are often rejected, parameters are estimated imprecisely, and inferences can be highly sensitive to model specifications and choice of instruments. This paper tests the fit of the classic C-CAPM and three model extensions against various Australian asset classes. There is very little prior work examining the success of the C-CAPM in an Australian context, and the few existing studies are restricted to the classic C-CAPM. Our results provide some support for the C-CAPM, especially in relation to equity returns. When using instruments, the model implied restrictions cannot be rejected for market indexes, industry portfolios and portfolios cross-sorted on size and book-to-market. However, the evidence rejects the C-CAPM restrictions for size-sorted portfolios and for fixed-income returns. Our results also cast some doubts on the comparative advantage of various extensions of the classic C-CAPM such as habit-persistence and recursive utility models. These model extensions bring significant complexity and computational challenges but without much improvement in the model fit over the classic C-CAPM. Moreover, these extensions, like the classic C-CAPM, also fail to price small stock portfolios and fixed-income assets.

TALKING LESS AND MOVING THE MARKET MORE: EVIDENCE FROM THE ECB AND THE FED

ABSTRACTThis paper examines and compares the communication strategies of the Federal Reserve and the European Central Bank, and their effectiveness. First, we find that the surprise components of both monetary policy actions and statements have important but differing effects on asset prices, with unexpected communication having a much greater impact on longer‐term interest rates. Second, both the ECB and the Fed have proven to be equally successful in moving their domestic asset prices using either monetary policy or news shocks. However, the response of the American yield curve to the surprise component of Fed's statements is larger than the reaction of the European term structure to ECB's announcements. This result is intimately related to the amplitude of the policy rate cycle that is much larger in the US than in the euro area combined with the bounded support of the news shock. Third, we analyze the cross‐effects and show that the Fed has been more able to move the European interest rates of all maturities than the ECB to move American rates. This finding is tied to the predominance of dollar fixed income assets rather than to an attempt of the ECB to mimic the Fed.

The Perils of Parity

This paper examines the recent trend of adding leverage to fixed income allocations of multi-asset class portfolios of large asset owners. We show that the optimality of adding leverage from a volatility-reduction perspective depends on the correlations between bonds and equities, the relative volatility of bonds versus equities, and the weights of the two asset classes in the portfolio. If correlations between bonds and equities are negative, adding leverage could reduce the volatility of a portfolio, especially if the weight in fixed income assets is low, leverage is moderate, and bonds have a low risk relative to equities. Negative correlations also increase the likelihood that adding leverage will improve the risk-return profile of the portfolio. Asset owners considering adding leverage to their fixed income allocation can examine these influences to decide whether negative correlations between bonds and equities, a low ratio of bond to equity volatility, and higher risk-adjusted returns of bonds relative to equities are likely to persist.

Risk Characteristics of Emerging Market Bonds

In 2009, emerging market bonds were among the top-performing assets in comparison to both the global equity and fixed income asset classes. The recent, rapid rise in US Treasury yields and the concern over tightening monetary policies in certain countries led us to evaluate the relationship between global interest rate risks and emerging market bonds. In this publication, we attempt to address this relationship with an emphasis on the risk characteristics of the market, along with the historical relationship of emerging market bonds with US Treasuries, other developed market sovereign bonds, and equity market volatility. We consider possible warning signals of impending volatility in emerging market bonds during the period we observed, as well as possible ways to have improved the diversification benefits with equities during this period.

REITs and Correlations with Other Asset Classes: A European Perspective

Executive Summary. Long present in the United States, real estate investment trusts (REITs) are a fairly new phenomenon in Europe. This paper examines the sensitivity of European REIT returns to returns in other asset classes, including equities, bonds, and commodities. Consistent with previous studies, the results suggest that a significant positive correlation is observed between REITs and equities, especially small cap- and value stocks; REIT correlation to fixed income securities is found negative. Temporal variations in asset volatilities and their effect on correlations are assessed: The motivation is for investors and portfolio managers alike to incorporate the time-varying nature of the relationship in their decision making. Whereas the diversification benefits for equities decrease with increasing volatility, fixed income assets provide an increased hedge. The case of commodities in this sense remains to a large extent blurred.

The Maturity of Fixed-Income Assets and Portfolio Risk

This article focuses on the decision of the appropriate maturity of nominal return Treasury bonds. The question it seeks to answer is: Are investors compensated for taking on additional risk by extending the maturity of fixed-income assets? As we will demonstrate, the answer (at least in terms of investments in Treasury bonds) is that it depends on the investor’s overall asset allocation and how far out the maturities are extended.

Axiomatization of Residual Income and Generation of Financial Securities

This paper presents an axiomatization of residual income, aka excess profit, and illustrates how it may univocally engenders fixed-income or variable-income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of residual income is generated: one is the standard theory, which historically traces back to Hamilton (1777) and Marshall (1890) and is a deep-rooted notion in economic theory, finance, and accounting. Another one is the systemic value added or lost-capital paradigm: introduced in Magni (2000, 2003), the theory is enfolded in Keynes's (1936) notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper reverts the usual analysis: instead of computing residual incomes profits from a pattern of cash flows, residual incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-income assets may be constructed on the basis of either theory starting from pre-determined growth rates for excess profit. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deducted as equilibrium vectors of residual-income-based assets.

Do REITs Outperform Stocks and Fixed-Income Assets? New Evidence from Mean-Variance and Stochastic Dominance Approaches

This paper re-examines the performance of REITs, stocks, and fixed-income assets based on the preferences of risk-averse and risk-seeking investors using mean-variance and stochastic dominance approaches. Our findings indicate no first-order stochastic dominance and no arbitrage opportunity among these assets. However, our stochastic dominance results reveal that in order to maximize their expected utility, the risk-averse prefer fixed-income assets over real estate, which, in turn, is preferable to stocks. On the other hand, to maximize their expected utility, all risk-seeking investors would prefer to invest in stocks than in real estate, but real estate, in turn, is preferable to fixed-income assets.

A simple model of emerging market portfolio structure

Many emerging market economies have experienced large buildups of foreign exchange rate reserves over the last decade. Much of the contemporary discussion of this phenomenon has focused on this reserve growth as the consequence of exchange rate policies which have maintained fixed pegs to the US dollar. By contrast, this paper focuses on emerging market reserve choice as a consequence of portfolio diversification, applied to the experience of Asian economies. While Asian economies have become significant gross creditors in bonds and other fixed income assets, their liability position in equity and FDI assets has also grown significantly. This suggests that a full understanding of the reserve growth episode must be seen as part of an overall model of portfolio choice. The paper constructs a model of the interaction between an emerging market and an advanced economy in which an optimal general equilibrium portfolio structure implies that emerging market economies simultaneously build up a stock of foreign exchange rate reserves while receiving FDI flows from the advanced economy. The model can provide a reasonable quantitative account of the recent Asian experience.

Condicionantes do crescimento dos fundos mútuos de renda fixa no Brasil

The aim of this research was to identify the determinants of the development of the fixed income mutual funds in Brazil through the study of net money flows, from February 1995 to September 2004. The data were analyzed by multiple regression analysis of monthly series. Looking for robustness of the results, the classic OLS estimators were compared with restricted M-estimators. The significant determinants were: the excess of return in relation to the savings account rate, the growth of the per capita GDP, the lower interest rates and the less volatility or risk. The introduction of valuation at market prices for fixed income assets, in circumstances of instability in the national and international markets motivated important withdraws in 2002. Furthermore, for investors of exclusive funds were identified indicators of larger sophistication. These results permit to define strategies for managing these institutions.

Market timing e avaliação de desempenho dos fundos brasileiros

Este trabalho avalia o desempenho de fundos de investimento brasileiros pelo seu market timing, ou seja, pela capacidade de os gestores anteciparem diferenças de retorno das ações em relação a um ativo de renda fixa. Utilizam-se testes - paramétrico e não-paramétrico - desenvolvidos por Henriksson e Merton para a análise do desempenho de 243 fundos, no período de setembro de 1998 a outubro de 2003. Encontra-se evidência de habilidade de market timing para uma minoria de gestores de fundos, resultado que aparentemente se deve à maior facilidade de se preverem grandes diferenças de retorno entre o mercado acionário e a taxa de juros livre de risco.

Do REITs Outperform Stocks and Fixed-Income Assets? New Evidence from Mean-Variance and Stochastic Dominance Approaches

This paper re-examines the performance of REITs, stocks, and fixed-income assets based on the preferences of risk-averse and risk-seeking investors using mean-variance and stochastic dominance approaches. Our findings indicate no first-order stochastic dominance and no arbitrage opportunity among these assets. However, our stochastic dominance results reveal that in order to maximize their expected utility, the risk-averse prefer fixed-income assets over real estate, which, in turn, is preferable to stocks. On the other hand, to maximize their expected utility, all risk-seeking investors would prefer to invest in stocks than in real estate, but real estate, in turn, is preferable to fixed-income assets.

Variable Annuities and the New Retirement Realities

People today face the prospect of a retirement that may likely last 25 years or even longer. Concerns about the stock markets' volatility and the potential impact on their portfolios has caused many individuals approaching retirement to retreat from investments in equities and shift into fixed-income assets, despite historical evidence that investment in equities provide long-term returns superior to fixed-income returns. This conservative approach, embodied in such tools as Target Date Funds, for some investors could hamper asset accumulation and may make it less likely that assets will remain adequate to provide sustained sources of income during a lengthy retirement period. The insurance industry is uniquely positioned to offer those nearing retirement an alternative investment and risk management strategy through variable annuities. Features in the newer variable annuity product designs encourage individuals to remain invested in equities at older ages by cushioning them from some of the consequences of market volatility. As a result, investors are more apt to maintain a more equity-weighted investment portfolio and thereby have an opportunity to realize a greater portion of the superior growth potential that equities have historically provided over the long term.

On multistage Stochastic Integer Programming for incorporating logical constraints in asset and liability management under uncertainty

We present a model for optimizing a mean-risk function of the terminal wealth for a fixed income asset portfolio restructuring with uncertainty in the interest rate path and the liabilities along a given time horizon. Some logical constraints are considered to be satisfied by the assets portfolio. Uncertainty is represented by a scenario tree and is dealt with by a multistage stochastic mixed 0-1 model with complete recourse. The problem is modelled as a splitting variable representation of the Deterministic Equivalent Model for the stochastic model, where the 0-1 variables and the continuous variables appear at any stage. A Branch-and-Fix Coordination approach for the multistage 0–1 program solving is proposed. Some computational experience is reported.

Securitization Demystified

Executive Summary.The concept of securitization can be standardized by focusing on its effect on investment characteristics rather than its effect on assets. The effect on investment characteristics impacts asset value. Although recent advances in securitization technology apply to the securitization of fixedincome assets, securitization has long been the primary investment banking function. Wide variation in securitization methodology reflects wide variation in asset investment characteristics.

DIVERGENT FAS-133 AND IAS-39 INTEREST RATE RISK HEDGE EFFECTIVENESS: PROBLEM AND REMEDIES

Generally, it is presumed that an interest rate hedge of fixed income assets and liabilities will be 100% effective. Specifically, SFAS-133.68 actualizes this effectiveness through its short-cut method (SCM) interest rate risk hedge specification. We show that this presumption is false. This negative finding leads to a severe IAS-39 implementation problem because IAS-39 explicitly precludes the SCM. Furthermore, this problem has major implications for bank (and insurance) capital requirements. We specify a series of remedies for this problem. We believe that the best remedy falls in the fine print of IAS-39.F.5.5 guidance. In this guidance, a theoretical swap hedge effectiveness method, (B), effectively, provides FAS-133 SCM treatment for analogous IAS-39 interest rate risk hedges.

Determinants of Operational Risk in Global Sourcing of Financial Services: Evidence from Field Research

The practice of global business process outsourcing (BPO) has gone beyond call centers to expertise-intensive functions such as tax accounting, equity research, cash flow forecasting, fixed income asset pricing research, transaction processing, supply chain coordination, and even research and development (R&D).1 Worldwide BPO is projected to reach $133.7 billion in 2005, an 8 per cent increase from 2004 revenue of $123.8 billion, according to the Wharton Gartner Research Forecast (2003).2 The production of business processes is different from the production of physical goods in some important ways. First, the production of business processes involves no movement of physical goods, raw materials, inventories, or shipping and delivery costs. Here, inputs, output, and work-in-process are all information. Second, there is often minimal latency between the production of a process by a service center and its being bundled into a service for the end cus tomer. An offshore service provider (a BPO firm) may process all the savings and checking account-related transactions of customers, and these customers may well make decisions based on their account balances a few minutes after the

How Much Credit?

Corporate bonds are an important asset class for fixed-income investors. For asset allocation, the crucial question is how to account for the fact that (particularly non-investment-grade) corporate bond returns show fat tails and significantly non-normal distributions. Some fixed-income asset classes also lack liquidity. Illiquidity induces positive serial correlation into asset returns. This in turn results in sample variances that underestimate the true level of risk. The effect is that optimal portfolios are heavily exposed to non-normality and illiquid asset classes. Adjusting for non-normality and autocorrelation patterns results in different allocations of high-yield and investment-grade bonds.

THE FISHER INFORMATION MEASURE AND TESTING MARKET EXPECTATIONS

In an efficient market, where the participants form their expectations rationally, all potential changes induced by a predictable event are incorporated into the asset prices before the uncertainty relating to the outcome of the event is resolved. This paper develops a methodology to test whether temporal prices of fixed income assets reflect market efficiency. The methodology developed employs the Fisher information measure, which is couched within the framework of a moving variance process. We empirically demonstrate the methodology for U.S. Treasury's first exercise, in three decades, of its option to call (on October 09, 1991) one of its outstanding callable bonds. Empirical results indicate a delayed market reaction.

Yield Spread and Term to Maturity: Default vs. Liquidity

The aim of this paper is the analysis of the yield spreads between Treasury and non–Treasury Spanish fixed income assets and its relationship with the term to maturity. We find a downward sloping term structure of yield spreads for investment–grade bonds that seems to be contrary to the ‘crisis at maturity’ theory. However, we claim that this outcome is caused mainly by the effect of liquidity on yield spreads. Once the effect of liquidity and other factors are removed we find that there is a positive relationship between default premiums and term to maturity. That result is now consistent with the existing literature.