Investment Risk Management Research Articles

A framework for developing high‐resolution multi‐model climate projections: 21st century scenarios for the UK

AbstractThis article proposes a framework for building climate projections from an ensemble of global circulation models (GCMs) at the local scale required for impact studies. The proposed method relies on a fine‐scale gridded baseline climatology and consists of the following steps: (1) building appropriate precipitation and temperature time series from land areas covered by GCM sea cells; (2) correction of GCM outputs inherent biases through ‘quantile‐based mapping’; and (3) disaggregation of bias‐corrected outputs with monthly spatial anomalies between GCM‐specific and observed spatial scales. The overall framework is applied to derive 21st century seasonal climate projections and inter‐annual variability for the UK based on an ensemble of six GCMs run under two different emissions scenarios. Results show a large dispersion of changes within the multi‐GCM ensemble, along with a good comparison between scenarios from individual ensemble members and from previous UK and European studies using dynamically downscaled outputs from corresponding GCMs. The framework presented in this article provides appropriate outputs to take account of the uncertainty in global model configuration within impacts studies that are influencing current decisions on major investments in flood risk management and water resources. Copyright © 2007 Royal Meteorological Society

Modeling Interdependent Risks

In an interdependent world the risks faced by any one agent depend not only on its choices but also on those of all others. Expectations about others' choices will influence investments in risk management and the outcome can be suboptimal for everyone. We model this as the Nash equilibrium of a game and give conditions for such a suboptimal equilibrium to be tipped to an optimal one. We also characterize the smallest coalition to tip an equilibrium, the minimum critical coalition, and show that this is also the cheapest critical coalition, so that there is no less expensive way to move the system from the suboptimal to the optimal equilibrium. We illustrate these results by reference to airline security and the control of infectious diseases via vaccination.

Risk Management in Large Physical Infrastructure Investments: The Context of Seaport Infrastructure Development and Investment

The growth of developing countries depends very much on having adequate physical infrastructure to support economic development. As a strategic response, many physical infrastructure investments like seaports are being privatised and highly purpose built. This paper investigates the merits of viable seaport infrastructure investment, typically ‘lumpy’ and requiring large capital expenditure and long payback period. A key feature of such an infrastructure investment is to structure a defensible risk management strategy to deal with uncertainties. This risk management strategy can provide responsive alternatives to new opportunities. Singapore's Jurong Port is the case study. The original risk management strategy is analysed in 1996, and deploys risk simulation for scenario planning in conjunction with constraint optimisation. This original risk management strategy finds that it is more defensible to configure Jurong Port, and a seaport in general, into the maritime industrial and logistics park (MILP) instead of the higher-margin and purpose-built container terminal strategy, which is inherently volatile (ie uncertain or risky). The planned scenarios and their projections, under the original risk management strategy are then compared with the consequential developments in reality. The results highlight that the sustained viability of Jurong Port in 2004 is attributed to that risk management strategy, originally developed in 1996.

Real options for risk management in petroleum development investments

Irreversible investments made with incomplete information are the mainstay of the petroleum industry. Sequential, non-repetitive investment decisions with alternative pathways associated with exploration through full-field development are common. We demonstrate a policy development approach that combines the Bellman equation for dynamic programming with a real options valuation algorithm. This represents the first demonstration of the mathematical union of the two techniques for branching decision pathways, producing a generalized policy development framework that provides risk management of investments. Production expansion investment decisions for a Central Asian gas condensate field are analyzed using the framework.

Hidden Risks to the Long-Term Goals of Pension Portfolios

The investment policies of defined-benefit plans are designed to maximize the long-term funding ratio (assets/liabilities) while limiting the risk of underfunding. Pension plan sponsors, in contrast, have a much shorter focus and a tendency to use any excess of assets over liabilities to improve benefits or reduce contributions. This practice negates the benefit of long-term investment risk management and increases the odds of having to rely on the sponsor deficiency guarantee at a time when pension plans have become large and risky relative to sponsor business operations. Maintaining a long-term mindset is difficult but necessary to keep defined-benefit plans sustainable.

A volatilidade do mercado e a instabilidade das correlações entre as ações

Portfolio diversification based on correlations between asset returns, fundamental to modern portfolio theory, has become an important tool in investment allocation and risk management. However, new studies find evidence of a reduction in diversification efficiency during more volatile periods, when return correlations rise. We investigate the relationship between correlations and market volatility in Brazil and Latin America. The methodology is based on Jacquier and Marcus (2001). We find, using a single index model, evidence of changes in correlations due to market volatility. This implies that diversification efficiency tends to de

Is Our Industry Intellectually Lazy?

Part of the mission of the Financial Analysts Journal is to stimulate creative thinking about financial analysis, including investment valuation, risk management, fiduciary issues, and asset allocation. As part of that mission, the editor raises questions about and calls for investigation of the following practices: Why does our industry forecast aggregate corporate earnings growth rates that are faster than sustainable GDP growth? Why do we not question pension return assumptions? Why accept rising pension return expectations in a rising market? Why allow actuarial or accounting assumptions to drive investment practice? Why readily accept return forecasts based on extrapolating the past? Why not “normalize” return assumptions? Why is the topic of expensing management stock options controversial? When various “earnings” figures diverge, why not ask why? Why is a negative equity risk premium considered shocking? Why is our industry often surprised and distrustful when empirical tests fail to support accepted dogma?

Langevin modelling of high-frequency Hang-Seng index data

Accurate statistical characterization of financial time series, such as compound stock indices, foreign currency exchange rates, etc., is fundamental to investment risk management, pricing of derivative products and financial decision making. Traditionally, such data were analyzed and modeled from a purely statistics point of view, with little concern on the specifics of financial markets. Increasingly, however, attention has been paid to the underlying economic forces and the collective behavior of investors. Here we summarize a novel approach to the statistical modeling of a major stock index (the Hang Seng index). Based on mathematical results previously derived in the fluid turbulence literature, we show that a Langevin equation with a variable noise amplitude correctly reproduces the ubiquitous fat tails in the probability distribution of intra-day price moves. The form of the Langevin equation suggests that, despite the extremely complex nature of financial concerns and investment strategies at the individual's level, there exist simple universal rules governing the high-frequency price move in a stock market.

Some developing trends in manufacturer-supplier relationships

An analysis of past developments in the relationship between "supplying" and "supplied" companies leads to the conclusion that "best-in-class" OEMs have initiated a new and more radical evolution of their supply chain. Their key long term objective is the creation of a truly integrated value-adding chain from raw materials to customer, devolving and decentralising investment risk, operational accountability and complexity management to a new hierarchy of managerially, financially and technically more competent suppliers. The competitive impact has been the emergence of extended organisations with distinctive skills in fast innovation, fast realisation and/or fast supply. This has given "time" a certain strategic credence as a measure of efficiency and effectiveness, whilst masking more radical and important organisational developments. The net effect has been an acceleration of the trend towards fewer, but more closely interlinked, direct suppliers and a further relegation of many to secondary or tertiary providers, competing on price/quality ratio alone. Surviving suppliers benefit from a shift of focus from piece-part cost to value-added contribution, increased volumes of bought-out materials and services, and greater contractual security. In Northern Europe at least, supplier requalification would seem well advanced. The present paper attempts to catalogue the needs and identify the critical success factors for future first tier direct OEM suppliers through a consideration of first-hand experience, specific case-studies and industrial sector surveys for mechanical and electro-mechanical enterprises. It is concluded that, to qualify, the new breed of first tier suppliers is obliged to choose whether to develop its technological abilities and "know-how", its manufacturing and assembly skills, or both. Failure to do so would imply relegation to "component supplier" competing on a "lowest cost" basis. The inherent dependency, trust and "open-book" dealing required calls for a difficult cultural shift for Western companies. At least one OEM, faced with strong negative reactions, is evaluating the economic and competitive disadvantage of abandoning a well-advanced supply chain integration strategy.

Risk management of an agricultural investment in a developing country utilising the CASPAR programme

This paper describes how the software programme Computer Aided Simulation for Project Appraisal and Review (CASPAR) can be used to determine the commercial viability of an agricultural investment. A case study involving the purchase of a farm and subsequent crop production of tobacco and paprika over a ten-year operation period in a developing country is presented. Initially a base estimate is prepared and a risk analysis performed. Risks are then mitigated and the risk analysis is performed again. The results of the risk analysis can then be used as part of the business plan.

Risk management and health investments

A common feature of production models of health is that they neglect the importance of uncertainty in health investment decisions. I regard this as a deficit. Given the uncertainty of the effect of health investments, the question arises as to how an individual should allocate his scarce resources oftime and money to reach an efficient health behavior. To analyze this central question, the original portfolio theory is applied to health investment decisions. By aportfolio approach to health investments, actions of health care are characterized in terms of bundles of actions. In this way, one can make use of gains of diversification. Since the portfolio theory considers the correlation between the outcome of actions, it introduces new insights into the effect of health investments. This new approach to investments in health has not only consequences for individual health behavior but is important for health policy-making as well.

Derivative mine valuation: strategic investment decisions in competitive markets

Successful management in competitive markets requires evaluation methods that respond to global market dynamics and provide investors with relevant information to make strategic investment decisions. These strategic decisions include decisions on investment timing, feasibility study and risk management and mine operating options. Conventional methods do not have the built-in capabilities to help investors handle these strategic issues. Advances in modern finance have had profound impacts on financial markets for options, futures and collaterized securities and offer appropriate tools in solving these problems. In this paper, the authors have extended the Brennan and Schwartz mineral resource model to develop the derivative mine valuation method based on the dynamic arbitrage theory. A copper mining venture has been evaluated using the derivative mine valuation and conventional methods. The results show that the derivative mine valuation method allows investors to maximize the venture's market value by exercising these strategic options.

Pension Schemes and Pension Funds in the United Kingdom.

Never has there been so much media interest in pensions as there is currently. Never has the pensions world changed so rapidly as it has over the last few years; we have seen the introduction of a new state supplementary pension scheme, new stakeholder pensions, and a flood of companies closing their final salary schemes and replacing them with defined contribution schemes. Never have there been so many complaints about our pension system; about the state pension falling behind earnings, about the misselling of personal pensions, about the perceived poor value of annuities, and about high charges and poor investment performance. This new edition of Pension Schemes and Pension Funds in the United Kingdom provides the latest information on all the key state and private pension schemes operating in the UK, including: the basic state pension, minimum income guarantee and pension credit; the state second pension; company pension schemes; and personal and stakeholder pension schemes. It does this within the context of the long historical development of the UK pensions system since medieval times. It also examines government pensions policy over the last twenty years, in particular the reduction in state pensions and the transfer of the burden of pension provision to the funded private sector. It also examines future trends and future concerns, such as increasing longevity and the adequacy of savings for retirement when people are young and in work. As most pension schemes are funded, the author also examines the latest issues in pension funding, such as the new accounting standard FRS17, active and passive fund management, investment risk budgeting and management, global investment performance standards, short-termism and the Myners review of institutional investment. The book concludes with a proposal for the Ideal Pension Scheme.