Reduce Downside Risk Research Articles

Does Environmental, Social, and Governance (ESG) Performance Improve Financial Institutions’ Efficiency? Evidence from China

Nowadays, the call for sustainable development is becoming stronger in all countries of the world, and environmental, social, and governance (ESG) performance, as a vivid practice of this concept, has gradually received extensive attention from enterprises and investors. Financial institutions have an important position in the national economy as an important tool for the state to regulate the macroeconomy. Whether ESG performance can improve financial institutions’ efficiency is of key significance for boosting sustainable development. Based on data from China’s listed financial institutions from 2015 to 2021, this study aims to investigate the impact of ESG performance on financial institutions. The robust nonparametric boundary model and fixed-effects model are employed for analysis. The empirical results demonstrate that ESG performance and its sub-indicators of environmental performance and social responsibility performance can significantly enhance financial institutions’ efficiency. In particular, this effect is more pronounced in the securities industry and diversified financial industry, as well as in non-state and small-scale financial institutions. The results remain unchanged after a series of robustness tests. Furthermore, the mechanism tests indicate that ESG performance can enhance financial institutions’ efficiency by reducing downside risk and agency costs.

Board gender diversity, firm risk, and the intermediate mechanisms: A meta‐analysis

AbstractResearch questionThe primary focus of this meta‐analysis is to synthesize previously discordant findings on the relationship between board gender diversity (BGD) and different types of firm risk and to explore potential moderating and mediating mechanisms underlying these relationships.Research findingsWe statistically combine the results from 193 studies and find a negative association between BGD and firm risk. Further investigation indicates that different measures of risk lead to systematically different effect sizes. Our meta‐analysis structural equation modeling (MASEM) analysis reveals that BGD's impact on risk operates primarily through the monitoring rather than advising function of the board. Regarding the moderating role of national institutions, we find that several aspects of the national institutional context (e.g., investor protection, gender equality, and national culture) influence the relationship between BGD and different types of risk.Theoretical implicationsOverall, our results suggest that agency theory has more explanatory power than resource dependence theory for understanding the association between BGD and risk, and women's board representation is more likely to reduce downside risk than upside risk. Our moderating effect analysis also highlights interesting avenues for further research on the interplay of BGD and different risks in national environments with varying institutional attributes.Practitioner/policy implicationsOur meta‐analysis offers important practical implications for corporate risk management, suggesting that BGD significantly mitigates downside risks associated with poor corporate transparency without stifling board support for corporate decisions shaping future growth potential. In an era of rising board vulnerability to litigation for insufficient transparency, this study contributes evidence supporting trends toward greater gender diversity.

Cryptocurrency Trading and Downside Risk

Since the debut of cryptocurrencies, particularly Bitcoin, in 2009, cryptocurrency trading has grown in popularity among investors. Relative to other conventional asset classes, cryptocurrencies exhibit high volatility and, consequently, downside risk. While the prospects of high returns are alluring for investors and speculators, the downside risks are important to consider and model. As a result, the profitability of crypto market operations depends on the predictability of price volatility. Predictive models that can successfully explain volatility help to reduce downside risk. In this paper, we investigate the value-at-risk (VaR) forecasts using a variety of volatility models, including conditional autoregressive VaR (CAViaR) and dynamic quantile range (DQR) models, as well as GARCH-type and generalized autoregressive score (GAS) models. We apply these models to five of some of the largest market capitalization cryptocurrencies (Bitcoin, Ethereum, Ripple, Litecoin, and Steller, respectively). The forecasts are evaluated using various backtesting and model confidence set (MCS) techniques. To create the best VaR forecast model, a weighted aggregative technique is used. The findings demonstrate that the quantile-based models using a weighted average method have the best ability to anticipate the negative risks of cryptocurrencies.

CEO inside debt and downside risk: Evidence from internal and external environments

In this study, we investigate whether inside debt held by CEOs is associated with downside risk and also consider the impact of internal (CEOs' and firms' characteristics) and external (industry competition and macroeconomic uncertainty) factors on the connection to CEO inside debt, which is debt-like compensation and corporate downside risk. We find that CEOs who hold more inside debt reduce downside risk. However, the negative impact of inside debt holdings on downside risk is offset in firms managed by younger or male CEOs, whereas the ability of inside debt held by a CEO to decrease corporate downside risk is amplified in firms operated by overconfident CEOs. Moreover, this reduction effect occurs in firms of good quality (higher earnings, smaller size, lower leverage, higher cash surplus, higher excess returns, and higher profitability). Finally, we find that this effect is more pronounced for firms operating in a low-competition industry, facing low economic policy uncertainty, and low equity market volatility.

Dynamic risk management in European energy portfolios: Evolution of the role of clean and carbon markets

This paper examines the potential of clean energy stocks and emission permits to reduce downside risk when combining them in a portfolio with dirty energy assets. We propose a strategy for building portfolios that are well diversified between equity energy and carbon markets that takes into account their dynamic price relationship. The asset allocation proposed is framed in a volatility-timing context, which reacts to changing market conditions, holding different weights at different times. To achieve this objective, we use multivariate GARCH models, specifically the Asymmetric Dynamic Conditional Correlations family, which allow us to obtain good estimations of the conditional covariance matrices of the daily asset returns. To determine the weights of the optimum minimum-risk portfolio, we use a method based on Engle and Colacito (2006) to compare the portfolio volatilities obtained with different models. The analysed period runs from January 19, 2010, to April 4, 2022, which, on the one hand, includes more than twelve years of the EU Emissions Trading System (EU ETS) beyond the Phase I pilot; and, on the other, considers the latest crisis episodes (Sovereign debt crisis, Brexit COVID-19, and the recent Russo–Ukrainian war). Our findings show that investing in clean energy companies is now valuable not only because of its contribution to a sustainable energy transition to renewable sources, but also due to its attractiveness from a financial point of view. This fact provides a ray of hope in terms of the climate emergency and avoiding the current geopolitical conflicts principally caused by certain countries’ energy dependence because their energy mix is still heavily overpowered by fossil fuels. The results of this research should encourage investors to decarbonise their equity portfolios, thus promoting the needed alignment of the financial system with the requirements of the energy transition.

CEO characteristics, multinationality and downside risk: evidence from Chinese multinational corporations

PurposeReal options theory posits that multinationality provides additional operating flexibility and helps firms reduce downside risk. This study aims to explore the effects of chief executive officer (CEO) characteristics on the downside risk implication of multinationality in Chinese multinational corporations (MNCs).Design/methodology/approachThis study gathers a sample of Chinese MNCs from 2009 to 2020 and deploys a Tobit panel estimation model with fixed effects in the empirical analysis.FindingsThis study finds that multinationality has a significant negative effect on downside risk. The downside risk reduction effect of multinationality is stronger in firms led by older CEOs, women CEOs, CEOs with overseas experience or broader functional backgrounds or those with higher educational levels. Additionally, the above effects of CEO characteristics on the downside risk reduction effect of multinationality are more pronounced in firms with smaller top management team (TMT) sizes. Hence, the findings show that the multinational network constructed by Chinese MNCs could offer great operating flexibility, and CEO characteristics and the CEO–TMT interface play an important role in achieving real options flexibility from multinationality.Originality/valueThis study shows that multinationality could be an effective way for emerging market firms to reduce business risk. This study helps identify CEO characteristics that are associated with real option performance and emphasizes that CEO personal attitudes and abilities could influence the real options flexibility obtained from multinationality. This study also contributes to the understanding of micro foundations in international business by focusing on the role of CEO characteristics and the CEO–TMT interface in the downside risk implications of multinationality.

Leveraged ETF Option Barbells

This article compares how Standard & Poor’s (S&P) 500 and Nasdaq-100 barbell strategies invested primarily in fixed income assets and in-the-money call options on the underlying index (or their 2x and 3x leveraged counterparts) achieve a significant percentage of upside appreciation while reducing downside risk. From 2010 to 2022, a barbell strategy composed of 88% 7 to 10-year Treasury bonds and 12% 0.7 delta 6-month call options on the underlying index achieves more than 81% of the geometric annual return of the index while reducing major losses by 21% to 52%, as exemplified by the market declines in the last quarter of 2018 and the 2020 COVID-19 crash. Using call options on the 2x or 3x LETF performs marginally worse than simply using options on the index and only gives a 32% to 47% participation rate of the underlying LETF returns. However, the outlined 88/12 barbell strategy is exposed to interest rate risk, and in the 10 months ending June 30, 2022, the 88/12 barbells lost −16% or more as the options lost more than 90% of their value while treasuries declined −10.4%.

The study of co-movement risk in the context of the Belt and Road Initiative

This study examines the potential risks of the Belt and Road Initiative (BRI) on the comovements of international stock markets. Using stock markets of related countries as a case study, we implement an asymmetric dynamic conditional correlation model to estimate dynamic conditional correlations between the China stock market and related stock markets. The results of testing the structural changes show that the breakpoints of dynamic conditional correlations are within the announcement dates of BRI, documenting that the comovements between China's stock market and related stock markets significantly increase following BRI actions. The positive comovements lead to a stronger volatility spillover effect when China's stock market is more volatile. To investigate the downside risk of BRI actions, we evaluate the performance of portfolio strategies by introducing gold. The findings show that portfolios composed of gold and stock markets perform well. These results suggest that using gold as a hedge could effectively increase the diversification benefits and reduce downside risk.

Are gold, USD, and Bitcoin hedge or safe haven against stock? The implication for risk management

AbstractThis study investigates whether gold, USD, and Bitcoin are hedge and safe haven assets against stock and if they are useful in diversifying downside risk for international stock markets. We propose a combined GO‐GARCH‐EVT‐copula approach to examine the hedge and safe haven properties of gold, USD, and Bitcoin. We then examine the attractiveness of these assets in reducing stock portfolio risk by using downside risk measures estimated by the proposed approach and other competing models. We also evaluate the relative performance of the proposed model in reducing downside risk with the competing models. The findings of the study indicate that the USD is the most valuable hedge and safe haven asset closely followed by gold, while Bitcoin is the least valuable. It is also observed that the proposed combined approach performs best in reducing the portfolio downside risk. The findings of this study are of significance for portfolio managers and individual investors who wish to protect the portfolio value during market turmoil.

Board Long-Term Orientation, Earnings Management, Disclosure and Risk

Short-term thinking continues to dominate corporate decision making due to the pressure to achieve expected quarterly earnings. As such, strategic goals take a back seat to short-term performance among the prime objectives of CEOs, the board of directors and management teams. Be that as it may, shareholders and stakeholders expect corporate leaders to pay equal attention to the long-term health of the corporate enterprise. An empirical study is conduced to test how long-term oriented board of directors diminish earnings management, increase disclosure and reduce risk. The results show that a long-term board orientation decreases earnings smoothing, stock price synchronicity and downside risk. To study this relationship, we construct a panel data from 2004 to 2015 comprising of 2834 OECD country firms. We conclude that board independence, board expertise and board audit committee activity increase long-term firm orientation. We find that boards with these characteristics are prone to the implementation of executives’ long-term incentives, suggesting that a long-term orientation is beneficial not only to increase firms’ transparency and disclosure but also to reduce firms’ downside risk. Firms with long-term orientation reveal enough information to avoid stock price synchronicity, prevent the use of earnings management to conceal real firm performance and reduce downside risk - all decreasing the chance of financial failure. The results of the study not only nullify the arguments that there is no impact of long-term orientation and long-term incentives but also bolster and enrich the stream of literature that supports these variables’ impact on earnings management, stock price synchronicity and downside risk. Within the context of the international setting of the paper, we have substantiated the external validity of the results across geographies and country-wide regulations.

Milk Income over Feed Cost Margin, Margin Protection Program, and Farm Finances for a Sample of Wisconsin Dairies in 2000–2017

AbstractThe relationship between farm‐level milk income over feed cost (IOFC) margin and national margin, profit risk, and terminal stress risk are investigated using data on Wisconsin dairy farms over the period 2000–2017. Results show that farm‐specific IOFC margins were not highly correlated with the national margin, higher farm IOFC margin increased profit level and volatility but decreased downside risk, and farm terminal stress appears unaffected by either the margin or the related payments. These findings suggest that, for sample farms, a policy that targets IOFC margin might reduce downside risk of net farm income.

Comparison of Long-Run Net Returns of Conventional and Organic Crop Rotations

This study compares the long-run net returns to land of conventional corn/soybean and corn/soybean/wheat crop rotations to that of an organic corn/soybean/wheat crop rotation. The net returns to land for the organic crop rotation were found to be approximately $68 and $74 per acre higher than those of the conventional corn/soybean and conventional corn/soybean/wheat crop rotations, respectively. Average net return estimates are sensitive to price, yield, and cost assumptions. Organic crop prices would have to drop more than 17.8 percent and organic crop yields would have to drop more than 16.8 percent before the conventional corn/soybean crop rotation was more profitable than the organic corn/soybean/wheat crop rotation. These percentage changes are relatively small compared to the historical relationships between organic and conventional crop prices and yields. A risk model was used to examine the trade-off between expected net returns and downside risk. Converting even a small proportion of acreage to an organic corn/soybean/wheat crop rotation improves net returns and reduces downside risk compared to only utilizing conventional crop rotations.

Cryptocurrency Trading Using Machine Learning

We present a model for active trading based on reinforcement machine learning and apply this to five major cryptocurrencies in circulation. In relation to a buy-and-hold approach, we demonstrate how this model yields enhanced risk-adjusted returns and serves to reduce downside risk. These findings hold when accounting for actual transaction costs. We conclude that real-world portfolio management application of the model is viable, yet, performance can vary based on how it is calibrated in test samples.

The Role of Gender Diversity in Downside Risk: Empirical Evidence from Vietnamese Listed Firms

Corporate governance has been marked as an important component of the fast-growing pace of the Vietnam economy recently. Aligning with the concern that gender plays a critical role in corporate management, this study aims to reveal the entire benefits of the appearance of women on board to reduce downside risk in the frontier countries. By using a unique dataset from Vietnamese listed firms and appropriate econometric methods, we present tight results that the presentation of women at firm management level is more likely to lessen the downside risk. In particular, female non-senior reduces all risk attributes, whereas the presence of women in executive board decrease firm risk only. Furthermore, the decreasing of individual and systemic risk are additionally driven by female Chief Executive Officer (CEO) and chairman. We found strong evidence that female leadership may decrease risk-taking in the low-risk firms at all managerial levels but not in the case of a female CEO. In summary, by examining data from specific frontier areas such as Vietnam, we confirm that the role of female leadership in terms of reducing the downside risk depend on their power managerial levels and the firm-risk behavior.

Does crop diversification reduce downside risk of external maize yield-enhancing technology? Evidence from Ethiopia

Unexpectedly lower yield outcomes (downside risks) challenge farmers’ use of external inputs that can enhance crop productivity. Using household-level panel data collected from Ethiopia, we estimated the effects of crop diversification through maize-legume intercropping/rotation on maize yield distribution and downside risk. Results from endogenous switching regression models and quintile moment approaches show that plots with maize-legume intercropping/rotation have the highest average maize yield. Such crop diversification reduces the downside risk in maize yield more when applied to plots receiving external inputs. The results imply that, in addition to the technical support around external input use in smallholder maize production, Ethiopia’s agricultural extension may also need to give due emphasis to both spatial and temporal crop diversification practices. This could enhance crop productivity further and reduce the potential downside risks typically hampering smallholders’ external input use in maize production.

A portfolio of leveraged exchange traded funds

This study demonstrates how a portfolio of leveraged exchange traded funds (LETFs) targeting a unit exposure to their underlying indexes outperforms a portfolio using traditional ETFs while simultaneously reducing downside risk. By extension, a 3x LETF portfolio designed to mimic 2x LETFs outperforms the underlying 2x LETF portfolio. The results are primarily a function of LETFs borrowing short while the investor lends the additional wealth generated from this leverage in one- to seven-year Treasury bonds or similar type of assets. For every one percent earned above the implied borrowing rate, a portfolio of 2x and 3x LETFs outperforms a traditional portfolio by 0.41% and 0.63%, respectively, corresponding roughly to the additional return on the 50% and 67% of the wealth invested in bonds. More than 90% of LETFs outperformance is explained by the borrowing lending differential.

Contrasting GARCH Daily Variance Predictions Between Foreign Exchange Returns and Carry Trade Strategy Returns

GARCH does a better job predicting carry trade strategy returns than the foreign exchange returns. Using two time periods from 1998-2010 and then from 2010-2018 we find the daily variance to have dropped between period 1 and period 2 for both daily foreign exchange spot prices and daily carry trade strategy returns. Comparing daily spot price returns to daily carry trade strategy returns in each time period we find differences in the sample variances. Daily variance in the foreign exchange market has changed within the last twenty years. As one of the most liquid markets, the FX market has seen significant losses in both spot price returns and carry trade strategy returns. The current market place has historic low levels of volatility. Since the 2008 financial crash asset prices have steadily risen in levels reducing downside risk. In addition, foreign exchange rates have been stable. Given a decade’s worth of slow and steady growth coupled with stabilization has reduced the variance in returns. Popular predictive volatility model GARCH has a long-run variance component. The inclusion of such a parameter allows for the model to remember past financial crisis or “normal” times. Returns in the carry trade are marked by periods of severe downward risk and losses. The carry trade will often have long-term trends of small positive returns only to give back all of the returns in one downward move.

Bitcoin as Hedge or Safe Haven: Evidence from Stock, Currency, Bond and Derivatives Markets

It is crucial for investors to manage their investment risk. This paper examines the dynamic equicorrelation relationship between Bitcoin and four major investment assets, namely, US stock (S&P 500), US dollar, Treasury bonds and gold futures. Our empirical analysis reveals an asymmetric causality between Bitcoin and other asset classes. The results indicate that Bitcoin may be employed as an effective safe haven for investors by providing invaluable information to reduce downside risk, hence strengthening diversification benefits in optimal asset allocation and portfolio risk management.

A Study on Optimal Foreign Exchange Risk Hedge Strategies for Korean Investors

Purpose - This paper aims to investigate the optimal foreign exchange risk hedging strategies of Korean investors investing in S&P 500 Index for 3 months. Full hedge, unhedge, and 5 tactical hedge strategies are considered during the period from 2000 to 2018. Design/methodology/approach - Among tactical hedge strategies, four are based on the probability of decrease in exchange rate which is obtained by simulations using nonparametric estimation results and the other strategy is established by the sign of the difference in sharpe ratio between unhedge and hedge strategies. As Won/Dollar exchange rate exhibit high volatility around subprime financial crisis, we analyze the performance of each strategy during the post-crisis period as well as total period. Findings - Our empirical findings are as follow: (1) tactical strategies outperform full hedge and unhedge strategy and (2) tactical strategies, which conduct full hedge if the probability of decrease in exchange rate is over 0.5, outperform strategies carried out by hedging proportional to the depreciation probability, in the aspect of sharpe ratio, skewness and kurtosis. Research implications or Originality - The results imply that tactical strategies, established by a threshold and the probability of decrease in exchange rate, are appropriate to reduce downside risk of U.S. dollar, thereby validating our estimation method and potential for practical use.

Risk Reduction Using Trailing Stop-Loss Rules

We consider the effectiveness of trailing stop-loss rules which, unlike traditional stop-loss rules, involve the sell trigger price being moved higher to protect profits as prices rise. Our results indicate that while these rules have inferior mean returns to a simple buy-and-hold strategy, they do a good job of stopping losses. They generate superior risk-adjusted returns for investors with normal levels of risk aversion and perform particularly well at reducing downside risk. These results hold in all U.S. stocks and are particular strong for stocks that end up being delisted.