Reduce Downside Risk Research Articles

Multinational risk and performance outcomes: Effects of knowledge intensity and industry context

A multinational presence can diversify corporate business activities and provide access to diverse overseas resources. This can enhance operational flexibility and create new business propositions that increase responsiveness to global market changes. Establishing an international corporate structure may also require irreversible investments and impose maintenance and processing costs that contravene the implied resilience and agility benefits. We distinguish between downside risk and upside potential as the relevant outcome measures to assess the implied advantages of multinationality. Consistent with the rationales of the OLI paradigm, we argue that multinational reach particularly in knowledge-based industries can reduce downside risk and enhance upside potential. These results introduce more nuances to the ongoing debate about multinational risk and performance effects. Based on a large cross-sectional dataset, we find that flexibility and responsiveness thrives on a multinational presence among firms operating in information-driven knowledge businesses. In contrast, internationalizing firms in capital-based network services display adverse risk effects.

An Empirical Exploration of the Cboe Volatility Index (Vix) Futures Market as a Hedge for Equity Market Investors

Several recent articles have shown that adding a position in equity volatility, as measured by the CBOE volatility index (VIX), to an equity or hedge fund portfolio can reduce the downside risk and unattractive higher moments exposures of portfolios. However, each of these studies used the cash VIX, which is an untradeable index that measures the 30 day forward implied volatility of the price of options traded on the S&P 500 stock index. Since the VIX futures started trading at the Chicago Board Options Exchange in March 2004, we have had the opportunity to compare the pricing of the cash VIX to the VIX futures. Unfortunately, VIX futures do not closely track the calculated cash value of the VIX index, so investors will likely be disappointed in the performance of VIX as a hedge designed to reduce downside risk during sharp bear markets. It has long been known that the implied volatility of options typically exceeds the realized volatility of the underlying equity index, as options sellers charge a risk premium to options buyers. This article introduces a new risk premium, where the cost of holding stock index volatility futures exceeds the cost of the cash VIX index by over 4% per month. The large size of this volatility futures risk premium prevents the cost-effective use of VIX futures as a hedge for equity market investors.

Crop genetic diversity, farm productivity and the management of environmental risk in rainfed agriculture

This paper presents an assessment of the linkages between crop genetic diversity, farm productivity and risk management. A flexible moment-based approach is used to analyse the impact of crop genetic diversity on the mean, variance and skewness of yield. Using farm-level data from Sicily (Italy), econometric evidence shows how crop genetic diversity can increase farm productivity and reduce risk exposure. The empirical results indicate that crop genetic diversity can reduce variance, but only if pesticide use is low. Furthermore, high diversity levels can reduce downside risk exposure (e.g. the risk of crop failure). This provides useful insights on the linkages between resilience and crop genetic diversity.

Option pricing for real estate development: Hong Kong Disneyland

It is well known that the traditional net present value (NPV) approach fails to take account of the multiple effects arising from the interactions of the operating and strategic flexibility during the course of a project. Option pricing theory (OPT) has been successfully applied in the valuation of both financial and real investments in the last two decades. However, it is still a relatively new approach in the valuation of real estate investments. This paper thus attempts to extend the application of OPT to the valuation of real estate development projects, providing insights into rectifying the limitations of traditional approaches. The paper starts with an overview of the development of OPT relating to real estate investments. It then examines the appraisal method adopted by the Government for Hong Kong Disneyland and explores the real options that may create added value to the project. A binomial option pricing model is proposed that estimates the potential values of the project with those options available. The study concludes that OPT is superior to NPV approach on the valuation of real estate investments in that it enhances upside potential as well as reducing downside risk.

Hedging individual mortgage risk

This paper investigates the feasibility of an individual hedging the interest rate risk involved in planning to take out a mortgage at a future point in time. Simulation using market data indicates that a simple futures hedge reduces the variation in mortgage capacity by about one half. Expected mortgage capacity is very close to 100% of the original capacity at a very low cost. Hedging the individual mortgage with a put futures option is less effective in reducing downside risk and has a higher expected cost.

Lower partial moment hedge ratios

Some investors may benefit from using measures of risk other than the variance in their investment decisions, specially if they are concerned with minimizing the downside risk of their portfolios. An accessible numerical method for calculating hedge ratios given any measure of risk is presented. The method is applied to the FTSE-100 index and the futures on FTSE-100, using a downside risk measure, namely the lower partial moment. The results show that lower partial moment hedge ratios are effective in reducing downside risk and increasing returns.