Systematic Risk Reduction Research Articles

Physical climate change risk and ESG green premium

ABSTRACT We build an asset pricing model that incorporates climate change risk and firms’ ESG engagement to analyse their interactive effects on equity returns. Our model shows that a firm’s ESG engagement has three channels for influencing stock returns: its direct impact on resisting climate change risk, indirect reduction in systematic risk and attraction of green preference, and the empirical evidence shows that both risk–return relation and ESG engagement are priced. We also point out an inevitably negative and convex relation between the market Sharp Ratio and stocks market beta in an economy with climate change risk.

Process & occupational safety integrated inherently safer chemical plant design: Framework development and validation

Chemical plants encompass diverse chemical and non-chemical hazards that can potentially lead to accidents. Consequently, it is imperative to implement appropriate risk management strategies to effectively reduce these hazards. Inherent safety, with its emphasis on eliminating hazards at source, has resulted in notable success in generating safer process routes. Conventional inherent safety methodologies are limited to optimizing process designs by reducing chemical and process hazards; however, occupational safety hazards (e.g., burns, electrocutions, drowning, and vehicle incidents) associated with ancillary services and working environments are not commonly scrutinized in the inherent safety framework. To this end, this work developed a dedicated tool called Safety Metric for Plant Design (SMPD), integrating occupational safety and process safety aspects, to generate a holistic safer chemical plant via inherent safety oriented modifications. Firstly, the index framework was constructed based on the safety consideration of chemical and process, ancillary services, and working environments. Then, the index framework was integrated with the Fuzzy Risk Rating (FRR), Precedence Chart (PC), and Bayesian Network (BN) to develop SMPD, and the Systematic Risk Reduction Framework (SRRF) was proposed to implement the inherent safety oriented design. Lastly, the SMPD was demonstrated using the case study of a methanol plant. The results revealed that the overall safety level increased from 2.7 to 3.39 after SRRF-based design modifications, implying that the revised chemical plant design is inherently safer than the base design. The proposed SMPD addresses both process hazards and occupational hazards by inherently safer approaches. This work provides a new perspective for designers to shift from inherently safer process design to plant design, aiming to establish a safety design framework for chemical plants oriented towards inherent safety.

An exploration of the mathematical structure and behavioural biases of 21st century financial crises

In this paper we contrast the dynamics of the 2022 Ukraine invasion financial crisis with notable financial crises of the 21st century — the dot-com bubble, global financial crisis and COVID-19. We study the similarity in market dynamics and associated implications for equity investors between various financial market crises and we introduce new mathematical techniques to do so. First, we study the strength of collective dynamics during different market crises, and compare suitable portfolio diversification strategies with respect to the unique number of sectors and stocks for optimal systematic risk reduction. Next, we introduce a new linear operator method to quantify distributional distance between equity returns during various crises. Our method allows us to fairly compare underlying stock and sector performance during different time periods, normalising for those collective dynamics driven by the overall market. Finally, we introduce a new combinatorial portfolio optimisation framework driven by random sampling to investigate whether particular equities and equity sectors are more effective in maximising investor risk-adjusted returns during market crises.

Investment, the Corporate Tax Rate, and the Pricing of Franking Credits

I apply a new single‐pass capital asset pricing model methodology for assessing systematic risk to all ASX stocks which indicates that securities which pay franking credits in Australia appear to face far less systematic risk than do stocks that never pay franking credits. But in this context, this apparent reduction in systematic risk can be interpreted as being due to franking credits that are close to being fully priced. An efficient equilibrium is reached in which the marginal investor in Australia pays little or no Australian corporate tax because, once she exhausts compulsory savings, she borrows offshore and converts debt to equity.

Investment, the Corporate Tax Rate, and the Pricing of Franking Credits

I apply a new single‐pass capital asset pricing model methodology for assessing systematic risk to all ASX stocks which indicates that securities which pay franking credits in Australia appear to face far less systematic risk than do stocks that never pay franking credits. But in this context, this apparent reduction in systematic risk can be interpreted as being due to franking credits that are close to being fully priced. An efficient equilibrium is reached in which the marginal investor in Australia pays little or no Australian corporate tax because, once she exhausts compulsory savings, she borrows offshore and converts debt to equity.

Using a "Positive Deviance" Framework to Discover Adaptive Risk Reduction Behaviors Among High-Risk HIV Negative Black Men Who Have Sex with Men.

Despite the high incidence of HIV among young Black MSM in the United States and engagement in high risk behaviors, many men in this group avoid infection. This suggests that some men may engage in systematic risk reduction behaviors when not always using condoms or abstaining from substances. Using a "positive deviance" framework, we conducted qualitative interviews with HIV-negative, Black MSM between 25 and 35 who reported unprotected anal sex and drug use in the past six months or current heavy drinking (N=29) to discover behaviors that could facilitate remaining HIV-uninfected. Findings showed that MSM who remain HIV negative despite continuing to engage in high-risk behaviors may be engaging in adaptive risk reduction behaviors that, through successive decisions and advance planning along the timeline to a sexual event, could lead to increased condom use, avoidance or delay of a risky sexual event, or reduction of HIV positive partners.

Allied health management of technology-related musculoskeletal complaints among children and adolescents.

Children and adolescents are prolific users of information and communication technologies (ICT) in learning, leisure, and social communication activities. High exposure to ICT is associated with musculoskeletal injuries in adults; however, the management of ICT physical complaints in children is not well-understood. An online survey of allied health professionals (occupational therapists, physiotherapists, and chiropractors) was undertaken to determine (i) the number of children and adolescents in Perth, Western Australia who accessed treatment for musculoskeletal complaints related to use of technology; (ii) the typical frequency and duration of service provision; and (iii) the nature of treatment provided. Costs associated with service provision were estimated. Data from 101 identified the most commonly treated musculoskeletal complaints among children and adolescents included: non-specific neck pain; thoracic postural pain disorder; non-specific low back pain; and lumbar postural pain disorder. Approximately 1445 children were treated in the previous 12months; with one-third of chiropractors each reported treating 31+ children. Most common treatments were soft tissue release, mobilisation, flexibility and conditioning exercises, soft tissue massage and kinesio-taping. Verbal education about healthy use of technology was provided by most clinicians (88%), with some inconsistent recommendations. The estimated cost of treatment was AUD$1,057,715; of which AUD$544,886 was health system funded. Children and adolescents received allied health treatment for a range of musculoskeletal complaints associated with ICT use. The potential long-term impacts on their health and wellbeing, and the economic burden associated with this health issue warrant the development of systematic risk reduction strategies.

The Effect of Risk Sharing on Asset Prices: Natural Experiment from the Chinese Stock Market Liberalization

In a recent stock market reform, over half of the stocks listed in the Shanghai Stock Exchange became purchasable by foreign investors. Theory predicts that the price revaluation of an investible stock should be positively associated with the reduction in systematic risk. Using the policy as a natural experiment, we test this implication using a difference-in-differences estimator and a sample of 786 stocks in the Shanghai market. We find that risk-sharing explains over 40 percent of the price revaluation of investible stocks during the eight-month window between reform announcement and implementation. The results support the efficiency of the Chinese stock market, to the extent that the reduction of systematic risk is priced into those stocks that are affected by the liberalization.

The Market Impact of Mandatory Interactive Data: Evidence from Bank Regulatory XBRL Filings

ABSTRACTWe investigate the market impact of banks filing regulatory reports using eXtensible Business Reporting Language (XBRL) interactive data format. Specifically, we examine whether stock returns and trading volume exhibit abnormal behavior when banks are first required to file Call Reports in XBRL format and whether XBRL adoption causes a shift in systematic risk. We find that banks experienced significant positive abnormal returns and a subsequent reduction in systematic risk in connection with filing their regulatory reports in XBRL. Our results are more pronounced for larger banks. Our trading volume analysis provides additional support of increases in trading volume (primarily with respect to larger banks) at the time of XBRL adoption. We, therefore, document investor-based benefits in support of the conversion to mandatory XBRL filing requirements.Data Availability: The data used in this study are available from sources indicated in the paper.

Case illustration of a decision framework for health, environment, and safety management

This paper presents and discusses a case in order to illustrate the application of a recently developed decision framework for management of health, environment, and safety. The case relates to the implementation of new equipment on an offshore platform and shows how a regime based on predefined risk acceptance criteria is replaced by systematic risk reduction processes, emphasizing aspects of uncertainties and manageability in addition to the calculated risk results. Although the starting point is the offshore oil and gas industry, the problem and discussion are to a large extent general and could also be applied in other areas.

The Introduction of the Euro and the Currency Risk Premium

Exchange rates arrangements aim at reducing uncertainty attached to currency fluctuations hence a reduction in systematic risks. This paper analyzes the behaviour of risk premiums in major equity markets, following the introduction of the euro. Using a multifactor asset pricing model, we find exchange rate risk premium in the largest eurozone markets (Germany and France) rose sharply after 1999, unlike in the markets (Italy and the Netherlands). Market risk premium declined in the eurozone markets except Germany. It appears the euro resulted in systematic risk reduction in the smaller eurozone markets at the expense of their larger partners. This challenges an important rationale for the euro.

Risk Sharing and Asset Prices: Evidence from a Natural Experiment

ABSTRACTWhen countries liberalize their stock markets, firms that become eligible for foreign purchase (investible), experience an average stock price revaluation of 15.1%. Since the historical covariance of the average investible firm's stock return with the local market is roughly 200 times larger than its historical covariance with the world market, liberalization reduces the systematic risk associated with holding investible securities. Consistent with this fact: (1) the average effect of the reduction in systematic risk is 6.8 percentage points, or roughly two fifths of the total revaluation; and (2) the firm‐specific revaluations are directly proportional to the firm‐specific changes in systematic risk.

The Information Content of Share Repurchase Programs

ABSTRACTContrary to the implications of many payout theories, we find that announcements of open‐market share repurchase programs are not followed by an increase in operating performance. However, we find that repurchasing firms experience a significant reduction in systematic risk and cost of capital relative to non‐repurchasing firms. Further, consistent with the free cash‐flow hypothesis, we find that the market reaction to share repurchase announcements is more positive among those firms that are more likely to overinvest. Finally, we find evidence to indicate that investors underreact to repurchase announcements because they initially underestimate the decline in cost of capital.

Risk Sharing and Asset Prices: Evidence from a Natural Experiment

When countries liberalize their stock markets, firms that become eligible for purchase by foreigners (investible), experience an average stock price revaluation of 10.4 percent. Since the covariance of the median investible firm's stock return with the local market is 30 times larger than its covariance with the world market, liberalization reduces the systematic risk associated with holding investible securities. Consistent with this fact: 1) the average effect of the reduction in systematic risk is 3.4 percentage points, or roughly one third of the total effect; and 2) variation in the firm-specific response is directly proportional to the firm-specific change in systematic risk. The statistical significance of this proportionality persists after controlling for changes in expected future profits and index inclusion criteria such as size and liquidity.

New insights into the impact of the introduction of futures trading on stock price volatility

We examine whether, and to what extent, the introduction of trading in share futures contracts on individual stocks (i.e., individual share futures, or ISFs) has impacted on the systematic risk and volatility of the underlying shares. The use of ISFs allows a unique experimental design that complements existing work on index futures. Our major findings are as follows. First, we found a general reduction in systematic risk on individual stocks after the listing of futures. Second, we found evidence of a decline in unconditional volatility. Third, we found mixed evidence concerning the impact on conditional volatility. Fourth, the introduction of futures was found to impact on the market dynamics, as reflected by a change in the asymmetric volatility response, although the direction of that change is stock-specific. In general, the results point to a number of features that are case-specific and provide new insights into the mixed results that are typical of existing studies. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:237–255, 2001

Integrated Risk Management: Techniques and Strategies for Reducing Risk

Integrated Risk Management: Techniques and Strategies for Reducing Risk, by Neil A. Doherty (New York: McGraw-Hill, 2000). Reviewer: Nicos A. Scordis, The College of Insurance, New York City Neil Doherty's book Integrated Risk Management begins by answering the question of why risk management programs add value to firms. Cash-flow smoothing cannot justify corporate risk management programs. The rate of return shareholders require from a firm depends on the covariance of the firm's cash-flow with broad market movement, not its overall cash-flow volatility, or variance. In general, risk managers reduce cash-flow volatility by insuring and hedging perils shareholders can eliminate themselves at lower cost by holding diversified portfolios of assets. The cashflow volatility shareholders cannot diversify is the unavoidable trapping of a business venture promising its shareholders a rate of return above the risk-free rate of government bonds. When risk managers reduce volatility associated with this nondiversifiable or systematic part of cash flow, they change the covariance of the firm's cash flow to broad market movements. Any reduction in systematic risk, however, is accompanied by reductions in the shareholder's return, according to traditional financial theory. If shareholders value a risk management program, it is because it mitigates the frictional costs created by cash-flow volatility. One frictional cost is management's unwillingness or inability to make optimal capital investment decisions. Another frictional cost is that progressive tax codes, together with the tax treatment of business expenses, create higher tax bills for firms with volatile taxable cash flows. Thus a risk management program may realize value for shareholders by making possible a program of optimal capital investments and by reducing tax bills. But there are alternative ways to mitigate suboptimal investment and reduce taxes. Doherty explores these alternatives and shows how they may have an effect on the value of a firm, as compared to a traditional risk management program. For example, managers can reduce the amount of interest-bearing debt in a firm's capital structure, and shareholders can alter the compensation structure of managers. Reductions in the leverage of the firm and changes in the incentives of managers have the same effect on the tendency for suboptimal investment as a risk management program. As for reducing taxes, managers can enter into operating leases, accelerate depreciation schedules, boost R&D spending, or increase the amount of interest-bearing debt in the firm's capital structure. Increases in these tax shields have the same effect as a risk management program on the firm's tax bill. Doherty explores these alternatives to illustrate the dual nature of integrated risk financing. …

Risk and Return Characteristics of American Depository Receipts

I nvestors able to buy and hold the New York Stock Exchange (NYSE) composite index would have earned a before-tax average annual return of 7.7% (without dividends) over the period 1972-1990. Investors able to buy and hold Morgan Stanley Capital International's Europe, Australia, and Far East (EAFE) index, by contrast, would have earned a before-tax average annual return of 13.5%. Replicating the EAFE index, however, would have exposed the holder to greater risk. The standard deviations of annual returns for this period were 16.9% and 24.4% for the NYSE and EAFE index, respectively. Because correlations between international equity markets are less than one, favorable and unfavorable events have offsetting impacts, and international investment leads to less rather than more portfolio risk (see Brinson and Carr [1989], Grubel [1968], Lessard [1973], Solnik [1974], and Solnik and Noetzlin [1982], for example). Reduction in systematic risk is partially offset by new risk exposures on both the macroand microeconomic level, with attendant ramifications for investor wealth. For example, recent events in Mexico such as the Chiapas Rebellion in January 1994 and the foreign currency devaluation in December contributed to a 50.6% decline in the value of the Mexican stock exchange index. Increased risk is not confined to emerging markets, however. Developed countries such as Sweden, Italy, Spain, and Canada face large fiscal imbalances, and Germany continues its struggle with reunification while being haunted by the specter of neo-Nazism. Hence, an assessment of general risks confronting international investors is both important and topical. One major problem to examining this issue empirically is the cost of acquiring data. Fortunately, we do have data for American depository receipts. American depository receipts (ADRs) are dollar-denominated, negotiable instruments issued by a depository bank to represent ownership of a foreign security in the bank's possession. ADRs supposedly offer investors an opportunity to invest globally without many of the risks and administrative problems associated with direct foreign investment. While Officer and Hoffineister [1987] have shown that portfolios comprising both domestic common stocks and ADRs provide risk-reducing benefits, no study has examined the other risks that arise from diversifying internationally. Presumably, risks associated with investing in emerging markets such as Mexico should be greater than risks of investing in developed markets, but the limited data on emerging market securities preclude a more complete examination at this time. Hence, this study focuses on examining risks associated with ADRs from developed countries. The evidence is that ADRs outperformed their respective home-country index for thirteen of the sixteen markets studied between January 1988 and January 1993. This superior performance appears to be time period-dependent and, at least to some extent, a consequence of foreign currency appreciation relative to the dollar. The study also shows that NYSE-listed ADRs are less liquid, as measured by the bid-ask spread, than a control

Repurchase tender offers and earnings information

Announcements of stock repurchase tender offers are examined as a source of information about firms' future earnings prospects and market risk levels. We document positive earnings surprises and equity systematic risk reduction following tender offers. Announcement stock price reactions are positively correlated with earnings surprises over the concurrent and subsequent two years, and negatively correlated with changes in equity market risk. Finally, stock price reactions to quarterly earnings announcements are more strongly correlated with time-series based earnings surprises in the year prior to the tender offer than during the subsequent year, consistent with tender offer announcements conveying earnings information.