Relative Riskiness Research Articles

Are stocks really riskier than bonds?

Conventional wisdom holds that stocks are riskier than bonds; thus when the stock market becomes volatile, money flows from the stock market into the perceived safe haven of the bond market. In this article, we find that this notion is not necessarily accurate and might lead people to make incorrect investment decisions. In fact, intermediate- and long-term bonds are riskier than stocks when we measure risk by the coefficient of variation. We examine a case where an inaccurate perception regarding the relative riskiness of the two types of assets could play a part in what appears to be short-sighted and potentially costly behaviour of investors in financial markets.

Behavioral impact of graduated driver licensing on teenage driving risk and exposure

Graduated driver licensing (GDL) is a critical policy tool for potentially improving teenage driving while reducing teen accident exposure. While previous studies demonstrated that GDL reduces teenage involvement in fatal crashes, much remains unanswered. We explore the mechanisms through which GDL influences accident rates as well as its long term effectiveness on teen driving. In particular, we investigate: (1) whether GDL policies improve teenage driving behavior, or simply reduce teenage prevalence on the roads; (2) whether GDL exposed teens become better drivers in later years. We employ a unique data source, the State Data System, which contains all police reported accidents (fatal and non-fatal) during 1990-2005 for 12 states. We estimate a structural model that separately identifies GDL's effect on relative teenage prevalence and relative teenage riskiness. Identification of the model is driven by the relative numbers of crashes between two teenagers, two adults, or a teenager and an adult. We find that the GDL policies reduce the number of 15-17-year-old accidents by limiting the amount of teenage driving rather than by improving teenage driving. This prevalence reduction primarily occurs at night and stricter GDL policies, especially those with night-time driving restrictions, are the most effective. Finally, we find that teen driving quality does not improve ex post GDL exposure.

The Relative Riskiness of Various Asset Focus Alternatives in Banking

This research examines whether the risk of focused banks is higher than that of diversified ones. Focused banks are defined as those with a large proportion of assets in one of six narrow industry segments including agricultural loans, credit cards, commercial lending, mortgage lending, consumer lending, and other focused loans. It also compares the relative levels of risk of those focused banks. This study takes a bank supervisor approach rather than adopting the perspective of a shareholder. It differs from similar work in the past because it compares focused banks to a sample including only diversified banks. Other studies, in contrast, compared one focused peer group to a comparator group of all banks but for the one focused group. Thus,the comparator group included both diversified and focused banks. The data in this study confirms the major hypothesis that banks following a diversified strategy are less risky than banks following an industry-focused approach. Interestingly, our study finds that, despite being more risky, the focused groups reported return-on-asset ratios below those of the diversified comparator groups in the majority of our comparisons. This study is also the first to examine the relative levels of risk of different bank asset focus strategies.

Risk Preference Discrepancy: A Prospect Relativity Account of the Discrepancy Between Risk Preferences in Laboratory Gambles and Real World Investments

In this article, we presented evidence that people are more risk averse when investing in financial products in the real world than when they make risky choices between gambles in laboratory experiments. To provide an account for this discrepancy, we conducted experiments which showed that the range of offered investment funds that vary in their risk-reward characteristics had a significant effect on the distribution of hypothetical funds to those products. We also showed that people are able to use the context provided by the choice set in order the make relative riskiness judgments for investment products. This context dependent relativistic nature of risk preferences is proposed as a plausible explanation of the risk preference discrepancy between laboratory experiments and real-world investments. We also discuss other possible theoretical interpretations of the discrepancy.

Exchange ratio determination in a market equilibrium

PurposeThe paper aims to present an exchange ratio for merging companies that incorporates the change in the level of riskiness.Design/methodology/approachThe paper is a theoretical one. Its main objective has been achieved exploiting standard modern finance results such as Capital Asset Pricing Model Capital Asset Pricing Model (CAPM).FindingsThe paper offers a formula that determines a risk‐adjusted exchange ratio that takes into account both risk and synergy.Research limitations/implicationsDue to the fact that CAPM is applied and beta factors are required, the formula is fully applicable only to companies whose stocks are traded on a financial market. Empirical test of the exchange ratio formula (using, for instance, an event‐study methodology) should be performed.Practical implicationsThe use of the formula allows the identification of whether the offered exchange ratio fully reflects the expected return/risk profile for stockholders of the merging companies.Originality/valueThe paper should be useful in both theoretical and managerial conditions. It carries a way to embed relative riskiness of two companies into a simple formula.

Firm Default and Aggregate Fluctuations

This paper studies the relation between macroeconomic fluctuations and corporate defaults while conditioning on industry affiliation and an extensive set of firm-specific factors. Using a multiperiod logit approach on a panel data set for all incorporated Swedish businesses over 1990-2002, we find strong evidence for a substantial and stable impact of aggregate fluctuations. Macroeffects differ across industries in an economically intuitive way. Out-of-sample evaluations show our approach is superior to both models that exclude macro information and best fitting naive forecasting models. While firm-specific factors are useful in ranking firms' relative riskiness, macroeconomic factors capture fluctuations in the absolute risk level.

Time Diversification and Long-Term Asset Allocation

This article asks whether it is possible to diversify investments through time—a hotly debated topic, and one that divides academics and practitioners perhaps like no other financial paradigm. In the late 1960s, Samuelson first argued strongly against the existence of time diversification. Since then, other academics have raised a theoretical challenge to the notion of time diversification. On the other hand, empirical evidence has hardly supported their view. To date, the question still remains wide open: Does time diversification exist? If so, what are the policy implications for asset allocation? This article addresses the gap between theory and empirical evidence by reexamining these issues using a time series framework. Three time series models are fitted with historical data on S&P 500 Index and T-bill and T-bond returns over the period 1802–2002. Although both T-bill and T-bond returns are found to evolve in different serial correlated stationary processes, stock returns are consistent with a mean-reversion process. The change in relative riskiness of stock over bill and bond returns as a result of different time diversification effects strongly supports the conventional recommendation on asset allocation policy with different investment horizons.

Risk, uncertainty, and learning in adoption of a crop innovation

AbstractRisk and uncertainty have often been suggested as causes of poor adoption of rural innovations, but empirical evidence has been scarce. This study focuses on a new crop‐type, chickpeas, in Western Australia to gather such evidence. The empirical models developed are based on a theoretical framework that conceptualizes adoption as a dynamic decision process involving information acquisition and learning‐by‐doing by growers who vary in their managerial abilities, risk preferences, and their perceptions of the profitability and riskiness of the innovation. Learning encompasses improvements in skill as well as reductions in uncertainty. An annual face‐to‐face survey of over 100 farmers was conducted over 3 years, eliciting the farmers' risk attitudes and their subjective distributions of yields and prices. Two limited dependent variable models, Tobit and Probit, are used to estimate the empirical model. There is a high degree of goodness‐of‐fit for both models. The study provides strong empirical support for the primarily economic character of the adoption decision, and highlight the importance of economic risk in the process. The two risk‐related factors with greatest impact on the adoption decision were risk aversion and relative riskiness of the innovation. Risk aversion tended to reduce adoption, and to do so to a greater extent as relative riskiness and scale increased. Results also reveal the key role that trialing of the innovation plays in adoption.

Distortion risk measures for sums of random variables

When we consider random couples (X 1,Y 1) and (X 2,Y 2), both elements ofR(F X, FY), relative riskiness of the sumsS i=X i+Y iresults from dependency structure between the summands. In this paper we investigated the relation between a measure of risk for sums of random variables derived from distortion functions and traditional measures of dependencies like Pearson’sr, Spearman’sρ and Kendall’sτ. In the general case we proved that there is no relation between distortion risk measures and Pearson’sr. We also showed that for many classes of distortion risk measures (non-concave distortion risk measures, Tail Value-at-Risk, proportional Hazard Transform, beta distortion risk measures and many others) the same holds true additionally for Spearman’sρ and Kendall’sτ. These findings aim to illustrate the problem of defining what the right measure of dependency is, and that risk measures widely used in practice are not always consistent with traditional measures of dependencies. Beim Betrachten von Paaren von Zufallsvariablen, (X 1,Y 1) und (X 2,Y 2), beide Elemente vonR(F X, FY), wird deutlich, dass das relative Risiko der SummenS i=X i+Y isich aus der Abhangigkeitsstruktur zwischen den Summanden ergibt. In dieser Studie untersuchen wir die Beziehung zwischen einem aus Verzerrungsfunktionen hergeleiteten Risikomas fur die Summen von Zufallsvariablen auf der einen Seite, und traditionellen Abhangigkeitsmasen wie Pearsonsr, Spearmansρ und Kendallsτ auf der anderen Seite. Wir zeigen auf, dass im Allgemeinfall kein Zusammenhang besteht zwischen dem Verzerrungsrisikomas und Pearsonsr. Desweiteren zeigen wir, dass fur viele Gruppen von Verzerrungsrisikomasen (nicht-konkave Verzerrungsrisikomase, Tail Value-at-Risk, proportionaler Hazard Transform, Beta Verzerrungsrisikomase und viele andere), auserdem das gleiche fur Spearmansρ and Kendallsτ gilt. Diese Ergebnisse veranschaulichen zum einen, dass das richtige Abhangigkeitsmas schwer definierbar ist und zum anderen, dass die weit verbreiteten Risikomase nicht immer ubereinstimmen mit traditionellen Abhangigkeitsmasen.

The Risk and Incentives Trade-off in the Presence of Heterogeneous Managers

Agency theory predicts a negative relationship between risk and incentives, yet recent empirical evidence has not consistently found such a relationship. In fact, some researchers have found a positive relationship. By introducing competition for heterogeneous managers, who differ in their degrees of risk aversion, into a standard agency model, this paper demonstrates that a negative or positive relationship is theoretically possible. Which arises depends on the relative risk aversion parameters of the managers and the absolute and relative riskiness of the environments.

Does Regional Economic Performance Affect Bank Conditions? New Analysis of an Old Question

The idea that regional economic performance affects bank health is intuitive and broadly consistent with the aggregate banking data. That said, micro-level research on this relationship provides a mixed picture of the importance, size, and timing of regional variables for bank performance. This paper helps reconcile the heterogeneous findings of previous research by: (1) employing a unique of regional economic performance that combines several regional indicators into a single index; (2) constructing bank-specific measures of regional economic conditions, based on bank deposit shares, that account for banks' presence in several states; and (3) estimating models for all banks and intra- and inter-state banks separately. Empirical results based on this bank-specific composite regional measure point to a tractable link between regional economic performance and bank health. The importance of regional variables holds for both intra- and inter-state banks. Out-of-sample forecasts indicate that the composite index also helps tie down the relative riskiness of bank portfolios across states. Finally, although interstate banks do seem to diversify away some of their portfolio risk, our analysis suggests it is too soon to conclude that interstate banks are immune from regional influences.

Does Regional Economic Performance Affect Bank Conditions? New Analysis of an Old Question

The idea that regional economic performance affects bank health is intuitive and broadly consistent with the aggregate banking data. That said, micro-level research on this relationship provides a mixed picture of the importance, size, and timing of regional variables for bank performance. This paper helps reconcile the heterogeneous findings of previous research by: (1) employing a unique "composite measure" of regional economic performance that combines several regional indicators into a single index; (2) constructing bank-specific measures of regional economic conditions, based on bank deposit shares, that account for banks' presence in several states; and (3) estimating models for all banks and intra- and interstate banks separately. Empirical results based on this bank-specific composite regional measure point to a tractable link between regional economic performance and bank health. The importance of regional variables holds for both intra- and inter-state banks. Out-of sample forecasts indicate that the composite index also helps tie down the relative riskiness of bank portfolios across states. Finally, although interstate banks do seem to diversify away some of their portfolio risk, our analysis suggests it is too soon to conclude that interstate banks are immune from regional influences.

Risk, Return and Degree of Owner Involvement in Privately Held Firms

Financial theory states that the variability of an asset’s return should be explained by the relative riskiness of that asset (Sharpe, 1964). This concept has been built around, and applied to, publicly-listed companies for which market information (which forms the basis of the risk and return measures) is easily visible and obtainable. Unfortunately, the fact that such information is rarely (if ever) available for small businesses, severely limits the usefulness of such a theory for privately-held enterprises. Therefore by using data from 100 small businesses and three measures of risk, this study provides empirical evidence that for small businesses, there is no significant relationship between financial returns and risk, but there is a relationship between the level of control exerted by the owners of a firm and the financial returns of that firm. This paper also provides evidence that owners with little or no control of a firm, take action to prevent agency costs. This action is in the form of disbursements to shareholders, rather than using debt as a means of reducing agency costs.

Estimating Production Risk and Inefficiency Simultaneously: An Application to Cotton Cropping Systems

By using a stochastic frontier framework, the mutual effect of input use on production risk and inefficiency is investigated. Disentangling this mutual effect proves important for empirical reasons, at least when applied to west Tennessee cotton systems grown after various cover crops. The most striking result is that the stochastic frontier model, when compared with a typical Just-Pope model, reorders the relative riskiness of cover-crop regimes associated with the cotton systems.

What has Happened to Monetarism? An Investigation into the Keynesian Roots of Milton Friedman's Monetary Thought and its Apparent Monetarist Legacies

It is widely perceived that today's conventional monetary wisdom, and the common practice of monetary policy based thereupon, is essentially monetarist by nature, if not by name. One objective of this paper is to assess whether monetarism has had a lasting effect on the theory and practice of monetary policy; another is to scrutinize the key dividing lines between Milton Friedman's monetary thought and that of John Maynard Keynes. Among the paper's main theoretical findings are that the key issue is the theory of interest, which is at the root of differences in approach to money demand and liquidity preference. Similarities are more pronounced with respect to the supply of money and monetary policy control issues. However, while Keynes favored a stabilized wage unit combined with a flexible central bank to steer interest rates and aggregate demand, Friedman advocated a stabilized central bank combined with a free interest rate and employment determination in financial and labor markets, respectively. Additional differences arise at the practical and empirical levels: the dynamics of adjustment processes and expectation formation on the one hand, and the relative efficiency and riskiness of market-driven versus government-guided adjustments on the other. The puzzling fact is that, despite today's dominant market-enthusiast ideology, Friedman's idea of delegation--not to independent central bankers, but to the markets--enjoys remarkably little popularity.

Tillage method and crop diversification: effect on economic returns and riskiness of cropping systems in a Thin Black Chernozem of the Canadian Prairies

Producers throughout the Canadian Prairies have begun to extend (reducing summerfallow frequency) and diversify their traditional cereal-based rotations by devoting more areas to oilseeds and pulses, and by managing these newer cropping systems with conservation tillage practices. This study examined the economic performance and relative riskiness of monoculture cereal, cereal–oilseed, and cereal–oilseed–pulse rotations, each managed under conventional-, minimum-, and zero-tillage practices over a 12-year period (1987–1998) in the sub-humid Black soil zone of Saskatchewan. These crop rotations included: spring wheat ( Triticum aestivum L.)–spring wheat–winter wheat ( T. aestivum L.)–fallow (Ws–Ws–Ww–F), spring wheat–spring wheat–flax ( Linum usitatissimum L.)–winter wheat (Ws–Ws–Fx–Ww), and spring wheat–flax–winter wheat–field pea ( Pisum sativum L.) (Ws–Fx–Ww–P). Annual production costs for the complete rotation systems increased with cropping intensity and cropping diversity (monoculture cereal ($ 249 ha −1) < cereal–oilseed ($ 304 ha −1) < cereal–oilseed–pulse ($ 310 ha −1)); however, costs were not affected by tillage method. The savings in labor, fuel, repair and machinery overhead with minimum- and zero-tillage practices (compared with conventional-tillage) were generally offset by increased expenditures for herbicides. For most grain price scenarios examined, gross returns and net returns were generally highest for Ws–Fx–Ww–P, intermediate for Ws–Ws–Fx–Ww ($ 7–33 ha −1 lower), and lowest for Ws–Ws–Ww–F ($ 35–70 ha −1 lower). Within the mixed rotations, economic returns tended to be higher when managed using minimum- and zero-tillage practices (compared to conventional-tillage), reflecting the higher grain yields they produced. Income variability, or degree of riskiness, was lowest for conservation tillage and the mixed cropping systems. Our findings explain the recent changes in land use practices that have been adopted by most producers in this region.

FOOD AVAILABILITY AND TIGER SHARK PREDATION RISK INFLUENCE BOTTLENOSE DOLPHIN HABITAT USE

Although both food availability and predation risk have been hypothesized to affect dolphin habitat use and group size, no study has measured both factors concurrently to determine their relative influences. From 1997 to 1999, we investigated the effect of food availability and tiger shark (Galeocerdo cuvier) predation risk on bottlenose dolphin (Tursiops aduncus) habitat use and group size in Shark Bay, Western Australia. Food availability was measured by fish trapping, while predation risk was assessed by shark catch rates, acoustic tracks, and Crittercam deployments. Dolphin habitat use was determined using belt transects. The biomass of dolphin prey did not vary seasonally and was significantly greater in shallow habitats than in deeper ones. Tiger sharks were virtually absent during cold months of 1997 and 1998, abundant in warm months of all years, and found at an intermediate density during cold months of 1999. When present, shark density was highest in shallow habitats. Decreased echolocation efficiency in very shallow water and poor visual detection of tiger sharks (camouflaged over seagrass) probably further enhance the riskiness of such habitats, and the relative riskiness of shallow habitats is supported by the observation that dolphins select deep waters in which to rest. The observed dolphin group sizes were consistent with a food–safety trade-off. Groups were larger in more dangerous shallow habitats and larger during resting than during foraging. Foraging dolphins matched the distribution of their food when sharks were absent. However, during warm months, the distribution of foraging dolphins significantly deviated from that of their food, with fewer dolphins foraging in the productive (but dangerous) shallow habitats than expected on the basis of food alone. When shark density was intermediate, habitat use by foraging dolphins was more similar to the high-shark-density seasons than periods of low shark density. These results suggest that foraging dolphin distributions reflect a trade-off between predation risk and food availability. Because the distribution and abundance of tiger sharks are influenced by species other than dolphins, the distribution of the tiger sharks' primary prey may indirectly influence dolphin habitat use, suggesting that it is important to consider the community context in studies of habitat use.

Credit ratings and the BIS capital adequacy reform agenda

In this paper, we have revised and updated our earlier study in order to analyze the most recent (second) draft of the BIS's proposed reforms of bank capital requirements. We conduct Monte-Carlo experiments using data on defaults and severity rates on publicly-traded US corporate bonds over the 1981–1999 period. Analyzing the whole period and various sub-periods, it is clear that the most recent draft of the BIS proposed reforms seriously overestimates the relative riskiness of high-quality debt relative to low quality debt in the so-called standardized model. As a result, the most recent proposal still contains inherent risk-shifting (taking) incentives for banks.

Do Investors Look Beyond Insured Triple–A Rating? An Analysis of Standard &amp; Poor’s Underlying Ratings

This article demonstrates that for insured municipal bonds, revelation of underlying ratings can be an effective mechanism for further alleviating the information asymmetry problems found in the municipal bond market. Due to the prevalence of municipal bond insurance, investors are increasingly relying on the underlying ratings of insured bonds in gauging the relative riskiness of these bonds. For a sample of 697 municipal bonds issued in 1998, the results indicate that Standard &amp; Poor’s underlying ratings are able to reduce borrowing cost by four basis points, due to the additional information provided through these ratings.

The Pitfalls in Inferring Risk from Financial Market Data

This paper examines two qualitative rules of thumb, frequently invoked in discussions of bank regulatory policy. The first, that equity holders prefer more risk to less, derives from a result in option pricing theory, that an option's value increases monotonically with the riskiness of the underlying asset. This result is shown to depend on very restrictive assumptions regarding the underlying asset's return distribution and the type of option being considered. These restrictive assumptions do not generally obtain in practice. The second rule of thumb is that bondholders' and deposit insurers' interests are aligned. The paper shows that, in fact, their interests can diverge in the sense that bondholders and deposit insurers will not necessarily agree on the relative riskiness of different banks or bank portfolios. The conclusion of this paper is that rules of thumb can be misleading. Furthermore, the concept of risk is shown to be model and agent specific.