Equity Risk Research Articles

Common Shocks and Climate Risk in European Equities

ABSTRACTWe examine the contribution of a shock to climate concern to the observed outperformance of a portfolio of European green stocks relative to a brown benchmark. We show, first, that an information set given by 1‐month stock return and realized volatility of each stock constituent (and their cross‐sectional averages) improves the (in‐sample) forecasting performance for the return series relative to the traditional market risk factors proxied by Fama–French portfolios. Moreover, the identification of the shock to climate concern occurs in two stages: First, we compute the historical decomposition based on a Panel SVAR fitted to the return and volatility of each green and brown portfolio constituent. Then, the contribution of the first common shock to the historical decomposition of returns is purged of macroeconomic forecast errors, and the residual is interpreted as the innovation to climate concern. The empirical evidence is robust to a number of different selections of stocks entering the green and brown portfolio.

A factor model for the cross-section of country equity risk premia

A factor model for the cross-section of country equity risk premia

Return smoothing in pooled annuity products

Abstract While trends in human longevity and volatile capital markets have verified the need for guaranteed income in retirement, existing literature on guaranteed contracts shows that such product designs can be costly. Pooled annuity products, where participants share mortality and investment risks and returns, offer a promising alternative to standard guaranteed products. However, challenges remain for pooled schemes, including highly volatile incomes, especially with significant equity investments. We introduce a pooled annuity product to provide pensioners with a lifetime income characterized by smooth investment returns. Our proposed design builds on the advantages of sharing mortality risk while incorporating equity investments with return smoothing mechanisms. Based on Australian data, we establish transparent and costless minimum guarantees on market returns using a zero-cost collar option which sets upper and lower bounds on market returns and constrains the fund value at any moment. The pension savings are divided into group-self annuitization (GSA) and smoothing accounts. The GSA account provides life-long retirement benefits, while the smoothing account adjusts the GSA benefits within specified bounds. Our method uses the smoothing account as part of the pooled savings, not backed up by the insurer, which helps to minimize guarantee costs through a zero-cost collar option. Results show that retirees face a trade-off regarding their annuity payouts: while smoothing can lead to more stable payments and reduced equity risk, it also means giving up upside gains to buy downside protection.

Out-of-Sample Predictability of the Equity Risk Premium

A large set of macroeconomic variables have been suggested as equity risk premium predictors in the literature. Acknowledging the different predictability of the equity premium in expansions and recessions, this paper proposes an approach that combines equity premium forecasts from two-state regression models using an agreement technical indicator as the observable state variable. A comprehensive out-of-sample forecast evaluation exercise based on statistical and economic loss functions demonstrates the superiority of the proposed approach versus combined forecasts from linear models or Markov switching models and forecasts from machine learning methods such as random forests and gradient boosting. The parsimonious state-dependent aspect of risk premium forecasts delivers large improvements in forecast accuracy. The results are robust to sub-period analyses and different investors’ risk aversion levels.

Out-of-Sample Predictability of the Equity Risk Premium

Out-of-Sample Predictability of the Equity Risk Premium

Bank of Japan’s ETF purchase program and equity risk premium: A CAPM interpretation

Bank of Japan’s ETF purchase program and equity risk premium: A CAPM interpretation

Analisis Faktor-Faktor Equity Risk Premium Perusahaan Sektor Kesehatan yang Terdaftar di Bursa Efek Indonesia

This study aims to analyze the determinants of equity risk premium among healthcare sector companies listed on the Indonesia Stock Exchange during the period from 2011 to 2022. The equity risk premium, a crucial concept in investment decision-making, represents the additional return investors require for holding risky assets compared to risk-free assets. The study uses independent variables such as book to market equity ratio, beta, leverage, and firm size to understand their influence on the equity risk premium. This research adopts a quantitative approach, utilizing panel data analysis to evaluate the relationships between the variables. The sample is selected using purposive sampling, focusing on healthcare companies listed on the Indonesia Stock Exchange that have published financial statements for the years 2011 to 2022. The results of the study indicate that beta significantly affect the equity risk premium in the healthcare sector. However, book to market equity ratio, leverage, and firm size do not show a significant impact on the equity risk premium. The findings contribute to the literature by providing insights into the unique determinants of the equity risk premium in the healthcare sector, particularly in the context of the Indonesian market. These insights are valuable for investors seeking to optimize their portfolios and manage risk effectively, as well as for companies aiming to improve their financial performance and investor relations.

Pension Risk and the Sustainable Cost of Capital

Prior research empirically finds that the systematic equity risk for US firms as measured by beta reflects the risk of their defined benefit pension plans, despite opaque and complicated pension accounting rules. This paper re-examines this question in the context of subsequent clarification of these rules, and the growing importance of non-defined benefit pension funds. This issue is examined by comparing standard equity-based models with a broader pre-existing shareholder model of the reporting entity to re-examine the relationship between firm equity risk and pension plan risk. The empirical tests are conducted on a sample of S&P 500 firms during the first three years of the introduction of the revised pension accounting rules (2006–2008), based on panel data regression relating firm risk to pension risk and controlling for other variables. In contrast to the prior findings of JMB, the estimated cost of capital is additionally sensitive to the following: (a) alternative explicit versus implicit definitions of pension liability; (b) the nature and scope of long-term deferred compensation arrangements; and (c) the scope and nature of investment-related risks through investment in sponsoring company stock that are associated with these pension arrangements.

The Association Between a Summary Measure of Social Determinants of Health/Health Equity and Cardiovascular Disease Burden Among Mississippi Adults

Cardiovascular disease is the leading cause of death among Mississippi adults. Social determinants of health are significant contributors to cardiovascular disease risk and associated mortality as well as health disparities. The authors examined the association between a summary measure of social determinants of health and cardiovascular disease among Mississippi adults. Using the social determinants of health and health equity module data from 3,994 respondents to the 2022 Mississippi Behavioral Risk Factor Surveillance System survey, the authors conducted multivariable logistic regression models to examine the association between cardiovascular disease and a social determinants of health/health equity summary measure. Participants who received food stamps or were enrolled in the Supplemental Nutrition Assistance Program (AOR=2.28; 95% CI=1.35, 3.86), experienced food insecurity (AOR=1.74; 95% CI=1.08, 2.79), and experienced mental distress (AOR=2.39; 95% CI=1.54, 3.73) had significantly higher odds of cardiovascular disease than their counterparts without any of these factors. Mississippi adults experiencing 4 or more of social determinants of health/health equity risk factors had a 2.56 (AOR=2.56; 95% CI=1.49, 4.41) higher odds of cardiovascular disease than those experiencing no social determinants of health/health equity risk factors. Mississippi adults with 4 or more social determinants of health/health equity risk factors had significantly higher odds of cardiovascular disease than those with no social determinants of health/health equity risk factors. These findings highlight the importance of social determinants of health/health equity factors in cardiovascular disease burden and suggest that interventions targeted at individuals with multiple social determinants of health/health equity risk factors are needed to reduce the high burden of cardiovascular disease among Mississippi adults.

Size, Book to Market Factors and Trading Volume Adjustment on Equity Risk Premium an Empirical Evidence from NSE, Kenya

Size, Book to Market Factors and Trading Volume Adjustment on Equity Risk Premium an Empirical Evidence from NSE, Kenya

Seasonal affective disorder and currency markets

AbstractHarry Markowitz is known as the grandfather of behavioral finance based on his 1952 work on utility theory. We study a behavioral issue applied to the currency market: seasonal affective disorder (SAD). As the days grow shorter (longer) in fall (spring), investors become more (less) risk averse due to changes in depression related to SAD. Our empirical results are consistent with changes in risk-taking in global equities and the associated change in currency hedging portfolios. In the spring/summer season of long daylight hours, we find evidence of greater short positions for the euro. This is consistent with investors taking more risk in global equities and adding to their currency shorts to hedge the FX exposure. Such changes in euro holdings are reversed in the season of shorter daylight hours, consistent with risky investments being reduced due to greater risk aversion so currency hedges are reduced. For currency returns, we find that the greater shorting in spring–summer is associated with currency depreciation over the season of long days. In the season of short days, currency buying associated with cutting hedging positions leads to currency appreciation. We find that the SAD influence on seasonal currency returns is much like the evidence for equity returns. Finally, we construct and backtest a SAD-inspired currency portfolio. We find that trading the spring/summer risk-on SAD effect from longer days and recovery from SAD-related depression had a decent positive risk-adjusted performance and displayed fairly consistent performance over time.

Optimal asset allocation and nonlinear return predictability from the dividend-price ratio

AbstractWe study non-linear predictability of stock returns arising from the dividend-price ratio and its implications for asset allocation decisions. Using data from five countries — U.S., U.K., France, Germany and Japan — we find empirical evidence supporting non-linear and time-varying models for the equity risk premium. Building on this, we examine several model specifications that can account for non-linear return predictability, including Markov switching models, regression trees, random forests and neural networks. Although in-sample return regressions and portfolio allocation results support the use of non-linear predictability models, the out-of-sample evidence is notably weaker, highlighting the difficulty in exploiting non-linear predictability in real time.

Research on Dynamic Evaluation Method of Tourist Destination Accessibility Based on Interpretive Structure Model

Because of its core role in the process of tourism, tourism destination has always been the focus of discussion among the industry, but the comprehensive evaluation of tourism destination is rarely mentioned. This paper selects tourism destination as the focus of investigation, gives the evaluation method of tourism destination, adapts to the trend of tourism modernization, and discusses the quantifiable model of tourism destination evaluation. This paper first selects several tourism destinations as samples, collects and combs the information related to spatial equity of tourism destinations, and determines the main problem categories of spatial equity of tourism destinations. Then, through the summary of relevant data and case analysis, a framework of tourism target accessibility risk factors is formed. At the same time, considering the interaction between risk factors, we then give a method to determine the weight that can improve granular computing. First, we use this method to obtain the quotient space family with hierarchical characteristics through the similarity relationship between data, and then we can calculate the importance of each feature in the quotient space family, so as to obtain the corresponding weight between different influence indexes. Finally, the paper takes the tourism destination spatial equity problem as the main research goal, and through the dynamic evaluation of the tourism destination spatial equity risk impact structure using the interpretive structure model, and describes the schematic diagram of its impact structure, so as to find out the direct, source, process and other factors that cause the problem.

Market Efficiency and Equity Risk Premium Predictability

Market Efficiency and Equity Risk Premium Predictability

Dynamic Spillovers from US (Un)Conventional Monetary Policy to African Equity Markets: A Time-Varying Parameter Frequency Connectedness and Wavelet Coherence Analysis

Since the implementation of unconventional monetary policies (UMPs) by the US in response to the global financial crisis (GFC) and the COVID-19 pandemic, there have been increasing concerns that these forward guidance and quantitative easing programmes have had spillover effects on global equity markets. We specifically question whether the implementation of these UMPs have had spillovers to African equities, which have been previously speculated to be decoupled from global markets and shocks. Time-varying-parameter (TVP) frequency connectedness and wavelet coherency methods were used to examine the dynamic time-frequency spillovers between daily time series of the US shadow short rate and African equities returns/volatility between 1 January 2007 and 31 March 2023. On one hand, the TVP frequency connectedness analysis reveals robust long-run spillovers from US monetary policy to African equity markets during specific periods: 2009, 2013, 2020, and 2021. These coincide with instances when the Federal Reserve announced their transition from conventional to unconventional monetary practices and vice versa. On the other hand, the wavelet analysis provides insights into the ‘sign’ of the spillovers, indicating mixed phase dynamics during UMPs responding to the GFC. In contrast, anti-phase or negative co-movements characterize UMPs implemented during the COVID-19 pandemic, implying that these policies increased both returns and volatilities to African equities. Altogether, we conclude that US UMP has increasing deteriorated market efficiency and amplified portfolio risk in African equities whilst during ‘normalization’ periods US monetary policy has little transmission effect.

Commodity tail risk and equity risk premia

Commodity tail risk and equity risk premia

Profitability, Investment Factors and Trading Volume Adjustment on Equity Risk Premium an Empirical Evidence from Nairobi Stock Exchange

Purpose: Equity markets have always fascinated and challenged financial researchers with their complexities and broad implications. This Study investigated the effect of profitability measures and investment factors on the Equity Premium of companies listed on the Nairobi Securities Exchange (NSE) from 2011 to 2022. Design/ Methodology/Approach: The research design used in this study was the time series regression approach of Black, Jensen, and Scholes (1972). The target population comprises companies in the Nairobi Securities Exchange (NSE). Secondary data was obtained from the NSE database. This study used panel data from over ten years of cross-section analysis. An autoregressive integrated moving average model (ARIMA) of controlled variables methodology was used on the FamaMac Beth portfolio formation. Findings: The finding implied a significant relationship between profitability and the Equity Premium of listed companies on the Nairobi Securities Exchange during the period of Study. The Study found no significant relationship between investment policies and the Equity Premium of listed companies on the Nairobi Securities Exchange (NSE). There was significant relationship between trading volume as measured by liquidity and the Equity Premium of listed companies on the Nairobi Securities Exchange. Implications/Originality/Value: The study will be helpful to those who seek to rebalance their portfolios, given the Fama French Model factors. Regulators and the policymakers could adopt appropriate policies to limit the damage to the real economy.

Impact of Sharia‐Based Screening on Equity Risk: International Evidence

ABSTRACTThis paper investigates the impact of mainstream Sharia‐based screening methodologies on equity risk. The study is based on the daily returns of 23 pairs of stock indices belonging to different index providers, namely Dow Jones, FTSE, and S&P. For risk measurement, the study uses five Value at Risk (VaR) methods. Moreover, the conditional VaR (CVaR) is used to analyze the tail behavior of return distributions. The results show that Sharia‐based screening is a source of significant differences in risk. There is strong evidence that Islamic stock indices (ISIs) tend to be less risky than their conventional peers. Also, the screening process allows for keeping extreme negative returns at a lower level relative to unscreened indices. The analysis during the Dotcom and Subprime crises shows that, globally, the results are time‐invariant. In sum, Islamic screening is tantamount to prudential rules that lead to low‐risk portfolios; it is, in its essence, a risk‐reduction strategy. Findings suggest that Sharia‐compliant stocks would be of great attractiveness to risk‐averse investors. They will find their claim in this asset class, as its riskiness is relatively low. For banks, a lower VaR of Islamic investing implies fewer capital requirements for market risk when holding portfolios that include Sharia‐compliant stocks. Fewer capital requirements will enhance the banks' ability to invest and make profits, which will, in turn, result in reducing the cost of capital.

Vertical acquisition and carbon capture and storage choices under cap-and-trade regulation with sustainable finance

In this paper, we establish a contingent claim framework for environmental management. The paper focuses on the vertical acquisition of a supply chain in the context of sustainable insurance (i.e., sustainable finance), specifically considering carbon capture and storage (CCS) technology choices and cap-and-trade regulations. The main results are as follows. Firstly, a more stringent cap-and-trade scheme increases equity efficiency in sustainable insurance, particularly when the green upstream manufacturer with advanced CCS technology acquires the brown downstream manufacturer, which also uses advanced CCS technology. Secondly, it harms risk efficiency, especially when the green upstream manufacturer with backward CCS technology acquires the brown downstream manufacturer, which uses advanced CCS technology. Thirdly, it increases the default risk in the insurer's equity, especially when the green upstream manufacturer with backward CCS technology acquires the brown downstream manufacturer, which also uses backward CCS technology. Overall, cap-and-trade's effects on equity and risk efficiency in vertical acquisition and default risk in insurer's equity within sustainable insurance depend on adopting CCS technology. Policymakers should incentivize advanced CCS technologies in vertical acquisitions to enhance equity and reduce default risks, supporting long-term financial stability and environmental sustainability toward Sustainable Development Goals.

Monetary policy and equity returns: The role of investor risk aversion

AbstractThis article examines the role of investor risk aversion in the transmission of monetary policy to stock returns based on U.S. data. Our results show that following an expansionary monetary policy shock, investor risk aversion falls, leading to a decrease in the equity risk premium and an increase in equity returns. Moreover, the returns of high‐beta stocks increase much more than those of low‐beta stocks. Finally, we investigate the mechanism through mutual fund flows. We find that high‐beta funds attract greater inflows in response to lower interest rates, and there is a positive relationship between fund returns and flows. Our findings have policy implications for financial stability.