Risky Returns Research Articles

Risk perception, risk preference and farmers’ indifference in grain sales

ABSTRACT This paper examines the mechanisms by which risk perception affects farmers’ timing of grain sales and the role played by risk preference based on 2019 China Family Database and China Household Finance Survey. The results indicate that high risk perception is more likely to lead farmers to current sales compared with intertemporal sales. It reveals that the underlying reason for farmers’ indifference in grain sales is the increased risk perception under constraints, which causes risky returns from intertemporal sales lower than certain returns from current sales in utility comparison. It is further found that risk preference has a substitution effect on risk perception in farmers’ intertemporal grain sales.

Carbon mitigation payments can reduce the riskiness of bioenergy crop production

AbstractPerennial bioenergy crops provide substantial carbon mitigation benefits but have risky returns. We couple economic analysis with a biogeochemical model (DayCent) to examine the effect of carbon mitigation payments on the spatially varying bioenergy crop returns and risk profiles relative to conventional crops across the rainfed United States. These payments increase the likelihood of positive profit in the Midwest for miscanthus and southern states for switchgrass. At low biomass prices, these payments make bioenergy crops appealing to risk‐averse farmers. At moderate biomass prices, these payments make bioenergy crops appealing to all farmers regardless of risk preference.

A new model for forecasting VaR and ES using intraday returns aggregation

AbstractThis paper proposes a new risk measurement model that directly incorporate information from high‐frequency data to predict daily Value‐at‐Risk and expected shortfall. In this model, Regular‐Vine copula and Monte Carlo simulation are applied to produce the predicted intraday returns that have nonlinear dependences. And the time‐varying marginal distribution of intraday returns is estimated under the framework of generalized autoregressive score. The model is so named R‐Vine‐Copula‐GAS (abbreviated as RVCGAS). The predicted intraday returns in the same day are added up to obtain the daily return and form its empirical distribution. The risk measurements are then calculated based on this simulated distribution. An empirical analysis is conducted using data from the index in China's stock market and some of its constituents, and the effects of the proposed model and several Benchmark models are compared through some backtestings. The results show that RVCGAS has an advantage over others in predicting tail risk when the risk level is high, since it could cover more risky returns and reduce more costs.

Scale‐dependent and risky returns to savings: Consequences for optimal capital taxation

AbstractI present a model of optimal capital taxation where agents with heterogeneous labor productivity randomly draw their rate of return to savings. Because of scale dependence, the distribution of rates of returns can depend on the amount saved. Uncertainty in returns to savings yields an insurance rationale for taxing capital on top of labor income. I first show that, because of scale dependence, agents making the same saving decision should access the same rate of return at the optimum. I then constrain the information set of the government and show that, as soon as return are uncertain, positive capital income taxation is needed at the optimum. The optimal linear tax on capital income trades off insurance with distortions to both savings and to the rate of return in a context of scale dependence. Eventually, I argue that scale dependence in and of itself is not sufficient to justify capital taxation on top of labor income taxes. These results are still valid when agents can optimize between a risk‐free and a risky‐asset that can both exhibit scale dependence.

Entry and exit decisions under public and private information: an experiment

We design an experiment to study how reversible entry decisions are affected by public and private payoff disclosure policies. In our environment, subjects choose between a risky payoff, which evolves according to an autoregressive process, and a constant payoff. The treatments vary the information disclosure rule on the risky payoff, such that in the public information treatment the risky payoff is always observable, while in the private information treatment, the risky payoff is observable only to the participants who enter the market. We find that under private information, market entry is higher, which suggests that subjects engage in exploration and place value on information.

A closed-form mean–variance–skewness portfolio strategy

This paper analyzes portfolio selection problems with multivariate normal-gamma distributed risky returns. We obtain a partial elliptic cone-shaped mean–variance–skewness (MVS) frontier and a closed-form MVS portfolio strategy for investors with a cubic utility function. We show that the utility improvement and Sharpe ratio loss of our MVS strategy relative to the traditional mean–variance strategy depend on the investor’s prudence and risk-aversion levels, and the mean and variance of a max-skewness portfolio. Moreover, we obtain a three-moment capital asset pricing model, and propose a max-skewness factor in addition to the market factor.

The economics of the performing arts before and during the COVID-19 pandemic. Part 2: an investment approach to cultural enents

The article demonstrates the possibilities of corporate governance methods and investment decision-making models for the cultural organizations and events (on the examples of federal theaters). Financial and investment analysis was applied in the study. The article discusses the hypothesis of the possibility of balancing budgets for new theatrical productions, taking the rehearsal period, premiere and running as a whole. The productions are not considered as deadweight losses, but are analysed as assets with risky returns. The results of the financial analysis of the staging activities of the leading theaters demonstrate their limited possibilities in balancing the budgets for new productions. The most popular performance (with an average ticket price above the market and a stable occupancy rate of over 90 %) requires at least 5–6 years of active running to recoup the initial investment. The author’s are expected to help the performing arts organizations to identify and assess losses during the pandemic crisis. The scientific novelty is to the approach to calculating and forecasting the return on production costs.

Abnormal Downside Tail Risk as a Predictor of Risky Bond Returns

Abnormal Downside Tail Risk as a Predictor of Risky Bond Returns

How an idiosyncratic (zero-beta) risk can greatly increase the firm’s cost of capital

The celebrated capital asset pricing model (‘CAPM’) brought numerous appealing insights and spawned a new theory of capital budgeting. One key intuition is that there is ‘no penalty for diversifiable risk’ – that is, any risky payoff that has zero-correlation with the wider economy, and hence zero-beta, is treated as ‘risk-free’. Does that mean that managers can bet the firm on a spin of the roulette wheel without attracting a higher CAPM discount rate? Our re-interpretation of CAPM reveals that potential financial losses which are conventionally regarded as firm-specific ‘unpriced’ risks can bring a large increase in the firm’s beta and CAPM cost of capital, despite having zero-beta and making only negligible difference at the aggregate market level. This mathematical result clashes with textbook expositions but is easily demonstrated and can be traced to authoritative but overlooked parts of the theoretical CAPM literature. JEL Classification: G11, G12

Reparations and Persistent Racial Wealth Gaps

Reparations is a policy proposal aiming to address the wealth gap between Black and White households. We provide a first formal analysis of the economics of reparations using a long-run model of heterogeneous dynasties with an occupational choice and bequests. Our innovation is to introduce endogenous dispersion of beliefs about risky returns, reflecting differences in dynasties' experiences with entrepreneurship over time. Feeding the exclusion of Black dynasties from labor and capital markets as driving force, the model quantitatively reproduces current and historical racial gaps in wealth, income, entrepreneurship, mobility, and beliefs about risky returns. We use the model to evaluate reparations and find that transfers eliminating the racial gap in average wealth today do not lead to wealth convergence in the long run. The logic is that century-long exclusions lead Black dynasties to enter into reparations with pessimistic beliefs about risky returns and to forego investment opportunities. We conclude by showing that entrepreneurial subsidies are more effective than wealth transfers in achieving racial wealth convergence in the long run.

Biased News and Irrational Investors: Evidence from Biased Beliefs about Uncertainty and Information Acquisition

Investors who use biased information from news media subsequently tend to make irrational decisions about acquiring firm-specific information compared to rational expectations. This model of information acquisition yields testable predictions that are verified by using a novel dataset. First, when sentiment in news articles, as a proxy for biased public information, is more optimistic, investors tend to acquire less earnings-relevant information before the earnings announcement and vice versa. Second, the return predictability from firm-specific news sentiment confirms that it contributes to variations in asset information risk due, in a biased belief equilibrium, to the proportion of informed investors deviating from rational expectations. Overall, these findings suggest that biased public information inherent in news sentiment serves to irrationalize investors’ acquisition of firm-specific information through a biased perception of uncertainties in the risky asset payoff.

The Expected Return on Risky Assets: International Long-run Evidence

This paper studies trends in the expected return on equity and housing and its relationship with the safe rate. Across 17 advanced economies, the expected risky return has been in steady long-run decline, but its trend is markedly different from that in the safe rate. As a consequence, the ex ante risk premium exhibits large secular movements, and risk premia and safe rates are strongly negatively correlated. We provide evidence linking these differential risky and safe rate trends to secular variation in macroeconomic risk.

Bilateral multiple gamma returns: Their risks and rewards

The bilateral gamma model for returns is naturally derived from the lognormal model. Maximizing entropy in a random time change delivers the symmetric variance gamma model. The asymmetric variance gamma follows on incorporating skewness. Differential speeds for the upward and downward motions lead to the bilateral gamma. A further generalizations results in the bilateral double gamma model when the speed parameter of the bilateral gamma model is itself taken to be gamma distributed on entropy maximization. A rich five to seven parameter specification of preferences renders possible the extraction of physical densities from option prices. The quality of such extraction is measured by examining the uniformity of the estimated distribution functions evaluated at realized forward returns. The economic value of risky returns is seen to embed three/five risk premia for the bilateral gamma/bilateral double gamma. For the bilateral gamma they are up and down side volatilities compensated in up and down side drifts, and the down side drift compensated in the up side drift. For the bilateral double gamma one adds in addition compensations for skewness. Results reveal a drop in the down side risk premium since the crisis with an increase in the recent period.

Risk Effects on Optimal Decision Making – A Question of the Right Order

We study risk effects, including higher-order risk effects, on optimal decision making in the linear-payoff model. This model includes the standard portfolio problem, the coinsurance problem, the problem of output choice with a risky price or a risky cost, and the problem of hedging a risky return as special cases. We distinguish between risk taking and risk mitigation and between uncertainty over a benefit and uncertainty over a cost. We identify restrictions on preferences for clear-cut comparative static effects of Nth-degree risk increases. For an uncertain benefit, the decision maker compensates increased risk by lowering exposure to risk; for an uncertain cost, the behavioral response depends on the parity of the order of the risk change. This is because only even-order risk changes increase the riskiness of terminal wealth while odd-order risk changes reduce it. To resolve this discrepancy, we introduce a new class of stochastic dominance relations that is suitable for uncertainty over a cost.

Range Utility Theory for Uncertain Cash-flows

We provide the behavioral foundations of a preference model for risky payoff streams, a broad domain having lotteries, income streams under certainty, and repeated lotteries as special cases. For an individual who cares not only about total profit at the end, but also about partial profits, a standard set of rational axioms yield Bell's (1974) discounted incremental utility model. The model captures the intuition of time as inherently uncertain. To this bedrock, we add the notion that preferences are affected by range effects. The result is a behavioral model with a broad domain and consistent with a plethora of phenomena (bias towards short payback periods, the four-fold patterns for risk and time, preference reversals for risk and time, temporal patterns of decreasing or increasing impatience, and magnitude effects).

Accounting Conservatism and Asset Price

This paper presents a static model of a competitive securities market. In the market there are two assets: risk-free asset and risky asset. The payoff of the risk-free asset is one and the payoff of the risky asset is unknown. Rational traders correctly estimate the mean and variance of the risky asset payoff. Earnings fixated traders are functionally fixated on accounting earnings numbers. Due to the conservative accounting practices, earnings fixated traders underestimate the mean and variance of the risky asset payoff. Noise traders' demand for the risky asset is assumed to be random. This paper proves analytically that the presence of accounting conservatism decreases the asset price and the volatility of the asset price and it increases the expected return of the asset. In addition, this paper proves that the presence of accounting conservatism decreases the likelihood of the asset price lying on the right tail of its distribution and depending on the model parameter values, the presence of accounting conservatism may increase or decrease the likelihood of the asset price lying on the left tail of its distribution.

Risky choices in strategic environments: An experimental investigation of a real options game

Managers frequently make decisions under conditions of fundamental uncertainty due the stochastic nature of the outcomes and competitive rivalry. In this study, we experimentally test a theoretical model under fundamental uncertainty and competitive rivalry by designing a sequential interaction game between two players. The first mover can decide either to choose a sure outcome that assigns a risky outcome to the second mover or to pass the decision to the second mover. If the second player gets the chance to decide, she can choose between a sure outcome, conditioned by the assignment of a risky payoff to the first mover, or the sharing of the risky outcome with the first mover. We then introduce the following experimental treatments: (i) relegating second-mover participants to a purely passive role and substituting them with a random device (absence of strategic uncertainty – that is, when the source of uncertainty is a human subject); (ii) providing information about the behaviour of second-mover counterparts; and (iii) completely removing the second-mover participant.We find that decision makers are sensitive to the presence or absence of strategic uncertainty; indeed, in the presence of strategic uncertainty, first movers more often diverge from the behaviour predicted by the model. Given our experimental results, the theoretical model needs to be revisited. The standard model of monetary payoff-maximizing agents should be substituted by one of decision makers who maximize a utility function which includes the psychological cost induced by strategic uncertainty.

Optimally Solving Banks' Legacy Problems

We characterize policy interventions directed to minimize the cost to the deposit guarantee scheme and the taxpayers of banks with legacy problems. Non-performing loans (NPLs) with low and risky returns create a debt overhang that induces bank owners to forego profitable lending opportunities. NPL disposal requirements can restore the incentives to undertake new lending but, as they force bank owners to absorb losses, can also make them prefer the bank being resolved. For severe legacy problems, combining NPL disposal requirements with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.

Afrikai vasutak kínai segítséggel – Kinek éri meg?

In Kenya and Ethiopia the new railways financed by Chinese loans and built by Chinese technology and by Chinese companies are already in service. Lot of people see these as a boost for development, but both of them are upgrades of already existent lines. It is questionable whether or not the countries will be able to repay the costs of these investments, and the railways can generate so high additional growth that can finance the loans. There are also other options for railway development than Chinese loans and it is interesting to analyse which option is the most straightforward and beneficial for the Africa countries from the current examples and potentials for railway development. From the analysis we can see that Chinese loans do not seem to be the best solution, countries are taking very high debt for projects with risky returns. The example of Tanzania shows that open international procurement and competition can lead to cheaper and sustainable railway development in Africa, as opposed to Chinese loan-driven investment schemes.

Bilateral Multiple Gamma Returns: Their Risks and Rewards

The bilateral gamma model for returns is naturally derived from the lognormal model. Maximizing entropy in a random time change delivers the symmetric variance gamma model. The asymmetric variance gamma follows on incorporating skewness. Differential speeds for the upward and downward motions lead to the bilateral gamma. A further generalizations results in the bilateral double gamma model when the speed parameter of the bilateral gamma model is itself taken to be gamma distributed on entropy maximization. A rich five to seven parameter specification of preferences renders possible the extraction of physical densities from option prices. The quality of such extraction is measured by examining the uniformity of the estimated distribution functions evaluated at realized forward returns.The economic value of risky returns is seen to embed three/five risk premia for the bilateral gamma/bilateral double gamma. For the bilateral gamma they are up and down side volatilities compensated in up and down side drifts, and the down side drift compensated in the up side drift. For the bilateral double gamma one adds in addition compensations for skewness. Results reveal a drop in the down side risk premium since the crisis with an increase in the recent period.