Variation In Premium Research Articles

Information Environment and Equity Risk Premium Volatility Around the World

This paper examines whether and how differences in investors' information environments (measured by a country's information disclosure, accounting standards, and financial transparency) are related to cross-country differences in the market risk premium volatility. We use the vector-autoregressive and implied cost of capital methods to extract time variation in risk premiums for 41 developed and emerging markets worldwide. Consistent with theoretical predictions, countries with better information environments tend to experience a lower risk premium volatility, even after controlling for various country variables that are potentially associated with variation in risk premiums. Our analysis of two exogenous events, specifically the 1997 Asian financial crisis and 2008 global financial crisis, further corroborates our key finding that information environments play an important role in explaining market risk premium variability.This paper was accepted by Wei Xiong, finance.

Understanding Bond Risk Premia

We study risk premium in US Treasury bonds. We decompose Treasury yields into inflation expectations and maturity-specific interest rate cycles, which we define as variation in yields orthogonal to expected inflation. The short-maturity cycle captures the real short-rate dynamics. Jointly with expected inflation, it comprises the expectations hypothesis (EH) term in the yield curve. Controlling for the EH term, we extract a measure of risk premium variation from yields. The risk premium factor forecasts excess bond returns in and out of sample and subsumes the common bond return predictor obtained as a linear combination of forward rates.

Hedge Fund Returns, Kalman Filter, and Errors-in-Variables

Many studies on hedge fund returns are formulated in a static framework, resorting to a multifactor model using mimicking portfolios or benchmarks accounting for the style of different hedge fund strategies. While classical linear regressions represent a parsimonious approach to the modeling of hedge fund strategies, time-invariant factor loadings might be misleading (Berkelaar, Kobor, and Kouwenberg, The VaR Modeling Handbook, 2009). Actually, hedge fund strategies are essentially dynamic processes. Since conditional models appear promising to explain portfolio managers dynamic strategies, we study in this paper how conditional alphas and betas react to financial market variables such as market risk premium, interest rate, market volatility, or macroeconomic variables related to the business cycle (Racicot and Theoret, Journal of Wealth Management, 2007). An interesting assumption tested in the literature (Swinkels and van der Sluis, Working Paper, Tilburg University, 2001; Bollen and Whaley, Working Paper, Vanderbilt University, 2006; Racicot and Theoret, Journal of Wealth Management, 2008) is the conjecture that the conditional alpha and beta follow a random walk. Actually, those parameters might also react to conditioning financial market or macroeconomic news. Using the Kalman filter setting, our study explores the reaction of HFR indices conditional alpha and beta to financial market variables, especially interest rates, market risk premia, and squared market risk premia, a proxy for volatility. Our results show that the alphas of most of the indices computed over strategies are not very sensitive to financial market variables. A pure recursive process seems, therefore, more relevant for the alpha. The data generating process of the alpha is thus more similar to a random walk process than to a conditional model, Atl Econ J (2010) 38:377–378 DOI 10.1007/s11293-010-9230-6

Taxing Cadillac Health Plans May Produce Chevy Results

It's often assumed that high-cost health insurance plans--sometimes called "Cadillac" plans--provide rich benefits to plan subscribers. Health reform provisions that treat these plans like luxuries may be misguided. Only 3.7 percent of variation in the cost of family coverage can be explained by benefit design (actuarial value). Benefit design plus plan type (HMO, PPO, POS, or high-deductible plans) explains 6.1 percent of this variation. Industry type and medical costs in the region also play a role. Most variation in premiums, however, remains largely unexplained.

Expected Returns and Volatility of Fama-French Factors

In this paper, I show that the variance of Fama-French factors, the variance of the momentum factor, as well as the correlation between these factors, predict an important fraction of the timeseries variation in post-1990 aggregate stock market returns. This predictability is particularly strong from one month to one year, and it dominates that afforded by the variance risk premium and other popular predictor variables such as P/D ratio, the P/E ratio, the default spread, and the consumption-wealth ratio. In a simple representative agent economy with recursive preferences, I model the portfolio weight in each asset as a function of a stock’s characteristics and show that the market return can be predicted by these variances.

Short Sales and Fundamental Value: Explaining the REIT Premium to NAV

This study explores the role of short sale constraints in explaining the variation in premiums to Net Asset Value (NAV) in REIT pricing. We use proprietary information on short sales between June 2006 and September 2008 to examine how short sales and short sale constraints affect the variation in monthly REIT NAV premiums using panel vector autoregression models. We find that variation in short sale activity across individual REITs can account for at least one-third of the variation in NAV premiums. Short sale constraints tend to be binding when there is strong demand and limited supply of shares to short. Excess demand leads to overvaluation and the correction of the overvaluation explains the under performance of premium REITs.

Doing Well by Doing Good? Green Office Buildings

This paper provides the first credible evidence on the economic value of “green buildings” derived from impersonal market transactions rather than engineering estimates. We analyze clusters of certified green and nearby buildings, establishing that “rated” buildings command substantially higher rents and selling prices than otherwise identical buildings. Variations in premiums are systematically related to energy-saving characteristics. Increased energy efficiency is associated with increased selling prices -- beyond the premiums paid for a labeled building. Evidence suggests that the intangible effects of the label itself may also play a role in determining the values of green buildings in the marketplace. (JEL G31,M14,Q52,R33)

Analysis of the efficiency of the Iberian power futures market

Market efficiency is analysed for the Iberian Power Futures Market and other European Power Markets, as well as other fuel markets through evaluation of ex-post Forward Risk Premium. The equilibrium price from compulsory call auctions for distribution companies within the framework of the Iberian Power Futures Market is not optimal for remuneration purposes as it seems to be slightly upward biased. In the period considered (August 2006–July 2008), monthly futures contracts behave similarly to quarterly contracts. Average risk premia have been positive in power and natural gas markets but negative in oil and coal markets. Different hypotheses are tested regarding increasing volatility with maturity and regarding Forward Risk Premium variations (decreasing with variance of spot prices during delivery period and increasing with skewness of spot prices during delivery period). Enlarged data sets are recommended for stronger test results. Energy markets tend to show limited levels of market efficiency. Regarding the emerging Iberian Power Futures Market, price efficiency is improved with market development of all the coexistent forward contracting mechanisms and with further integration of European Regional Electricity Markets.

Potato demand in an increasingly organic marketplace

AbstractThe authors investigate pricing and demand issues for four fresh potato categories (russet, red, white, and minor colored), organic fresh potatoes, and two processed potato categories (frozen/refrigerated and dehydrated) using a nonlinear generalized almost ideal demand system (GAIDS) that is closed under unit scaling (CUUS). The model used regionally aggregated at‐home consumption data from 2000 to 2005. Estimated uncompensated own price elasticities for fresh potatoes were highly significant and ranged between −0.5 and −1.6. The study was designed to capture the effects of the aggregate organic market on the prices, expenditures, and demand for each potato category. Organic food market penetration elasticities suggest that specialty potatoes (organic and minor‐colored) are particularly well positioned if demands for organic products continue to rise, red potatoes are not well positioned and evidence of the early warning signs of slippage in market share for white and russet potatoes may exist. Producers and promoters of conventional potato products should account for the increasingly important role of organic products in making decisions. As an auxiliary exercise, we also statistically sourced the variance of the organic potato price premium relative to the other four fresh potato prices. At the present time, the variability of the organic potato premium is not much affected by production costs or other supply‐related factors: the premium variability was driven largely by demand, and demographic/seasonal factors. Producers should be cautious about shifting to organic potato production until lower cost practices emerge. [JEL Codes: D120, Q130, Q180]. © 2009 Wiley Periodicals, Inc.

Is prior performance priced through closed‐end fund discounts?

AbstractIn open‐end mutual funds (unit trusts), there is a strong positive cross‐sectional relationship between net inflows to individual funds and past performance, as if investors attributed performance to managerial skill. Performance shows only very weak persistence, however, so at first sight investors do not appear to gain anything by responding to past performance information. This behaviour can be explained by the fact that past performance is effectively unpriced in the unit trust market, since management fees are unresponsive to demand. If investors believe that there is a non‐zero probability that future performance will turn out to be positively correlated with past performance (i.e. that there is an element of managerial skill in performance), but a zero probability that this correlation will be negative, it is rational to prefer funds with better past performance when performance is not priced. In other words, it costs nothing to insure against the possibility of some managerial skill effect.If this explanation of the flow–performance relationship in unit trusts is correct, one would expect the relationship between investor demand and past fund performance to be much weaker if past performance were to be priced. We test this hypothesis in the market for closed‐end funds (investment trusts). Because closed‐end funds do not trade at net asset value, but at a price determined in the market, strong demand will raise the ratio of price to net asset value (known as the premium). Since it is well established that premiums are mean‐reverting, future shareholder returns on funds currently on high premiums tend to be depressed by the reversion of the premium to the mean. In the closed‐end fund market, as for open‐end funds, there is little evidence of performance persistence, and therefore, to the extent that funds with good past performance are pushed to higher premiums, the expected return on them is less than on the average fund. This implicit pricing mechanism should mean that demand is a declining function of the premium, so that, even if demand is an increasing function of past performance for a given premium, any effect on the premium itself will be muted.We test this hypothesis for closed‐end funds traded in the US and the UK. We find that there is a statistically significant effect of past performance on the premium in both countries. However, consistent with the hypothesis, it has limited economic significance, since it represents only a small component of premium variability. Copyright © 2008 John Wiley & Sons, Ltd.

Where Do the Sick Go? Health Insurance and Employment in Small and Large Firms

Small firms that offer health insurance to their employees may face variable premiums if the firm hires an employee with high‐expected health costs. To avoid expensive premium variability, a small firm may attempt to maintain a workforce with low‐expected health costs. In addition, workers with high‐expected health costs may prefer employment in larger firms with health insurance rather than in smaller firms. This results in employment distortions. We examine the magnitude of these employment distortions in hiring, employment, and separations using the Medical Expenditure Panel Survey from 1996 to 2001. We find that workers with high‐expected health costs are less likely to be new hires in insured small firms and are less likely to be employed in insured small firms. We find no evidence that state small group health insurance reforms designed to restrict insurers' ability to deny coverage and restrict premium variability have reduced the extent of these distortions.

Investor Irrationality and the Nasdaq Bubble

We exploit the information in the options market to study the risk and risk premium variations around the Nasdaq bubble period. In particular, we investigate whether the dramatic rise and fall of the Nasdaq can be justified by changes in return risk, or there were corresponding unusual shifts in how investors price risks. We specify a model that accommodates fluctuations in both risk levels and market prices of different sources of risks, and we estimate the model using time-series returns and option prices on the Nasdaq 100 index. Our analysis reveals three key pieces of evidence that foretell the arrival and burst of a bubble. First, during the Nasdaq bubble period, return volatility increased together with the rising index level, even though the two tend to move in opposite directions in general. Second, while the market price of volatility risk is strongly negative historically as investors dislike high volatility levels and volatility risk, the market price of volatility risk declined in absolute magnitude and approached zero at the end of 1999. In contrast to the average risk premium at normal market conditions, aversion to volatility risk completely disappeared during the height of the bubble period. Third, the options market showed an increasing market price of downside jump risk that peaked three month prior to the bursting of the bubble, highlighting the increasing demand for hedging against the potential crash of the Nasdaq market valuation. On the other hand, the market price of the downside jump risk dropped suddenly three months prior to the burst, pointing to capital flight from the Nasdaq market and the unwinding of the associated option hedging positions. Our approach suggests that having options on the bubble asset provides a window into investor behavior unavailable from earlier bubbles.

The Impact of the Health Insurance Market on Small Firm Employment

AbstractSmall firms that offer health insurance to their employees may face variable premiums if they hire employees with high expected health costs. To avoid expensive premium variability, small firms may attempt to maintain a workforce with low expected health costs. This results in employment distortions. I examine the magnitude of these employment distortions using the 1987 National Medical Expenditure Survey and the 1996 Medical Expenditure Panel Survey. Based on the underwriting behavior of insurance companies in 1988, I classify medical conditions into three categories: conditions that led to denial of coverage; conditions that led to exclusion restrictions; and, conditions that led to higher premiums. In 1987, I find that insured small firms were less likely to employ workers with families that had conditions that led to higher premiums than insured large firms. However, in 1996, possibly due to the passage of small group health insurance reforms that restrict insurers' ability to exclude or deny coverage, insured small firms were less likely to employ workers with denial conditions compared to insured large firms. These results suggest that the pattern of employment distortions in insured small firms is consistent with the evolving small group health insurance market.

Can the Private Annuity Market Provide Secure Retirement Income?

Annuity premiums are often assumed to be constant, although they can be expected to vary with the yield curve. Variations in premiums will become an important public policy issue as defined-contribution (DC) pension plans play an increasingly prominent role in providing retirement income. As DC plan holders retire, many will annuitize at least a part of their account balances. In the absence of current data on annuity prices, the paper relies on U.S. Treasury interest rate data to simulate the impact of interest rate variation on annuity premiums. For a spectrum of feasible interest rates, the variation in retirement income is not negligible.

Can the Private Annuity Market Provide Secure Retirement Income?

Annuity premiums are often assumed to be constant, although they can be expected to vary with the yield curve. Variations in premiums will become an important public policy issue as defined-contribution (DC) pension plans play an increasingly prominent role in providing retirement income. As DC plan holders retire, many will annuitize at least a part of their account balances. In the absence of current data on annuity prices, the paper relies on U.S. Treasury interest rate data to simulate the impact of interest rate variation on annuity premiums. For a spectrum of feasible interest rates, the variation in retirement income is not negligible.

Physician Market Power—Evidence From the Allocation of Malpractice Premiums

Based on evidence from variations in malpractice premiums, physicians have local market power, at least in some dimensions. It is observed that higher‐cost physicians pass on a significant portion of idiosyncratic costs to patients as higher prices. I test two hypothesized sources of this market power: barriers to entry from specialization and relatively inelastic firm‐level demand for certain services. Examining the relationship of physician‐specific malpractice premiums to fees, I find no observable difference in the ability of surgeons and nonsurgeons to pass on these costs; however, both types of physicians pass them on more to surgical than to nonsurgical patients.

Explaining the Discount to NAV in REIT Pricing: Noise or Information?

This paper explores the determinants of both the level of and changes in premiums to NAV in REIT pricing over the 1996-1999 period. The first part of the paper specifies and estimates a model of cross-sectional and time variation in premiums to NAV using a sample of individual REITs. We find that the level of premium to NAV is positively related to REIT size (market capitalization), debt to equity ratio and the level of REIT liquidity as measured by the relative effective spread. Changes in premiums to NAV over time have a strong common element across REITs, which is related to but not entirely explained by a common element in REIT liquidity. The common, sector effect is stronger in the 1998-99 down-market. The second part of the paper aims to determine if the common effect in REIT pricing relative to NAV reflects informed trading or noise. We examine changes in REIT spreads in relation to fluctuations in the average REIT sector premium to NAV and show that the transaction costs of trading in REITs increase when REIT prices are getting closer to NAVs. This holds when controlling for changes in volume and changes in volatility. This result is consistent with a higher proportion of uninformed traders being in the market when REIT prices are diverging from NAV, which in turn is consistent with the noise theory of departures from NAV.

Premium variation in the individual health insurance market.

Recent proposals to decrease the number of uninsured in the U.S. indicate that the individual health insurance market's role may increase. Amid fears of possible risk-segmentation in individual insurance, there exists limited information of the functioning of such markets. This paper examines the relationship between expected medical expense and actual paid premiums for households with individual insurance in the 1996-1997 Community Tracking Study's Household Survey. We find that premiums vary less than proportionately with expected expense and vary only with certain risk characteristics. We also explore how the relationship between risk and premiums is affected by local regulations and market characteristics. We find that premiums vary significantly less strongly with risk for persons insured by HMOs and in markets dominated by managed care insurers.

Merger market dynamics: insights into the behavior of target and bidder firms

This study presents a framework deriving the demand and supply of target firm shares in merger, and tests it using event study methodology and regression analysis. Target and bidder behavior are not mirror images; instead bidders rank and pursue targets which either accept or reject bids. Merger cycles are motivated by bidder demand shifts, target quality is as important as strategic fit for bidders, and transaction type is confirmed as the most reliable predictor of variation in premiums. Target institutional investors raise the cost to the bidder.

Market potential for certified forest (wood) products in Ontario, Canada

This study, conducted in the fall of 1997, documents: i) consumer perceptions regarding environmental marketing; ii) consumer willingness to purchase certified forest (wood) products and to pay a premium for such products; iii) variations in premium across products and prices; and, iv) levels of awareness and acceptance of certification within the forest industry. Analysis indicates that Ontario consumers are environmentally conscious. The mean response of consumers indicates that they are willing to pay a 10% premium for nearly all certified products. In some cases, premium varies with the price of certified products; low-price furniture items command a higher premium than do high-price furniture products. Approximately 90% of consumers prefer to purchase certified furniture and lumber products over non-certified, and 73% of consumers prefer to purchase recycled paper products over certified paper products. Generally, awareness and acceptance of certification among primary producers and re- manufacturers are low. Only 39% of respondents indicate a willingness to pay a 10% premium for certified products, but almost all respondents are willing to purchase certified forest products if all other aspects, such as price and quality, are equal. Separation of certified and non-certified wood and wood products may pose a problem for many companies. Key words: forest certification premium, green premium, market segmentation, niche markets