The paper discusses the problem of hedging not perfectly replicable contingent claims by using a benchmark, the numerraire portfolio, as reference unit. The proposed concept of benchmarked risk minimization generalizes classical risk minimization, pioneered by Follmer, Sondermann and Schweizer. The latter relies on a quadratic criterion, requesting the square integrability of contingent claims and the existence of an equivalent risk neutral probability measure. The proposed concept of benchmarked risk minimization avoids these restrictive assumptions. It employs the real world probability measure as pricing measure and identifies the minimal possible price for the hedgable part of a contingent claim. Furthermore, the resulting benchmarked profit and loss is only driven by nontraded uncertainty and forms a martingale that starts at zero. Benchmarked profit and losses, when pooled and sufficiently independent, become in total negligible. This property is highly desirable from a risk management point of view. It is making a symptotically benchmarked risk minimization the least expensive method for pricing and hedging for an increasing number of not fully replicable benchmarked contingent claims.
{"title":"Three-Benchmarked Risk Minimization for Jump Diffusion Markets","authors":"Ke Du, E. Platen","doi":"10.2139/ssrn.2170169","DOIUrl":"https://doi.org/10.2139/ssrn.2170169","url":null,"abstract":"The paper discusses the problem of hedging not perfectly replicable contingent claims by using a benchmark, the numerraire portfolio, as reference unit. The proposed concept of benchmarked risk minimization generalizes classical risk minimization, pioneered by Follmer, Sondermann and Schweizer. The latter relies on a quadratic criterion, requesting the square integrability of contingent claims and the existence of an equivalent risk neutral probability measure. The proposed concept of benchmarked risk minimization avoids these restrictive assumptions. It employs the real world probability measure as pricing measure and identifies the minimal possible price for the hedgable part of a contingent claim. Furthermore, the resulting benchmarked profit and loss is only driven by nontraded uncertainty and forms a martingale that starts at zero. Benchmarked profit and losses, when pooled and sufficiently independent, become in total negligible. This property is highly desirable from a risk management point of view. It is making a symptotically benchmarked risk minimization the least expensive method for pricing and hedging for an increasing number of not fully replicable benchmarked contingent claims.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"90 4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123221587","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We examine the impact of trading costs on pairs trading profitability in the US equity market over the period 1963-2009. After controlling for commissions, market impact and short selling fees; we find that pairs trading remains profitable, albeit at much more modest levels. Specifically, we document a risk-adjusted return of about 30 basis points (bps) per month amongst portfolios of well matched pairs that are formed within refined industry groups. Strategies that are implemented on the top 30% largest stocks produce an average alpha of 24 bps per month. Pairs trading exhibits a lower risk and lower return profile than a short-term reversal strategy that sorts stocks relative to their industry peers. Notably, both of these forms of contrarian investing are largely unprofitable in the period post 2002.
{"title":"Are Pairs Trading Profits Robust to Trading Costs?","authors":"B. Do, R. Faff","doi":"10.2139/ssrn.1707125","DOIUrl":"https://doi.org/10.2139/ssrn.1707125","url":null,"abstract":"We examine the impact of trading costs on pairs trading profitability in the US equity market over the period 1963-2009. After controlling for commissions, market impact and short selling fees; we find that pairs trading remains profitable, albeit at much more modest levels. Specifically, we document a risk-adjusted return of about 30 basis points (bps) per month amongst portfolios of well matched pairs that are formed within refined industry groups. Strategies that are implemented on the top 30% largest stocks produce an average alpha of 24 bps per month. Pairs trading exhibits a lower risk and lower return profile than a short-term reversal strategy that sorts stocks relative to their industry peers. Notably, both of these forms of contrarian investing are largely unprofitable in the period post 2002.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"770 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-01-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134304276","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The aim of this paper is to model the dependencya mong log-returns when security account prices are expressed in units of a well diversified world stock index. The paper uses the equi-weighted index EWI104s, calculated as the average of 104 world industry sector indices. The log-returns of its denominations in different currencies appear to be Student-t distributed with about four degrees of freedom. Motivated by these findings, the dependency in log-returns of currency denominations of the EWI104s is modeled using time-varying copulae, aiming to identify the best fitting copula family. The Student-t copula turns generally out to be superior to e.g. the Gaussian copula, where the dependence structure relates to the multivariate normal distribution. It is shown that merely changing the distributional assumption for the log-returns of the marginals from normal to Student-t leads to a significantly better fit. Furthermore, the Student-t copula with Student-t marginals is able to better capture dependent extreme values than the other models considered. Finally, the paper applies copulae to the estimation of the Value-at-Risk and the expected shortfall of a portfolio, constructed of savings accounts of different currencies. The proposed copula-based approach allows to split market risk into general and specific market risk, as de fied in regulatory documents. The paper demonstrates that the approach performs clearly better than the Risk Metrics approach.
{"title":"Using Dynamic Copulae for Modeling Dependency in Currency Denominations of a Diversifed World Stock Index","authors":"Katja Ignatieva, E. Platen, Renata Rendek","doi":"10.2139/ssrn.2170183","DOIUrl":"https://doi.org/10.2139/ssrn.2170183","url":null,"abstract":"The aim of this paper is to model the dependencya mong log-returns when security account prices are expressed in units of a well diversified world stock index. The paper uses the equi-weighted index EWI104s, calculated as the average of 104 world industry sector indices. The log-returns of its denominations in different currencies appear to be Student-t distributed with about four degrees of freedom. Motivated by these findings, the dependency in log-returns of currency denominations of the EWI104s is modeled using time-varying copulae, aiming to identify the best fitting copula family. The Student-t copula turns generally out to be superior to e.g. the Gaussian copula, where the dependence structure relates to the multivariate normal distribution. It is shown that merely changing the distributional assumption for the log-returns of the marginals from normal to Student-t leads to a significantly better fit. Furthermore, the Student-t copula with Student-t marginals is able to better capture dependent extreme values than the other models considered. Finally, the paper applies copulae to the estimation of the Value-at-Risk and the expected shortfall of a portfolio, constructed of savings accounts of different currencies. The proposed copula-based approach allows to split market risk into general and specific market risk, as de fied in regulatory documents. The paper demonstrates that the approach performs clearly better than the Risk Metrics approach.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"48 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132800288","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper uses data on 1542 board committees and director compensation in a sample of 352 Fortune 500 companies in 1998 to analyze variation in board behavior. I use this data to quantify the amount of effort boards devote to their three different functions: monitoring, dealing with strategic issues and considering the interests of stakeholders. I show that boards appear to take their traditional oversight role seriously, since on average boards devote effort primarily to monitoring. However, there is a fair amount of variation across firms in the amount of effort boards devote to their different functions. In particular boards of larger firms and firms that face more uncertainty devote relatively less effort to monitoring, while boards of diversified firms devote relatively more effort to monitoring. Boards of larger, growing and older firms devote more effort to stakeholder interests on both an absolute and a relative basis. Finally, boards of growing firms devote relatively more effort to strategic issues.
{"title":"What Do Boards Do? Evidence from Board Committee and Director Compensation Data","authors":"Renée B. Adams","doi":"10.2139/ssrn.397401","DOIUrl":"https://doi.org/10.2139/ssrn.397401","url":null,"abstract":"This paper uses data on 1542 board committees and director compensation in a sample of 352 Fortune 500 companies in 1998 to analyze variation in board behavior. I use this data to quantify the amount of effort boards devote to their three different functions: monitoring, dealing with strategic issues and considering the interests of stakeholders. I show that boards appear to take their traditional oversight role seriously, since on average boards devote effort primarily to monitoring. However, there is a fair amount of variation across firms in the amount of effort boards devote to their different functions. In particular boards of larger firms and firms that face more uncertainty devote relatively less effort to monitoring, while boards of diversified firms devote relatively more effort to monitoring. Boards of larger, growing and older firms devote more effort to stakeholder interests on both an absolute and a relative basis. Finally, boards of growing firms devote relatively more effort to strategic issues.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"6 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2003-03-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130740273","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2003-01-01DOI: 10.1108/02652320310498447
Parmendra Sharma, Mahendra Reddy
Driven by higher profit incentives, banks’ marketing strategies have tended increasingly to exclude sections of the retail market on socio‐economic lines. Ironically, these strategies are now seen to have profitability and social responsibility implications. Little previous attempt has been made to quantify the relationship between bank service access and the determinants that act as deterrents, to improve general understanding of the extent of exclusionary influence of each determinant and the relevant implications. This study examines quantified relationships using the Probit model and data collected through primary research from a developing economy in the Asia Pacific region. Results show that bank‐driven pricing strategies may have an overriding effect on other factors. The analysis demonstrates that profits may be increased, socio‐economic exclusionary effects reduced and social image improved by voluntarily reconsidering pricing and other bank‐driven exclusionary strategies.
{"title":"Empirical Modelling of Bank Market Exclusion","authors":"Parmendra Sharma, Mahendra Reddy","doi":"10.1108/02652320310498447","DOIUrl":"https://doi.org/10.1108/02652320310498447","url":null,"abstract":"Driven by higher profit incentives, banks’ marketing strategies have tended increasingly to exclude sections of the retail market on socio‐economic lines. Ironically, these strategies are now seen to have profitability and social responsibility implications. Little previous attempt has been made to quantify the relationship between bank service access and the determinants that act as deterrents, to improve general understanding of the extent of exclusionary influence of each determinant and the relevant implications. This study examines quantified relationships using the Probit model and data collected through primary research from a developing economy in the Asia Pacific region. Results show that bank‐driven pricing strategies may have an overriding effect on other factors. The analysis demonstrates that profits may be increased, socio‐economic exclusionary effects reduced and social image improved by voluntarily reconsidering pricing and other bank‐driven exclusionary strategies.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"53 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2003-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132739014","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper employs a Generalized Autoregressive Conditional Heteroskedasticity in Mean (GARCH-M) model to consider the effect of macroeconomic factors on Australian property returns over the period 1985 to 2002. Three direct (office, retail and industrial property) and two indirect (listed property trust and property stock) returns are included in the analysis, along with market returns, short, medium and long-term interest rates, expected and unexpected inflation, construction activity and industrial employment and production. In general, the macroeconomic factors examined are found to be significant risk factors in Australian commercial property returns. However, the results also indicate that forecast accuracy in these models is higher for direct office, listed property trust and property stock returns and that the persistence of volatility shocks varies across the different markets, with volatility half lives of between five and seven months for direct retail and industrial property, two and three months for direct office property and less than two months with both forms of indirect property investment.
{"title":"The Usefulness of Economic Value-Added in the Australian Context","authors":"Tracey West, A. Worthington","doi":"10.2139/ssrn.2128981","DOIUrl":"https://doi.org/10.2139/ssrn.2128981","url":null,"abstract":"This paper employs a Generalized Autoregressive Conditional Heteroskedasticity in Mean (GARCH-M) model to consider the effect of macroeconomic factors on Australian property returns over the period 1985 to 2002. Three direct (office, retail and industrial property) and two indirect (listed property trust and property stock) returns are included in the analysis, along with market returns, short, medium and long-term interest rates, expected and unexpected inflation, construction activity and industrial employment and production. In general, the macroeconomic factors examined are found to be significant risk factors in Australian commercial property returns. However, the results also indicate that forecast accuracy in these models is higher for direct office, listed property trust and property stock returns and that the persistence of volatility shocks varies across the different markets, with volatility half lives of between five and seven months for direct retail and industrial property, two and three months for direct office property and less than two months with both forms of indirect property investment.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"6 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"1999-05-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124360399","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A body of evidence accumulated over the past several years, via different methods and estimation techniques, using firm–and household–level data, across many regions and countries show that finance matters for growth. Yet the role of finance in fostering growth in the Pacific, ironically, a region in dire need of sustainable growth and development, continues to appear less important, possibly for the reason that the relationship in the case of the region is not properly understood, due in turn to perhaps a lack of systematic empirical evidence. This study provides a first cross–country insight into the finance–growth nexus in the Pacific. Results, using balanced panel data extending 25 years, and the dynamic Generalised Method of Moments (GMM) estimation technique, show that finance is likely to matter for growth in the small, open Pacific Island Countries as well. Our findings strengthen the growing finance–growth literature, further alleviate scepticisms that may arise from shortcomings of different methods and estimation techniques, and have important policy implications for the Pacific.
{"title":"Does Finance Matter for Growth in the Small, Open Pacific Island Countries?","authors":"Parmendra Sharma, Neelesh Gounder","doi":"10.2139/ssrn.2204288","DOIUrl":"https://doi.org/10.2139/ssrn.2204288","url":null,"abstract":"A body of evidence accumulated over the past several years, via different methods and estimation techniques, using firm–and household–level data, across many regions and countries show that finance matters for growth. Yet the role of finance in fostering growth in the Pacific, ironically, a region in dire need of sustainable growth and development, continues to appear less important, possibly for the reason that the relationship in the case of the region is not properly understood, due in turn to perhaps a lack of systematic empirical evidence. This study provides a first cross–country insight into the finance–growth nexus in the Pacific. Results, using balanced panel data extending 25 years, and the dynamic Generalised Method of Moments (GMM) estimation technique, show that finance is likely to matter for growth in the small, open Pacific Island Countries as well. Our findings strengthen the growing finance–growth literature, further alleviate scepticisms that may arise from shortcomings of different methods and estimation techniques, and have important policy implications for the Pacific.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"7 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"1900-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126748501","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
With increasing pressure on firms to deliver shareholder value, there has been a renewed emphasis on devising measures of corporate financial performance and incentive compensation plans that encourage managers to increase shareholder wealth. One professedly recent innovation in the field of internal and external performance measurement is a trade‐marked variant of residual income known as economic value‐added (EVA). This paper attempts to provide a synoptic survey of EVA's conceptual underpinnings and the comparatively few empirical analyses of value‐added performance measures. Special attention is given to the GAAP‐related accounting adjustments involved in EVA‐type calculations.
{"title":"Economic Value-Added: A Review of the Theoretical and Empirical Literature","authors":"A. Worthington, Tracey West","doi":"10.1108/EB060736","DOIUrl":"https://doi.org/10.1108/EB060736","url":null,"abstract":"With increasing pressure on firms to deliver shareholder value, there has been a renewed emphasis on devising measures of corporate financial performance and incentive compensation plans that encourage managers to increase shareholder wealth. One professedly recent innovation in the field of internal and external performance measurement is a trade‐marked variant of residual income known as economic value‐added (EVA). This paper attempts to provide a synoptic survey of EVA's conceptual underpinnings and the comparatively few empirical analyses of value‐added performance measures. Special attention is given to the GAAP‐related accounting adjustments involved in EVA‐type calculations.","PeriodicalId":246130,"journal":{"name":"FIRN (Financial Research Network) Research Paper Series","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"1900-01-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129339273","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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