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Past Finance & Real Estate Seminar Series

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Volatility Risk and Expected Returns

Presented by Philippe Mueller, Warwick Business School and Paul Whelan is at Copenhagen Business School.

This paper studies the relationship between risk and expected returns. We show that while there is a weak positive relationship between return variance and expected returns, across stock and bond markets, the relationship between variance risk premia and expected returns is strong and can be summarised by a single factor: the spread between Treasury variance risk premia on a long dated bond versus a short dated bond.

A coskewness shrinkage approach for estimating the skewness of linear combinations of random variables

Presented by Kris Boudt, Vrije Universiteit Brussel

Decision making in business and economics often requires an accurate estimate of the coskewness matrix to optimize the allocation to random variables with asymmetric distributions. The classical sample estimator of the coskewness matrix performs
poorly in terms of mean squared error (MSE) when the sample size is small. A solution is to use shrinkage estimators, de ned as the convex combination between the sample coskewness matrix and a target matrix, with the aim of minimizing the MSE.
In this paper, we propose unbiased consistent estimators for the MSE loss function and include the possibility of having multiple target matrices. Simulations show that these improvements lead to a substantial reduction in the MSE when estimating the
third order comoment matrix of asymmetric distributions, as well as for the estimation of the skewness of a linear combination of random variables. In a nancial portfolio application, we nd that the proposed shrinkage coskewness estimators are e ective
in determining the linear combination with the highest expected utility.

The Negative Effects of Mergers and Acquisitions on the Value of Rivals

Presented by Philip Valta, University of Bern

Average stock price reactions of industry rivals in horizontal U.S. mergers and acquisitions around deal announcements are robustly negative. This finding is in contrast to the results in the existing literature, which focuses on smaller samples of deals involving mostly publicly listed firms. Rivals’ returns are more negative in growing and concentrated industries. Moreover, the negative rivals’ stock price reactions are related to future decreases in operating performance, increased probability of bankruptcy and challenges by antitrust authorities, and increased probability of rivals’ future acquisitions. Overall, these results suggest that M&As have strong competitive effects for the rivals of target companies.

The Sustainability Footprint of Institutional Investors

Presented by Philipp Krüger, University of Geneva and Swiss Finance Insitute

Little is known about the environmental and social (or sustainability) preferences of 13F institutional investors. In this paper, we propose a novel measure to quantify the portfolio-level sustainability of institutional investors. We show that portfolios of institutions with longer investment horizons exhibit higher sustainability and that risk-adjusted performance is positively related to sustainability, primarily through a reduction of portfolio risk. Using exogenous shocks to investor sustainability induced by natural disasters we provide evidence of a causal impact of sustainability on risk-adjusted performance. An instrumental variable strategy using geographic variation in constituency statutes further supports a causal interpretation of our results.

The Long-term Performance of IPOs, Revisited

Presented by Daniel Höchle, HES Nordwestschweiz, Basel

The literature on IPO long-term performance generally focuses on three- to five-year post-issue time horizons. Research published in the 2000s shows that the apparent underperformance of IPOs documented in the 1990s disappears when the different risk exposures between IPO and mature firms are accounted for by using a Carhart (1997) factor model. In this paper, we show that a sample of 7,487 U.S. IPOs between 1975 and 2014 continues to significantly underperform mature firms in terms of Carhart-alphas over two years, with underperformance peaking one year after going public. We apply a regression-based portfolio sorts approach (RPS), which allows to decompose the Carhart-alpha into firm-specific characteristics, to explain one-year IPO underperformance using a multitude of market and firm characteristics in a statistically robust setting. In fact, our RPS-model that augments the Carhart factors by a set of firm characteristics related to investments, internationality, liquidity, and leverage can explain IPO underperformance. We find similar results when using the Fama-French three-factor model or an augmented version of the Carhart model. We challenge our RPS-model by applying it to the most severely underperforming sub-samples in terms of firm size, time period, venture capital involvement, and IPO underpricing, and find it to explain IPO underperformance across all sub-samples.

Lobbying on Regulatory Enforcement Actions: Evidence from U.S. Commercial and Savings Banks

Presented by Thomas Lambert, Rotterdam School of Management

This paper analyzes the relationship between bank lobbying and supervisory decisions of regulators, and documents its moral hazard implications. Exploiting bank-level information on the universe of commercial and savings banks in the United States, I  find that regulators are 44.7 percent less likely to initiate enforcement actions against lobbying banks. This result is robust across measures of lobbying, and accounts for endogeneity concerns by employing instrumental variables strategies. In addition, I show that lobbying banks are riskier and reliably underperform their non-lobbying peers. Overall, these results appear rather inconsistent with an information-based explanation of bank lobbying, but consistent with the theory of regulatory capture.

A diagnostic criterion for approximate factor structure

Presented by Olivier Scaillet, University of Geneva & Swiss Finance Institute

We build a simple diagnostic criterion for approximate factor structure in large cross-sectional equity datasets. Given a model for asset returns with observable factors, the criterion checks whether the error terms are weakly cross-sectionally correlated or share at least one unobservable common factor. It only requires computing the largest eigenvalue of the empirical cross-sectional covariance matrix of the residuals of a large unbalanced panel. A general version of this criterion allows us to determine the number of omitted common factors. The panel data model accommodates both time-invariant and time-varying factor structures. The theory applies to random coefficient panel models with interactive fixed effects under large cross-section and time-series dimensions. The empirical analysis runs on monthly and quarterly returns for about ten thousand US stocks from January 1968 to December 2011 for several time-invariant and time-varying specifications. For monthly returns, we can choose either among
time-invariant specifications with at least four financial factors, or a scaled three-factor specification. For quarterly returns, we cannot select macroeconomic models without the market factor.

How Do Investors and Firms React to an Unexpected Currency Appreciation Shock?

Presented by Rüdiger Fahlenbrach, Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute

We examine the impact of a sudden home currency appreciation on the valuation and behavior of corporations in a developed economy. The Swiss National Bank surprisingly repealed the minimum exchange rate of 1.2 Swiss francs per Euro on January 15, 2015. On that day the franc appreciated by 15% and the main stock market index dropped by 8.7%. The impact was largest for export oriented firms with high domestic costs. These firms experienced 5% lower announcement returns, subsequently faced economically sizeable reductions in sales and profitability, and responded by reducing investment by 8.1% while only slightly reducing employment.

Factor-Based v. Industry-Based Asset Allocation: The Contest

Presented by Marie Brière, Amundi & Paris Dauphine University

Factor investing has emerged as the new paradigm for long-term investment. This paper organizes a multi-trial contest opposing factor investing and sector investing. The results suggest
that factor investing is the best strategy when short sales are permitted. When short-selling is forbidden, investors are typically better-off with the defensive opportunities of sector investing.
The contest reveals that there is a trade-off between the risk premia associated with factors and the diversification potential of sectors. Overall, factor investing keeps its promises, but it still has
a long way to go before it can oust sector investing.

The peer performance ratios of hedge funds

Presented by David Ardia, Institute of Financial Analysis, University of Neuchâtel, Neuchâtel, Switzerland

We propose to evaluate an investment fund’s performance by the percentage of peers the fund outperforms and underperforms, after correction for luck. We call these measures the fund’s outperformance ratio and underperformance ratio. When applied to hedge funds, we find that fund size tends to increase the underperformance ratio, but the effect is lower for funds with a longer track record. Our results also indicate that the outperformance ratio is a better predictor of future fund performance than alternative peer performance measures, and that, the best forecast performance is obtained when combining the outperformance ratio with a relative or peer alpha measure.

Forecasting the equity risk premium: The ups and the downs

Presented by Dimitrios Karyampas, ICMA Centre, University of Reading

Asset allocation is critically dependent on the ability to forecast the equity risk premium (ERP) out-of-sample. Constrained forecasting models have been recently introduced in order to improve the poor out-of-sample forecasting ability of macroeconomic variables like the dividend-price ratio. This paper critically investigates the nature of these constraints and their implications for dynamic asset allocation. Consistent with the existing evidence, such models improve the economic benefit for a mean-variance investor over a very long sample period (1947-2013). However, seen from a conditional viewpoint, we show that constrained models generate significant economic relative losses in periods of high volatility and market drawdowns, when it matters the most for asset allocators to retain assets and client base. Additionally, we find that risk-averse investors that face investment constraints –either by mandate or regulation– like short-selling or leverage constraints, can find little benefit in constrained ERP forecasting models, even across the business cycle. Our findings pose a significant challenge on the practical application of constrained ERP forecasting models and call for new model designs that actively incorporate some form of regime dependency.

Founding Family Ownership, Stock Market Performance and Agency Problems

Presented by Nicolas Eugster and Dušan Isakov, University of Fribourg

This paper explores the relationship between founding family ownership and stock market performance. Using a comprehensive sample of firms listed on the Swiss stock market over the period 2003-2013, we find that stock returns of family firms are significantly higher than those of non-family firms. Since families usually hold a large stake in the firm, we relate this result to the risk of potential expropriation faced by investors. This assumption is confirmed by the fact that the outperformance of family firms is related to the stake of the family. We also document that family firms tend to surprise the market more positively than other firms when they announce their earnings and that the magnitude of surprise is also related to the family stake. These results show that the abnormal stock returns of family firms can be explained by investors' skepticism and the fact that market participants are systematically positively surprised by firms where agency problems are potentially more severe.

Strategic Interaction between Hedge Funds and Prime Brokers

Presented by Nataliya Gerasimova and Eric Jondeau, University of Lausanne, Swiss Finance Institute

We develop a framework of strategic interaction between prime brokers and hedge funds. The hedge fund optimally determines its cash holdings and the fraction of shorted securities. The prime broker optimally determines its cash holdings, the margin rates, and the rehypothecation rate. The lending rate is determined at the equilibrium. Optimal decisions are obtained when the hedge fund and the prime broker maximize their expected return on equity. To do so, we describe how the evolution of the market return affects the equity of the hedge fund and may force it to delever or even default. As the eventual default of the hedge fund would severely affect the prime broker's performance, the broker tries to mitigate the risk induced by the fund by fixing the margin rates (or haircuts) it imposes to the hedge fund. We then explore the interaction between the hedge fund and the prime broker decisions by calibrating and solving our model for realistic parametrizations. We find that the interaction between the hedge fund and the prime broker may give rise to some undesirable implications such as an increase in overall risk and/or leverage.

Measuring House Price Bubbles, 31 May 2016

Presented by Martin E. Hoesli, Geneva Finance Research Institute and Swiss Finance Institute

Using data for six metropolitan housing markets in three countries, this paper provides a comparison of methods used to measure house price bubbles.  We use an asset pricing approach to identify bubble periods retrospectively and then compare those results with results produced by six other methods.  We also apply the various methods recursively to assess their ability to identify bubbles as they form.  In view of the complexity of the asset pricing approach, we conclude that a simple price-rent ratio measure is a reliable method both ex post and in real time.  Our results have important policy implications because a reliable signal that a bubble is forming could be used to avoid further house price increases.

Hedge Fund Portfolio Management with Illiquid Assets

Serges Darolles, University of Paris Dauphine, CREST ENSAE - 15 April 2016

We study hedge fund optimal portfolios in the presence of market and funding liquidity risks. We consider a two-period economy with a single hedge fund. The fund has access to cash which is available every period and to an illiquid asset which pays off only at the end of the second period. Funding liquidity risk takes the form of a random proportion of the fund's assets under management being withdrawn by clients in period one. The fund can then liquidate a part of the illiquid position by bidding on a secondary market where a random haircut on the effective selling price is applied. We solve the allocation problem of the fund and find its optimal portfolio. Whereas the cash buffer is monotonously decreasing in the secondary market liquidity, we show that the fund's default probability is bell-shaped. Finally, we apply our model in an asset pricing framework for different hedge fund strategies to see how both risks are priced over time.

Puzzles in Index Option Returns and Skewness Premium and Index Options Returns

Martin Wallmeier, University of Fribourg, 18 February 2016

For one-month S&P 500 index options, Constantinides, Jackwerth and Perrakis (2009) report widespread and substantial violations of stochastic dominance bounds. According to the subsequent study of Constantinides et al. (2011), the violations can be exploited to generate abnormal trading profits. The reported mispricing, which is far more extreme than known from the pricing kernel puzzle, calls into question that option markets meet the most basic requirements of rational pricing. We argue that this analysis is seriously flawed, and provide evidence that options on the S&P 500, EuroStoxx 50 and DAX index are priced almost perfectly in line with stochastic dominance bounds. Our results indicate that index option markets are much more efficient than previous literature suggests.

Learning Externalities in Opaque Asset Markets: Evidence from International Commercial Real Estate

Roland Fuess, University of St. Gallen, 21 January 2016

This paper uses a unique dataset to empirically test the implications of limited transparency in decentralized markets. We capture differences in the transparency level as a linkage mechanism among international commercial real estate markets. This connectivity arises from learning externalities of international investors. Our identification strategy exploits the specific feature of spatial econometrics to analyze the transmission of these externalities across opaque markets. We find empirical evidence of cross-sectional dependence and co-movements among global property market excess returns. Furthermore, local shocks are amplified via spillovers and feedback loops, which provide a source of instability in international property markets.