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ABSTRACT: We study the importance of time-varying bond risk premia in a consumption and portfolio-choice problem for a life-cycle investor facing short-sales and borrowing constraints. Tilts in the optimal asset allocation in response to changes in bond risk premia exhibit pronounced life-cycle patterns. We find that the investor is willing to pay an annual fee up to 1% to implement a strategy that optimally conditions on prevailing bond risk premia in addition to her age and wealth. To solve our model, we extend recently developed simulation-based techniques to life-cycle problems featuring multiple state variables and multiple risky assets. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
Review of Financial Studies 01/2010; 23(2):741-780. · 4.75 Impact Factor
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ABSTRACT: We study the optimal consumption and portfolio choice problem over an individual's life-cycle taking into account annuity risk at retirement. Optimally, the investor allocates wealth at retirement to nominal, inflation-linked, and variable annuities and conditions this choice on the state of the economy. We also consider the case in which there are, either for behavioral or institutional reasons, limitations in the types of annuities that are available at retirement. Subsequently, we determine how the investor optimally anticipates annuitization before retirement. We find that i) using information on term structure variables and risk premia significantly improves the optimal annuity choice, ii) restricting the annuity menu to nominal or inflation-linked annuities is costly for both conservative and more aggressive investors, and iii) adjustments in the optimal investment strategy before retirement induced by the annuity demand due to inflation risk and time-varying risk premia are economically significant. This holds as well for sub-optimal annuity choices. The adjustment to hedge real interest rate risk is negligible. We estimate that the welfare costs of not taking these three factors into account at retirement are 9% for an individual with an average risk aversion ( = 5). Not hedging annuity risk before retirement causes an additional welfare costs between 1% and 13%, depending on the annuitization strategy implemented at retirement.
02/2006;
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ABSTRACT: The riskless nature in real terms of inflation-linked bonds has led to the conclusion that inflation-linked bonds should constitute a substantial part of the optimal investment portfolio of long-term investors. This conclusion is reached in models where investors do not receive labor income during the investment period. Since such an income stream is often indexed with inflation, labor income in itself constitutes an implicit holding of real bonds. As such, the optimal investment in inflation-linked bonds is substantially reduced. By extending recently developed simulation-based techniques, we are able to determine the optimal portfolio choice among inflation-linked bonds, nominal bonds, and stocks for investors endowed with an indexed stream of income. We find that the fraction invested in inflation-linked bonds is much smaller than reported in the literature, the duration of the optimal nominal bond portfolio is lengthened, and the utility gains of having access to inflation-linked bonds are substantially reduced. We investigate as well the robustness of our results to time-variation in bond risk premia, the riskiness of labor income, and correlation between labor income risk and financial risks. We find that especially accounting for time-variation in bond risk premia and correlation between labor income risk and financial risks is important for both optimal portfolios and the utility gains of having access to inflation-linked bonds.
02/2005;
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ABSTRACT: Taylor's [Taylor, J. (2003). Risk-taking behavior in mutual fund tournaments, Journal of Economic Behavior and Organisation 50, 373-383] extension of the tournament model of Brown et al. [Brown, K. C., Harlow, W. V., Starks, L. T. (1996). Of tournaments and temptations: An analysis of managerial incentives in the mutual fund industry, Journal of Finance 15, 85-110] proposes that using an exogenous (endogenous) benchmark, will induce losing (winning) managers to gamble. This presents two competing testable hypotheses that are investigated in the current study. We use a sample period covering 1989 to 2001 of Australian multi-sector growth funds. We apply the non-parametric Cross-Product Ratio methodology. Generally, we find evidence in support of Taylor's model.
Journal of Empirical Finance 01/2005; 12(1):127-137. · 0.84 Impact Factor
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ABSTRACT: A recent paper (Busse, 2001) presents new empirical evidence on the validity of the tournament hypothesis for the behavior of US mutual fund managers. This new evidence, based on daily observations of fund returns, contradicts previously published evidence based on monthly data (see, e.g., Brown, Harlow, and Starks, 1996). Busse (2001) provides two possible explanations for this conflicting evidence. On one hand, Busse (2001) argues that autocorrelation in daily fund returns biases volatility estimates used so far in the empirical tests of the tournament hypothesis. On the other hand, Busse (2001) notes that cross-dependencies in mutual fund returns invalidate the independence assumption underlying the standard statistical tests for the tournament hypothesis. When empirically accounting for either of these e#ects, Busse (2001) finds that the evidence in favor of the tournament hypothesis based on monthly fund returns disappears.
07/2004;
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ABSTRACT: This paper analyzes trading strategies which capture the various risk premiums that have been distinguished in futures markets. On the basis of a simple decomposition of futures returns, we show that the return on a short-term futures contract measures the spot-futures premium, while spreading strategies isolate the term premiums. Using a broad cross-section of futures markets and delivery horizons, we examine the components of futures risk premiums by means of passive trading strategies and active trading strategies which intend to exploit the predictable variation in futures returns. We find that passive strategies which capture the spot-futures premium do not yield abnormal returns, in contrast to passive spreading strategies which isolate the term premiums. The term structure of futures yields has strong explanatory power for both spot and term premiums, which can be exploited using active trading strategies that go long in low-yield markets and short in high-yield markets. The profitability of these yield-based trading strategies is not due to systematic risk. Furthermore, we find that spreading returns are predictable by net hedge demand observed in the past, which can be exploited by active trading. Finally, there is momentum in futures markets, but momentum strategies do not outperform benchmark portfolios.
04/2004;
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Journal of Empirical Finance 02/2004; 11(1):29-53. · 0.84 Impact Factor
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ABSTRACT: Performance persistence studies typically suffer from selection biases. As recently shown by Carhart [1997b] and Carpenter and Lynch [1998], standard methods of analysis on a survivorship free dataset still suffer from look-ahead bias. In this paper we show how one can easily correct for look-ahead bias using weights based on probit regx'essions.
08/2002;
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ABSTRACT: This paper tests whether hedging currency risk improves the performance of international stock portfolios. We show that an auxiliary regression provides a wealth of information about the optimal portfolio holdings for non mean-variance investors, analogous to the information provided by the Jensen regression about optimal portfolio holdings for the mean-variance case. We find that static hedging with currency forwards does not lead to significant improvements in portfolio performance for a US-Dollar based stock portfolio from the G5 countries, whereas dynamic hedges that are conditional on the interest rate spread do. These conclusions hold for both mean-variance and power utility investors and show up both in-sample and out-of-sample.
02/2002;
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ABSTRACT: We propose regression-based tests for mean-variance spanning in the case where investors face market frictions such as short sales constraints and transaction costs. We test whether U.S. investors can extend their efficient set by investing in emerging markets when accounting for such frictions. For the period after the major liberalizations in the emerging markets, we find strong evidence for diversification benefits when market frictions are excluded, but this evidence disappears when investors face short sales constraints or small transaction costs. Although simulations suggest that there is a possible small-sample bias, this bias appears to be too small to affect our conclusions. THE QUESTION OF WHETHER OR NOT an investor can extend his efficient set by including additional assets in his portfolio has recently received considerable attention in the literature. If extension of the efficient set is not possible for a specific mean-variance utility function, the mean-variance...
01/2002;
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ABSTRACT: Performance persistence studies typically suffer from ex-post conditioning biases. As stressed by Carhart [Carhart, M.M., 1997. Mutual Fund Survivorship, Working Paper, Marshall School of Business, U.S.C.] and Carpenter and Lynch [J. Financ. Econ. 54 (1999) 337.], standard methods of analysis on a survivorship free sample are subject to look-ahead biases. In this paper, we show how one can easily correct for look-ahead bias using weights based on probit regressions.First, we model how survival probabilities depend upon historical returns, fund age and aggregate economy-wide shocks, using two samples of US based ‘income’ and ‘growth’ funds. Subsequently, we employ a Monte Carlo study to analyze the size and shape of the look-ahead bias in performance persistence that arise when a survivorship free sample is used with standard techniques. In particular, we show that look-ahead bias induces a spurious U-shaped pattern in performance persistence. Finally, we demonstrate how a weighting procedure based upon probit regressions can be used to correct for this bias. In this way, we obtain look-ahead bias-corrected estimates of abnormal performance relative to a one-factor and the Carhart [J. Finan. 52 (1997) 57.] four-factor model, as well as its persistence. The results suggest that in this sample, look-ahead bias is of minor importance and does not seriously affect estimates of persistence. Our bias-corrected results closely correspond to the findings of Carhart [J. Finan. 52 (1997) 57.], implying that there is no evidence on a risk-adjusted basis for persistence in performance.
Journal of Empirical Finance 02/2001; · 0.84 Impact Factor
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ABSTRACT: In this paper we evaluate applications of (return based) style analysis. The portfolio and positivity constraints imposed by style analysis are useful in constructing mimicking portfolios without short positions. Such mimicking portfolios can be used, e.g., to construct ecient portfolios of mutual funds with desired factor loadings if the factor loadings in the underlying factor model are positively weighted portfolios. Under these conditions style analysis may also be used to determine a benchmark portfolio for performance measurement. Attribution of the returns on portfolios of which the actual composition is unobserved to specific asset classes on the basis of return based style analysis is attractive if moreover there are no additional cross exposures between the asset classes and if fund managers hold securities that on average have a beta of one relative to their own asset class. If such restrictions are not met, and in particular if the factor loadings do not generate a positiv...
09/2000;
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ABSTRACT: Poor performing mutual funds are less likely to be observed in the data sets that are typically available. This so-called survivor problem can induce a substantial bias in measures of the performance of the funds and the persistence of this performance. Many studies have recently argued that survivorship bias can be avoided by analyzing a sample that contains returns on each fund up to the period of disappearance using standard techniques. Such data sets are usually referred to as 'survivorship free'. In this paper we show that the use of standard methods of analysis on a 'survivorship free' data-set typically still suffers from a bias and we show how one can easily correct for this using weights based on probit regressions. Using a sample with quarterly returns on U.S. based equity funds, we first of all model how survival probabilities depend upon historical returns, the age of the fund and upon aggregate economy-wide shocks. Subsequently we employ a Monte Carlo study to analyze the size and shape of the survivorship bias in various performance measures that arise when a 'survivorship free database' is used with standard techniques. In particular, we show that survivorship bias induces a spurious U-shape pattern in performance persistence. Finally, we show how a weighting procedure based upon probit regressions can be used to correct for the bias. In this way, we obtain bias-corrected estimates of abnormal performance relative to a one-factor and the Carhart [1997] four-factor model, as well as its persistence. Our results are in accordance with the persistence pattern found by Carhart [1997], and do not support the existence of a hot hand phenomenon in mutual fund performance.
Katholieke Universiteit Leuven, Centrum voor Economische Studi�n, Center for Economic Studies - Discussion papers. 01/1998;
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ABSTRACT: In this paper, the authors develop a test for the hypothesis that a series (observed in discrete time) is generated by a diffusion process. This test is based on an overidentifying relation between variance and kurtosis parameters that holds for GARCH diffusions. The proposed test is not specific to a particular data frequency and clearly indicates the presence of jumps in dollar exchange rates. To assess the size and intensity of the jumps, the authors estimate a model containing both jumps and conditional heteroskedasticity.
Journal of Business and Economic Statistics 01/1998; 16(2):237-43. · 1.78 Impact Factor
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ABSTRACT: The authors derive low frequency, say weekly, models implied by high frequency, say daily, ARMA models with symmetric GARCH errors. They show that low frequency models exhibit conditional heteroskedasticity of the GARCH form as well. The parameters in the conditional variance equation of the low frequency model depend upon mean, variance, and kurtosis parameters of the corresponding high frequency model. Moreover, strongly consistent estimators of the parameters in the high frequency model can be derived from low frequency data. The common assumption in applications that rescaled innovations are independent is disputable, since it depends upon the available data frequency. Copyright 1993 by The Econometric Society.
Econometrica 01/1993; 61(4):909-27. · 2.98 Impact Factor
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ABSTRACT: This paper tests whether hedging currency risk improves the performance of international stock portfolios. We use both mean-variance and generalized performance measures which allow for investor-dependencies such as different utility functions. In addition we show that an auxiliary regression, similar to the Jensen regression, provides a wealth of information about the optimal portfolio holdings for investors for the non mean-variance case. This is analogous to the information provided by the Jensen regression about optimal portfolio holdings for the mean-variance case. Our empirical results show that static hedging with currency forwards or options does not lead to improvements in portfolio performance for a US investor that holds a stock portfolio from the G5 countries. On the other hand, hedges that are conditional on the current interest rate spread do lead to significant performance improvements. These conclusions hold for both mean-variance and power utility investors....
02/1970;
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ABSTRACT: We present a simple model implying that futures risk premia depend on both own-market and cross-market hedging pressures. Empirical evidence from 20 futures markets, divided into four groups (financial, agricultural, mineral, and currency) indicates that, after controlling for systematic risk, both the futures own hedging pressure and cross hedging pressures from within the group significantly affect futures returns. These effects remain significant after controlling for a measure of price pressure. Finally, we show that hedging pressure also contains explanatory power for returns on the underlying asset, as predicted by the model. 1 Futures prices are known to deviate from expected future spot prices because of risk premia that traders expect to earn (or pay) when trading in futures markets. Futures risk premia are important, because they affect the costs and benefits of hedging, as well as the diversification benefits that result from including futures in investment portfol...
02/1970;
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ABSTRACT: In this paper we analyze the use and implications of (return-based) style analysis. First, style analysis may be used to estimate the relevant factor exposures of a fund. We use a simple simulation experiment to show that imposing portfolio and positivity constraints in style analysis leads to significant efficiency gains if the factor loadings are indeed positively weighted portfolios, in particular when the factors have low cross-correlations. If this is not the case though, imposing the constraints can lead to biased exposure estimates. Second, style analysis may be used in performance measurement. If the actual factor exposures are a positively weighted portfolio and if the risk-free rate is one of the benchmarks, then the intercept coincides with the Jensen measure. In general, the intercept in the style regression can only be interpreted as a special case of the familiar Jensen measure. Third, style estimates may be compared with actual portfolio holdings. We show that the actual portfolio holdings will in general not reveal the actual investment style of a fund because of cross exposures between the asset classes and because fund managers may hold securities that on average do not have a beta of one relative to their own asset class. Although return-based style analysis is less suitable to predict future portfolio holdings, our empirical analysis suggests that it performs better than holding-based style analysis in predicting future fund returns.
Journal of Empirical Finance.
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ABSTRACT: In this paper, we present a survey on the various approaches that can be used to test whether the mean-variance frontier of a set of assets spans or intersects the frontier of a larger set of assets. We analyze the restrictions on the return distribution that are needed to have mean-variance spanning or intersection. The paper explores the duality between mean-variance frontiers and volatility bounds, analyzes regression-based test procedures for spanning and intersection, and shows how these regression-based tests are related to tests for mean-variance efficiency, performance measurement, optimal portfolio choice and specification error bounds.
Journal of Empirical Finance.
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ABSTRACT: We study a dynamic asset allocation problem over the investor's life-cycle taking into account annuity risk at the moment of retirement. Optimally, the investor allocates wealth at retirement to nominal, inflation-linked, and variable annuities and conditions the annuity choice on the state of the economy. We also consider the case in which there are, either for behavioral or institutional reasons, limitations in the types of annuities that are available at retirement. Subsequently, we determine how the investor optimally anticipates the retirement choice in the period before retirement. We show in particular that i) conditioning information is important for the optimal annuity choice, ii) additional hedging demands induced by the annuity demand due to inflation risk and time-varying risk premia are economically significant, while the additional demand to hedge real interest rate risk is negligible in welfare terms, and iii) restricting the annuity menu to nominal or inflation-linked annuities is costly for both conservative and more aggressive investors.
