EDHEC Publications
Do Multiple Credit Ratings Signal Complexity? Evidence from the European Triple-A Structured Finance Securities
2014
In much of the current research on market practices with respect to the use of credit ratings, the rating shopping hypothesis and the information production hypothesis feature prominently. Both of these hypotheses predict an inverse relationship between the number of ratings and a security’s funding cost; that is, more ratings will reduce funding costs and, conversely, fewer ratings will increase funding costs. This study finds precisely the opposite to have been the case for the mainstay of the structured finance securities market in Europe prior to 2007, namely the triple-A tranches of...
Comparing Different Regulatory Measures to Control Stock Market Volatility: A General Equilibrium Analysis
2014
In this paper, we compare the effects of different regulatory measures used to reduce excess volatility of stock-market returns, which is generated by investors trading on sentiment. The regulatory measures we study are the Tobin tax, shortsale constraints, and leverage constraints. The main contribution of our research is to evaluate these regulatory measures within the same dynamic, stochastic general equilibrium model of a production economy, so that one can compare both the direct and indirect effects of the different measures on the financial and real sectors within the same economic...
Dynamic Liability-Driven Investing Strategies: The Emergence Of A New Investment Paradigm For Pension Funds? A Survey Of The LDI Practices For Pension Funds
2014
A number of profound changes have taken place, which have collectively led to the emergence of a new investment paradigm for pension funds. The standard paradigm for pension fund investments, which used to be firmly grounded around one overarching foundational concept of the policy portfolio, is slowly but surely being replaced by a new, more modern, investment paradigm known as the dynamic liability-driven investing (DLDI) paradigm. This new paradigm has two main defining characteristics: on the one hand, a focus on the management of portfolio risk relative to the liabilities, as opposed to...
Improved Risk Reporting With Factor-Based Diversification Measures
2014
This paper analyses various measures of portfolio diversification, and explores the implication in terms of advanced risk reporting techniques. We use the minimal linear torsion approach (Meucci et al. (2013)) to turn correlated constituents into uncorrelated factors, and focus on the effective number of (uncorrelated) bets (ENB), the entropy of the distribution of risk factor contribution to portfolio risk, as a meaningful measure of the degree of diversification in a portfolio. In an attempt to assess whether a relationship exists between the degree of diversification of a portfolio and its...
Why Haven't Weather Derivatives Been More Successful as Futures Contracts? A Case Study
2014
Why have some seemingly promising futures contracts not succeeded in the recent past? This paper examines one such example, the weather derivatives market. First, it provides a brief history of weather derivatives contracts as well as a description of these contracts. Next it reviews customised over-the-counter (OTC) weather derivatives contracts, as provided by reinsurers, and then it reviews why futures contracts are not as successful a method of risk transfer. Lastly, it describes how weather exposures do not sufficiently match up against the criteria for the successful launch of a futures...
Why Haven't Uranium Futures Contracts Succeeded? A Case Study
2014
Why have some seemingly promising futures contracts not succeeded in the recent past? This paper examines one such example, the uranium futures market. It first provides some background on the uranium futures contract as well as a description of this contract, and then notes how the uranium market does not sufficiently match up against the criteria for the successful launch of a futures contract.
Why Haven't Pulp Futures Contracts Succeeded? A Case Study
2014
Why have some seemingly promising futures contracts not succeeded in the recent past? This paper examines one such example, the pulp market, first summarising the individual attempts at launching pulp futures contracts, and then noting how the pulp markets match up (or not) against the various criteria for the successful launch of a futures contract. A revisited version of this paper was published in the Volume 4, Issue 4, 2015 issue of the Journal of Governance and Regulation.
Who Needs Inflation Hedging? A Quantitative Analysis Of The Benefits Of Inflation-Linked Bonds, Real Estate And Commodities For Long-Term Investors With Inflation-Linked Liabilities
2014
This paper proposes an empirical analysis of the opportunity gains (costs) involved in introducing (removing) various assets with attractive inflation-hedging properties for long-term investors facing inflation-linked liabilities. Using formal intertemporal spanning tests, we find that interest rate risk dominates inflation risk so dramatically within instantaneous liability risk that introducing or removing inflation-linked bonds, or real estate and commodities, from their liability-hedging portfolio has relatively little impact on investors’ welfare from a short-term perspective.
Discussion of the Central Bank of Ireland discussion paper on loan origination by investment funds
2013
The Central Bank of Ireland has issued a discussion paper on loan origination by investment funds, in which it suggests that developing alternative sources of financing to bank loans may be beneficial to the real economy but requires the careful consideration of the potential development of "shadow banking" risks. In this response to the discussion paper, we argue that the development of alternative sources of financing is most relevant with regards to long-term private debt, in particular the financing of SMEs and infrastructure projects. The demand for such financing has been identified as...
Challenges Facing Commodity Futures Market Participants: The Anti-Speculation Cycle, the RORO Environment, and Position Limits
2013
Professor Scott Irwin of the University of Illinois has argued that there is a reasonably predictable “anti-speculation cycle” due to periodic bouts of inflation and deflation in commodity prices. Therefore, market participants have an obligation to periodically explain the economic role of futures trading and the role of speculators in these markets. This will be the main task of this article. In addition, this article will discuss two other challenges facing market participants: the impact of the Risk On / Risk Off (RORO) environment in managing commodity risk, and the prospects for the...
Commodity Strategies Based on Momentum, Term Structure and Idiosyncratic Volatility
2013
This article demonstrates that momentum, term structure and idiosyncratic volatility signals in commodity futures markets are not overlapping, which motivates the design of a new triple-screen strategy. Over the period between January 1985 and August 2011, systematically buying contracts with high past performance, high roll-yield and low idiosyncratic volatility, while shorting contracts with poor past performance, low roll-yields and high idiosyncratic volatility generates an average Sharpe ratio that is five times that of the S&P-GSCI. The triple-screen strategy dominates each of the...
Analysing Statistical Robustness of Cross-Sectional Volatility
2013
This paper proposes a robust method of estimation which is intuitive and is functionally similar to the weighted-average estimator studied by Garcia, Mantilla-Garcia and Martellini (2013) in the context of one-factor and multi-factor regression models. To meet this objective, we adopt a statistical technique called M-estimation.
LTGA Impact Assessment and Bond Management: Has Solvency II reached a Deadlock?
2013
This study analyses the effect of the new LTGA spread risk calibration on bond management. The analysis is conducted comparatively to the QIS5 calibration in order to evaluate the potential contributions of the LTGA study, particularly with respect to the quality of the bond SCR risk measure and its impact on bond investment choices.
Commodity Position Limit Rules Should Be Based on a Finding of Necessity
2013
According to a Commodity Futures Trading Commission (CFTC) official, the CFTC will unveil new speculative commodity position limits soon. Energy Risk magazine reported that CFTC Commissioner Scott O’Malia had stated in mid-May that the rules should be released within the next six weeks. Energy Risk also noted that Commissioner O’Malia “appeared skeptical that the CFTC would be able to craft a rule that would survive further court scrutiny.” On 28 September 2012, a federal court had struck down the agency’s previous efforts to impose speculative position limits because the CFTC did not...
Scepticism About Commodity Futures Markets: An Answer
2013
This paper argues that commodity futures markets and its participants have an essential economic role. As such, the task of this paper is to explain why this is the case. Specifically, given the re-emergence of controversies over commodities trading, including in the oil markets, this paper will provide a basic primer on the following topics: the role of futures prices in revealing fundamental information on commodity markets, especially in the crude oil markets; the short-term interaction effect between traders and price; the economic role of hedgers and speculators in the commodity futures...
An Update on the Debate over Commodity Futures Position Limits
2013
On 28 September 2012 a federal judge struck down the U.S. Commodity Futures Trading Commission’s (CFTC’s) current iteration of federal position limits on holdings of commodity futures contracts. A month and a half later, the CFTC announced that the commission would appeal the court’s decision. At this time, therefore, the federally imposed position limits are in limbo.
The Local Volatility Factor For Asian Stock Markets
2013
The study finds strong evidence for a very significant local volatility factor in the Asian market index returns. In particular, the analysis reveals that the relationship between the Asian equity index returns and the Asian model-free option-implied (MFOI) volatility indices is significantly stronger than the relationship between Asian equity index returns and VIX. The analysis suggests either a weaker or insignificant relationship between the Asian equity market returns and the US VIX in the presence of Asian volatilities, implying that the Asian volatility indices can absorb the...
Analysing and Decomposing the Sources of Added-Value of Corporate Bonds Within Institutional Investors' Portfolios
2013
This paper provides a formal analysis of the benefits of corporate bonds in investors’ portfolios, distinguishing between the impact of introducing them in performance-seeking portfolios and the impact of introducing them in liability-hedging portfolios. It shows that investor welfare can be improved by the design of performance-seeking portfolios with improved liability-hedging properties, or conversely by the design of liability-hedging portfolios with improved performance properties.
Measuring infrastructure debt credit risk
2013
In this paper, the authors develop a framework to measure the credit risk of unlisted infrastructure debt, including the first formulation of "distance to default" in infrastructure project finance. The authors propose to use the debt service cover ratio (DSCR or the ratio of the firm's free cash flow to its debt service in a given period), which is routinely collected by project finance lenders, to measure and benchmark credit risk in infrastructure project finance.
Tail Risk Of Asian Markets: An Extreme Value Theory Approach
2013
This paper aims to draw inference about the tail behaviour of different markets through the fitted parameters of a GARCH-EVT model, with an emphasis on Asian markets. The empirical results indicate that the tail thickness is time-varying but there is no regional structure in the tail risk across the different regions. The comparison of the in-sample and out-of-sample tail risk measures, however, reveals higher tail risk for Asian markets indicating that the key difference over the long run is in the levels of volatility rather than in the residual tail thickness. Our findings highlight the...
Optimal Hedging With Higher Moments
2013
This study proposes a utility-based framework for the determination of optimal hedge ratios that can allow for the impact of higher moments on hedging decisions. We examine the entire hyperbolic absolute risk aversion (HARA) family of utilities which include quadratic, logarithmic, power and exponential utility functions. We find that for both moderate and large spot (commodity) exposures, the performance of out-of-sample hedges constructed allowing for non-zero higher moments is better than the performance of the simpler OLS hedge ratio. A revisited version of this paper was published in the...
Stock Return Serial Dependence and Out-of-Sample Portfolio Performance
2013
This paper studies whether investors can exploit stock return serial dependence to improve the out-of-sample performance of their portfolios. To do this, it first shows that a vector-autoregressive (VAR) model estimated with ridge regression captures daily stock return serial dependence in a stable manner. Second, it characterizes (analytically and empirically) expected returns of VAR-based arbitrage portfolios, and shows that they compare favorably to those of existing arbitrage portfolios. Third, it evaluates the performance of VAR-based investment (positive-cost) portfolios. The paper...
The Trial-and-Error Development of the Chicago Futures Markets
2013
Financial professionals are well aware that the ongoing implementation of the Dodd-Frank Act may cause changes to market structure, including in the futures markets. Should market participants be concerned? The short answer is not necessarily, given that the history of U.S. futures trading is one of responding to constant adversity through innovation.
Momentum Strategies in Futures Markets and Trend-Following Funds
2013
In this paper, we rigorously establish a relationship between time-series momentum strategies in futures markets and commodity trading advisors (CTAs) and examine the question of capacity constraints in trend-following investing. First, we construct a very comprehensive set of time series momentum benchmark portfolios. Second, we provide evidence that CTAs follow time-series momentum strategies, by showing that such benchmark strategies have high explanatory power in the time-series of CTA index returns. Third, we do not find evidence of statistically significant capacity constraints based on...
Smart Beta 2.0
2013
This position paper seeks to draw the attention of investors to the risks of traditional smart beta equity indices and proposes a new approach to smart beta investing to take account of these risks. This new approach, referred to as “Smart Beta 2.0,” enables investors to measure and control the risks of their benchmark and revolutionises the offerings of advanced equity benchmarks.
Investment Solutions For East Asia's Pension Savings
2013
Two of the most commonplace stylised facts about East Asia have to do with pension issues: the region's population is ageing fast and its household sector has high savings rates. Both ideas are intuitively related: as demographic transitions occur, more individuals should save in preparation for their retirement. This paper examines the relationship between savings and retirement income in East Asia, defined as North-East Asia and Greater China (Japan, Korea, Taiwan, China and Hong Kong).
The Benefits of Sovereign, Municipal and Corporate Inflation-Linked Bonds in Long-Term Investment Decisions
2013
This paper proposes an empirical analysis of the opportunity gains involved in investing in inflation-linked bonds for long-term investors facing inflation-linked liabilities. Using formal intertemporal spanning tests, it finds that substantial welfare gains are obtained, especially over long-horizons. Introducing inflation-linked bonds allows investors to improve investor welfare because of their hedging and performance benefits; hence investors may attain the same welfare (risk-return trade-off) with a lower initial investment when inflation-linked bonds are available compared to investing...
Returns-Based Analyses of Hedge Funds
2013
This article discusses the state of the art in applying returns-based analyses to hedge funds. It pays particular attention to those hedge fund strategies where the use of derivatives and dynamic trading strategies can lead to highly asymmetric outcomes.
Implicit Options in Hedge Fund Products
2013
This article discusses the option-like exposures of a number of hedge fund strategies based on a review of the literature on the topic. Specifically, recent academic articles have argued that implicit options arise in hedge fund products due to a number of factors. Accordingly, it will briefly cover the investor preferences, risk-transfer function, and manager incentives that lead to the implicit optionality embedded in hedge fund products.
Related Securities and Equity Market Quality: The Case of CDS
2013
We document that the emergence of markets for single-name credit default swap (CDS) contracts adversely affects equity market quality. The finding that firms with traded CDS contracts on their debt have less liquid equity and less efficient stock prices is robust across a variety of market quality measures and to controlling for endogeneity. We analyse the potential mechanisms driving this result and find evidence consistent with negative trader-driven information spillovers that result from the introduction of CDS.
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About EDHEC
Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 15 business schools. Fully international and directly connected to the business world, EDHEC commands a strong reputation for research excellence and the ability to train entrepreneurs and managers capable of breaking new ground. EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses. The School’s teaching is inspired by its research work and a focus on “learning by doing”, all with the aim of equipping people with the skills to succeed in business.
