EDHEC Publications
Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry
2012
This paper concludes three years of research on better management of non-financial risks within the European fund management industry and puts forward a series of proposals to limit these risks which emerged during the 2007-2008 crisis and undermined the quality of the UCITS label.
A Fully Integrated Liquidity Market Risk Model
2012
Going beyond the simple bid—ask spread overlay for a particular value at risk, this paper introduces a framework that integrates liquidity risk, funding risk, and market risk. We overlay a whole distribution of liquidity uncertainty on future market risk scenarios and we allow the liquidity uncertainty to vary from one scenario to another, depending on the liquidation or funding policy implemented. The result is one easy-to-interpret, easy-to-implement formula for the total liquidity-plus-market-risk profit and loss distribution. A revisited version of this paper was published in the November...
Improving Risk Management in DC and Hybrid Pension Plans
2012
This short paper highlights the key conclusions of Amenc et al. (2012) regarding the best practices for managing risks in defined-contribution (DC) and hybrid plans.
Comparing First, Second and Third Generation Commodity Indices
2012
The rising interest of institutional investors for commodities since the early 2000s prompted remarkable financial engineering in the commodity index space which is now in its third generation. The purpose of this article is to review this evolution and to give an assessment of index performance.
The Risks of Volatility ETNs: A Recent Incident and Underlying Issues
2012
Getting volatility exposure has become easier for investors after the relatively recent introduction of volatility ETNs (exchange-traded notes) and volatility ETFs (exchange-traded funds) and some of these products have enjoyed a surge in popularity. This paper uses the recent crisis with TVIX – a volatility ETN – to underline important differences between ETNs and ETFs which appear to be at the source of the observed market distortion. A revisited version of this paper was published in the Fall 2013 issue of the Journal of Index Investing.
Who Sank the Boat? Response to the Finance Watch paper "Investing Not Betting"
2012
This EDHEC-Risk position paper specifically responds to a recent report by Finance Watch on regulatory proposals for commodity derivatives markets in Europe. The paper describes an alternative narrative for what caused the recent commodity price spikes and then notes what implications this narrative has for addressing Finance Watch’s µ regulatory proposals.
The Impact of Solvency II on Bond Management
2012
Solvency II, which could come into effect in 2016, will have a significant impact on the way insurance companies, as well as financial markets, perceive risk. One of the major changes with Solvency II is the treatment of market risks, which represent an additional capital cost that now needs to be incorporated into the analysis of insurers’ investment choices. This study analyses the impact of the new prudential regulation on bond management. It considers the appropriateness of the bond Solvency Capital Requirement (SCR) as a risk measure, the effects of this risk measure on bond management...
Long-Term Investing Strategies In Private Wealth Management
2012
This paper argues that improved long-term investing strategies can be designed for private wealth management. These dynamic allocation strategies exploit the presence of mean-reversion in interest rates, equity Sharpe ratio and equity volatility. The resulting asset allocation strategy is based on an industrialisation of three key paradigms that have recently emerged in institutional money management: liability-driven investing (LDI), for taking into account private clients’ consumption objectives, life-cycle investing (LCI), for taking into account private clients’ horizon, and risk-control...
Robust Assessment of Hedge Fund Performance through Nonparametric Discounting
2012
This paper evaluates the performance of hedge funds through a new nonlinear risk adjustment of returns. The risk adjustment is such that it prices exactly the usual set of risk factors considered in the hedge fund literature. This nonlinear risk adjustment goes beyond the usual linear regression methodology used in many hedge fund performance papers, including nonlinear exposures based on option-like features. The approach proposed in this paper overcomes two important limitations of the linear methodology: it captures the nonlinear exposure of a hedge fund strategy to several risk factors,...
Seeing through the Smoke Screen of Fundamental Indexers: What are the Issues with Alternative Equity Index Strategies?
2012
With an ever-growing number of alternative index construction methods on offer, investors should, in principle, be thankful for comparative analysis. Such comparison has recently been provided in several articles written by promoters of fundamentally-based equity indices.
EDHEC-Risk North American Index Survey 2011
2012
As the choice of an index is a crucial step in both asset allocation and performance measurement, it is useful to investigate index use and perceptions about indices. The EDHEC-Risk North American Index Survey 2011 aims to analyse the current uses of and opinions on stock, bond and equity volatility indices. While information on index vehicles is widely available, particularly in the case of exchange-traded vehicles, the objective of the survey is to provide unique insight into the users’ perspective in the index industry, not only including a description of the current practices, but also...
Improving Time-Series Momentum Strategies: The Role of Trading Signals and Volatility Estimators
2012
Constructing a time-series momentum strategy involves the volatility-adjusted aggregation of univariate strategies and therefore relies heavily on the efficiency of the volatility estimator and on the quality of the momentum trading signal. Using a dataset with intra-day quotes of 12 futures contracts from November 1999 to October 2009, we investigate these dependencies and their relation to time-series momentum profitability and reach a number of novel findings.
Executive Stock Options as a Screening Mechanism
2012
The finance literature has shown that option grants can help to screen out low-ability executives. In this paper we develop a framework that allows us to analyse when options are likely to be optimal for this purpose. We consider a dynamic setting with asymmetric information, in which risk-neutral firms hire risk-averse executives who can exercise costly effort and choose among a menu of risky projects. We show that the likelihood of using options increases with the dispersion of types and the size of the firm, and decreases with the availability of growth opportunities for the firm.
Revisiting Mutual Fund Performance Evaluation
2012
Mutual fund manager excess performance should be measured relative to their self-reported benchmark rather than the return of a passive portfolio with the same risk characteristics. Ignoring the self-reported benchmark results in different measurement of stock selection and timing components of excess performance. This paper revisits baseline empirical evidence in mutual fund performance evaluation utilising stock selection and timing measures that incorporate the self-reported benchmark.
Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks”
2012
EDHEC-Risk Institute has conducted extensive research into advanced debt management practices, including a study on the possibility of increasing firm value through the issuance of an optimal level of inflation-linked bonds, which would allow for a reduction in the variability of cash flows, net of debt costs.
The Benefits of Volatility Derivatives in Equity Portfolio Management
2012
The focus of this paper is to provide a formal analysis of the benefits of volatility derivatives in equity portfolio management from the perspective of a European investor. Its main contribution is to compare the risk/return characteristic of equity portfolios combined with long volatility exposure to those of a GMV equity portfolio – the conventional approach to managing equity volatility. This paper is in fact the first to provide an explicit comparison of managed volatility strategies based on GMV portfolios and managed volatility strategies based on volatility derivatives. The results...
New 'Stylised facts' about Hedge Funds and Database Selection Bias
2012
This paper presents new stylized facts about hedge fund performance and database selection biases based on a novel database aggregation. By highlighting economically important effects of database selection bias on previously documented results we aim to improve the ability of researchers in this literature to compare results across different studies. We carefully motivate and test a set of eight hypotheses regarding the impact of database selection biases on stylised facts.
Revisiting Core-Satellite Investing - A Dynamic Model of Relative Risk Management
2012
Tracking error is not necessarily bad. Just like with good and bad cholesterol, there is “good” tracking error, which refers to out-performance of a portfolio with respect to the benchmark, and “bad” tracking error, which refers to underperformance with respect to the benchmark. By severely restricting the amounts invested in active strategies as a result of tight tracking error constraints, investors forgo an opportunity for significant out-performance, especially during market downturns. In this paper, the authors introduce a new methodology that allows investors to gain full access to good...
EDHEC-Risk Asian Index Survey 2011
2012
This is the first comprehensive survey of Asian investment professionals that identifies the criteria investors use to assess and select stock and bond indices, measures satisfaction of Asian investors with existing indices, and documents their segmentation practices. It includes comparisons with results from sister surveys of European and North-American investors. This new survey-based evidence will be useful to Asian investors who wish to benchmark their indexation practices to research advances as well as to the practices of their peers in the region and globally. It will also provide much...
Stock Return Predictability of Cross-Market Deviations in Option Prices and Credit Default Swap Spreads
2012
Cross-market deviations in (deep out-of-the-money) equity put option prices and credit default swap spreads of the same firm are temporary and predict future movements in the put options and credit default swaps (Carr and Wu, 2011). We document that these deviations are only temporary and the prices of the two insurance contracts revert to their usual level shortly after they occur, on average within about one week. The process of reversion involves changes in the CDS and the equity option, and, as we show for the first time, also involves largely predictable changes in the equity values of...
Inferring the Value of Intangible Assets
2012
This paper examines whether financial statement analysis can be effective in inferring the intangible value of firms. It measures the intangible value by means of a firm’s Intellectual Capital, which encompasses the intangible assets and the organizational knowledge of a firm that are not reported directly by financial statements. Our analysis decomposes Intellectual Capital into its three primary components: Human Capital, Structural Capital, and Relational Capital.
Optimal Market Estimates of French Office Property Performance
2012
In the world of institutional investment, the performance of the office property sector has traditionally been valued using indices constructed from appraisal values, rather than values derived from transactions. These indices constructed from appraised values are obtained by gathering in a single database property experts’ valuations of the largest possible number of institutional portfolios invested in office properties. This analysis is carried out in a comprehensive manner so as to diversify away the idiosyncratic risk of each property. Appraisals requiring a lot of information and...
Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios?
2012
This paper compares the performance of equal-, value-, and price-weighted portfolios of stocks in the major U.S. equity indices over the last four decades. It finds that the equal-weighted portfolio with monthly rebalancing outperforms the value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return, even though the equal-weighted portfolio has greater portfolio risk.
Performance of Socially Responsible Investment Funds against an Efficient SRI Index: The Impact of Benchmark Choice when Evaluating Active Managers - An Update
2012
This paper conducts a performance measurement of SRI funds and assesses the impact of changing the reference from a standard SRI index to an efficient SRI index. The analysis of fund performance shows that an efficient SRI index raises the bar for actively managed SRI funds. While about 62% of funds have a positive information ratio when compared to the cap-weighted EuroStoxx Sustainability Index, only about 36% of funds do so with respect to the Efficient SRI Index. It is also interesting to note that the median information ratio across funds is slightly positive (0.04) when using the...
What Asset-Liability Management Strategy For Sovereign Wealth Funds?
2012
This publication presents the industry reactions to an EDHEC-Risk Institute study entitled “Asset-Liability Management Decisions for Sovereign Wealth Funds”. That study put forward a model to optimise the investment and risk management practices of sovereign wealth funds, which can be regarded as the extension to sovereign wealth funds of the liability-driven investing paradigm recently developed in the pension fund industry. The model suggested that the investment strategy of a sovereign wealth fund should involve a state-dependent allocation to three main building blocks: a performance-...
The EDHEC European ETF Survey 2011
2012
The EDHEC European ETF Survey 2011 presents the results of a comprehensive survey of 174 institutional investment managers and private wealth managers. In addition to analysing ETF investment, the survey sheds light on the role of ETFs in asset allocation and compares ETFs and other investment products traditionally used as indexing vehicles – namely futures, index funds and total return swaps.
Shifting Towards Hybrid Pension Systems: A European Perspective
2012
This paper examines recent developments and the major risks of retirement systems, from both the sponsor and pension risk perspective, while focusing on European pension schemes. The study looks at plan design and governance, with the aim of moving towards an ideal retirement plan, and analyses the challenges for the financial management of hybrid pension plans.
Commodity Futures Returns and Idiosyncratic Volatility
2012
This paper studies the relationship between idiosyncratic volatility and expected returns in commodity futures markets. Measuring idiosyncratic volatility relative to traditional pricing models that fail to account for backwardation and contango leads to the puzzling conclusion that idiosyncratic volatility is negatively priced. In sharp contrast, idiosyncratic volatility is not priced when the fundamental backwardation and contango cycle of commodity futures markets is factored in an appropriate benchmark. Further evidence suggests that the idiosyncratic volatility inferred from traditional...
Pension Fund Investment in Social Infrastructure: Insights from the 2012 reform of the private finance initiative in the United Kingdom
2012
In February 2012, EDHEC-Risk Institute responded to the UK Treasury’s Call for Evidence about the reform of the Private Finance Initiative (PFI) with a particular reference to the opportunity for pension funds to invest in infrastructure assets, which the UK Treasury has earmarked as a priority theme. In this publication, we extend our response to the issues relating to pension fund investment in social µ infrastructure.
Dynamic Investment Strategies For Corporate Pension Funds In The Presence Of Sponsor Risk
2012
This paper aims to go beyond simple forms of dynamic strategies, and to show that more sophisticated dynamic allocation strategies could usefully be implemented by pension funds. For instance, it shows that imposing a cap on the funding ratio, in addition to a floor, has a positive impact on both pensioners and bondholders, while only having a minor negative effect on equity value. The paper also introduces novel forms of dynamic strategies that recognise that pension risk is not only driven by the funding ratio of the pension fund, but also by the financial strength or weakness of the...
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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.
