EDHEC Publications
Assessing Misspecified Asset Pricing Models with Empirical Likelihood Estimators
2011
Hansen and Jagannathan (1997) compare misspecified asset pricing models based on least-square projections on a family of admissible stochastic discount factors. We extend their fundamental contribution by considering Minimum Discrepancy projections where misspecification is measured by a family of convex functions that take into account higher moments of asset returns. A revisited version of this paper was published in the October 2012 issue of the Journal of Econometrics.
Asset Allocation with Shadow Assets
2011
The wealth of most investors contains both financial assets as well as non-financial assets. This paper defines shadow assets as (mostly) non-financial and non-tradable assets that are exogenous to the investor’s asset allocation decision. Examples for shadow assets are human capital, non-financial sovereign assets (e.g. underground oil reserves) the present value of future alumni contributions for university endowments or the non-listed family business for the client of a family office. Allocations to these shadow assets can hardly be changed and yet their existence will change the investor’...
A Post-crisis Perspective on Diversification for Risk Management
2011
Since the global financial crisis of 2008, improving risk management practices—management of extreme risks, in particular—has been a hot topic. The postmodern quantitative techniques suggested as extensions of mean-variance analysis, however, exploit diversification as a general method. Although diversification is most effective in extracting risk premia over reasonably long investment horizons and is a key component of sound risk management, it is ill-suited for loss control in severe market downturns. Hedging and insurance are better suited for loss control over short horizons. In...
Case Studies and Risk Management in Commodity Derivatives Trading
2011
Until recently, one could only gain expertise in commodity-derivatives relationships if one had worked in niche commodity-processor companies or in banks that specialised in hedging project risk for natural-resource companies. The contribution of this article is to help fill the knowledge gap in the risk management of commodity derivatives trading.
Never the Twain Shall Meet? Addressing the Disconnect between Banks’ Financial and Regulatory Reporting
2011
This paper reviews the arguments for and against the decoupling of capital ratio calculations based on IFRS from those based on Basel II. We analyse recent trends in both accounting and regulatory supervision after the financial crisis and identify areas where there are still deficiencies in the transparency of IFRS-based financial reports and regulatory-based capital disclosures and calculations. We find that the variation in disclosure practices across IFRS and BIS-based capital estimations is significant for a sample of major European banks.
Giants at the Gate: On the Cross-Section of Private Equity Investment Returns
2011
This paper examines the determinants of private equity returns using a newly constructed worldwide database of 7,500 investments made over forty years. The median investment IRR (PME) is 21% (1.3), gross of fees. One in ten investments goes bankrupt, whereas one in four has an IRR above 50%. Only one in eight investments is held for less than two years, but such investments have the highest returns. The scale of private equity firms is a significant driver of returns: investments held at times of a high number of simultaneous investments underperform substantially.
Introducing a New Form of Volatility Index: The Cross-Sectional Volatility Index
2011
This paper introduces a new form of volatility index, the cross-sectional volatility index. Through formal central limit arguments, it shows that the cross-sectional dispersion of stock returns can be regarded as an efficient estimator for the average idiosyncratic volatility of stocks within the universe under consideration. Among the key advantages of the cross-sectional volatility index measure over currently available measures are its observability at any frequency, its model-free nature, and its availability for every region, sector, and style of the world equity markets, without the...
Diversification in Funds of Hedge Funds: Is it Possible to Overdiversify?
2011
Samuelson (1967) argues that as a general matter it is easy to show that investors should be maximally diversified. For this reason many institutions are attracted to diversified portfolios of hedge funds, referred to as Funds of Hedge Funds (FOFs). In this paper we examine a new database that separates out for the first time the effects of diversification (the number of underlying hedge funds) from scale (the magnitude of assets under management). We find with others that the variance reducing effects of diversification peter out once FOFs hold more than 20 underlying hedge funds. Yet the...
Media and Investment Management
2010
This paper measures the differential impact of alternative media outlets. We classify news items about equity hedge funds over 1999 to 2008 into three source groups: General newspapers, Specialized magazines, and Corporate Communication. Applying a textual analysis to news items, we uncover three types of media biases. First, a reporting style bias, that is, when a fund is covered by multiple sources at the same time, the sentiment is most positive in Corporate coverage and least in General coverage. The differences in source sentiment are more significant in cases of exclusive coverage,...
An Integrated Approach To Asset-Liability Management: Capital Structure Choices, Pension Fund Allocation Decisions And The Rational Pricing Of Liability Streams
2010
Correctly assessing the value of a pension plan in deficit with a weak sponsor company is a real challenge given that no comprehensive model is currently available for the joint quantitative analysis of capital structure choices, pension fund allocation decisions and their impact on rational pricing of liability streams.
EDHEC-Risk European Private Wealth Management Survey
2010
A survey drawing on responses from 159 European private wealth managers, the three main findings of which are: Private wealth managers see the relationships they forge with their clients as the principle source of the value they add but they fail to exploit this close relationship to customise the services they offer their clients (when portfolios are designed for clients, market factors are taken into account more frequently than are the individual characteristics of the clients); Private wealth managers fail, on the whole, to provide state-of-the art means of horizon-dependent asset...
Does Finance Theory Make the Case for Capitalisation- Weighted Indexing?
2010
Proponents of cap-weighted stock market indices often argue that such indices provide efficient risk/return portfolios. This paper reviews the evidence in the academic literature and concludes that only under very unrealistic assumptions would such indices be efficient investments. In the presence of realistic constraints and frictions, cap-weighted indices cannot, according to the academic literature, be expected to be efficient investments. A revisited version of this working paper was published in the Fall 2011 issue of the Journal of Index Investing.
Asset-Liability Management Decisions For Sovereign Wealth Funds
2010
This paper proposes a quantitative dynamic asset allocation framework for sovereign wealth funds, modelled as large long-term investors that manage fluctuating revenues typically emanating from budget or trade surpluses in the presence of stochastic investment opportunity sets. The optimal asset allocation strategy takes into account the stochastic features of the sovereign fund endowment process (where the money is coming from), the stochastic features of the sovereign fund's expected liability value (what the money is going to be used for), and the stochastic features of the assets held in...
Risk Reduction in Style Rotation
2010
This paper investigates the potential improvement in the implementation of style rotation strategies by techniques addressing estimation errors. We select two approaches that have recently stood out in the statistics and econometric literature and have been applied to portfolio construction literature. One builds on regularization methods which address estimation error by focusing on the weights of the constructed portfolios. And a second method that uses pooled forecasts obtained across different observation windows. Thus it focuses on minimizing estimation error in the moments of the return...
A Suggestion for Remedying the Overstated Performance of Non-Investable Hedge Fund Indices
2010
Investable indices tend to recursively underperform their non-investable versions. In light of recent events, we can wonder whether the liquidity crisis that occurred in the wake of the Lehman collapse and had a significant impact on the performance of hedge fund strategies (more particularly on the strategies that are exposed to credit risk) has increased this excess return or not. In this respect, it would be interesting to compare the excess returns of non-investable indices and those of their investable counterparts before and after 2008.
Alternative Measurement Bases in Pension Accounting: A Simulation Analysis
2010
This paper explores the financial statement implications of alternative measurement bases underlying defined benefit pension accounting rules via a simulation analysis. Simulation analysis can be used to examine the effect of alternative discount rate assumptions on the strength of associations between an economic or generational accounting basis, an actuarial funding basis of measurement and two alternative accounting measurement bases of pension assets and liabilities; value-in-use and value-in-exchange. Accounting measures are found to be more highly correlated with economic unfunded...
From Deterministic To Stochastic Life-Cycle Investing: Implications For The Design Of Improved Forms Of Target Date Funds
2010
In an attempt to address the concern over financially illiterate individuals being increasingly responsible for investment decisions related to retirement risk, the financial industry has started to design dedicated mutual fund products known as target date funds. These funds, whose aim is to provide investors with one-stop solutions to their life-cycle investment needs, typically propose a deterministic decrease of equity allocation until a date called the target date of the fund. This approach, however, has been found inconsistent with the prescriptions of standard life-cycle investment...
New Frontiers In Benchmarking And Liability-Driven Investing
2010
Meeting the challenges of modern investment practice involves the design of novel forms of investment solutions, as opposed to investment products, customised to meet investors' long-term objectives while respecting the short-term (regulatory or otherwise) constraints they have to face. This paper argues that such new forms of investment solutions should rely on the use of improved performance-seeking and liability-hedging building-block portfolios, as well as on the use of improved dynamic allocation strategies.
Optimal Hedge Fund Allocation with Improved Estimates for Coskewness and Cokurtosis Parameters
2010
Since hedge fund returns are not normally distributed, mean-variance optimisation techniques, which would lead to substantial welfare losses from the investor’s perspective, need to be replaced by optimisation procedures incorporating higher-order moments and comoments. In this context, optimal portfolio decisions involving hedge fund style allocation require not only estimates for covariance parameters but also estimates for coskewness and cokurtosis parameters. This is a formidable challenge that severely exacerbates the dimensionality problem already present with mean-variance analysis....
Do Funds of Hedge Funds Really Add Value: A Post-Crisis Analysis
2010
In spite of a somewhat disappointing performance throughout the crisis, and a series of high-profile scandals, investors are showing interest in hedge funds. Still, funds of hedge funds keep on experiencing outflows. Can this phenomenon be explained by the failure of fund of hedge fund managers to deliver on their promise to add value through active management, or is it symptomatic of a move toward greater disintermediation in the hedge fund industry? Little attention has been paid so far to the added value, and the sources of the added value, of funds of hedge funds. A revisited version of...
The Performance of Socially Responsible Investment and Sustainable Development in France: An Update after the Financial Crisis
2010
In an initial study done in 2008, EDHEC-Risk Institute established that socially responsible (SRI) funds—those funds made by selecting securities that meet ESG (environmental, social, governance) criteria—distributed in France did not produce both positive and statistically significant alpha. That study, which relied on the Fama-French three-factor model, covered a six-year period ending in December 2007, thus not including the recent financial crisis. The purpose of the present study was to update these results by extending the analysis to the years 2008 and 2009.
Banking on Liquidity: Liquidity, Collateral and Derivatives
2010
Changes in the nature and magnitude of banking activities over the past few decades are fundamental to comprehension of the failings that resulted in the financial crisis. The provision of financial risk management services and products by banks on the scale documented appears problematic. Derivatives contracts are the principal instruments used in financial risk management. The role and extent of liquidity and collateral security in facilitating these developments is investigated and policy recommendations advanced.
A Portfolio Approach to Venture Capital Financing
2010
This paper studies the contracting choices between an entrepreneur and venture capital investors in a portfolio context. We rely on the mean-variance framework and derive the optimal choices for an entrepreneur with and without the presence of different kinds of venture capitalists. In particular, we show that the entrepreneur always has the incentive to share the risk and benefits of the venture whenever possible. On the basis of their objectives and characteristics, we distinguish the situations of the corporate, independent, and bank-sponsored venture capital funds. Our framework enables...
A New Look At Minimum Variance Investing
2010
Disappointed with the performance of market-weighted benchmark portfolios yet skeptical about the merits of active portfolio management, investors in recent years turned to alternative index definitions. Minimum variance investing is one of these popular rule driven, i.e. new passive concepts. This paper shows theoretically and empirically that the portfolio construction process behind minimum variance investing implicitly picks up risk-based pricing anomalies. In other words the minimum variance tends to hold low beta and low residual risk stocks. Long/short portfolios based on these...
The Sophisticated and the Simple: The Profitability of Contrarian Strategies from a Portfolio Manager's Perspective
2010
Valuation signals have been among the most popular with equity portfolio managers and have recently attracted significant interest from cross-asset managers. Given a large variation of techniques and theories with regard to how value is measured, this paper investigates the efficacy of alternative value measures. It considers a cross-section of simple and sophisticated alternative measures and focuses on comparison metrics that are of primary interest for equity portfolio managers. A revisited version of this paper was published in the January 2014 issue of European Financial Management.
Strategic and Tactical Roles of Enhanced-Commodity Indices
2010
This article compares the risk and performance of two traditional commodity indices with enhanced long-only versions that exploit signals based on momentum, term structure and the time-to-maturity of the contracts. Regarding risk diversification and inflation hedging properties, the enhanced indices are as effective tools for strategic asset allocation as the traditional ones.
French Corporate Social Responsibility: Which Dimension Pays More?
2010
We use a sample of 148 events related to corporate social responsibility (CSR) to assess the impact of CSR on corporate financial performance. There is considerable heterogeneity in market reaction to different dimensions of CSR. Not all dimensions offer a positive reward; some yield a negative and even statistically significant impact on the firms’ stock returns. One main conclusion of this study is that socially responsible investment is not an excuse for passive management. There is still room for timing and stock picking within the socially responsible universe of stocks.
EDHEC Survey Of The Asset And Liability Management Practices Of European Pension Funds
2010
EDHEC-Risk Institute took a recent survey of pension funds, their advisers, regulators, and fund managers. One hundred twenty-nine of these asset/liability management (ALM) specialists, representing assets under management (AUM) of around €3 trillion, responded to the survey. Pension funds and their sponsors account for approximately €0.9 trillion.
The EDHEC European ETF Survey 2010
2010
The EDHEC European ETF Survey 2010 presents the results of a comprehensive survey of 192 institutional investors, asset managers and private wealth managers conducted between January and March 2010. It analyses the possible uses of ETFs (exchange-traded funds) in investment management and gives a detailed account of current perceptions and practices of European investors in ETFs.
Option Pricing and Hedging in the Presence of Cross-Hedge Risk
2010
This paper addresses the question of option pricing and hedging when the underlying asset is not available for dynamic trading, and some other asset is used as a substitute. It first provides an overview of the various hedging methodologies that can be used in this incomplete market setting, distinguishing between self-financing and non-self-financing strategies. Focussing on a local risk-minimization criterion, it presents an analytical expression for the optimal hedging strategy and the corresponding option price. It also provides a quantitative measure of the residual risk over the life of...
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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.
