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"Posch, Peter N"
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How Do Investors Value Sustainability? A Utility-Based Preference Optimization
We investigate how an investor’s preference for sustainable assets in the portfolio varies for differing levels of risk aversion. Using a sample of 411 publicly listed firms in the S&P 500, we calculate financial and sustainability returns, on which the investor’s utility depends. We approximate the investor’s preference by the exponential and s-shaped utility function and optimize with regard to the sustainability preference. We find that with increasing levels of risk aversion, both minimum-variance and maximum Sharpe ratio type investors seek to incorporate sustainable assets in the portfolio.
Journal Article
Whale Watching on the Trading Floor: Unravelling Collusive Rogue Trading in Banks
Recent history reveals a series of rogue traders, jeopardizing their employers' assets and reputation. There have been instances of unauthorized acting in concert between traders, their supervisors and/or firms' decision makers and executives, resulting in collusive rogue trading. We explore organizational misbehaviour theory and explain three major collusive rogue trading events at National Australia Bank, JPMorgan with its London Whale and the interest reference rate manipulation/LIBOR scandal through a descriptive model of organizational/structural, individual and group forces. Our model draws conclusions on how banks can set up behavioural risk management and internal control frameworks to mitigate potential collusive rogue trading.
Journal Article
Detecting structural changes in large portfolios
Model-free tests for constant parameters often fail to detect structural changes in high dimensions. In practice, this corresponds to a portfolio with many assets and a reasonable long time series. We reduce the dimensionality of the problem by looking at a compressed panel of time series obtained by cluster analysis and the principal components of the data. With this procedure, we can extend tests for constant correlation matrix from a sub-portfolio to whole indices, which we exemplify using a major stock index.
Journal Article
Managing and trading sovereign risk using credit derivatives and government markets
Purpose
– The sovereign debt crisis in Europe increased the demand for asset manager worldwide to monitor and manage their sovereign risk. While using information from the credit derivatives and bond markets has been used widely in the corporate sector its usage for sovereign risk is novel. The paper aims to discuss these issues.
Design/methodology/approach
– The basis between a sovereign credit default swap (CDS) and the government bond contains valuable information for assets managers and traders alike. The paper demonstrates the use of the basis between the announcement date and the issue date of a new government bond to decide whether an investment in this bond is profitable.
Findings
– With this strategy, the authors are able to generate both over all excess returns with a European sovereign portfolio since 2008 as well as a constant outperformance of simple average euro government bond portfolios. The paper furthermore tests the economic rationale behind this trading strategy and confirms prior findings from the corporate market. CDS market liquidity is among the main driver and it follows that the CDS market is faster in anticipating risks than the bond market not only for corporate but also for sovereign entities.
Originality/value
– The authors are the first to study the sovereign basis in a sound trading and asset management environment. The paper provides economic explanations and checks for the robustness of the results before the primary issuance of a new government bond.
Journal Article
Value-based assessment of sovereign risk
Purpose
– The purpose of this paper is to introduce a methodology to evaluate sovereign risk. Hereby, a value-based approach using different market measures is introduced.
Design/methodology/approach
– This study’s approach aims to provide a value-based assessment of sovereign risk, combining market measures from government bond, credit derivatives and other markets as well as economic indicators.
Findings
– The study finds that the assessment of sovereign risk is only possible when using information from different markets and adjusting according to the information included in these measures. Combining both market-based and economic information leads to a value-based evaluation of sovereign risk.
Practical implications
– The practical implications are given for any institution with sovereign risk on their asset side. In fact, part of this research was done for the German Actuarial Foundation which uses the recommendations of this paper for the insurance industry.
Originality/value
– The study’s approach is novel because it is the first to include several market-based and economic measures of a sovereign and combines it into a value-based assessment.
Journal Article
Managerial behavior in fund tournaments—the impact of TrueSkill
Measuring mutual fund managers’ skills by Microsoft’s TrueSkill algorithm, we find highly skilled managers to behave self-confident resulting in higher risk-taking in the second half of the year compared to less skilled managers. Introducing the TrueSkill algorithm, which is widely used in the e-sports community, to this branch of literature, we can replicate previous findings and theories suggesting overconfidence for mid-years winners.
Journal Article
Wrong-way-risk in tails
With new regulations like the credit valuation adjustment, the assessment of wrong-way-risk is of utter importance. We analyse the effect of a counterparty’s credit risk and its influence on other asset classes (equity, currency, commodity and interest rate) in the event of extreme market movements like the counterparty’s default. With an extreme value approach, we model the tail of the joint distribution of different asset returns belonging to the above asset classes and counterparty credit risk indicated by changes in CDS spreads and calculate the effect on the expected shortfall when conditioning on counterparty credit risk. We find the conditional expected shortfall to be 2 to 440% higher than the unconditional expected shortfall depending on the asset class. Our results give insights both for risk management and for setting an initial margin for non-centrally cleared derivatives which becomes mandatory in the European Market Infrastructure Regulation.
Journal Article
Bail-in and asset encumbrance - Implications for banks’ asset liability management
In response to the financial crisis the European Union proposes bail-ins as a new regulatory instrument. For banks this mechanism affects the funding costs that now depend on the amount of assets under encumbrance. The bank’s optimal level of asset encumbrance, however, is not necessarily optimal for its senior unsecured investors. In a new simulation framework, we access the effects of the bail-in regulation and the effect on the costs of banks and investors. Analyzing major EU banks’ funding structure we find funding cost should be up to 49 basis points higher to reflect the increased risk for senior unsecured investors. On the other hand all banks of our sample could lower their overall cost level by up to 17 basis points by increasing the level of asset encumbrance.
Journal Article
Analysing digits for portfolio formation and index tracking
A general methodology is proposed for using digit distributions as an approach to examining arbitrary datasets. With the Newcomb-Benford law as a starting point, a more general framework for digital analysis is developed. A new measure is proposed based on this framework, namely the Digital-Fit Factor (DFF). The use of index comparison on the S&P500 and the Dow Jones Industrial Average is demonstrated. The DFF is then used to construct portfolios and measure their performance compared with that of the index. The average returns using the measure exceed the index composition by 6-14 percentage points per year by being more stable at the same time. Furthermore, these measures require only a very small proportion of the available information and are thus very efficient.
Journal Article