Roger M. Stein Volume 10, Number 4, Fourth Quarter 2012 In this article, we outline some concepts relating to the use of stress testing in credit risk management. We begin by providing a simple taxonomy of stress scenarios and discussing the trade-offs that different approaches require for implementation. Our taxonomy is modeled after one that… Read more
Articles
The Controversy in Fundamental Indexation: Why Both Sides of the Argument are (Mostly) Correct
Michael Dempsey Volume 10, Number 4, Fourth Quarter 2012 We examine the contribution of noise to the theoretical underpinnings of Fundamental Indexation (FI). Although we argue that market capital-weighted indexes do not incur a structural drag due to noise as claimed by the proponents of FI, we conclude, nevertheless, that noise as advanced by FI… Read more
Coherent Asset Allocation and Diversification in the Presence of Stress Events
Riccardo Rebonato and Alexander Denev Volume 10, Number 4, Fourth Quarter 2012 We propose a method to integrate frequentist and subjective probabilities in order to obtain a coherent asset allocation in the presence of stress events. Our working assumption is that in normal market asset returns are sufficiently regular for frequentist statistical techniques to identify… Read more
Portfolio Monitoring In Theory and Practice
Richard O. Michaud, David N. Esch and Robert O. Michaud Volume 10, Number 4, Fourth Quarter 2012 The when-to-trade decision is a critical yet neglected component of modern asset management. Typical rebalancing rules are based on suboptimal heuristics. Rebalancing is necessarily a statistical similarity test between current and proposed optimal portfolios. Available tests ignore many… Read more
A New Perspective on the Validity of the CAPM: Still Alive and Well
Moshe Levy and Richard Roll Volume 10, Number 3, Third Quarter 2012 The Capital Asset Pricing Model (CAPM) has far-reaching practical implications for both investors and corporate managers. The model implies that the market portfolio is mean-variance efficient, and thus advocates passive investment. It also provides the most widely used measure of risk, beta, which… Read more
Estimating the Negative Impact of “Noise” on the Returns of Cap-Weighted Portfolios In Various Segments of the Equity Markets
Russell J. Fuller, Bing Han and Yining Tung Volume 10, Number 3, Third Quarter 2012 Capital Market Theory assumes that the ex ante market portfolio (which is cap-weighted) lies on the (ex ante) efficient frontier. However, we show that ex ante cap-weighted portfolios will always be interior portfolios relative to the end-of-investment-period ex post efficient… Read more
The Relative Strength of Industries versus Countries in Global Equity Markets
Jose Menchero and Andrei Morozov Volume 10, Number 3, Third Quarter 2012 The relative strength of industries versus countries is of great practical interest for global equity investors. In this article, we investigate the relative strength of these effects in the global equity markets over the sample period 1994-2010. In particular, we examine three market… Read more
How Does Your State Stack Up? Participation Costs in Higher Education Optional Retirement Plans
Daniel Bradley and Lei Wedge Volume 10, Number 3, Third Quarter 2012 We examine the costs to higher education employees investing in optional retirement plans (ORP). We find vast differences across states in terms of the number of providers, number of funds offered per provider, and fees. We find the same provider offering the same… Read more
Redemption Fees and the Risk-Adjusted Performance of International Equity Mutual Funds
Iuliana Ismailescu and Matthew Morey Volume 10, Number 3, Third Quarter 2012 In the wake of the market timing and late trading mutual fund scandals, many mutual funds adopted redemption fees to limit market timing. In this paper we investigate the impact of redemption fees on the risk-adjusted performance of U.S. based international equity funds… Read more
The Downside of High Water Marks: An Empirical Study
Sugata Ray Volume 10, Number 2, Second Quarter 2012 Using a large sample of hedge funds, I study the effects of the high water mark (HWM) on fund performance, risk, and fund closure. I find that as funds fall below the HWM, the standard deviation of future returns increases, the future expected Sharpe ratio decreases… Read more