Volume 2, No. 3, Third Quarter 2004
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Practitioner's Digest
Practitioner’s Digest • Vol. 2, No. 3
The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.
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Article
The IPO Quiet Period Revisited
A newly public company is subject to a "quiet period," which restricts insiders and affiliated underwriters from issuing earnings forecasts and research reports regarding the firm for a specified period following the initial public offering (IPO). As soon as this quiet period ends, the analysts of managing underwriters typically initiate research coverage with favorable recommendations, and the market responds positively even though this information is predictable. In this article, we discuss previous findings regarding price patterns and analyst initiations at the end of the quiet period and introduce new evidence based on recent trends in the IPO market. We discuss trading implications and examine the effect of new regulatory requirements that extend the quiet period from 25 to 40 calendar days post-IPO.
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Article
MaxVaR: Long-Horizon Value at Risk in a Mark-to-Market Environment
The standard VaR approach considers only terminal risk, completely ignoring the path of the portfolio value prior to this final horizon. This assumption is unrealistic interim risk may be critical in a mark-to-market environment because interim values of a portfolio may generate margin calls and affect trading strategies.We provide a simple framework for adjusting standard VaR for interim risk. We introduce the notion of MaxVaR, which is analogous to VaR except that it considers the probability of seeing a given low cumulative return on or before the terminal date. Under the standard lognormality assumption and for reasonable parameterizations MaxVaR may exceed VaR by over 40%. We show that adjustingVaR for interim mark-to-market risk is critically important for high Sharpe Ratio portfolios (e.g., for hedge funds).
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Article
Active Risk and Information Ratio
One of the underlying assumptions of the Fundamental Law of Active Management is that the active risk of an active investment strategy equates estimated tracking error by a risk model. We show there is an additional source of active risk that is unique to each strategy. This strategy risk is caused by variability of the strategy's information coefficient over time. This implies that true active risk is often different from, and in many cases, significantly higher than the estimated tracking error given by a risk model. We show that a more consistent estimation of information ratio is the ratio of average information coefficient to the standard deviation of information coefficient. We further demonstrate how the interaction between information coefficient and investment opportunity, in terms of cross sectional dispersion of actual returns, influences the IR.We then provide supporting empirical evidence and offer possible explanations to illustrate the practicality of our findings when applied to active portfolio management.
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Article
Predictability of Long-Term Spinoff Returns
Investment strategies of buying and holding recently spun off companies and their parents have received significant attention from the investment community in the recent past. Despite their popularity, the existing evidence on the attractiveness of spinoffs appears piecemeal. In this paper, we examine in detail the stock price performance of spinoffs and their parents on a comprehensive sample that covers the last 36 years.We show that excess returns are indeed positive for both subsidiary and parent companies over almost all holding periods considered. For subsidiaries, the results appear both economically and statistically significant after various adjustments for risk. This evidence is consistent with investors earning an above normal rate of return by investing in recently spun off subsidiaries. For parents, however, after correcting for one very large positive outlier, returns are not statistically or economically different from zero.
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Article
In Search of a Modigliani-Miller Economy
The Modigliani-Miller theorem describes conditions under which the value of a firm is independent of its leverage ratio. It is one of the cornerstones of finance. A history of this result along with a modern perspective on its derivation is given in Rubinstein (2003), Journal of Investment Management 1(2). We extend this history by examining the relationship between theModigliani-Miller theorem and quantitative models of credit risk. In the first part of the paper, we sort out the role of the Modigliani-Miller theorem and Merton's classical structural model. This material may be familiar to some readers. Subsequently, we explore the relationship between theModigliani-Miller theorem and I 2, which is a hybrid structural-reduced form model based on incomplete information, Goldberg (2004), Risk 17(1), 515-518. The I 2 model is not consistent with the Modigliani-Miller theorem. It provides a new way to measure the deviation of real markets from the idealized markets in which the Modigliani-Miller theorem holds.
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Case Study
Poosha-Carta Food Stores
“Case Studies” presents a case pertinent to contemporary issues and events in investment management. Insightful and provocative questions are posed at the end of each case to challenge the reader. Each case is an invitation to the critical thinking and pragmatic problem solving that are so fundamental to the practice of investment management.
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Book Review
Capital-The Story of Long-Term Investment Excellence
Asset Pricing and Portfolio Performance
“Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.
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Survey & Crossover
The Progeny of CAPM
“Surveys& Crossovers” This section provides surveys of the literature in investment management or short papers exemplifying advances in finance that arise from the confluence with other fields. This section acknowledges current trends in technology, and the cross-disciplinary nature of the investment management business, while directing the reader to interesting and important recent work.