Volume 22, No. 2, Second Quarter 2024

Practitioner’s Digest • Vol. 22, No. 2

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.

The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival

by: Mark Kritzman • reviewed by: Junming Cui

“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.

AI Applications in Mass Customization: From Predictive Analytics to Generative AI.

by: Seoyoung Kim

“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.

Full-Scale Currency Hedging

by: Megan Czasonis, Mark Kritzman and David Turkington

After years of spirited debate, most investors agree that to minimize the risk currencies add to a portfolio they should hedge its currency exposures based on its betas relative to the currencies to which it is exposed. However, this notion of hedging makes sense only if the betas reliably reflect the co-occurrences of the cumulative returns of the portfolio and currencies over the investor’s horizon. And this will be true only if the correlations of currencies with the portfolio and with each other are constant across the return intervals used to estimate them and stationary through time. Neither of these conditions holds empirically. The authors propose a new currency hedging technique called full-scale hedging, which explicitly considers the full distribution of horizon co-occurrences.

Night Moves: Is the Overnight Drift the Grandmother of all Market Anomalies?

by: Victor Haghani, Vladimir Ragulin and Richard Dewey

Our research in single name stocks suggests that retail trading likely explains the phenomenon of outsized overnight returns at both the level of the overall stock market, and that of individual stocks. We find that the effect exists at the index level as previously reported, but more strikingly in a suggestively clustered pattern of individual stocks returns, particularly those known as “Meme” stocks. The effect is also prominent in other investments such as Bitcoin that appeal to retail investors. This research is important for three reasons. First, Retail traders are potentially missing out on billions of dollars of returns due to mistimed trades. Second, there is speculation that the overnight effect might have implications for the long-term valuation of the entire equity market. And finally, assuming our findings are correct, this is one of the most consistent, significant and overlooked anomalies in finance.

Extreme Weather and Retirement Savings

by: Ted Daverman, Joshua Kazdin, Michael Pensky and Fiona Sloof

In this paper, we discuss the impact of extreme weather on US families with a specific focus on household finances. We first derive a life-cycle model of consumption, then introduce climate change-oriented consumption shocks as an additional expense which is proportional to labor income. Our key finding is that exposure to shocks associated with natural disasters may lower lifetime wealth by interrupting savings contributions. We test this model by demonstrating that households living in counties which experience a high amount of natural disasters suffer lower contributions to long-term savings between 1970 and 2020. We suggest this is driven in part by temporarily lowered income and increased labor market turnover. We conclude with a discussion on how climate change may accelerate a retirement crisis and recommend suggestions for how the financial industry can help households address this challenge.

Optimal Portfolio Choice with Absorbing Markov Chains: Application to Markets that May Potentially Decouple

by: Andrew Ang, Henry Shen, Jeff Shen and Rui Zhao

We develop a model of optimal asset allocation with a market that has the potential to decouple. There are three Markov regimes: a regime where the market remains fully investable, a second regime where the market may become potentially decouple, and a third regime where the market becomes decoupled and investors lose all capital. The investor wishes to hold the potentially decoupled market as it can provide a source of returns that can be partially liquidated to provide intermediate consumption. With the framework, we compute certainty equivalents of foregoing investment in the potentially decoupling market and investigate a range of comparative statics including varying the probability of decoupling