Jaime Lee, Terry Marsha, Robert Maxim and Paul Pfleiderer Volume 4, Number 4, Fourth Quarter 2006 This paper provides an analysis of the relation between equity and fixed income returns over time. As measured by realized correlation, this relation has changed substantially over the last decade, from positive to negative through the market collapse and… Read more
2006
Aggregate Idiosyncratic Risk and Market Returns
Turan G. Bali and Nusret Cakici Volume 4, Number 4, Fourth Quarter 2006 This paper tests the empirical performance of a model-independent measure of aggregate idiosyncratic risk introduced by Bali and Cakici (2004) in the intertemporal capital asset pricing framework. The results indicate a significantly positive relation between the equal-weighted average stock volatility and the… Read more
CASE STUDIES: The Worldwide Financier
Jack L. Treynor Volume 4, Number 4, Fourth Quarter 2006 View PDF… Read more
The Stock Market’s Reaction to Unemployment News, Stock-Bond Return Correlations, and the State of the Economy
John H. Boyd, Ravi Jagannathan and Qianqiu Liu Volume 4, Number 4, Fourth Quarter 2006 We confirm Boyd et al.’s (2005) finding that on average a surprise increase in unemployment is “good news” for stocks during economic expansions and “bad news” during economic contractions. Unemployment news bundles information about future interest rates, equity risk premium… Read more
BOOK REVIEWS: Empirical Dynamic Asset Pricing: Model Specification and Econometric Assessment / Confession of an Economic Hit Man
Volume 4, Number 4, Fourth Quarter 2006 Empirical Dynamic Asset Pricing: Model Specification and Econometric Assessment Kenneth J. Singleton Reviewed by Cel Kulasekaran Confession of an Economic Hit Man John Perkins Reviewed by Tim Adler View PDF… Read more
The Right Answer to the Wrong Question: Identifying Superior Active Portfolio Management
W. V. Harlow and Keith C. Brown Volume 4, Number 4, Fourth Quarter 2006 The debate over the value of active portfolio management has often centered on whether the average active manager is capable of producing returns that exceed expectations. We argue that a more useful way to frame this issue is to focus on… Read more
On the Financial Interpretation of Risk Contribution: Risk Budgets Do Add Up
Edward Qian Volume 4, Number 4, Fourth Quarter 2006 Due to a lack of clear financial interpretation, there are lingering questions in the financial industry regarding the concepts of risk contribution. This paper provides as well as analyzes risk contribution’s financial interpretation that is based on expected contribution to potential losses of a portfolio. We… Read more
TECHNOLOGY REVIEW: Multiple-Core Processors For Finance Applications
Sanjiv R. Das Volume 4, Number 2, Second Quarter View PDF… Read more
BOOK REVIEWS: A History of the Theory of Investments / The Nobel Memorial Laureates in Economics: An Introduction to Their Careers and Main Published Works, 2005
Volume 4, Number 3, Third Quarter 2006 A History of the Theory of Investments Mark Rubinstein Reviewed by Craig W. French The Nobel Memorial Laureates in Economics: An Introduction to Their Careers and Main Published Works, 2005 Howard R. Vane and Chris Mulhearn Reviewed by Frank Jones View PDF… Read more
SURVEY OF THE LITERATURE: Credit Default Swap Spreads
Sanjiv R. Das and Paul Hanouna Volume 4, Number 3, Third Quarter 2006 We review the literature on credit default swap spreads, which are fast replacing bond spreads as source data for analyzing and predicting credit risk. We review results that examine the basis, i.e. the difference between bond and CDS spreads, enabling the extraction… Read more
CASE STUDIES: Gas Caps and the Sherman Act
Jack L. Treynor Volume 4, Number 3, Third Quarter 2006 View PDF… Read more
Stock Return Momentum and Investor Fund Choices
Travis Sapp and Ashish Tiwari Volume 4, Number 3, Third Quarter 2006 Recent research by Gruber (1996) and Zheng (1999) has shown that investors are able to predict mutual fund performance and invest accordingly. This phenomenon has been dubbed the “smart money” effect. We show that the smart money effect is explained by stock return… Read more
The Fundamental Law of Active Portfolio Management
Roger Clarke, Harindra de Silva and Steven Thorley Volume 4, Number 3, Third Quarter 2006 The strategic perspectives and terminology of the fundamental law is a common framework in the practice of active portfolio management. For tractability, fundamental law theory depends on the simplifying assumption of a diagonal covariance matrix of security returns, though the… Read more
Cap Weighted Portfolios Are Sub-Optimal Portfolios
Jason Hsu Volume 4, Number 3, Third Quarter 2006 In this paper, we show that under a fairly innocuous assumption on price inefficiency, market capitalization weighted portfolios are sub-optimal. If market prices are more volatile than is warranted by changes in firm fundamentals, then cap-weighted portfolios do not capture the full premium commensurate their risk… Read more
Bruno de Finetti, The Problem of Full-Risk Insurances
Luca Barone Volume 4, Number 3, Third Quarter 2006 We examine-in its different aspects-the problem of the risk due to hedging a set of insurances and, consequently, the problem of the retention levels, i.e., of the most efficient method to reinsure a part of such insurances to reduce the risk within the desired limits, while… Read more
de Finetti Scoops Markowitz
Harry M. Markowitz Volume 4, Number 3, Third Quarter 2006 In 1940, in the context of choosing optimum reinsurance levels, Bruno de Finetti essentially proposed mean-variance analysis with correlated risks. It was not until 1952 that Markowitz and Roy introduced mean-variance analysis with correlated risks into the financial literature. De Finetti solved the problem of… Read more
Bruno de Finetti and Mean-Variance Portfolio Selection
Mark Rubinstein Volume 4, Number 3, Third Quarter 2006 Bruno de Finetti is generally regarded as the finest Italian mathematician of the 20th century. Among his many achievements, economists are familiar with his work on the axiomatization of subjective probability. To the surprise of many, a treasure-trove of other results in economics has recently come… Read more
BOOK REVIEWS: The Undercover Economist /The Future for Investors
Volume 4, Number 2, Second Quarter 2006 The Undercover Economist Tim Harford Reviewed by Javier Estrada The Future for Investors Jeremy Siegel Reviewed by Javier Estrada View PDF… Read more
CASE STUDIES: Answers to Quiz for Fed Candidates
Jack L. Treynor Volume 4, Number 2, Second Quarter 2006 View PDF… Read more
Are the Probabilities Right? Dependent Defaults and the Number of Observations Required to Test for Default Rate Accuracy
Roger M. Stein Volume 4, Number 2, Second Quarter 2006 Users of default prediction models often desire to know how accurate the estimated probabilities are. There are a number of mechanisms for testing this, but one that has found favor due to its intuitive appeal is the examination of goodness of fit between expected and… Read more
How Do IPO Issuers Pay for Analyst Coverage?
Michael T. Cliff and David J. Denis Volume 4, Number 2, Second Quarter 2006 This article reports evidence consistent with the view that initial public offering (IPO) issuers purchase high-quality analyst coverage with greater underpricing of the IPO. Specifically, we report that underpricing is positively related to analyst coverage by the lead underwriter and to… Read more
Employee Stock Options and Taxes
Courtney H. Edwards, John R. Graham, Mark H. Lang and Douglas A. Shackelford Volume 4, Number 2, Second Quarter 2006 In this paper, we investigate the effect of stock options on the tax position of the firm. We argue that option tax deductions can significantly affect a firm’s marginal tax rate and that the effect… Read more
S&P 500 Index Changes and Investor Awareness
Honghui Chen, Gregory Noronha and Vijay Singal Volume 4, Number 2, Second Quarter 2006 We find that, on average, firms added to the S&P 500 index experience a permanent price increase, while those deleted from it suffer only a temporary price decline. Existing theories, such as a downward sloping demand curve, liquidity, and information, fail… Read more
A Dynamic Model of Portfolio Management
Richard Grinold Volume 4, Number 2, Second Quarter 2006 This paper presents a simplified model of dynamic active portfolio management. It is designed to answer questions about product design and provide a guide to better implementation. The model has four inputs: an information ratio that measures the anticipated ability to add value, a risk aversion… Read more
BOOK REVIEWS: Understanding Arbitrage: An Intuitive Approach to Financial Analysis / The Legacy of Fisher Black
Volume 4, Number 1, First Quarter 2006 Understanding Arbitrage: An Intuitive Approach to Financial Analysis Randall S. Billingsley Reviewed by Tim Adler The Legacy of Fisher Black Bruce Lehmann Reviewed by Craig W. French View PDF… Read more
CASE STUDIES: When Plant Wears Out – A Case
Jack L. Treynor Volume 4, Number 1, First Quarter 2006 View PDF… Read more
Great Moments in Financial Economics: IV. The Fundamental Theorem (Part II)
Mark Rubinstein Volume 4, Number 1, First Quarter 2006 This is Part II of the fourth in a series of articles in this Journal examining the historical origins of key ideas in the history of financial economics. It describes an extension of the “fundamental theorem” from buy-and-hold strategies developed in Part I to dynamic portfolio… Read more
Can Contrarian Strategies Improve Momentum Profits
Kalok Chan and Hung Wan Kot Volume 4, Number 1, First Quarter 2006 This paper investigates whether investors can exploit the contrarian cycle to improve the profitability of momentum strategies. We conjecture that the momentum strategies implemented in the early stage of price reversal (MSES) are more profitable than those implemented in the late stage… Read more
Mutual Fund Dilution from Market Timing Trades
Jason T. Greene and Conrad S. Ciccotello Volume 4, Number 1, First Quarter 2006 This paper introduces a model to measure the dilution impact on an open-end fund due to market timing trades. When a timer buys shares of a fund just prior to positive returns, the extra cash in the fund dilutes the fund’s… Read more
Does the Stock Market Underreact to R&D Increases?
Allan C. Eberhart, William F. Maxwell and Akhtar R. Siddique Volume 4, Number 1, First Quarter 2006 We examine a sample of 8,313 cases, between 1951 and 2001, where firms unexpectedly increase their research and development expenditures (R&D) by a significant amount. We find consistent evidence that our sample firms are undervalued following their R&D… Read more
INSIGHTS: Skill – Based Investment Management: The Next Evolution in the Asset Management Industry
Pranay Gupta and Jan Straatman Volume 4, Number 1, First Quarter 2006 In this paper, we discuss the structure of investment management organizations from a business model perspective, investment structure perspective, and return analysis perspective. We argue that the definition of a business model to align the interest of the asset owner and asset manager… Read more