Showing papers in "The Journal of Portfolio Management in 1993"

The Effect of Errors in Means, Variances, and Covariances on Optimal Portfolio Choice

Abstract: There is considerable literature on the strengths and limitations of mean-variance analysis. The basic theory and extensions of MV analysis are discussed in Markowitz [1987] and Ziemba & Vickson [1975]. Bawa, Brown & Klein [1979] and Michaud [1989] review some of its problems…

Index- Based Futures And Options Markets In Real Estate

Abstract: Most institutional and individual portfolios are very undiversified in real estate: many hold no real estate at all, many have holdings highly concentrated in certain regions or types of real estate. The risk of these concentrated holdings is not hedged. We propose here that cash-settled futures and options markets be opened on real estate to better allow diversification and hedging, and show that these markets solve problems that have hampered other real estate hedging media in the past. Related institutions, such as home equity insurance, might develop around the futures and options markets. The establishment of these markets is likely to increase the quantity of reproducible real estate, and lower rents on real estate. It may also reduce the amplitude of speculative real estate price movements and dampen the business cycle.

Returns to E/P Strategies, Higgledy-Piggledy Growth, Analysts' Forecast Errors, and Omitted Risk Factors

Abstract: High E/P (low P/E) investing has been a popular investment strategy for many years. A n u mber of academic studies document that high E/P strategies have historically generated, on average, above-normal returns. Some examples are Basu [1983], Goodman and Peavey [1986], and Jaffe, Keim, and Westerfield [l989]. Fama and French [1992] also find positive abnormal returns associated with high E/P stocks, but they find an even stronger relationship between book value t o p rice ratios (B/P) and abnormal returns.

Long/Short Equity Investing

Abstract: Investors who have the flexibility to invest both long and short can benefit from both “winners” and “losers.” This will be especially advantageous if the latter — the short-sale candidates — are less efficiently priced than the winners — the purchase candidates. This is likely to be the case in markets in which investors hold diverse opinions and short selling is restricted. Short positions can be combined with long positions to create market-neutral, hedge, or equitized strategies. Practical issues include restrictions on shorting, trading requirements, custody issues, and tax treatment.

Calculation of an Efficient Frontier for a Commercial Loan Portfolio

Abstract: dxussions. raditionally, banks have managed loan portfolios at the micro level on a loan-by-loan basis. This is evidenced by the well-estabT lished organizational structures that exist to facilitate this process, as most bank credit officers have been thoroughly trained in credit analysis, credit underwriting, credit approval, and credit monitoring. Management of the loan portfolio at the macro level, acknowledging the inter-relationships of loans and industry concentrations in the total portfolio, has become a consideration only recently. Management of loan portfolios at the macro level has been constrained largely because of a lack of publicly available data and applied research in this area. Banks have difficulty measuring the diversification of a commercial loan portfolio. This article represents the first attempt to calculate an efficient frontier for a commercial loan portfolio based on the structure of the Markowitz stock portfolio model. Two relatively new data sources on credit risk and loan pricing are used to quantify risk and return. In modern portfolio theory, the Markowitz stock portfolio model is optimized by minimizing the risk of the portfolio as measured by the variance of stock prices, subject to a given portfolio return. The model solves for the optimal weights, or percentage of each stock, in the portfolio, Varying the returns between the minimum risk portfolio and the maximum return portfolio generates the efficient frontier.

Gaming Manager Benchmarks

Abstract: n an environment dominated by specialized approaches to investing, an increasing number of plan sponsors and investment managers have I turned to custom benchmark portfolios to help resolve issues ranging from performance evaluation to multiple-manager structuring. These custom benchmarks provide a passive replication of a manager’s investment style. Ideally, they should contain securities from which the manager’s investment style leads h m or her to select and should be weighted in a manner consistent with the manager’s portfolio construction process. A valid custom benchmark d l display a risk profile reflecting the positions that the manager would hold in the absence of active investment decisions.

Predicting Sign Changes in the Equity Risk Premium Using Commercial Paper Rates

Abstract: (Ontario, Canada N6A 3K7). here is a large and growing literature that documents that the excess returns on both stocks and bonds are predlctable. Fama and T Schwert [1977], Campbell [1987], Breen, Glosten, and Jagannathan [ 19891, Ferson [ 19891, and Shanken [1990] have all documented that short-term nominal interest rates can predict U.S. asset returns during the period 1953 to 1986 (or some subset thereoq. Other studies, including Keim and Stambaugh [1986], Fama and French [1989], and Jegadeesh [1990] have shown that additional variables such as dividend yields, default premiums, and the serial correlation of returns also predict future returns. In all these studies, monthly excess stock returns are regressed on one or more predictor variables, and the implied variation in expected monthly excess returns is only a small fraction of the total. Although point forecasts of excess returns are occasionally negative, such negative forecasts are rarely significantly different from zero. This article focuses on the economic significance of negative forecasts of the equity risk premium using 150 years of U.S. data. In all the studies mentioned above, asset returns are regressed on one or more predetermined variables. A linear relationship is implicitly assumed, but there is no a priori reason to believe that the relationship between predetermined variables such as short-term interest rates and stock and bond returns should be linear. There is, however, substantial evidence that many macro series including stock returns are non-linear.

Structural Changes in Trading Stocks

Abstract: partner in HOLT Value Associates in Chicago (IL 60606). fundamentally shape the evolution of securities trading and ultimately the face of the U.S. capital market. We begin with an overview of the new competition that emergent proprietary electronic trading systems represent for the established exchanges. Reasons are presented for the Clinton administration to give strong support to electronic trahng as a way to foster the expansion of small business firms and of the economy. This broad view is followed by a summary of especially important SEC concerns about the evolving structure of trading. With this background, three key elements are used to predict changes in trading procedures. First, economic fundamentals make single-price call auctions formidable competition for continuous-time trading exchanges, and such auctions would thrive under reduced regulatory restrictions. Second, increased competition from call auctions for OTC (over-thecounter) dealers could result in vast improvements in the trading of less liquid stocks. Third, competition could force the New York Stock Exchange (NYSE) finally to adopt significant innovations. The NYSE innovation I propose would benefit both institutional and retail investors, while changing the roles of’ specialists and block traders.

The Behavior of Equity and Debt Risk Premiums

Abstract: he most widely recognized source of risk premium data is the pioneering study by Ibbotson and Sinquefield [1982], updated T annually by Ibbotson Associates (see Siegel [1990]). Accordmg to Siegel [1990, p. 1031, the best forecast for a future-period risk premium is given by the arithmetic average of its associated values observed since 1926, which is the initial year in Ibbotson and Sinquefield’s study.’ Ibbotson and Sinquefield define four types of risk premiums equity, bond horizon, small stock, and default risk premiums. The equity risk premium is defined as the excess of the S&P 500 Index Rate of Return (denoted ROR) over the T-bill ROR. Similarly, the bond horizon risk premium (hereafter referred to simply as the “horizon risk premium”) is defined as the excess of the long-term T-bond ROR over the T-bill ROR. The s m a l l stock risk premium is defined as the excess of the composite ROR of the fifth quintile (by market capitalization) of NYSE-listed common stocks over the S&P 500 Index ROR; and the default risk premium is defined as the excess of the long-term corporate bond ROR over the long-term T-bond ROR. The Ibbotson Associates approach assumes that the random process generating each of the risk premiums is stationary.2 Because portfolio managers, investors, utility regulators, and corporate financial officers use these forecasted risk premiums as guides in decision-making and performance evaluation, it is

Investing Abroad: A Review of Capital Market Integration and Manager Performance

Abstract: ecent history is witness to a remarkable breakdown of barriers to inter-regional trade and finance. Suppliers of capital have R leapt beyond their borders to pursue opportunities for profit. With some trepidation, most students of global finance probably would forecast the continuation of this movement. . This article reviews key recent trends in the world capital markets to draw portfolio implications of practical interest to investors embarking on a financial voyage abroad. Questions addressed include:

The “Efficient Index” and Prediction of Portfolio Variance

Abstract: Haugen and Baker [1990]) is that the market portfolio will not be efficient because of taxes, restrictions on short-selling, heterogeneous expectations, and opportunity sets that differ across investors. The authors assert that a minimum-variance portfolio subject to constraints does not suffer from these problems. In an attempt to identify what wdl be the minimum-variance portfolio, the authors form portfolios with the minimum variance over the trailing twentyfour months (subject to certain conditions). These portfolios are then tracked for the next quarter, and reformed. The resulting simulation has lower variance and higher return than the Wilshire 5000 in the period 1972 to 1989. The authors suggest that portfolio efficiency is responsible for this behavior. This article explores several questions raised by the EI: I

Equilibrium in Commercial Real Estate Markets: Linking Space and Capital Markets

Abstract: Chicago (IL 60611). here have been wide swings in effective rental rates and vacancy rates in commercial real estate markets over the past twenty T years. These swings are explainable in part by changes in factors affecting the demand for space and the absorption of new space. Such changes include o%ice employment and the required amount of space per employee for different types of firms. During most of the 1980s, however, increases in the supply of office space could not be explained simply by examining the demand for space by users. This is because the demand for real estate (space) was also driven by an increase in the demand for real estate as a capital asset not simply an increase in the demand for space by users. Throughout the decade, the commercial real estate market experienced both the euphoric highs of a classic “bull market” and the devastating lows of a recessionary “bear market.” These cycles have not been national in scope, but have varied by property type and geographic performance cycles. For example, during the early 1980s, tight office vacancy rates resulted in double-digit office returns, while retail performance lagged. During the mid-l980s, locations dominated by energy employment faltered badly with the collapse of international oil prices, while financial services markets flourished. At the same time, there have been dramatic changes in the flows of capital to the commercial real

Risk and Return in the Canadian Bond Market

Abstract: Bonds are exposed to many sources of risk. The term structure of interest rates can shift and twist in different ways. Issuers may default because of sectorwide problems or individual credit difficulties. Only a multifactor model can adequately capture bond risk exposure. Duration, the traditional bond risk assessment, is but a single number and measures only the risk arising from parallel term structure shifts.