Showing papers on "Financial risk published in 1975"

An analysis of alternative measures of investment risk

Abstract: DESPITE THE THEORETICAL and empirical difficulties in defining and measuring risk, the investment community is concerned with the "investment risk" of alternative securities and firms. This study restricts itself to an analysis of the similarity between two widely employed measures of investment risk: common stock systematic risk and corporate bond ratings.' The capital asset pricing model [11, 14, 21] specifies that in a properly diversified portfolio, the relevant measure of risk is the covariance of the asset return with the market return divided by the variance of the market return-known as systematic risk or beta. In an efficient market an investor is rewarded only for bearing systematic (i.e., market-wide or non-diversifiable) risk. Systematic risk information is now routinely provided investors by many investment advisory agencies on a large number of common stocks. A number of recent studies [2, 4, 7] have indicated varying relationships between systematic risk and financialor firm-related estimates of risk. Corporate bond ratings provide a simple indication of the relative investment risk associated with the fixed income offerings of a large number of publicly owned firms. These ratings, which attempt ". . . to look at 'worst' potentialities in the 'visible' future. . ." [13, p.v.], appear to be based on a combination of objective and subjective factors [16]. Earlier studies have indicated a consistent relationship between bond ratings and actual rates of default [1, 9]. In recent years a number of models for predicting ratings, incorporating a combination of bondrelated and financialor firm-related variables, have been developed [10, 15, 17, 22]. While bond rating agencies do not claim complete precision, the ratings seek ". . . to provide the American investor with a simple system of gradation by which relative investment qualities of bonds may be noted" [13, p.v.]. The purpose of this study is to examine the relationship between these two different measures of investment risk that are readily available to virtually all investors. Given the high level of efficiency in our capital markets [5], and the fact that previous studies of both common stock systematic risk and bond ratings have indicated definite relationships with certain financial variables, we hypothesize that common stock sys-

Environmental Uncertainty Reduction by Smoothing and Buffering: An Empirical Verification

Abstract: The article presents a study which examined the proposition that firms smooth input and output activities to decrease environmental uncertainty within the framework of portfolio theory, a model emp...

Structural planning under controllable business risk

Abstract: IN HIS FUNDAMENTAL WORKS [15] and [16] Douglas Vickers integrates the production, investment and financing decisions of the firm into a useful and illuminating model. He deals with uncertainty using riskadjusted capitalization and interest rates, assumes constant business risk and treats financial risk as a function of leverage. This paper extends Vickers' analysis by allowing business risk to depend on production and investment decisions.' In particular, it derives a criterion for investment decisions under general uncertainty and market organization conditions when business risk is subject to control. The effect of investment decisions on business risk has been studied by several authors (Hamada [4], Mossin [9], and Tuttle and Litzenberger [13]) under the conditions of idealized uncertainty assumed in the Sharpe-Lintner capital market theory. The investment criterion derived in this paper is shown to be generalization of theirs, and of the one obtained

Capital Gains, Losses, and Financial Results in the Non-Life Insurance Industry

Abstract: The purpose of this paper is to explore the impact of 1956-72 capital gains and losses upon the risk/return and solvency positions of randomly selected samples of stock and mutual nonlife insurers. The results indicate that for most of the insurers the risk/retum relationships deteriorated when capital gains and losses were included in earnings. If the risk dimension is ignored, however, most of the insurers appeared to be heavily dependent upon capital gains for average earnings improvements. The study also reveals that ample capital and/or surplus margins were available to enable most of the insurers to absorb substantially greater capital losses than those which had occurred. The main conclusion is that equity investments provided additional regulatory problems but did not on the average contribute to the efficiency of these firms. Capital gains and losses on the bond portfolio are not included in this study. Some recent discussion has occurred regarding the reliance of nonlife insurance companies upon investment results for maintenance of profitability and solvency. Greene, for example, has observed in his 1973 edition that "investment profits have been the mainstay of leading property and liability insurers and that had it not been for these profits, most insurers could not have continued in business."' Taking a different approach to the problem, Cooper has noted that insurance regulations have made the maintenance of solvency more difficult by allowing insurers to engage in unnecessary investment risk. He has argued that the capital and surplus requirements of nonlife insurers could be reduced substantially if insurers had no need to protect themselves against fluctuations in the prices of assets.3 Considerable debate has prevailed as to whether unrealized capital gains and losses should be included in reported earnings. The argument has Stephen WV. Forbes is Associate Professor of Finance in the University of Illinois at Urbana-Champaign. 'Mark R. Greene, Risk and Insurance, 3d. Ed. (Cincinnati: South-Western Publishing Co., 1973), pp. 687-88. 2 Robert WV. Cooper, Investment Return in Property-Liability Insurance Ratenaking (Homewood, Ill.: Richard D. Irwin, Inc., 1974), p. 21. s ibid.

Uncertainty, risk of default and the savings-consumption decision

Abstract: The relationship between uncertainty and the optimal savings-consumption decision has been discussed. A simple model has been used to show that the existence of default risk has potentially important effects on the nature of this relationship and should not be neglected in its analysis.