Showing papers on "Financial risk published in 1994"

The Moderating Effects of Message Framing and Source Credibility on the Price-perceived Risk Relationship

Abstract: One factor that research has identified as a critical determinant of consumers' willingness to buy a new product or brand is the perceived risk associated with the purchase. Consequently, a better understanding of the factors affecting consumers' perceptions of the financial and performance risk entailed by the purchase of a new brand is of both theoretical and pragmatic importance. Previous research has suggested that a new product's price affects consumers' perceptions of risk. The current article extends and integrates previous research by proposing that the effect of price on consumers' perceptions of risk is moderated by two communication factors: message framing and source credibility. The results of an experiment support the predictions that the influence of price on consumers' perceptions of performance risk is greater when the message is framed negatively or the credibility of the source is low. In addition, the results support the prediction that the effect of price on consumers' perceptions of financial risk is greater when the message is framed positively.

Financial innovation and risk sharing

Abstract: Part 1 Financial innovation - an overview: history and institutions industrial organization approaches to innovation an outline of our theory other approaches and future research Part 2 Models of financial innovation and risk sharing: optimal security design arbitrage, short sales and financial innovation incomplete markets and incentives to set up an options exchange the efficient design of public debt, Douglas Gale standard securities, Douglas Gale the changing nature of debt and equity - a financial perspective, Franklin Allen

Using Default Rates to Model the Term Structure of Credit Risk

Abstract: (1994). Using Default Rates to Model the Term Structure of Credit Risk. Financial Analysts Journal: Vol. 50, No. 5, pp. 25-32.

Problems and Risks in the Purchasing of Consultancy Services

Abstract: This article integrates some of the literature relevant to the purchasing of industrial professional services with a view to highlighting the risks and dificulties involved. Many factors con- tribute to increasing the risk involved in the decision, including: the characteristics of services; the high financial risk; the conflict of interest; the length of purchase commitment; organisational risks, the inexperience of decision makers; the conspicuousness of the decision and extent of linked decisions. The decision making process can involve eight stages; problem identification, determining if the problem is to be handled internally or ex- ternally, identifying possible consultants, searching for information about consultants, evaluating consultants, selecting consultants, managing the project and reviewing the consultant's performance. The paper takes the buying process as it main framework and integrates the risks and problems encountered as well as discussing practical ways to overcome them.

Pricing of Unit-linked Life Insurance Policies

Abstract: The key feature of unit-linked or equity-linked life insurance policies is the uncertain value of the future insurance benefit. By issuing unit-linked insurances that guarantees the policy-holder a minimum benefit, the insurance company is exposed to financial risk. The value of the insurance benefit is assumed to be a function of a particular stochastic process. We use the financial theory of arbitrage pricing and martingale theory to derive single premiums for different policies. We derive risk-minimizing trading strategies describing how the issuing company can reduce financial risk. We derive a partial differential equation for the market value of the premium reserve which we compare to Thiele's equation of the actuarial sciences. Our equation contains some new terms stemming from our economic model. The interpretation of the principle of equivalence may be revisited in this framework; the principle still holds but under a new risk adjusted probability measure, equivalent to—but different fro...

Customers′ Risk Perceptions of Electronic Payment Systems

Abstract: One reason for the slow adoption rate of Electronic Fund Transfer at Point‐of‐Sale (EFTPoS) is that consumers perceive that EFTPoS has a higher level of risk than other traditional payment methods. Makes use of a concept in consumer behaviour and perceived risk to study the differences of consumers′ risk perceptions among alternative payment methods and whether these perceptions will be affected by the size of purchase and EFTPoS usage experience. The major findings are: (1) EFTPoS has the lowest physical risk and highest financial risk, the credit card has the lowest psychological risk and highest time loss risk, while cash has the highest physical risk and lowest performance risk; (2) Physical risk, financial risk and time loss risk for cash payment are significantly higher when the purchase is large, while performance risk for EFTPoS and credit card payment is significantly higher when the purchase is small; and (3) users of EFTPoS have a significantly higher level of perceived financial and time loss ...

Risk Assessment with Asymmetric Information

Abstract: The risk analysis of small business propositions is characterized by uncertainty and asymmetric information, producing problems of moral hazard and adverse selection for the banks and liquidity constraints for entrepreneurs. Decision making is based on information supplied and the application of different criteria. Concerns the relative importance of different criteria and whether the right criteria are being used to assess small firm ventures by banking institutions, and reports the results of research carried out into the importance of different criteria used in risk assessment by bank officers. Finds a high degree of variability in the approach by different bank officers and a bias towards financial information. The findings have marketing implications. Risk assessment cannot be divorced from the nature of the relationship with the small business customer. Investment in improving techniques of risk assessment increases profitability for the bank and improves marketing opportunities through the developm...

Measuring Investment Risk: A Review

Abstract: LESLIE A. BALZER is manager of investment technologyfor Lend Lease Corporate Services Limited in Sydney, Australia. He was previously a principal of consulting actuaries William M. Mercer, and dean ofengineering at the Royal Melbourne Institute of Technology. Dr. Balzer holds a B.E. in mechanical engineering and a B.Sc. in mathematics and physicsfrom the University of New South Wales, Australia. In addition, he holds a Ph.D. from the Control and Management Systems Division of the University of Cambridge, England. Dr. Balzeer is a fellow of a number ofprofessional societies, and is vice president of the QGroup (Australia) and chairman ofits mrking Patty on Investment Risk.

Investment and financing considerations : evidence from Finnish panel data

Abstract: This paper presents a simple intertemporal model for the determination of corporate investment when the required rate on debt financing depends on the financial risk involved When the actual lending rate does not fully reflect the financial risk, the balance sheet position of firms affects investment, as do the lending rate and demand factors Specifically, the model implies that investment decreases with the amount of debt financing and increases with the availability of new equity financing and cash flow Moreover, the financing conditions should be more important the greater the leverage Empirical results using Finnish panel data over the period 1985-92 conforms with the predictions of the theoretical model

Over-the-Counter Derivatives and Systemic Risk to the Global Financial System

Abstract: Over the last decade dealing in derivative financial instruments (basically forwards, futures, options and combinations of these), particularly in the over-the-counter (OTC) derivatives market has become a central activity for major wholesale banks and financial institutions. Measured in terms of notional principal amount, OTC derivatives outstanding are near, if not greater than, US$10 trillion, even after deduction of double-counting for intra-dealer transactions. Major new regulatory initiatives, including proposed new capital requirements, are under consideration as a means of reducing systemic risk. This paper examines the concept of systemic risk -- that failure of one firm will lead to the failure of a large number of other firms or indeed the collapse of the international financial system. Alternative proposed definitions are considered and integrated and the effects of OTC derivatives on these risks discussed. The key conclusion is that systemic risk has been reduced by the development of the OTC derivatives market due to shifting economic risks to those better able either to bear the risk or, in many cases, cancel it against offsetting risks. The implications of the Basle II capital proposals for systemic risk are analyzed and shown to increase this risk due to encouraging transactions which increase portfolio risks of the dealers and discouraging transactions which decrease their portfolio risk.

Financial Engineering: Tools and Techniques to Manage Financial Risk

Abstract: Financial Engineering is about using financial instruments to reduce or eliminate risk, or to restructure a financial exposure to improve its characteristics. This book shows how to apply the latest techniques by managing financial risks of all kind. The book carefully explains the tools of financial engineering and defines each instrument in depth. It describes the markets on which they are traded, and clearly illustrates how each product is priced and hedged. All applications are illustrated with fully-worked practical examples, and recommended tactics and techniques are "tested" by demonstrating the results with recent historical data. The book provides a solid understanding of the underlying theory as well as a clear demonstration of effective practice. The book:* clearly defines all the tools used in financial engineering* caefully explains instruments such as FRAs, financial futures, options, currency and interest-rate swaps, caps, floors, collars, corridors, swaptions, IRGs, SAFE's and many others* covers advanced products like barrier options, diff swaps, multi-factor and path-dependent options, leveraged floaters and other structured products* considers exactly how each one is used in practice* shows ways in which financial engineering techniques can be applied to manage risks in currencies, interest rates,equities and commodities.

Risk and the discount rate in forestry

Abstract: One of the most common ways to account for investment risk is to add a risk premium to the risk-free discount rate when computing present values of expected revenues which are uncertain. Using cert...

Financial Markets in 2020

Abstract: At Bankers Trust, we spend a lot of time anticipating trends in the financial markets, not only those affecting short-term price movements but also those that are responsible for the long-term evolution of the system itself. Anticipating the longer term is especially compelling today considering the speed at which the financial system is changing. Even our inherent romanticism doesn't let us forget that we are straddling the 20th and 21st centuries, a period when more than ever the future seems just around the corner. But there's the future and the future. For the purpose of this paper, let's impose a stop-loss on our observations. I like the year 2020. For one thing, it is the year when the Jet Propulsion Laboratory predicts that Voyager will stop transmitting data back to Earth--a forecast that for some reason I find exciting. Twenty-seven years also is far enough away to allow trends to develop, yet near enough to be useful for long-range planning. And it doesn't hurt to know that 20/20 stands for perfect vision. Maybe that alone will improve the odds of my being correct. Thus this paper will focus on the period between now and the year 2ust 1993.u020, contemplating how the financial functions will evolve over that period and how quickly change will come. Anyone who deals in the financial markets knows that anticipating trends is difficult at best. But he or she also realizes that not to try is tantamount to accepting the most unlikely scenario of all: no change. So I will plunge ahead. CONSTANTS AND CHANGE Heraclitus said it best: "All is flux, nothing stays still. Nothing endures but change." That is true. Nonetheless, between now and 2020 two phenomena will remain constant. First, human nature will not change. Second, the basic financial functions, as I will define them, will not change, although how we perform these functions will change. First for human nature. A very basic element of that nature is a hunger for security--law and order, job security, retirement security, decent and affordable health care, and financial security. For a variety of reasons, people have begun to feel that organizations, especially governments, designed to provide their basic security no longer can be relied on. This societal change is having a profound impact on financial institutions' relationships with their clients and employees, who once automatically accepted an institution's promise that "We know what is best for you." By necessity, not by preference, people are becoming more involved in creating their own security by doing their own homework and making their own decisions. "One-way broadcasting" and "command and control" styles are no longer acceptable. This pervasive sense of vulnerability is putting risk management at the top of the agenda for many people and organizations. To the degree that financial institutions can better help their clients deal with risk, the clients are very ready for change. In any event, gaining their trust will be an essential challenge for financial institutions. In addition to the sense of individual vulnerability, two other facets of human nature will affect the pace of change: people's inherent thirst for knowledge and their frequent aversion to change. The first is the motivator behind financial innovation and the second is the greatest barrier to it. That barrier is deeply entrenched, as evidenced by a report from an observer at the Digital World Conference, which was held in Los Angeles in July 1993: "Given that this was a conference on digital technology for industry insiders, I saw very few laptop computer note takers; 99 percent used paper and pen. Very few had mobile telephones with them, and consequently the lines at the pay phones were lengthy." We see that even technologists have trouble adjusting to the new environment. I have no doubts, though, that their children, steeped in today's technology, will be far less likely to be lining up for pay phones by the time they dominate the work force-well before 2020. …

Is Research in Mining Geostats as Dead as a Dodo

Abstract: This paper challenges mining geostatisticians to start solving today’s problems, in particular to produce more meaningful recoverable reserve estimates for input into financial risk assessment studies. After reviewing several techniques for risk analysis, it focuses on Monte Carlo simulation and encourages geostatisticians to develop a new type of grade—tonnage simulation, a shortcut on traditional conditional simulations. Using high quality interactive graphics in colour, these simulated grade—tonnages curves could be displayed as a 3D cloud with metal price as the variable giving the third dimension. This would allow mining engineers and financial analysts to visualise the inter-relationships between the recoverable reserves and the metal price in a new and appealing way.

Risk allocation in capital markets: portfolio insurance, tactical asset allocation and collar strategies

Abstract: The theory of risk exchange is applied on the allocation of financial risk m capital markets It Is shown how the shape of individual payoff functions depends on risk tolerance and cautiousness. For the special case where the Neumann-Morgenst ern utility functions of all individual investors belong to the HARA class and have non decreasing risk tolerance it is proved that generalized versions of "portfoho insurance", "tactical asset allocation" and "collars" are the only strategies occurring in price equihbrium.

Portfolio selection in downside risk optimization approach: application to the Hong Kong stock market

Abstract: In this paper, we consider the portfolio selection problem. For 60 selected Hong Kong stocks, we form portfolios based on 10 years of observations. The classical Markowitz mean-variance model is compared with a downside risk optimization model for the Hong Kong stock market, fn particular, the downside risk model provided better downside risk protection in the sense of offering lower risk and higher return for the chosen data. The results also indicate that longer holding periods tend to result in higher portfolio returns. Lastly, the downside risk optimization approach allows investors to specify both required return levels and target return rates in order to reflect their risk attitudes.

The regulation and supervision of domestic financial conglomerates

Abstract: Financial conglomerates are groups of financial institutions related by ownership or control. Specific regulatory and supervisory issues arise when financial services -- such as commercial and retail banking, securities underwriting and trading, investment management, and insurance underwriting -- are provided by a financial conglomerate structure. The author provides a handbook for authorities responsible for financial conglomerate regulation and supervision, identifying key issues, spelling out regulatory and supervisory alternatives, and describing both preferred solutions and alternatives. He makes reference to the regulatory framework adopted in the European Economic Community. Among the main tools available to the authorities are prudential regulations, accounting consolidation, and consolidated supervision. Prudential regulation for financial conglomerates preferably would be applied on a uniform and fully consolidated basis. Alternatively, existing regulations applicable to different financial sectors can be modified, in particular to mitigate the potential that intragroup transactions overstate capital or earnings. Accounting consolidation of the financial entities in a group is a prerequisite for consolidated prudential regulation and improves the transparency of the group's financial position. The authorities should use consolidated supervision to ensure that the risks from all group entities are identified and assessed.

Analytical Approaches to Limit Downside Risk: Semivariance and the Need for liquidity

Abstract: ince the development of the Capital Asset Pricing Model (CAPM), the financial community has focused1 on statistical S measures of risk and their ability to model and predict investor behavior. Sharpe [1964] stresses the need for a positive model to relate a security price to its risk, and defines risk in terms of the expected return and variance of its expected return. Recently, Harlow [1991] and R o m and Ferguson [1993] have challenged the use of variance as a measure of risk. They contend that a more appropriate measure is the semivariance, which focuses on downside risk, or the portion of variance that causes the return to fail to meet some target rate of return. Citing Harry Markowitz, Rom and Ferguson argue that a superior modeling of expected returns and allocation of assets can be achieved when investors’ aversion to “downside” risk is measured by the semivariance statistic. They particularly focus on skewness as evidence that distributions that are not symmetric and flat-tailed show the need to develop alternatives to mean-variance portfolio construction. The significance of semivariance as opposed to variance depends on assumptions on the distribution of returns and the reference level of return. For example, suppose an investment has an expected return of 10% and a standard deviation of 1%. If the investor requires a return of 2%, then little downside risk exists, as the minimum acceptable return is virtually assured. Kaplan and Siegel [1994] contend that the use of semivariance is likewise flawed. In a rebuttal to d o m and Ferguson, they counter with several points. First, they assert that the downside risk approach assumes a degenerative form of the Fishburn [1977] utility function, which ignores all volatility once the minimum acceptable rate of return is achieved. Second, they argue that the class of investors who exhibit asymmetric risk aversion is insignificant. In an update of his original work on meanvariance, Markowitz [1991] reflects this dilemma. He says he is unsure as to the value of the mean-variance approach versus mean-semivariance. Markowitz suggests that empirical testing may help to resolve the dialectic. Given the divergence in approaches, the most salient research question is one posed indirectly by Kaplan and Siegel. The question is whether a significant investment base exists to justify the use of the downside risk approach. That is the question this article addresses. First, we consider the assertion by Kaplan and Siegel that the class of investors who are downside risk-averse is small. We identify shortto intermediate-term investment strategies who appropriate for the semivariance approach. We consider which ,’

The risks of ignoring insurance risk management.

Abstract: Prologue: Given America's penchant for a limited government and private-sector collaboration in solving the ills of society, policymakers are forever looking for solutions that require private/public collaboration. The Clinton administration prescribed such a formula in its health care reform proposal. Ironically, at the same time that the president and Hillary Rodham Clinton were bashing the private health insurance industry for its traditional ways, their reform proposal called on insurers to assume an enlarged new role and bear greater financial risk in a reconfigured system based on managed competition. The three authors of this paper discuss the nature of this risk and underscore the danger that inadequate support for good risk management poses for reform. They propose a series of approaches that might help to reduce risk to a manageable level. Stan Jones, an independent consultant, is well respected in health policy circles as an analyst who delivers incisive perspectives without heavy ideologic bag...

Default Risk, Firm Characteristics, and the Valuation of Variable-Rate Debt Instruments

Abstract: This paper extends the valuation framework developed by Ramaswamy and Sundaresan (1986) to examine the relationship between the risk premium on corporate issues of variable-rate, or floating-rate, debt instruments, and the issuer's risk of default. The investor's expected loss on default of any issue is modeled as a call option written on the stochastic values of future bond payments and the firm's value. Evidence from a sample of 154 U.S. corporate floaters issued over the period 1978 to 1991 shows that investors demand significantly lower risk premiums when positive and large correlations between the issuing firm's operating cash flows and index interest rates are present. There is also evidence concerning the existence of some structural differences in risk premiums based on the issuer's industry and the types of indices used. The impact of callability / puttability and several other market and firm-specific variables are also tested.

Specialization in Risk Management

Abstract: The financial press is full of stories lately about the risks associated with financial derivatives. The casual reader might think that some new risks have been invented, or that our financial system is riskier now than it was a few years ago.

Risk management for tactical nitrogen fertiliser applications in pastoral farming

Abstract: The physical and financial outcome from the tactical application of nitrogen fertiliser in pastoral farming is always uncertain. A management policy is therefore required to minimise uncertainty. Listing the sources of production, price and financial risk for nitrogen fertiliser inputs and identifying management actions that mitigate these creates awareness of risk and indicates where management effort can be focused. Data obtained from traditional pasture response research trials are not well suited to decision-maki ng at the farm level. However, results obtained using an expert knowledge approach demonstrated that response relationships for nitrogen can be generated in a form which is more applicable to decision-maki ng situations faced on farms. These data can be adapted to a decision tree framework which allows the likelihood of uncertain events to be formally incorporated in the estimation of financial returns for alternative application decisions for nitrogen fertiliser. A bull beef example showed that highest returns for different weather scenarios were consistently obtained for the application of 50 kg - N/ha (as -urea);rather-than-O-or-25-kg-N/ha. .

Integration of financial and construction risks: a simulation approach

Abstract: A general approach for quantifying construction and financial risks of a major capital transit project was developed. The methodology relies on Monte Carlo simulation. The technique was used to estimate the probability of time and cost overruns in construction projects. The value of integrating both financial and construction risks into such an analysis was emphasized because these risks are interrelated and, in many cases, cannot be separated. When the two sources of risk are examined in isolation, there is the possibility that some risks at the intersection may be omitted or double counted. With an integrated approach, however, the potential impact of project cost overruns can be assessed consistently and completely. The proposed methodology can be used by the planners and owners of capital transit projects to help them decide on the levels of funding needed to meet construction and design costs, given various uncertainties. Rather than providing a safety factor to guard against unfavorable scenarios, the simulation approach allows the planner to define a consistent confidence level in regard to achieving project objectives. The approach is illustrated with an example involving a hypothetical capital transit project.

Taming Toxic Risks

Abstract: In late February of 1993, FDIC issued its "Guidelines for an Environmental Risk Program." The guidelines state that FDIC examiners will criticize a bank and require corrective action if the bank has no such program or fails to follow it. Since then, banks not directly regulated by FDIC may have been receiving similar scrutiny from their own federal examiners. Even some stock analysts, prompted by general environmental disclosures required by the Securities and Exchange Commission, are starting to ask banks for more specifics. Environmental risks examined Banks face two basic types of environmental risks: direct legal liability and the risk that a borrower's own liability will endanger a loan. The FDIC guidelines seek to address both risks. Often it is secured lenders who worry most about environmental risk. Yet even unsecured loans may present financial risks caused by environmental problems. For example, suppose one year into a loan a borrower receives a government order to install air scrubbers or a wastewater treatment system at a cost of several hundred thousand dollars. If this was not anticipated, then the bank may be in for a nasty surprise when the customer's cash flow is affected and he stops making timely payments or begins to use an operating line of credit for capital expenditures. The FDIC guidelines provide banks with a great deal of latitude in developing a program. They take into consideration the bank's internal resources and the types of loans made. However, the guidelines also contain four basic requirements that examiners have been looking for: policies, training, risk assessment, and documentation. Policies underpin all The bank must develop written environmental-risk-management policies and include them in the appropriate lending, documentation, and foreclosure manuals. Such policies must be reviewed and approved by the bank's board of directors, which must also "designate a senior officer knowledgeable in environmental matters" to administer the program. As with any bank policy, an environmental policy that is too long or too complicated probably won't be read, and certainly won't be followed. At First Union, the core of our environmental policy statement for new loans and foreclosures/workouts runs four pages. About 16 more pages are devoted to sample forms, checklists, and such. Carrying out the policies requires reexamining five factors. Staffing The successful environmental risk management program balances business considerations and the suggestions of outside engineers or lawyers so that prudent loans are made and the bank is not put at a competitive disadvantage. While it is by no means necessary for all banks to have an environmental staff, it is absolutely critical that each bank have at least one person who combines an understanding of environmental risk with experience in lending. Industries and loan exposure The bank's policies should identify those industries that are suspected of having to address environmental matters in the normal course of business. Such industries may require closer scrutiny than other industries posing less risk. For example, a large loan to a chemical manufacturer may warrant a regulatory compliance audit performed by a qualified consultant as part of the underwriting process. (For an explanation of this audit and other environmental terms, see, "What phase are you in?") A small loan to the developer of a ten-unit apartment complex, on the other hand, may only warrant the completion of an internal environmental checklist by a loan officer. If the checklist discloses potential problems on-site or nearby, more work may be needed. The policies might establish a simple matrix in which the type of industry and dollar amount of the bank's exposure are considered in determining whether an environmental report is required. …

The informational efficiency of the Vancouver log market and the financial risk of holding logs in storage

Abstract: Viewed on an annual or quarterly basis, the Vancouver Log Market appears to process price information efficiently, but apparently does not do so for monthly trading intervals. For the longer holdin...