Essays on Risk Modeling. Applications to Portfolio and Risk Management (summary section only)

In this thesis we deal with the concept of risk. The objective is to bring together and conclude on some normative information regarding quantitative portfolio management and risk assessment. The first essay concentrates on return dependency. We propose an algorithm for classifying markets into rising and falling. Given the algorithm, we derive a statistic: the Trend Switch Probability, for detection of long-term return dependency in the first moment. The empirical results suggest that the Trend Switch Probability is robust over various volatility specifications. The serial dependency in bear and bull markets behaves however differently. It is strongly positive in rising market whereas in bear markets it is closer to a random walk. Realized volatility, a technique for estimating volatility from high frequency data, is investigated in essays two and three. In the second essay we find, when measuring realized variance on a set of German stocks, that the second moment dependency structure is highly unstable and changes randomly. Results also suggest that volatility is non-stationary from time to time. In the third essay we examine the impact from market microstructure on the error between estimated realized volatility and the volatility of the underlying process. With simulation-based techniques we show that autocorrelation in returns leads to biased variance estimates and that lower sampling frequency and non-constant volatility increases the error variation between the estimated variance and the variance of the underlying process. From these essays we can conclude that volatility is not easily estimated, even from high frequency data. It is neither very well behaved in terms of stability nor dependency over time. Based on these observations, we would recommend the use of simple, transparent methods that are likely to be more robust over differing volatility regimes than models with a complex parameter universe. In analyzing long-term return dependency in the first moment we find that the Trend Switch Probability is a robust estimator. This is an interesting area for further research, with important implications for active asset allocation.

Essays on the Determinants of International Portfolio Investments

Investors significantly overweight domestic assets in their portfolios. This behavior which is commonly called “home bias” contradicts the prescriptions of portfolio theory. This thesis explores potential reasons for the “home bias” by examining the characteristics of the investing and the target countries and features of the interaction between them. A common theme of the four essays is a focus on the importance of information about foreign markets in explaining the share of these markets in investors’ portfolios. The results indicate that the size of the equity ownership in another country strongly relates to the distance to the financial capital of that country, and to trade in goods with and direct investments (FDI) to that country. The first essay empirically investigates the relationship between trade in real goods and portfolio investments. Overall, the evidence indicates a substantial role for trade in reducing the information cost relating to portfolio investments. The second essay examines the implications of the launch of the European Monetary Union (EMU) on international portfolio investments. The evidence on the allocation of Finnish international portfolio investments is more consistent with an information-based than a diversification motive explanation. The third essay employs new data for a large number of countries and further explores the role of trade on international portfolio investments. The results indicate that trade provides important information especially on firms in countries in which the corporate governance structure and the information environment of firms generate less reliable information. The fourth essay examines the relationship between direct investments (FDI) and portfolio investments. In contrast to the predications of portfolio theory, it provides evidence that FDI is a complement rather than a substitute for portfolio investments.

Customer asset management in action: using customers portfolio for allocating resources across business-to-business relationships for improved shareholder value

Suvi Nenonen Customer asset management in action: using customer portfolios for allocating resources across business-to-business relationships for improved shareholder value Customers are crucial assets to all firms as customers are the ultimate source of all cash flows. Regardless this financial importance of customer relationships, for decades there has been a lack of suitable frameworks explaining how customer relationships contribute to the firm financial performance and how this contribution can be actively managed. In order to facilitate a better understanding of the customer asset, contemporary marketing has investigated the use of financial theories and asset management practices in the customer relationship context. Building on this, marketing academics have promoted the customer lifetime value concept as a solution for valuating and managing customer relationships for optimal financial outcomes. However, the empirical investigation of customer asset management lags behind the conceptual development steps taken. Additionally, the practitioners have not embraced the use of customer lifetime value in guiding managerial decisions - especially in the business-to-business context. The thesis points out that there are fundamental differences between customer relationships and investment instruments as investment targets, effectively eliminating the possibility to use financial theories in a customer relationships context or to optimize the customer base as a single investment portfolio. As an alternative, the thesis proposes the use of customer portfolio approach for allocating resources across the customer base for improved shareholder value. In the customer portfolio approach, the customer base of a firm is divided into multiple portfolios based on customer relationships’ potential to contribute to the shareholder value creation. After this, customer management concepts are tailored to each customer portfolio, designed to improve the shareholder value in their own respect. Therefore, effective customer asset management with the customer portfolio approach necessitates that firms are able to manage multiple parallel customer management concepts, or business models, simultaneously. The thesis is one of the first empirical studies on customer asset management, bringing empirical evidence from multiple business-to-business case studies on how customer portfolio models can be formed, how customer portfolios can be managed, and how customer asset management has contributed to the firm financial performance.

Customer asset management in action: using customers portfolio for allocating resources across business-to-business relationships for improved shareholder value

Suvi Nenonen Customer asset management in action: using customer portfolios for allocating resources across business-to-business relationships for improved shareholder value Customers are crucial assets to all firms as customers are the ultimate source of all cash flows. Regardless this financial importance of customer relationships, for decades there has been a lack of suitable frameworks explaining how customer relationships contribute to the firm financial performance and how this contribution can be actively managed. In order to facilitate a better understanding of the customer asset, contemporary marketing has investigated the use of financial theories and asset management practices in the customer relationship context. Building on this, marketing academics have promoted the customer lifetime value concept as a solution for valuating and managing customer relationships for optimal financial outcomes. However, the empirical investigation of customer asset management lags behind the conceptual development steps taken. Additionally, the practitioners have not embraced the use of customer lifetime value in guiding managerial decisions - especially in the business-to-business context. The thesis points out that there are fundamental differences between customer relationships and investment instruments as investment targets, effectively eliminating the possibility to use financial theories in a customer relationships context or to optimize the customer base as a single investment portfolio. As an alternative, the thesis proposes the use of customer portfolio approach for allocating resources across the customer base for improved shareholder value. In the customer portfolio approach, the customer base of a firm is divided into multiple portfolios based on customer relationships’ potential to contribute to the shareholder value creation. After this, customer management concepts are tailored to each customer portfolio, designed to improve the shareholder value in their own respect. Therefore, effective customer asset management with the customer portfolio approach necessitates that firms are able to manage multiple parallel customer management concepts, or business models, simultaneously. The thesis is one of the first empirical studies on customer asset management, bringing empirical evidence from multiple business-to-business case studies on how customer portfolio models can be formed, how customer portfolios can be managed, and how customer asset management has contributed to the firm financial performance.

The Impact of the EMU on International Portfolio Investments

This paper analyses the impact of the launch of the European Monetary Union (EMU) on the allocation of international portfolio investments. The initiation of the EMU provides an opportunity for comparison of competing theoretical explanations for investment behavior. Models stressing the diversification motive would predict that the increased dependence between countries participating in the EMU should reduce the attractiveness of portfolio holdings in other EMU countries. Models based on asymmetric information would instead emphasize the increased intensity in the flow of information resulting from an increase in cross border transactions between the EMU countries. The consequent decline in information asymmetry should increase, rather than reduce portfolio holdings in other EMU countries. Our results based on the allocation of Finnish foreign portfolio investment support the information-based explanation against predictions based on the diversification motive.

The Impact of New Capital Requirements on the Portfolio Decisions of Finnish Pension Institutions

This paper examines the potential impact of new capital requirements on asset allocations of Finnish pension institutions. We describe the new requirements and consider portfolio construction to minimize regulatory capital, given the investor’s preferred level of expected return. Results identify portfolio transactions that enhance expected return without increasing capital needs. Regulation calls for portfolio diversification and prudence in management, but this paper shows that market participants can exploit inconsistencies in regulation. Possible future consequences include capital outflows from the pension system and an unintended decrease in pre-funding of old-age pensions.

International Portfolio Investments and The Informational Value of Trade

A large volume of literature suggests that information asymmetry resulting from the spatial separation between investors and investments have a significant impact on the composition of investors’ domestic and international portfolios. I show that institutional factors affecting trading in tangible goods help explain a substantial portion of investors’ spatial bias. More importantly, I demonstrate that an information flow medium with breadth and richness directly linked to the bilateral commitment of resources between countries, that I measure by their trading intensity in tangible goods, is consistent with the prevailing country allocation in investors’ international portfolios.

The Impact of FDI on International Portfolio Investments

Some empirical research has argued that part of the reason for the observed "home bias" is that investors are able to indirectly achieve internationally diversified portfolios via domestically listed multinational firms. Another branch of this research attributes the "home bias" and country allocations to more deeply rooted informational causes. Using a four-year annual panel of Finnish international portfolios and Foreign Direct Investments in twenty-five countries, I provide evidence consistent with an information asymmetry explanation

Dietary aspects of cow's milk allergy in young children

Cow s milk allergy (CMA) affects about 2-6% of infants and young children. Environmental factors during early life are suggested to play a role in the development of allergic diseases. One of these factors is likely to be maternal diet during pregnancy and lactation. The association between maternal diet and development of CMA in offspring is not well known, but diet could contain factors that facilitate development of tolerance. After an established food allergy, another issue is gaining tolerance towards an antigen that causes symptoms. The strictness of the elimination depends on the individual level of tolerance. This study aimed at validating a questionnaire used to inquire about food allergies in children, at researching associations between maternal diet during pregnancy and lactation and subsequent development of cow s milk allergy in the offspring, and at evaluating the degree of adherence to a therapeutic elimination diet of children with CMA and factors associated with the adherence and age of recovery. These research questions were addressed in a prospective birth cohort born between 1997 and 2004 at the Tampere and Oulu University Hospitals. Altogether 6753 children of the Diabetes Prediction and Prevention (DIPP) Nutrition cohort were investigated. Questionnaires regarding allergic diseases are often used in studies without validation. High-quality valid tools are therefore needed. Two validation studies were conducted here: one by comparing parentally reported food allergies with information gathered from patient records of 1122 children, and the other one by comparing parentally reported CMA with information in the reimbursement records of special infant formulae in the registers of the Social Insurance Institution for 6753 children. Both of these studies showed that the questionnaire works well and is a valid tool for measuring food allergies in children. In the first validation study, Cohen s kappa values were within 0.71-0.88 for CMA, 0.74-0.82 for cereal allergy, and 0.66-0.86 for any reported food allergy. In the second validation study, the kappa value was 0.79, sensitivity 0.958, and specificity 0.965 for reported and diagnosed CMA. To investigate the associations between maternal diet during pregnancy and lactation and CMA in offspring, 6288 children were studied. Maternal diet during pregnancy (8th month) and lactation (3rd month) was assessed by a validated, 181-item semi-quantitative food frequency questionnaire (FFQ), and as an endpoint register-based information on diagnosed CMA was obtained from the Social Insurance Institution and complemented with parental reports of CMA in their children. The associations between maternal food consumption and CMA in offspring were analyzed by logistic regression comparing the highest and lowest quarters with two middle quarters of consumption and adjusted for several potential confounding factors. High maternal intake of milk products (OR 0.56, 95% CI 0.37-0.86 p = 0.002) was associated with a lower risk of CMA in offspring. When stratified according to maternal allergic rhinitis or asthma, a protective association of high use of milk products with CMA was seen in children of allergy-free mothers (OR 0.30, 95% CI 0.13 - 0.69, p < 0.001), but not in children of allergic mothers. Moreover, low maternal consumption of fish during pregnancy was associated with a higher risk of CMA in children of mothers with allergic rhinitis or asthma (OR 1.47, 95% CI 0.96 - 2.27 for the lowest quarter, p = 0.043). In children of nonallergic mothers, this association was not seen. Maternal diet during lactation was not associated with CMA in offspring, apart from an inverse association between citrus and kiwi fruit consumption and CMA. These results imply that maternal diet during pregnancy may contain factors protective against CMA in offspring, more so than maternal diet during lactation. These results need to be confirmed in other studies before giving recommendations to the public. To evaluate the degree of adherence to a therapeutic elimination diet in children with diagnosed CMA, food records of 267 children were studied. Subsequent food records were examined to assess the age at reintroduction of milk products to the child s diet. Nine of ten families adhered to the elimination diet of the child with extreme accuracy. Older and monosensitized children had more often small amounts of cow s milk protein in their diet (p < 0.001 for both). Adherence to the diet was not related to any other sociodemographic factor studied or to the age at reintroduction of milk products to the diet. Low intakes of vitamin D, calcium, and riboflavin are of concern in children following a cow s milk-free diet. In summary, we found that the questionnaires used in the DIPP study are valid in investigating CMA in young children; that there are associations between maternal diet during pregnancy and lactation and the development of CMA in offspring; and that the therapeutic elimination diet in children with diagnosed CMA is rigorously adhered to.

Dietary habits and obesity: the role of emotional and cognitive factors

In post-industrialised societies, food is more plentiful, accessible and palatable than ever before and technological development has reduced the need for physical activity. Consequently, the prevalence of obesity is increasing, which is problematic as obesity is related to a number of diseases. Various psychological and social factors have an important influence on dietary habits and the development of obesity in the current food-rich and sedentary environments. The present study concentrates on the associations of emotional and cognitive factors with dietary intake and obesity as well as on the role these factors play in socioeconomic disparities in diet. Many people cognitively restrict their food intake to prevent weight gain or to lose weight, but research on whether restrained eating is a useful weight control strategy has produced conflicting findings. With respect to emotional factors, the evidence is accumulating that depressive symptoms are related to less healthy dietary intake and obesity, but the mechanisms explaining these associations remain unclear. Furthermore, it is not fully understood why socioeconomically disadvantaged individuals tend to have unhealthier dietary habits and the motives underlying food choices (e.g., price and health) could be relevant in this respect. The specific aims of the study were to examine 1) whether obesity status and dieting history moderate the associations of restrained eating with overeating tendencies, self-control and obesity indicators; 2) whether the associations of depressive symptoms with unhealthier dietary intake and obesity are attributable to a tendency for emotional eating and a low level of physical activity self-efficacy; and 3) whether the absolute or relative importance of food choice motives (health, pleasure, convenience, price, familiarity and ethicality) contribute to the socioeconomic disparities in dietary habits. The study was based on a large population-based sample of Finnish adults: the participants were men (N=2325) and women (N=2699) aged 25-74 who took part in the DILGOM (Dietary, Lifestyle and Genetic Determinants of Obesity and Metabolic Syndrome) sub-study of the National FINRISK Study 2007. The participants weight, height, waist circumference and body fat percentage were measured in a health examination. Psychological eating styles (the Three-Factor Eating Questionnaire-R18), food choice motives (a shortened version of the Food Choice Questionnaire), depressive symptoms (the Center for Epidemiological Studies Depression Scale) and self-control (the Brief Self-Control Scale) were measured with pre-existing questionnaires. A validated food frequency questionnaire was used to assess the average consumption of sweet and non-sweet energy-dense foods and vegetables/fruit. Self-reported total years of education and gross household income were used as indicators of socioeconomic position. The results indicated that 1) restrained eating was related to a lower body mass index, waist circumference, emotional eating and uncontrolled eating, and to a higher self-control in obese participants and current/past dieters. In contrast, the associations were the opposite in normal weight individuals and those who had never dieted. Thus, restrained eating may be related to better weight control among obese individuals and those with dieting experiences, while among others it may function as an indicator of problems with eating and an attempt to solve them. 2) Emotional eating and depressive symptoms were both related to less healthy dietary intake, and the greater consumption of energy-dense sweet foods among participants with elevated depressive symptoms was attributable to the susceptibility for emotional eating. In addition, emotional eating and physical activity self-efficacy were both important in explaining the positive association between depressive symptoms and obesity. 3) The lower vegetable/fruit intake and higher energy-dense food intake among individuals with a low socioeconomic position were partly explained by the higher priority they placed on price and familiarity and the lower priority they gave to health motives in their daily food choices. In conclusion, although policy interventions to change the obesogenic nature of the current environment are definitely needed, knowledge of the factors that hinder or facilitate people s ability to cope with the food-rich environment is also necessary. This study implies that more emphasis should be placed on various psychological and social factors in weight control programmes and interventions.