Generalized Systematic Risk

We generalize the concept of .systematic risk to a broad class of risk measures potentially accounting for high distribution moments, downside risk, rare disasters, as well as other risk attributes. We offer two different approaches. First is an equilibrium framework generalizing the Capital Asset Pricing Model, two-fund separation, and the security market line. Second is an axiomatic approach resulting in a systematic risk measure as the unique solution to a risk allocation problem. Both approaches lead to similar results extending the traditional beta to capture multiple dimensions of risk. The results lend themselves naturally to empirical investigation.

Systematic risk estimation in symmetric models

The aim of this article is to discuss the estimation of the systematic risk in capital asset pricing models with heavy-tailed error distributions to explain the asset returns. Diagnostic methods for assessing departures from the model assumptions as well as the influence of observations on the parameter estimates are also presented. It may be shown that outlying observations are down weighted in the maximum likelihood equations of linear models with heavy-tailed error distributions, such as Student-t, power exponential, logistic II, so on. This robustness aspect may also be extended to influential observations. An application in which the systematic risk estimate of Microsoft is compared under normal and heavy-tailed errors is presented for illustration.

Listed property trusts and downside systematic risk sensitivity

Purpose: This paper aims to identify and examine the determinants of downside systematic risk in Australian listed property trusts (LPTs).

Design/methodology/approach: Capital asset pricing model (CAPM) and lower partial moment-CAPM (LPM-CAPM) are employed to compute both systematic risk and downside systematic risk. The methodology of Patel and Olsen and Chaudhry et al. is adopted to examine the determinants of systematic risk and downside systematic risk.

Findings: The results confirm that systematic risk and downside systematic risk can be individually identified. There is little evidence to support the existence of linkages between systematic risk in Australian LPTs and financial/management structure determinants. On the other hand, downside systematic risk is directly related to the leverage/management structure of a LPT. The results are also robust after controlling for the LPTs' investment characteristics and varying target rates of return.

Practical implications: Investors and real estate analysts should conscious with the higher returns from high leverage and internally managed LPTs. Although there is no evidence that these higher returns are related to higher systematic risk, there could be the compensation for higher downside systematic risk.

Originality/value: This study provides invaluable insights into the management of real estate risk in Australian LPTs with implications for REITs in other countries. Unlike previous studies of systematic risk in REITs or LPTs, this is the first study to assess downside systematic risk and explore the determinants of downside systematic risk in LPTs.

Downside systematic risk in Australian listed property trusts

Previous studies on systematic risk have demonstrated the link between financial and management structure determinants and systematic risk. However, systematic risk is estimated by assuming return is normally distributed. This assumption is generally rejected for real estate returns. Therefore, downside systematic risk appears as a more sensible risk measure in estimating market-related risk. This study contributes to this body of knowledge by examining the determinants of downside systematic risk in Australian Listed Property Trusts (LPTs) over 1993-2005. The results reveal that systematic risk and downside systematic risk are empirically distinguishable. More specifically, there is limited evidence on the connection between these financial and management structure determinants and systematic risk. However, downside systematic risk is sensitive to leverage and management structure.

The pricing of deposit insurance in the presence of systematic risk

Based on the Merton (1977) put option framework, we develop a deposit insurance pricing model that incorporates asset correlations, a measurement for the systematic risk of a bank, to account for the risk of joint bank failures. Estimates from our model suggest that actuarially fair risk-based deposit insurance that considers only individual bank failure risk is underpriced, leaving insurance providers exposed to net losses. Our estimates also capture the size premium where big banks are priced with higher deposit insurance than small banks. This result is particularly relevant to the current regulatory concerns on big banks that are too-big-to-fail. Above all, our approach provides a unifying framework for integrating risk-based deposit insurance with risk-based Basel capital requirements.

Estimation of global systematic risk for securities listed in multiple markets

The market model is the most frequently estimated model in financial economics and has proven extremely useful in the estimation of systematic risk. In this era of rapid globalization of financial markets there has been a substantial increase in cross listings of stocks in foreign and regional capital markets. As many as a third to a half of the stocks in some major exchanges are foreign listed. The multiple listings of stocks has major implications for the estimation of systematic risk. The traditiona1 method of estimating the market model by using data from only one market will lead to misleading estimates of beta. This study demonstrates that the estimator for systematic risk and the methodology itself changes when stocks are listed in multiple markets. General expressions are developed to obtain the estimator of global beta under a variety of assumptions about the error terms of the market models for different capital markets. The assumptions pertain both to the volatilities of the abnormal returns in each market, and to the relationship between the markets. ^ Explicit expressions are derived for the estimation of global systematic risk beta when the returns are homoscedastic and also under different heteroscedastic conditions both within and/or between markets. These results for the estimation of global beta are further extended when return generating process follows an autoregressive scheme.^

Systematic property risk: quantifying UK property betas 1983-2005

The increased frequency in reporting UK property performance figures, coupled with the acceptance of the IPD database as the market standard, has enabled property to be analysed on a comparable level with other more frequently traded assets. The most widely utilised theory for pricing financial assets, the Capital Asset Pricing Model (CAPM), gives market (systematic) risk, beta, centre stage. This paper seeks to measure the level of systematic risk (beta) across various property types, market conditions and investment holding periods. This paper extends the authors’ previous work on investment holding periods and how excess returns (alpha) relate to those holding periods. We draw on the uniquely constructed IPD/Gerald Eve transactions database, containing over 20,000 properties over the period 1983-2005. This research allows us to confirm our initial findings that properties held over longer periods perform in line with overall market performance. One implication of this is that over the long-term performance may be no different from an index tracking approach.

A systematic approach to risk management for construction

Systematic risk management is expecting the unexpected – it is a tool which helps control risks in construction projects. Its objective is to introduce a simple, practical method of identifying, assessing, monitoring and managing risk in an informed and structured way. It provides guidance for implementing a risk control strategy that is appropriate to control construction projects at all levels. This paper will review systematic management approaches to risk. It discusses the allocation of risk and suggests that risk needs to be identified and managed early in the procurement process. In addition, a case study of a small project that was affected by difficult economic circumstances is included to demonstrate the effectiveness of systematic risk management.

A systematic component of the jump-risk premium in an AJD model

We develop an affine jump diffusion (AJD) model with the jump-risk premium being determined by both idiosyncratic and systematic sources of risk. While we maintain the classical affine setting of the model, we add a finite set of new state variables that affect the paths of the primitive, under both the actual and the risk-neutral measure, by being related to the primitive's jump process. Those new variables are assumed to be commom to all the primitives. We present simulations to ensure that the model generates the volatility smile and compute the "discounted conditional characteristic function'' transform that permits the pricing of a wide range of derivatives.

Essays on the Linkages Between Financial Markets, and Risk Asymmetries (summary section only)

During the last few decades there have been far going financial market deregulation, technical development, advances in information technology, and standardization of legislation between countries. As a result, one can expect that financial markets have grown more interlinked. The proper understanding of the cross-market linkages has implications for investment and risk management, diversification, asset pricing, and regulation. The purpose of this research is to assess the degree of price, return, and volatility linkages between both geographic markets and asset categories within one country, Finland. Another purpose is to analyze risk asymmetries, i.e., the tendency of equity risk to be higher after negative events than after positive events of equal magnitude. The analysis is conducted both with respect to total risk (volatility), and systematic risk (beta). The thesis consists of an introductory part and four essays. The first essay studies to which extent international stock prices comove. The degree of comovements is low, indicating benefits from international diversification. The second essay examines the degree to which the Finnish market is linked to the “world market”. The total risk is divided into two parts, one relating to world factors, and one relating to domestic factors. The impact of world factors has increased over time. After 1993, when foreign investors were allowed to freely invest in Finnish assets, the risk level has been higher than previously. This was also the case during the economic recession in the beginning of the 1990’s. The third essay focuses on the stock, bond, and money markets in Finland. According to a trading model, the degree of volatility linkages should be strong. However, the results contradict this. The linkages are surprisingly weak, even negative. The stock market is the most independent, while the money market is affected by events on the two other markets. The fourth essay concentrates on volatility and beta asymmetries. Contrary to many international studies there are only few cases of risk asymmetries. When they occur, they tend to be driven by the market-wide component rather than the portfolio specific element.

Essays on Risk and Return

Perhaps the most fundamental prediction of financial theory is that the expected returns on financial assets are determined by the amount of risk contained in their payoffs. Assets with a riskier payoff pattern should provide higher expected returns than assets that are otherwise similar but provide payoffs that contain less risk. Financial theory also predicts that not all types of risks should be compensated with higher expected returns. It is well-known that the asset-specific risk can be diversified away, whereas the systematic component of risk that affects all assets remains even in large portfolios. Thus, the asset-specific risk that the investor can easily get rid of by diversification should not lead to higher expected returns, and only the shared movement of individual asset returns – the sensitivity of these assets to a set of systematic risk factors – should matter for asset pricing. It is within this framework that this thesis is situated. The first essay proposes a new systematic risk factor, hypothesized to be correlated with changes in investor risk aversion, which manages to explain a large fraction of the return variation in the cross-section of stock returns. The second and third essays investigate the pricing of asset-specific risk, uncorrelated with commonly used risk factors, in the cross-section of stock returns. The three essays mentioned above use stock market data from the U.S. The fourth essay presents a new total return stock market index for the Finnish stock market beginning from the opening of the Helsinki Stock Exchange in 1912 and ending in 1969 when other total return indices become available. Because a total return stock market index for the period prior to 1970 has not been available before, academics and stock market participants have not known the historical return that stock market investors in Finland could have achieved on their investments. The new stock market index presented in essay 4 makes it possible, for the first time, to calculate the historical average return on the Finnish stock market and to conduct further studies that require long time-series of data.

Cross-Industry Product Diversification and Contagion in Risk and Return: The Case of Bank-Insurance and Insurance-Bank Takeovers

We investigate the impact of domestic/international bancassurance deals on the risk-return profiles of announcing and non-announcing banks and insurers within a GARCH model. Bank-insurance deals produce intra- and inter-industry contagion in both risk and return, with larger deals producing greater contagion. Bidder banks and peers experience positive abnormal returns, with the effects on insurer peers being stronger than those on bank peers. Insurance-bank deals produce insignificant excess returns for bidder and peer insurers and positive valuations for peer banks. Following the deal, the bank bidders’ idiosyncratic (systematic) risk falls (increases), while insurance bidders exhibit a lower systematic risk and maintain their idiosyncratic risk.

How bank business models relate with risk?: The case of Portugal in times of financial crisis

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics

Macroeconomic risk in commodities market

The thesis studies the presence of macroeconomic risk in the commodities futures market. I present strong evidence that there is a strong relationship between macroeconomic risk and individual commodities future returns. Furthermore, long-only trading strategies seem to be strongly exposed to systematic risk, while long-short trading strategies (based on basis, momentum and basis-momentum) are found to present no such risk. Instead, I found a strong sentiment exposure in the portfolio returns of these long-short strategies, mainly during recessions. The advantages of following long-short strategies become even clearer when analyzing different macroeconomic regimes.

How contractors price risk in bids: theory and practice

Formal and analytical models that contractors can use to assess and price project risk at the tender stage have proliferated in recent years. However, they are rarely used in practice. Introducing more models would, therefore, not necessarily help. A better understanding is needed of how contractors arrive at a bid price in practice, and how, and in what circumstances, risk apportionment actually influences pricing levels. More than 60 proposed risk models for contractors that are published in journals were examined and classified. Then exploratory interviews with five UK contractors and documentary analyses on how contractors price work generally and risk specifically were carried out to help in comparing the propositions from the literature to what contractors actually do. No comprehensive literature on the real bidding processes used in practice was found, and there is no evidence that pricing is systematic. Hence, systematic risk and pricing models for contractors may have no justifiable basis. Contractors process their bids through certain tendering gateways. They acknowledge the risk that they should price. However, the final settlement depends on a set of complex, micro-economic factors. Hence, risk accountability may be smaller than its true cost to the contractor. Risk apportionment occurs at three stages of the whole bid-pricing process. However, analytical approaches tend not to incorporate this, although they could.