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1 – 10 of over 57000This study analyzes the variability of rates of return for 11,772 U.S. commercial banks from 1979 through 1985. The objective is to determine whether variability that is not…
Abstract
This study analyzes the variability of rates of return for 11,772 U.S. commercial banks from 1979 through 1985. The objective is to determine whether variability that is not explained by exogenous variables can be explained by prospect theory. Below target, strong correlations are shown, consistent with prospect theory. When regression analysis is applied, the results are confirmed.
Chunsuk Park, Dong-Soon Kim and Kaun Y. Lee
This study attempts to conduct a comparative analysis between dynamic and static asset allocation to achieve the long-term target return on asset liability management (ALM). This…
Abstract
This study attempts to conduct a comparative analysis between dynamic and static asset allocation to achieve the long-term target return on asset liability management (ALM). This study conducts asset allocation using the ex ante expected rate of return through the outlook of future economic indicators because past economic indicators or realized rate of returns which are used as input data for expected rate of returns in the ābuilding blockā method, most adopted by domestic pension funds, does not fully reflect the future economic situation. Vector autoregression is used to estimate and forecast long-term interest rates. Furthermore, it is applied to gross domestic product and consumer price index estimation because it is widely used in financial time series data. Based on asset allocation simulations, this study derived the following insights: first, economic indicator filtering and upper-lower bound computation is needed to reduce the expected return volatility. Second, to reach the ALM goal, more stocks should be allocated than low-yielding assets. Finally, dynamic asset allocation which has been mirroring economic changes actively has a higher annual yield and risk-adjusted return than static asset allocation.
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G.H. Lawson and R.C. Stapleton
This article is based on responses to the 1982 general invitation from the Review Board for Government Contracts. The authors' main contention is that the pricing of government…
Abstract
This article is based on responses to the 1982 general invitation from the Review Board for Government Contracts. The authors' main contention is that the pricing of government contracts has hitherto been deficient in at least two fundamental respects ā the use of the historic cost accounting model as a computational framework for the costing and pricing of nonācompetitive Government contracts and the use of ex post accounting rates of return for estimating target rates of return.
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Essia Ries Ahmed, Md Aminul Islam, Tariq Tawfeeq Yousif Alabdullah and Azlan bin Amran
The purpose of this paper is to find applicable Islamic pricing benchmarks (IPBs) instead of the market interest rates which are currently used in Islamic finance as benchmark.
Abstract
Purpose
The purpose of this paper is to find applicable Islamic pricing benchmarks (IPBs) instead of the market interest rates which are currently used in Islamic finance as benchmark.
Design/methodology/approach
The suggested model (Islamic pricing benchmark model (IPBM)) obviously reveals the feasibility and practical effectiveness of a substitute to London Interbank Offered Rate (LIBOR) and as an evaluator tool to suggested investment projects. The model is a suggested mechanism which could be used as an alternative choice to the conventional borrowing based on the forbidden Riba or on interest. The suggested IPBM depends on estimating the rate of return for any project on consideration of the cash flows in future which is expected to be relative to the invested capital.
Findings
The IPBM approach might be applied to financial tools, where the fund owner bears the loss since it is not because of negligence. An instrument to help identify the investment for target rates of return (as an alternative choice to LIBOR) to identify a breakeven point based on expected cash flows for the project to be financed instead of based on seeking the indicators of interest or Riba (as LIBOR). This feature of the IPBM model as an Islamic benchmark renders it as a Shariah pricing mechanism for the Islamic financial products.
Practical implications
The IPBM could be used as a financial instrument to assist in identifying the investment for the target return rates to determine a breakeven point based on expected cash flows for the project to be funded instead of being based on seeking the interest indicators or Riba (as LIBOR). This feature as an Islamic benchmark is considered as a Shariah pricing mechanism for the Islamic financial products. In particular, the proposed model incorporates the Shariah parameters. In that, it is hoped that the Islamic financial instruments will be more comprehensive in their Shariah compliance and thereby may bring more credibility to the Islamic financial system in general.
Originality/value
This paper highlights several important issues related to the IPBMs in Islamic financial institutions which are not widely discussed among researchers. This study contributes to finding an alternative IPB for the Islamic financial products which is currently using the conventional interest rate (LIBOR) as its benchmark. The current study provides empirical evidence for the possibility of relying on the IPBM as an Islamic benchmark to price Islamic financial transactions.
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Andreas Wibowo and Hans Wilhelm Alfen
The present paper aims to introduce a new methodology taking risk behavior of decision maker into account to fineātune the value of a risky publicāprivateāpartnership (PPP…
Abstract
Purpose
The present paper aims to introduce a new methodology taking risk behavior of decision maker into account to fineātune the value of a risky publicāprivateāpartnership (PPP) project and the corresponding cost of capital based on the target rate of return set by the project sponsor and the degree of project risks.
Design/methodology/approach
The proposed methodology combines the cumulative prospect theory (CPT) to characterize the risk preference of the project sponsor and the Monte Carlo simulation to assess the project riskiness. The methodology requires a preāset target rate of return that will define the relative gains and losses for a prospect theory project sponsor. The application was illustrated using a build/operate/transfer toll road project as a case study.
Findings
As the project sponsor sets a greater target return, the probability of the project not meeting the target is accordingly greater. Given that losses have greater impact than gains on the decision, other things being equal, a higher target return leads to a higher value correction. It has also been demonstrated that the corresponding project's cost of capital can be upā or downadjusted depending on the project's riskiness which may result in a reverse preference to favor a higher risk scenario.
Research limitations/implications
The methodology uses the CPT parameters that need to be further confirmed and validated if applied to value large risky projects like PPP investments.
Originality/value
The proposed methodology offers a different approach to correctly value a risky PPP project by extending the application of the cumulative prospect theory that well explains the irrationality of human decision behavior under risk into a financial decisionāmaking process. It takes the full benefit of simulation to understand project risks and also assists financial decisionāmaking.
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The purpose of this paper is to discuss the principal measures of performance used in property and other investment types. In particular, the briefing will explore the…
Abstract
Purpose
The purpose of this paper is to discuss the principal measures of performance used in property and other investment types. In particular, the briefing will explore the relationship of the expected IRR with the initial return, highlighting the role of growth in the investment dynamic.
Design/methodology/approach
This education briefing is an overview of investment growth models with worked examples.
Findings
The analysis of property growth models is akin to the Fisher and Gordon growth models used in other finance markets.
Practical implications
This comparison of the models can work for all forms of investment. Similarly, instead of looking at the overall return as the measure of comparison (expected vs required), it is possible to work backwards and deduce market expectations and compare these with the investors view on those variables.
Originality/value
This is a review of existing models.
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Raimond Maurer and Shohreh Valiani
This study seeks to examine the effectiveness of controlling the currency risk for international diversified mixedāasset portfolios via two different hedge instruments, currency…
Abstract
Purpose
This study seeks to examine the effectiveness of controlling the currency risk for international diversified mixedāasset portfolios via two different hedge instruments, currency forwards and currency options. So far, currency forward has been the most common hedge tool, which will be compared here with currency options to control the foreign currency exposure risk. In this regard, several hedging strategies are evaluated and compared with one another.
Design/methodology/approach
Owing to the highly skewed return distributions of options, the application of the traditional meanāvariance framework for portfolio optimization is doubtful. To account for this problem, a mean lower partial moment model is employed. An inātheāsample as well as an outāofāthe sample context is used. With ināsample analyses, a block bootstrap test has been used to statistically test the existence of any significant performance improvement. Following that, to investigate the consistency of the results, the outāofāsample evaluation has been checked. In addition, currency trends are also taken into account to test the timeātrend dependence of currency movements and, therefore, the relative potential gains of riskācontrolling strategies.
Findings
Results show that European putāinātheāmoney options have the potential to substitute the optimally forwardāhedged portfolios. Considering the composition of the portfolio in using inātheāmoney options and forwards shows that using any of these hedge tools brings a much more diversified selection of stock and bond markets than no hedging strategy. The optimal option weights imply that a putāinātheāmoney option strategy is more active than atātheāmoney or outāofātheāmoney put options, which implies the dependency of put strategies on the level of strike price. A very interesting point is that, just by dedicating a very small part of the investment in options, the same amount of currency risk exposure can be hedged as when one uses the optimal forward hedging. In the outāofāsample study, the optimally forwardāhedged strategy generally presents a much better performance than any types of put policies.
Practical implications
The research shows the risk and return implications of different currency hedging strategies. The finding could be of interest for asset managers of internationally diversified portfolios.
Originality/value
Considering the findings in the outāofāsample perspective, the optimally forwardāhedged minimum risk portfolio dominates all other strategies, while, in the depreciation of the local currency, this, together with the forwardāhedged tangency portfolio selection, would characterize the dominant portfolio strategies.
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Risk capital is an important input for management functions. Capital structure decisions, capital budgeting, and ex post performance measurement require different measures of risk…
Abstract
Risk capital is an important input for management functions. Capital structure decisions, capital budgeting, and ex post performance measurement require different measures of risk capital. While it has become common to estimate risk capital using VaR models, it is not clear that VaRābased capital estimates are optimal for applications to management functions (e.g. risk management, capital budgeting, performance measurement, or regulation). This article considers three typical problems that require an estimate of credit risk capital: an optimal equity capital allocation; an optimal capital allocation for capital budgeting decisions; and an optimal capital allocation to remove moral hazard incentives from a compensation contract based on ex post performance. The optimal credit risk capital allocation is different for each problem and is never consistent with a credit VaR estimate of unexpected loss. The results demonstrate that the optimal risk capital allocation depends on the objective.
Michael Patrick and Nick French
The purpose of this paper is to discuss the use of the internal rate of return (IRR) as a principal measure of performance of investments and to highlight some of the weaknesses of…
Abstract
Purpose
The purpose of this paper is to discuss the use of the internal rate of return (IRR) as a principal measure of performance of investments and to highlight some of the weaknesses of the IRR in evaluating investments in this way.
Design/methodology/approach
This Education Briefing is an overview of the limitations of the IRR in making capital budgeting decisions. It is illustrated with a number of counter-intuitive examples.
Findings
The advantage of the IRR is that it is, on the surface, a wonderfully simple benchmark. One figure that tells a story. But, the disadvantage is that if used in isolation the IRR can give misleading results when used to assess investment proposals.
Practical implications
The IRR should be used in conjunction with other analyses to appraise projects, so that the user can determine its veracity in the context of other benchmarks. This context is particularly important when assessing investments with unusual cash flows.
Originality/value
This is a review of existing models.
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Konrad Finkenzeller, Tobias Dechant and Wolfgang Schäfers
The purpose of this paper is to provide conclusive evidence that infrastructure constitutes a separate asset class and cannot be classified as real estate from an investment pointā…
Abstract
Purpose
The purpose of this paper is to provide conclusive evidence that infrastructure constitutes a separate asset class and cannot be classified as real estate from an investment pointāofāview. Furthermore, optimal allocations are determined for direct and indirect infrastructure within a multiāasset portfolio.
Design/methodology/approach
Portfolio allocations are optimized by using an algorithm, which accounts for downside risk, rather than variance. This approach is more in accordance with the actual investor behaviour and might meet their investment objectives more effectively. An Australian dataset comprising stocks, bonds, direct real estate, direct infrastructure and indirect infrastructure is applied for portfolio construction.
Findings
Although infrastructure and real estate have common characteristics, the conclusion is that that they constitute two different asset classes. Furthermore, the diversification benefits of direct and indirect infrastructure within multiāasset portfolios are highlighted and determine efficient allocations up to 78 percent for target rates of 0.0 percent, 1.5 percent and 3.0 percent quarterly.
Practical implications
The results will help investors and portfolio managers to efficiently allocate funds to various asset classes. Most institutional investors are not familiar with investments in infrastructure. The study facilitates a better understanding of the asset class infrastructure and yields some important implications for the optimal allocation of infrastructure within institutional investment portfolios.
Originality/value
This is the first study to examine the role of direct and indirect infrastructure within a multiāasset portfolio by applying a downsideārisk approach.
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