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on Risk Management |
| By: | Elisa Luciano; Elena Vigna |
| Abstract: | In this note we use doubly stochastic processes (or Cox processes) in order to model the evolution of the stochastic force of mortality of an individual aged x. These processes have been widely used in the credit risk literature in modelling the default arrival, and in this context have proved to be quite flexible and useful. We investigate the applicability of these processes in describing the individual's mortality, and provide a calibration to the Italian case. Results from the calibration are twofold. Firstly, the stochastic intensities seem to better capture the development of medicine and long term care which is under our daily observation. Secondly, when pricing insurance products such as life annuities, we observe a remarkable premium increase, although the expected residual lifetime is essentially unchanged. |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:icr:wpmath:1-2005&r=rmg |
| By: | Gilbert W. Bassett Jr; Roger Koenker (Institute for Fiscal Studies and University of Illinois); Gregory Kordas |
| Abstract: | Recent developments in the theory of choice under uncertainty and risk yield a pessimistic decision theory that replaces the classical expected utility criterion with a Choquet expectation that accentuates the likelihood of the least favorable outcomes. A parallel theory has recently emerged in the literature on risk assessment. It is shown that a general form of pessimistic portfolio optimization based on the Choquet approach may be formulated as a problem of linear quantile regression. |
| Date: | 2004–06 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:cemmap:wp09/04&r=rmg |
| By: | Sutthisit Jamdee (Kent State University); Cornelis A. Los (Kent State University) |
| Abstract: | This paper demonstrates the impact of the observed financial market persistence or long term memory on European option valuation by simple simulation. Many empirical researchers have observed the non-Fickian degrees of persistence or long memory in the financial markets different from the Fickian neutral independence (i.i.d.) of the returns innovations assumption of Black-Scholes' geometric Brownian motion assumption. Moreover, Elliott and van der Hoek (2003) provide a theoretical framework for incorporating these findings into the Black- Scholes risk-neutral valuation framework. This paper provides the first graphical demonstration why and how such long term memory phenomena change European option values and provides thereby a basis for informed long term memory arbitrage. By using a simple mono-fractal Fractional Brownian motion, it is easy to incorporate the various degrees of persistence into the Black-Scholes pricing formula. Long memory options are of considerable importance in corporate remuneration packages, since stock options are written on a company's own shares for long expiration periods. It makes a significant difference in the valuation when an option is 'blue' or when it is 'red.' For a proper valuation of such stock options, the degrees of persistence of the companies' share markets must be precisely measured and properly incorporated in the warrant valuation, otherwise substantial pricing errors may result. |
| Keywords: | Options, Long Memory, Persistence, Hurst Exponent, Identification, Simulation, Executive Remuneration |
| JEL: | G14 G15 G33 C14 |
| Date: | 2005–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0505003&r=rmg |
| By: | Santiago Budria (University of Madeira & CEEAplA) |
| Abstract: | This paper explores asset returns in a production economy with habit forming households. I show that a model with capital adjustment costs and relative habits is consistent with salient financial facts, such as the equity premium, the market price of risk, and the riskfree interest rate. These predictions are not at odds with good business cycle predictions. In the model economy investment is strongly procyclical and more volatile than output, which in turn is more volatile than consumption. Moreover, consumption growth is positively autocorrelated and negatively (positively) correlated with future (past) stock returns. |
| Keywords: | Equity premium, Business cycles, Habit persistence. |
| JEL: | G12 E22 |
| Date: | 2005–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0505004&r=rmg |
| By: | Christos Papahristodoulou (Mälardalen University, School of Business); Erik Dotzauer (Mälardalen University, Department of Mathematics) |
| Abstract: | The classical Quadratic Programming (QP) formulation of the well-known portfolio selection problem has traditionally been regarded as cumbersome and time consuming. This paper formulates two additional models, (i) maximin, and (ii) minimization of mean absolute deviation. Data from 67 securities over 48 months are used to examine to what extent all three formulations provide similar portfolios. As expected, the maximin formulation yields the highest return and risk, while the QP formulation provides the lowest risk and return, which also creates the efficient frontier. The minimization of mean absolute deviation is close to the QP formulation. When the expected returns are confronted with the true ones at the end of a six months period, the maximin portfolios seem to be the most robust of all. |
| Keywords: | Finance, linear programming, investment analysis, risk analysis |
| JEL: | G |
| Date: | 2005–05–04 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0505006&r=rmg |
| By: | Jean-Marc Boussard (INRA - MONA Paris, France) |
| Abstract: | Most economists congregate on the idea that commodity price instability should be reduced. Since at least one century a variety of instruments have been designed to that end, without much success, especially for agricultural commodities. The failure might be a consequence of the fact that most policies have neglected the reason for price fluctuations. Commodity price fluctuations are endogenous, caused by the market equilibrium local dynamic instability. It means that any measure relying on the “law of large numbers” is likely to be inoperative. In addition, because, in agriculture, the production function is homogenous and of degree one, any effective stabilisation leads to over production. Only production quotas can cope with these difficulties. They may be designed in such a way as to maintain the essential feature of market equilibrium, i.e. marginal cost equating price. |
| Keywords: | Crop insurance agriculture commodity price stabilisation |
| JEL: | L16 G22 O13 Q13 Q14 Q28 |
| Date: | 2005–05–05 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpri:0505001&r=rmg |