Abstract: The authors analyze how property rights affect the allocation of firms' available resources among different types of assets. In particular, they investigate empirically for a large number of countries whether firms in environments with more secure property rights allocate available resources more toward intangible assets and consequentially grow faster. The authors find that improved asset allocation due to better property rights has an effect on growth in sectoral value added equal to improved access to financing arising from greater financial development. The results are robust, using various samples and specifications, including controlling for growth opportunities.

Abstract: Claessens and Laeven analyze how property rights affect the allocation of firms' available resources among different types of assets. In particular, they investigate empirically for a large number of countries whether firms in environments with more secure property rights allocate available resources more toward intangible assets and consequentially grow faster. The authors find that improved asset allocation due to better property rights has an effect on growth in sectoral value added equal to improved access to financing arising from greater financial development. The results are robust, using various samples and specifications, including controlling for growth opportunities. This paper - a product of the Policy Division, Financial Sector Strategy and Policy Department - is part of a larger effort in the department to study the link between finance and growth.

Abstract: We develop a simple framework for analyzing a finite-horizon investor's asset allocation problem under inflation when only nominal assets are available. The investor's optimal investment strategy and indirect utility are given in simple closed form. Hedge demands depend on the investor's horizon and risk aversion and on the maturities of the bonds included in the portfolio. When short positions are precluded, the optimal strategy consists of investments in cash, equity, and a single nominal bond with optimally chosen maturity. Both the optimal stock-bond mix and the optimal bond maturity depend on the investor's horizon and risk aversion. AN INVESTOR WHO HAS A LONG-TERM but finite horizon and can invest only in nominal bonds or stocks faces a basic problem. Is it better to purchase a zero coupon bond corresponding to the horizon and bear the inflation risk, to follow a policy of rolling over short-term bonds, or to adopt some quite different strategy? Despite the simplicity of this issue, there is still no wellaccepted framework for analyzing it because nominal long-term bonds have two important characteristics that cannot be represented adequately within the classical static, single-period, framework introduced by Markowitz (1959). First, the prices of bonds decline as interest rates rise so that, as Merton (1973) originally pointed out, long-term bonds can provide a hedge against adverse shifts in the investor's future investment opportunity set. Second, and somewhat weakening the hedging role of long-term bonds, is the sensitivity of their prices to changes in expectations about future inflation. Therefore, a satisfactory counterpart to classical static portfolio theory that would enable us to address the problem faced by the hypothetical long-term investor must satisfy two criteria. It must yield simple closed-form expressions for optimal portfolios for investors with different horizons and attitudes towards risk, and it must deal realistically with both the price and return characteristics of long-term bonds, as well as with inflation. In this paper, we develop a simple model that satisfies these criteria. The investor's opti

Abstract: Returns on international equities are characterized by jumps; moreover, these jumps tend to occur at the same time across countries leading to systemic risk. In this paper, we evaluate whether systemic risk reduces substantially the gains from international diversification. First, in order to capture these stylized facts, we develop a model of international equity returns using a multivariate system of jump-diffusion processes where the arrival of jumps is simultaneous across assets. Second, we determine an investor's optimal portfolio for this model of returns. Third, we show how one can estimate the model using the method of moments. Finally, we illustrate our portfolio optimization and estimation procedure by analyzing portfolio choice across a riskless asset, the US equity index, and five international indexes. Our main finding is that, while systemic risk affects the allocation of wealth between the riskless and risky assets, it has a small effect on the composition of the portfolio of only-risky assets, and reduces marginally the gains to a US investor from international diversification: For an investor with a relative risk aversion of 3 and a horizon of one year, the certainty-equivalent cost of ignoring systemic risk is of the order $1 for every $1000 of initial investment. These results are robust to whether the international indexes are for developed or emerging countries, to constraints on borrowing and shortselling, and to reasonable deviations in the value of the parameters around their point estimates; the cost increases with the investment horizon and decreases with risk aversion.

Abstract: In this article we demonstrate that the optimal portfolios generated by the Black-Litterman asset allocation model have a very simple, intuitive property. The unconstrained optimal portfolio in the Black-Litterman model is the scaled market equilibrium portfolio (reflecting the uncertainty in the equilibrium expected returns) plus a weighted sum of portfolios representing the investor's views. The weight on a portfolio representing a view is positive when the view is more bullish than the one implied by the equilibrium and the other views. The weight increases as the investor becomes more bullish on the view, and the magnitude of the weight also increases as the investor becomes more confident about the view.

Abstract: One of the puzzles about the equity risk premium is that in the U.S. market, the premium has historically been much greater than standard finance theory would predict. The cause may lie in the mismatch between the actual asset allocation decisions of investors and their forecasts for the equity risk premium. In this review of the theoretical explanations for this puzzle, two questions are paramount: (1) How well does the explanatory theory explain the data? (2) Are the behavioral assumptions consistent with experimental and other evidence about actual behavior? The answers to both questions support the theory of "myopic loss aversion"—in which investors are excessively concerned about short-term losses and exhibit willingness to bear risk based on their most recent market experiences.

Abstract: This paper examines the correlation between stock and bond returns. It first documents that the major trends in stock-bond correlation for G7 countries follow a similar reverting pattern in the past forty years. Next, an asset pricing model is employed to show that the correlation of stock and bond returns can be explained by their common exposure to macroeconomic factors. The link between the stock-bond correlation and macroeconomic factors is examined using three successively more realistic formulations of asset return dynamics. Empirical results indicate that the major trends in stock-bond correlation are determined primarily by uncertainty about expected inflation. Unexpected inflation and the real interest rate are significant to a lesser degree. Forecasting this stock-bond correlation using macroeconomic factors also helps improve investors' asset allocation decisions. One implication of this link between trends in stock-bond correlation and inflation risk is the Murphy's Law of Diversification: Diversification opportunities are least available when they are most needed.

Abstract: We develop an integrated simulation and optimization framework for multicurrency asset allocation problems. The simulation applies principal component analysis to generate scenarios depicting the discrete joint distributions of uncertain asset returns and exchange rates. We then develop and implement models that optimize the conditional-value-at-risk (CVaR) metric. The scenario-based optimization models encompass alternative hedging strategies, including selective hedging that incorporates currency hedging decisions within the portfolio selection problem. Thus, the selective hedging model determines jointly the portfolio composition and the level of currency hedging for each market via forward exchanges. We examine empirically the benefits of international diversification and the impact of hedging policies on risk–return profiles of portfolios. We assess the effectiveness of the scenario generation procedure and the stability of the model's results by means of out-of-sample simulations. We also compare the performance of the CVaR model against that of a model that employs the mean absolute deviation (MAD) risk measure. We investigate empirically the ex post performance of the models on international portfolios of stock and bond indices using historical market data. Selective hedging proves to be the superior hedging strategy that improves the risk–return profile of portfolios regardless of the risk measurement metric. Although in static tests the MAD and CVaR models often select portfolios that trace practically indistinguishable ex ante risk–return efficient frontiers, in successive applications over several consecutive time periods the CVaR model attains superior ex post results in terms of both higher returns and lower volatility.

Abstract: Designing an investment strategy in transition economies is a difficult task, because stock markets opened through time, time series are short, and there is little guidance how to obtain expected returns and covariance matrices necessary for mean-variance asset allocation. Moments of market returns can be expected to be time varying as structural changes occur in nascent market economies. We develop an ad-hoc optimal asset-allocation strategy with a flavor of Bayesian learning adapted to these various characteristics. Since an extreme event often heralds a new state of the economy, we re-initialize learning when unlikely returns materialize. By considering a Cornell benchmark, we show the usefulness of our strategy for certain types of re-initializations. Our model can also be used in situations when new industries emerge or when companies are subject toimportant restructuring.

Abstract: A method, system and medium for optimally allocating investment assets for a given investor within and between annuitized assets and non-annuitized assets retrieves an investor's utility of consumption, utility of bequest, objective and subjective probabilities of survival and expected rates of return from each of a plurality of annuity and nonannuity assets having varying degrees of risk and return. Based on these inputs, an objective utility function is maximized by adjusting the asset allocation weights. The optimal asset allocation weights may be used to allocate the assets of the investor's portfolio among predetermined investment vehicles or as an analytical tool by portfolio managers.

Abstract: Preface. Introduction. 1. Psychological Foundations. Introduction. Biases of Judgement or Perception is Reality. Errors of Preference or There is No Such Thing as Context free Decision Making. Conclusions. 2. Imperfect Markets and Limited Arbitrage. Introduction. Ketchup Economics. Efficiency and LOOP. Stock Market. Other Markets. Imperfect Substitutes. Limited Arbitrage. Positive Feedback Trading. Risk Management and Limited Arbitrage. On the Survival of Noise Traders. Informational Imperfections. Conclusions. 3. Style Investing. Introduction. The Data. The History. Potential Gains to Style Rotation. Life Cycle of an Investment Style. Value vs. Growth: Risk or Behavioural? Style Rotation. Quantitative Screens. Timing the Switch. Conclusions. 4. Stock Valuation. Introduction. Keynes Beauty Competition. The (Ir)relevance of Fundamentals. Valuation and Behavioural Biases. Cost of Capital. Factors from Limited Arbitrage. An Analyst s Guide. 5. Portfolio Construction and Risk Management. Introduction. Covariances. Correlations. Distribution of Returns. Fat Tails or Outliers? 6. Asset Allocation. Introduction. Markets and Fundamentals. Dividend Yield, Spreads and Ratios. Earnings Yield, Spreads and Ratios. Payout Ratio. The Equity Risk Premium. Should Corporate Financiers be Running TAA? Market Liquidity. Crashes as Critical Points. 7. Corporate Finance. Introduction. Irrational Managers/Rational Markets. Rational Managers/Irrational Markets. Conclusions. 8. The Indicators. Introduction. Liquidity Measures. Sentiment Measures. Asset Allocation Measures. Earnings Measures. Technical Measures. Others. Final Thoughts. Bibliography. Index.

Abstract: The present paper considers a retiree of a certain age who is endowed with a certain amount of wealth and is facing alternative investment opportunities. One possibility is to buy a single premium immediate (participating) annuity-contract. This insurance product pays a life-long pension payment of a certain amount, depending e.g. on the age of the retiree, the operating cost of the insurance company and the return the company is able to realize from its investments. The alternative possibility is to invest the single premium into a portfolio of mutual funds and to periodically withdraw a fixed amount that is assumed to be equivalent to the consumption stream generated by the annuity. The particular advantage of this self annuitization strategy compared to the life annuity is its greater liquidity and the possibility of leaving out money for heirs. However, the risk of self annuitization is to outlive assets before the uncertain date of death. The risk can thus be specified by considering the probability of running out of money before the uncertain date of death. The determination of this personal probability of consumption shortfall with respect to German insurance and capital market conditions is the objective of this paper.

Abstract: This paper presents several applications of cointegration based trading strategies: a classic index tracking strategy, a long-short equity market neutral strategy and a number of strategies combining index tracking and long-short market neutral. As opposed to other traditional index tracking or long-short equity strategies, the portfolio optimisation is based on cointegration rather than correlation. The first strategy aims to replicate a benchmark accurately in terms of returns and volatility, while the other seeks to minimise volatility and generate steady returns under all market circumstances. The combinations of index tracking and long-short market neutral are designed as to enhance the properties of the basic strategies. To validate the applicability of the cointegration technique to asset allocation, pioneered by Lucas (1997) and Alexander (1999), and explain how and why it works, we have employed a panel data on DJIA and its constituent stocks. When applied to constructing trading strategies in the DJIA, the cointegration technique produced encouraging results. For example, between January 1995 and December 2001 the most successful self-financing statistical arbitrage strategies returned (net of transaction and repo costs) approximately 10% with roughly 2% annual volatility and negligible correlation with the market. The comprehensive set of back-test results reported is meant to offer a detailed picture of the cointegration mechanism, and to emphasise its practical implementation issues. Its key characteristics, i.e. mean reverting tracking error, enhanced weights stability and better use of the information contained in stock prices, allow a flexible design of various funded and self-financing trading strategies, from index and enhanced index tracking, to long-short market neutral and alpha transfer techniques. Further enhancement of the strategy should target first, the identification of successful stock selection rules to supplement the simple cointegration results and second, the investigation of the potential benefits of applying optimal rebalancing rules.

Abstract: A system, method, and computer program product for dynamic, cost effective reallocation of assets among a plurality of investment products comprising a processor, a memory and a computer program stored in the memory. The computer program implementing the present invention controls the reallocation of assets to reduce the transactions costs associated with rebalancing the investor's composite assets according to a composite asset allocation model. Information relating to the composite asset allocation model, the investor's assets, and the investor are stored in memory. Periodically, or upon occurrence of an event, the composite assets are evaluated to determine if rebalancing is necessary. If rebalancing is necessary, the transaction costs associated with the available transactions for performing the rebalancing are compared to select the most economically favorable transaction. Thus, the reallocation is achieved by selecting the least costly transaction that will serve to realize the composite asset allocation model, which is independent of the structure of the investor's portfolio among particular accounts or products. In addition, the computer program compares the available options for recovery of the transaction fees to select the most economically favorable means of recovering the fees associated with the transaction to further reduce the transaction cost of the reallocations.

Abstract: Provided are a method, system, and program for defining asset classes in a digital library. At least one asset class is defined to include at least one attribute and attributes are defined for each asset class to have an attribute object type. The attribute object type is defined to indicate one of a plurality of different data structure formats that are searchable through separate application programs, wherein the attribute object types in one asset class are implemented in different data structure formats. A asset object instance is generated for each asset class and information is generated in the asset object instance on a file location of attribute objects providing the attributes for the generated asset object instance.

Abstract: Recent studies inspired by results from random matrix theory [1,2,3] found that covariance matrices determined from empirical financial time series appear to contain such a high amount of noise that their structure can essentially be regarded as random. This seems, however, to be in contradiction with the fundamental role played by covariance matrices in finance, which constitute the pillars of modern investment theory and have also gained industry-wide applications in risk management. Our paper is an attempt to resolve this embarrassing paradox. The key observation is that the effect of noise strongly depends on the ratio r = n/T, where n is the size of the portfolio and T the length of the available time series. On the basis of numerical experiments and analytic results for some toy portfolio models we show that for relatively large values of r (e.g. 0.6) noise does, indeed, have the pronounced effect suggested by [1,2,3] and illustrated later by [4,5] in a portfolio optimization context, while for smaller r (around 0.2 or below), the error due to noise drops to acceptable levels. Since the length of available time series is for obvious reasons limited in any practical application, any bound imposed on the noise-induced error translates into a bound on the size of the portfolio. In a related set of experiments we find that the effect of noise depends also on whether the problem arises in asset allocation or in a risk measurement context: if covariance matrices are used simply for measuring the risk of portfolios with a fixed composition rather than as inputs to optimization, the effect of noise on the measured risk may become very small.

Abstract: Concerns about corporate governance standards have often centred on emerging markets, notably after the 1997-98 Asian crisis. A series of corporate scandals have now raised investor concerns over the quality of earnings and opaque balance sheet structures in the US and other developed countries. The paper assesses the impact of higher risk on developed-country corporate assets on the prospects for private capital flows and their composition to emerging-market economies. While investors have been paying a higher premium (in terms of higher price/earning ratios and lower interest rates) for US assets partly because of the perceived superiority in the quality of their earnings reporting, one could expect a shift away from asset classes with rising risk to assets where risks were already high — emerging-market debt and equity, for example. Higher flows to emerging markets, however, can be impeded by the negative repercussion of lower asset prices in the developed markets on the real ...

Abstract: Asset allocation and consumption towards the end of the life cycle is complicated by the uncertainty associated with the length of life. Although this risk can be hedged with life annuities, empirical evidence suggests that voluntary annuitization amongst the public is not very common, nor is it well understood. This paper develops a normative model of when, and if, one should purchase an immediate life annuity. This problem is particularly relevant given the increasing number of Defined Contribution pension plans in the U.S – for which participants must make this decision – and the corresponding trend away from Defined Benefit guarantees. Specifically, our main qualitative argument is that there is a real option – akin to the corporate finance usage of the word – embedded in the decision to annuitize. A life annuity can be viewed as a project with a positive net present value. However, quite distinct from a fixed-income bond or period certain annuity, once purchased, a life annuity can never be sold, reversed, or exchanged. Its purchase is final because of the severe moral hazard involved in trying to terminate a life-contingent claim. We use standard continuous-time technology to solve the optimal asset allocation and annuitization timing problem. We then define the value of the real option to defer annuitization (RODA) as the compensating utility loss from being unable to behave optimally. By using reasonable capital market and actuarial parameters, we estimate that the real option to defer annuitization is quite valuable until the mid-70s or mid-80s. Of course, the precise values depend on one’s gender, risk aversion, and subjective health assessment. Finally, we show that low-cost variable immediate annuities, which are currently not widely available, greatly reduce the option value to wait and create substantial welfare gains. This might explain the large number of TIAA-CREF participants who rightfully choose to annuitize their DC pension plan, as a result of the availability of both fixed and variable payments in the payout stage. JEL Classification: J26; G11

Abstract: March 2001 Abstract The main objective of a hedge strategy is to generate positive returns irrespective of market conditions. This paper presents a classic hedge fund strategy: an investment vehicle whose key objective is to mi nimize investment risk in an attempt to deliver profits under all market circumstances. The hedge is designed to have minimal correlation with the market and, irrespective of market direction, the fund seeks to generate positive alpha. A significant diffe rence between this model and more traditional hedge fund strategies is that portfolio optimization is based upon the cointegration of prices rather than the correlation of returns. Models that are based on mean -variance analysis seek portfolio weights to minimise the variance of the portfolio for a given level of return. The portfolio variance is measured using a covariance matrix and these matrices are notoriously difficult to estimate. Moreover the mean -variance criterion has nothing to ensure that trac king errors are stationary. Although the portfolios will be efficient, the tracking errors will in all probability be random walks. Therefore the replicating portfolio can drift very far from the benchmark unless it is frequently re -balanced. This paper sh ows that it is possible to devise allocations that have stationary tracking errors: any strategy that guarantees a stationary tracking error must be based on cointegration. Efficient long short hedge strategies may be achieved with relatively few stocks an d with much lower turnover rates compared to traditional market neutral strategies . JEL Classification : C32, G11, G15

Abstract: Methods for a data processor implemented system monitor for enabling persons to turn over the allocation their investment assets, and/or receive assistance concerning how to receive disbursements from investments, in a manner that is free from or ameliorates the traditional conflicts of interest in previous systems. The methods are adapted to ameliorate the tension between other functions where the compensation may be affected by asset allocation. The systems and methods collect, monitor, and direct information from persons who hold indicative data, e.g., employers, to provide professional asset allocation services including automatic allocation, rebalancing, and reallocation of investment assets, on a regular basis; as well as assistance in determining how much to save or how to receive disbursements in a manner that ameliorates conflicts of interest, which, in the case of employee benefit plans, is consistent with the regulatory restraints of ERISA.

Abstract: One striking feature of international portfolio investment is the extent to which equity portfolios are concentrated in the domestic equity market of the investor - the home bias puzzle. In this paper, I examine the role of investors' perception of the risk of foreign investment on their portfolio choices. The expected returns and risk of foreign investment are specified through an asset pricing model with the home portfolio being the benchmark asset - the domestic CAPM of Pastor (2000). The model serves as a point of reference around which investors can center their prior beliefs. I focus on investors' prior beliefs that are consistent with the literature on confidence in the familiar-foreign equities, in terms of both expected returns and risk, being viewed less favorably than domestic equities. These prior beliefs are then combined with the data on G7 equities, and the revised beliefs are used to obtain the global optimal asset allocation. I find that in order to hold predominantly domestic equities, each G7 investor has to believe that the risk of foreign investment is several times higher than the actual risk. The home bias is more of a puzzle for a US investor during the 1970s. Specifying investors' prior beliefs around the world CAPM does not help resolve the puzzle.

Abstract: Existing studies provide conflicting results regarding whether real estate investment trusts (REITs) effectively optimize and diversify institutional portfolios. Based on the style analysis of Sharpe, we extend Liang and McIntosh’s study with a more complete set of asset classes over a longer sample period. We provide additional evidence suggesting that practicing analysts should include REITs as an asset class to optimize their portfolios. Specifically, our results show that the price behavior of REITs is unique and cannot be satisfactorily duplicated by combining equity, fixed‐income securities, and unsecuritized real estate. The time series of the styles on REITs indicates that it is difficult to ex ante produce returns on REITs without diversifying into REITs.

Abstract: The need to rebalance institutional assets to a policy benchmark is a simple fact of life While it may be possible for investors to allow portfolios to drift over a period of time, they will eventually have to address the misallocation this causes, as the mix becomes increasingly concentrated, overexposed to the riskier asset classes and underexposed to the more conservative asset classes Some investors may rebalance the asset mix by systematically directing new money into the underweight asset classes or by choosing the overweight asset classes as a source for withdrawals Others may choose to rebalance on a quarterly basis, before they are called upon to report to their investment committee However loosely the constraints on active moves away from policy benchmark are defined, the authors argue that the fact remains that a fund9s assets and liabilities must appropriately balance; drifting too far from the policy benchmark can prove disastrous when markets fail to deliver what one has been conditioned to expect

Abstract: We present a rigorous framework for asset allocation and selecting mutual funds that takes into account the unique preferences and constraints of an individual investor. The framework is based on the analytic hierarchy process (AHP), and the model generates reasonable asset-allocation recommendations and identifies the most suitable funds within an asset class. We include sample mutual fund selection for a hypothetical investor. A mutual fund selection model that uses the AHP framework is flexible, is user friendly, and ensures consistency throughout the portfolio decision process.

Abstract: This article analyzes the effects of various rebalancing decisions on the risk and return of a multi–asset class portfolio. The findings show that the daily monitoring of a portfolio coupled with interval rebalancing can add to performance net of costs while simultaneously controlling for risk. Implementing a daily monitoring and interval rebalancing system for the multi–asset class (and multi–managed) portfolio requires attentive professional management with the expertise to address structural obstacles in some asset classes.

Abstract: The objective of a defined-benefit pension fund9s asset allocation policy should be to fully fund accrued pension liabilities at the lowest cost to the plan sponsor, subject to sensible risk. A major risk plan sponsors face is that higher contributions will be required should the asset portfolio not be constructed properly. Specifically, the plan sponsor in establishing its asset allocation strategy should take into account both the present value of liabilities (cash flows) and the volatile behavior of the value of the liabilities due to changes in interest rates. While fluctuations in the present value of assets versus liabilities (funding ratios) represent high financial risk for all plan sponsors, most plan sponsors fail to recognize this risk because it is seriously attenuated by actuarial and accounting smoothing of financial statements. Instead, due to the way pension contributions are calculated, and earnings reported, plan sponsors focus on the return on asset assumption rather than assets versus liabilities. The authors look at the performance of defined-benefit corporate pension plans in 2000 and 2001, and consider the implications of this performance for future corporate earnings. They then address issues associated with measuring pension liabilities and offer solutions to deal with this measurement problem.

Abstract: This paper examines portfolio allocation decisions for a large sample of demographically diverse survey respondents in light of finance theory and the recommendations of financial advisors. We investigate whether asset allocation decisions vary for respondents who differ across several dimensions including gender, home ownership, age, net worth, and psychological orientation. Sample respondents’ decisions are consistent with popular advice and finance theory. We find that only age affects the mix of risky securities. When we consider the allocation of total portfolio assets to equity, all individual characteristics except age matter. Psychological orientation contributes to our ability to explain asset allocation decisions.