omega performance measure and portfolio insurance abstract we analyze the performance of the two main portfolio insurance methods the obpi and cppi strategies using downside risk measures for this purpose we introduce kappa performance measures and especially the omega measure these measures take account of the entire return distribution we show that the cppi method performs better than the obpi as a by product we determine the set of threshold values for these risk reward performance measures

purchasing power parity in the long run a cointegration approach this paper utilizes cointegration analysis to examine purchasing power parity relationships over a long time horizon the results indicate that the exchange rate is cointegrated strongly with the wholesale price index ratio and somewhat weakly with the consumer price index ratio the cointegrating coefficient between the exchange rate and the price ratio is close to one when cointegration is confirmed the hypothesis that the real exchange rate follows a random walk is rejected in most cases finally a new test for common trends finds no such common trends in exchange rates or price ratios copyright 1990 by ohio state university press

currency carry trade regimes beyond the fama regression abstract we show that carry trade strategies resemble fx option strategies that sell out of the money puts on high interest rate currencies both strategies collect premiums to generate persistent excess returns that unwind sharply when volatility increases we also show that the widely documented negative slope coefficient in regressions of exchange rate depreciation on forward currency premiums is an artifact of the volatility regime in high volatility regimes the so called fama regression produces a positive coefficient greater than unity we finally document the existence of an intuitive co movement between currency risk premiums and yield curve risk factors

benchmarking portfolio insurance and technical analysis a monte carlo comparison of dynamic strategies of asset allocation abstract this paper makes an extensive simulation comparison of popular dynamic strategies of asset allocation for each strategy alternative measures have been calculated for risk return and risk adjusted performance sharpe ratio sortino ratio return at risk moreover the strategies are compared in different market situations bull bear no trend markets and with different market volatility taking into account transaction costs and discrete rebalancing of portfolios the simulations show a dominant role of constant proportion strategies in bear and no trend markets and a preference for benchmarking strategies in bull markets these results are independent of the volatility level and the risk adjusted measure adopted

twin picks disentangling the determinants of risk taking in household portfolios this paper investigates risk taking in the liquid portfolios held by a large panel of swedish twins we document that the portfolio share invested in risky assets is an increasing and concave function of financial wealth leading to different risk sensitivities across investors human capital which we estimate directly from individual labor income also affects risk taking positively while internal habit and expenditure commitments tend to reduce it our microfindings lend strong support to decreasing relative risk aversion and habit formation preferences furthermore heterogeneous risk sensitivities across investors help reconcile individual preferences with representative agent models

portfolio choice with puts evidence from variable annuities this study investigated the asset allocation behavior of individuals who select an out of the money long dated longevity put option on their investment funds the asset allocations of these people within their variable annuity subaccounts are 5 30 percent more risky than the allocations of those who do not choose this protection investors who do not choose the longevity put option follow the classic life cycle age phased reduction in equity a rudimentary model of utility maximizing behavior is suggested that justifies the increased allocation to risk as long as the investor understands the payoff structure of the longevity put and is willing and able to exercise the annuity option if and when it matures in the money

new evidence on the forward premium puzzle the forward premium anomaly exchange rate changes are negatively related to interest rate differentials is one of the most robust puzzles in financial economics we recast the underlying parity relation in terms of lagged forward interest rate differentials documenting a reversal of the anomalous sign on the coefficient in the traditional specification we show that this novel evidence is consistent with recent empirical models of exchange rates that imply exchange rate changes depend on two key variables the interest rate differential and the magnitude of the deviation of the current exchange rate from that implied by purchasing power parity

a note on chui gai and haldane s sovereign liquidity crisis analytics and implications for public policy this note corrects the welfare calculations in chui gai and haldane s paper on sovereign liquidity crisis chui m gai p haldane a g 2002 sovereign liquidity crisis analytics and implications for public policy journal of banking and finance 26 519 544 we show that the exact formula not only dramatically reduces the computed welfare consequences from 66 of ex ante expected output to roughly 13 but also changes the direction of some reported comparative static results in addition we clarify the difference between fundamentals driven and belief driven welfare costs and extend some of the sensitivity calculations

the behavior of interest rates the evidence in fama and bliss 1987 that forward interest rates forecast future spot interest rates for horizons beyond a year repeats in the out of sample 1986 2004 period but the inference that this forecast power is due to mean reversion of the spot rate toward a constant expected value no longer seems valid instead the predictability of the spot rate captured by forward rates seems to be due to mean reversion toward a time varying expected value that is subject to a sequence of apparently permanent shocks that are on balance positive to mid 1981 and on balance negative thereafter copyright 2006 oxford university press

ppp strikes back aggregation and the real exchange rate we show the importance of a dynamic aggregation bias in accounting for the ppp puzzle we prove that the aggregate real exchange rate is persistent because its components have heterogeneous dynamics established time series and panel methods fail to control for this using eurostat data we find that when heterogeneity is taken into account the estimated persistence of real exchange rates falls dramatically its half life for instance may fall to as low as eleven months significantly below the consensus view of three to five years

real exchange rate behavior the recent float from the perspective of the past two centuries using annual data spanning two centuries for dollar sterling and franc sterling real exchange rates we find strong evidence of mean reverting real exchange rate behavior using simple stationary autoregressive models estimated on prefloat data we easily outperform nonstationary real exchange rate models in dynamic forecasting exercises over the recent float such stationary univariate equations explain 60 80 percent of the in sample variation in real exchange rates although the degree of short run persistence may be high the econometric estimates imply a half life of shocks to the real exchange rate of about 6 years for dollar sterling and a little under 3 years for franc sterling

changing monetary policy rules learning and real exchange rate dynamics when the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the taylor rule the real exchange rate will be determined by expected inflation and the output gap or the unemployment gap of the home and foreign countries this paper examines the implications of these taylor rule fundamentals for real exchange rate determination because the true parameters in central bank policy rules are unknown to the public and change over time the model is presented in the context of a least squares learning environment this simple learning model captures the volatility and the major swings in the real deutschemark euro dollar exchange rate from 1976 to 2007

taylor rules and the deutschmark dollar real exchange rate we explore the link between an interest rate rule for monetary policy and the behavior of the real exchange rate the interest rate rule in conjunction with some standard assumptions implies that the deviation of the real exchange rate from its steady state depends on the present value of a weighted sum of inflation and output gap differentials the weights are functions of the parameters of the interest rate rule an initial look at german data yields some support for the model

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

time invariant portfolio insurance strategies this paper characterizes the complete class of time invariant portfolio insurance strategies and derives the corresponding value functions that relate the wealth accumulated under the strategy to the value of the underlying insured portfolio time invariant strategies are shown to correspond to the long run policies for a broad class of portfolio insurance payoff functions

asymmetry in forward exchange rate bias a puzzling result abstract in this paper we document that the hypothesis that the forward exchange rate discount is an unbiased predictor of future currency depreciation holds in periods when the forward us dollar is quoted at a premium against the japanese yen and the deutschmark but fails when it is quoted at a discount for the post bretton woods floating exchange rate era moreover the observed asymmetry is statistically significant this puzzling result remains to be explained

on biases in the measurement of foreign exchange risk premiums abstract the hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies this paper examines several sources of measurement error and misspecification that might induce biases in such studies although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates we show that the parameters were not stable over the 1975 89 sample period estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980s jel f31

equilibrium analysis of portfolio insurance a martingale approach is used to characterize general equilibrium in the presence of portfolio insurance insurers sell to noninsurers in bad states and general equilibrium requires that the risk premium rises to induce noninsurers to increase their holdings we show that portfolio insurance increases price volatility causes mean reversion in asset returns raises the sharpe ratio and volatility in bad states and causes volatility to be correlated with volume we also explain why out of the money sp that is the demand for an absolute level of price protection is equivalent to a demand for put options 1 we show that a similar argument can be used in a

a multicountry comparison of term structure forecasts at long horizons abstract this paper extends previous work on the information in the u s term structure at longer maturities to britain west germany and switzerland we find strong evidence that the term structure does have significant ability to forecast changes in inflation particularly at long maturities on the other hand the ability of the term structure to forecast changes in one year interest rates is somewhat weaker only at the very longest horizon five years is there significant forecasting ability for interest rate changes

the time variation of risk and return in foreign exchange markets a general equilibrium perspective this article successively introduces variable velocity durability and habit persistence in a standard two country general equilibrium model and explores their effects on the variability of exchange rate changes forward premiums and the foreign exchange risk premium a new feature of the model is that agents make decisions at a weekly frequency and face conditionally heteroskedastic shocks nevertheless even the most complex model fails to deliver sufficiently variable risk premiums without causing forward premiums and exchange rates to be excessively variable unlike previous models the model can roughly match the persistence of forward premiums article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

perfect option hedging and the hedge ratio abstract this paper examines the common practice of combining stock options and the underlying stock to eliminate risk using solely the hedge ratio it provides necessary and sufficient conditions on the stock price process for this approach to work

a comparison of inflation forecasts interest rate models provide slightly better monthly forecasts and substantially better eight and fourteen month forecasts of inflation than a univariate time series model the livingston surveys underestimate eight and fourteen month inflation rates especially during the high inflation period of 1978 81 in contrast eight and fourteen month inflation forecasts extrapolated from one month interest rates show little bias and track ex post eight and fourteen month inflation rates better than the survey forecasts

the time variation of expected returns and volatility in foreign exchange markets this article analyzes the time variation in conditional means and variances of monthly and quarterly excess dollar returns on eurocurrency investments all results are based on a vector autoregression with weekly sampled data on exchange rate changes and forward premiums of three currencies both past exchange rate changes and forward premiums predict future forward market returns moreover past forward premium volatilities predict the volatility of exchange rates expected forward market returns are very variable and persistent and exhibit marked comovements these results carry over to cross rate e g yen mark investments as well

performance evaluation of portfolio insurance strategies using stochastic dominance criteria abstract this paper evaluates the performance of the stop loss synthetic put and constant proportion portfolio insurance techniques based on a block bootstrap simulation we consider not only traditional performance measures but also some recently developed measures that capture the non normality of the return distribution value at risk expected shortfall and the omega measure we compare them to the more comprehensive stochastic dominance criteria the impact of changing the rebalancing frequency and level of capital protection is examined we find that even though a buy and hold strategy generates higher average excess returns it does not stochastically dominate the portfolio insurance strategies nor vice versa our results indicate that a 100 floor value should be preferred to lower floor values and that daily rebalanced synthetic put and cppi strategies dominate their counterparts with less frequent rebalancing

a continuous time portfolio turnpike theorem abstract we prove a continuous time portfolio turnpike theorem the proof uses the theory of martin gales and is more intuitively appealing than the usual discrete time mode of proof using dynamic programming when the interest rate is strictly positive the present value of any contingent claim having payoffs bounded from above can be made arbitrarily small when the investment horizon increases thus an investor concentrates his wealth in buying contingent claims that have payoffs unbounded from above at the very beginning of his horizon as a consequence it is the asymptotic property of his utility function as wealth goes to infinity that determines his optimal investment strategy at the very beginning of his horizon

investor overconfidence and the forward premium puzzle we offer an explanation for the forward premium puzzle in foreign exchange markets based upon investor overconfidence in the model overconfident individuals overreact to their information about future inflation which causes greater overshooting in the forward rate than in the spot rate thus when agents observe a signal of higher future inflation the consequent rise in the forward premium predicts a subsequent downward correction of the spot rate the model can explain the magnitude of the forward premium bias and several other stylized facts related to the joint behaviour of forward and spot exchange rates our approach is also consistent with the availability of profitable carry trade strategies