Øystein Olsen: Financial economics and the challenges in managing
Norway's Government Pension Fund
Introductory remarks by Mr Øystein Olsen, Governor of Norges Bank (Central Bank of Norway),
at the NBIM (Norges Bank Investment Management) Financial Research Conference, Oslo,
30 August 2011.
* * *
It is a great pleasure for me to welcome each of you to the first NBIM Financial Research
Conference. The objective of today's conference is to present and discuss a set of papers at
the forefront of academic research on financial economics.
This event is also part of Norges Bank's efforts to strengthen ties with the academic
community. In addition to some of the best researchers in financial economics, we have in
this room some of the top investment professionals in Norway. The opportunities for
interesting discussions should be good.
At the outset, the intention of this conference was to present leading academic research,
without placing weight on its direct relevance to NBIM. However, as this conference will
show, there is considerable common ground between the research frontier of financial
economics and our challenges in managing the Government Pension Fund.
Over the last three decades, researchers have moved a long way from the Capital Asset
Pricing Model. One important result of empirical financial research is that expected returns
on traded assets vary much more over time and across assets, than was previously thought
and implicitly assumed by the CAPM.
Researchers have documented and studied how asset valuations seem to move far more on
news that affects risk premiums than on news on future cash flows. This was vividly
illustrated by the market turbulence of 2008-2009, as well as the last few weeks.
In their investigation of why risk premiums vary so much, researchers have moved far
beyond the simplest models of introductory finance classes. Theoretical progress, data
availability and computational advances have made it possible to study the implications of
potentially important features:
 investors are different and not necessarily fully informed or rational;
 markets are incomplete and have frictions;
 returns might have fat tails and face sudden disasters;
 and government regulations are important.
Models of investor heterogeneity, non-tradable, non-financial risk, market frictions and
timevarying uncertainty go a long way in accounting for variations in market risk premiums. This
has profound implications for portfolio theory and practical portfolio strategies. Modern
portfolio theory builds on differences in defining characteristics between investors. Investors
with distinctly different non-tradable, non-financial risk, who are affected differently by market
frictions and regulations, should hold different portfolios.
In the NBIM Strategy Plan for 2011-2013, we stated that we will implement an investment
strategy built on the Fund's defining characteristics - with strategies that are long-term
oriented, scalable, and focused on underlying value. This sentence covers a wide range of
interesting questions. All the speakers today will, in fact, offer perspectives on the challenges
outlined here.
All the prominent scholars who are presenting papers today will analyse some of the aspects
of how and why market risk premiums vary. Financial regulations and financial frictions are
important to our understanding of why risk premiums change over time. A thorough
understanding of financial regulations and financial frictions might also be important in
identifying unique investor characteristics.
Axel Weber will shed light on the implications of financial sector regulation on the functioning
of markets and the pricing of assets.
Lasse Pedersen has provided valuable research on the micro structure of funding markets
and how liquidity risks create systemic problems. In particular, he will cover frictions in
financial markets.
It is quite clear that the Government Pension Fund differs from the average investor in
important respects. In addition, we need to understand how variation in risk premiums can be
consistent with highly competitive financial markets. Why don't all investors buy "value" or
rebalance?
Ken Froot will talk about rare events and disaster risks, how these events are priced in
markets. He will also give insights on individual investor characteristics which give
comparative advantages in holding these priced risk premiums.
Ken French will speak about two ways for an investor to generate excess returns:
informational advantages and systematically harvesting risk premiums which the investor has
a comparative advantage in holding.
Both Froot and French will mainly talk about average portfolio weights in highly competitive
markets. In the last talk today, Stan Zin will cover how different investors will change asset
weights over time. He will also discuss what kind of risks an investor is exposed to through
rebalancing and why investors might look at the same risk-reward trade-off differently.
All of these exciting papers we will discuss today offer interesting perspectives for academic
researchers and practitioners alike. As I argued at the start of my talk here, the challenges
facing the management of our fund overlap with the research frontier of financial economics.
However, we should not expect final and absolute answers. CAPM, partly developed by our
own Jan Mossin, represented a huge leap forward in 1966. Today it has been replaced by
better tested theories, just as future research will make today's research frontier look
antiquated.
Rounding off the day, the CEO of NBIM, Yngve Slyngstad, will present the Norwegian
Finance Initiative. This is part of NBIM's efforts to build capacity to ensure our strategies
have a well-founded theoretical basis.