Is portfolio rebalancing good for investors?

Our study seeks to examine the value of various portfolio rebalancing strategies using historical data for 20-years period for U.S. which includes business cycles - expansion and contractions, our study is based on hypothetical of portfolio asset allocations - 60/40 (stock fund), 50/50 (balanced fund), and 40/60 (bond fund). We combine both periodical rebalancing (daily, monthly, quarterly, semi-annually, annually, 2nd-yearly, 3rd-yearly, 4th-yearly, and 5th-yearly) and threshold rebalancing (0%, 5%, 10%, 15%, 20%, 25% and 30%) in our study. We investigate for the whole 20-years period contraction and expansion periods. In the 20-years period, our findings show that: a) rebalancing strategies improve return of a portfolio as compared with buy-and-hold strategy, b) the rebalancing strategies results is slightly lower risk than buy-and-hold strategy, c) periodic rebalancing leads to better risk-return outcome than buy-and-hold strategy, and d) portfolio rebalancing based on certain threshold choice perform better buy-and-hold strategy in the long run. Based on the results of the study, we recommend the optimal rebalancing strategy for investors to be threshold rebalancing 25 percent/annually or 30 percent/annually. In addition, our results also indicate that the returns of rebalancing strategies during business cycles perform better than buy-and-hold strategy. However, the difference in portfolio performance of various rebalancing strategies vis-~\u2020-vis buy and hold strategy is not substantial to warrant a definitive recommendation of a particular portfolio rebalancing strategy. --Leaf iii.The original print copy of this thesis may be available here: http://wizard.unbc.ca/record=b195067

Frontiers of Asset Pricing

This book is comprised of articles published in a Special Issue of the Journal of Risk and Financial Management entitled "Frontiers in Asset Pricing" with Guest Editors Professor James W. Kolari and Professor Seppo Pynnonen. The book contains papers in various areas related to asset pricing: (1) models; (2) multifactors; (3) theory; (4) empirical tests; (5) applications; (6) other asset classes; and (7) international tests

A Statistical Response to Challenges in Vast Portfolio Selection

The thesis is written in response to emerging issues brought about by an increasing number of assets allocated in a portfolio and seeks answers to puzzling empirical findings in the portfolio management area. Over the years, researchers and practitioners working in the portfolio optimization area have been concerned with estimation errors in the first two moments of asset returns. The thesis comprises several related chapters on our statistical inquiry into this subject. Chapter 1 of the thesis contains an introduction to what will be reported in the remaining chapters. A few well-known covariance matrix estimation methods in the literature involve adjustment of sample eigenvalues. Chapter 2 of the thesis examines the effects of sample eigenvalue adjustment on the out-of-sample performance of a portfolio constructed from the sample covariance matrix. We identify a few sample eigenvalue adjustment patterns that lead to a definite improvement in the out-of-sample portfolio Sharpe ratio when the true covariance matrix admits a high-dimensional factor model. Chapter 3 shows that even when the covariance matrix is poorly estimated, it is still possible to obtain a robust maximum Sharpe ratio (MSR) portfolio by exploiting the uneven distribution of estimation errors across principal components. This is accomplished by approximating the vector of expected future asset returns using a few relatively accurate sample principal components. We discuss two approximation methods. The first method leads to a subtle connection to existing approaches in the literature, while the second one named the ``spectral selection method" is novel and able to address main shortcomings of existing methods in the literature. A few academic studies report an unsatisfactory performance of the optimized portfolios relative to that of the 1/N portfolio. Chapter 4 of the thesis reports an in-depth investigation into the reasons behind the reported superior performance of the 1/N portfolio. It is supported by both theoretical and empirical evidence that the success of the 1/N portfolio is by no means due to the failure of the portfolio optimization theory. Instead, a major reason behind the superiority of the 1/N portfolio is its adjacency to the mean-variance optimal portfolio. Chapter 5 examines the performance of randomized 1/N stock portfolios over time. During the last four decades these portfolios outperformed the market. The construction of these portfolios implies that their constituent stocks are in general older than those in the market as a whole. We show that the differential performance can be explained by the relation between stock returns and firm age. We document a significant relation between age and returns in the US stock market. Since 1977 stock returns have been an increasing function of age apart from the oldest ages. For this period the age effect completely dominates the size effect

Essays on Share Repurchases and Boom-Bust Cycles

My doctoral dissertation consists of three chapters on financial economics. In the first chapter, I examine whether a firm\u27s share repurchases and issuances reveal information on its future 2-year stock returns. Firm-quarter observations with repurchases or issuances are each divided into twenty 5-percentile bins sorted by their magnitude. I regress 2-year future stock returns on the bins and find a non-linear relationship between the change in shares outstanding and returns. Firms making repurchases (issuances) of less than 9.3% (1.4%) of shares outstanding outperform the equal-weight portfolio by 6.4% (3.9%). These observations account for 90% of repurchases and 70% of issuances. Firms making larger repurchases (issuances) underperform by 1.9% (5.1%). In the second chapter, I examine whether investors could use share repurchases and issuances to create outperforming portfolios from 2003-2019. First, I examine two exchange-traded funds which track repurchasing companies and find no evidence they outperformed. Second, I investigate whether repurchases and issuances of U.S. firms have predictive effects from 2003-2017, and I find large issuances predict lower returns. Finally, I construct a portfolio which short-sells the stocks of firms which make large share issuances and a portfolio which invests in all firms except the large share issuers. I backtest these strategies and find both outperformed the market. In the third chapter, I show an economy with delegated investment management and assets with correlated tail risk will experience endogenous boom-bust cycles where longer booms lead to larger crashes. I examine a dynamic model populated by savers and investment managers, where savers delegate their wealth to investment managers to invest in a project. Risky projects produce returns that depend on the investment manager\u27s ability. Tail-risk projects produce high average outputs after a good aggregate shock but produce no output after a bad shock. In equilibrium, savers fire managers who generate low returns. Low-ability managers to invest in tail-risk projects to reduce their chance of being fired. As such, the population of low-ability managers increases after good shocks and falls after bad shocks, which produces boom-bust cycles in output where longer booms are followed by larger crashes

Exchange rate volatility and the returns on diversified South African investment portfolios

Globalisation has made it much easier to invest in foreign countries. This creates endless options accessible to investors, including exploiting opportunities for investment in international economies. Although foreign investment portfolio diversification provides significant opportunities for financial returns, exchange rate volatility may play a prominent role when investing in foreign markets. Since the introduction of a floating exchange rate system, together with the inflation-targeting monetary policy framework in South Africa, there has been significant volatility in the exchange rate, far more than during the previous dispensations. This, however, creates a strong need to consider how the unpredictable nature of the exchange rate affects these investments. The purpose of this study is to analyse the effect of exchange rate volatility on the returns on diversified South African investment portfolios. This research examined whether there is a homogenous relationship between South African (domestic) portfolios and the internationally diversified portfolios. In addition, the study investigated the long-run relationship between the exchange rate volatility and both domestic portfolios and the internationally diversified portfolios for the period 2007-2019. To achieve these goals, a panel ARDL model was employed. This study found that exchange rate volatility does not account for a significant portion of returns on investment portfolios fluctuations. Moreover, the relationship is not homogenous because returns on domestic investment portfolios react positively to the exchange rate volatility, whereas returns international investment portfolios respond negatively/positively to the exchange rate volatility depending on whether the relationship is short or long run. This study will contribute to the existing literature, and it is important for investors intending to diversify their investment portfolios both domestically and internationally using different mutual funds in South Africa.Thesis (MCom) -- Faculty of Commerce, Economics and Economic History, 202

Tail Risk in Funds of Hedge Funds

Funds of hedge funds (FOFs) are portfolios of investment in hedge funds. Marketed to retail investors who are otherwise unable to access hedge fund investments, FOFs are normally depicted as well-diversified investment vehicles that benefit investors with their due-diligence selection process. However, some earlier research has suggested that FOFs work like disaster insurance writers (Stulz, 2007; Agarwal and Naik, 2004). The implication is that they gain stable premium income during normal times but lose dramatically when the insured event occurs. The primary objective of this dissertation is to study the tail risk exposures of FOFs. Compared with hedge funds, which are exposed to tail risk mainly through dynamic trading, large leverage, and holdings of tail-risk-sensitive or illiquid assets (Agarwal et al., 2015), FOFs are obviously exposed to tail risk for different reasons. After conducting a hedge fund tail risk measurement (HFTR), I found that HFTR significantly explains the returns of FOFs. Moreover, HFTR substantially enhances the adjusted R-square of Fung and Hsieh’s (2004a) seven-factor model. Despite FOFs being ostensibly more diversified portfolios, they have even higher exposure to tail risk compared to hedge funds. Moreover, FOFs with short histories, higher management fees and leverage, and shorter lockup periods are more sensitive to tail risk. I further documented a strong return-predictive power in FOFs’ tail risk exposures. In particular, I found that the possible losses to one unit of tail risk exposure in a bearish market are double the possible gains in a bullish market. This non-linear payoff structure is a testimony to the claim that FOFs write crash insurance for hedge funds

Asset pricing in the foreign exchange market

The exchange rate is one of the most vital components in any economic and investment decision. With the increase in globalisation, there is a concomitant increase in the exchange rate risk in any global investment decision. This Ph.D. thesis examines asset pricing in the foreign exchange market in various dimensions, introduces new techniques for performance measurement and information flow, and attempts to explain the carry trade in the foreign exchange market. The economic significance of empirical exchange rates models in a portfolio-based framework was examined, using a thirty-year time series of five exchange rates. The forecast performances were evaluated in mean-variance and performance index (indices of acceptability) to compare the fundamental exchange rate models with a benchmark random walk model. The parameters were computed using advanced computational finance and econometric techniques. The performance measurements obtained from mean-variance by various models were compared using the Sharpe ratio. It was concluded that the structural model, although unable to beat the random walk model, did not perform worse than the forecasts obtained from the benchmark model. The results from the indices of acceptability evaluation indicate that one-month ahead forecasts obtained from the monetary model of the exchange rate performed better than the benchmark model. Furthermore, the information flow in the foreign exchange market was examined by evaluating the relationship between volatility and the customers' trading activity. An attempt was made to explain the relationship between volatility and customer order flows in a portfolio-based framework with unique aggregate and disaggregate customer order-flow data from the Union Bank of Switzerland (UBS). This was the largest private dataset used to-date in a study of the foreign exchange market. The relationship was found to be robust; that is, the order flow is one of the main sources for transmitting private information to the foreign exchange market. This relationship holds across all the currencies and in various volatility estimates. This study is the first in the foreign exchange market in the aforementioned setup, and robustly elucidates the cited relationship in the foreign exchange market. The results give significant support to information being asymmetric across classes of customers and that private information is transmitted to the foreign exchange market by the trading behaviour of informed customers. Moreover, the volatility patterns in the foreign exchange market are significantly and substantially affected by the customer order flows. The size of the trade impact on volatility in a portfolio-based approach was also examined and it was found that the large sales are more influential trades on volatility in the foreign exchange market. In addition, to study the subsequent volatility, there was an examination of two existing hypotheses; i.e., the liquidity-driven-trade-hypothesis (positive subsequent relationship), and the information-driven-trade-hypothesis (negative subsequent relationship.) Both phenomena were found to exist, depending on the economic condition of the market. Finally, an explanation was given for the existence and identification of the carry trade in the foreign exchange market. When an investor borrows from a low interest-rate currency and invests in a higher interest-rate currency, zero-investment portfolio, this trading strategy is called carry trade strategy. Again, a novel data set provided by the UBS was examined to establish a relationship between the ordering patterns of informed customers and the carry trade. The forward discount bias and the carry trade were studied using theories of microstructure finance and the consumption-based asset-pricing model in a portfolio-based framework. The microstructure approach is the standard model of Evans and Lyons (2002). It was found that the order flow significantly explained the excess return in the carry trade, implying that informed customers knew about the carry trade opportunities in the market and reorganised their portfolios in order to realise these gains. Volatility and customer order flows were also examined, using a GMM approach, as a global innovation factor, and it was found that both variables significantly explained the cross-section of carry returns in the foreign exchange market

A Re-examination of the Size and Value Effects in the UK: Evidence, Explanations and Implications for Style Rotation Strategies

There is a lot of evidence in the academic literature that stock returns are predictable especially when various fundamental variables are used as predictors. Firm - specific variables, such as market value, book - to - price, cash flow - to - price, earnings yield or earnings growth have been extensively used either directly in static asset pricing models, as instruments in a conditional pricing framework, or as important factors in the construction of investment strategies. Whether the relationship between firm-specific variables reflects compensation for risk or some sort of market inefficiency is not yet clear. This thesis examines the characteristics and performance of various investment strategies constructed using fundamental variables, and investigate whether the difference in returns between portfolios can be attributed to differences in sensitivity to market industry and macroeconomic risk factors. Furthermore, market overreaction to past growth and analysts’ earnings projections is examined as alternative explanation for existence of the value-growth premium. The second part of the thesis focuses on the short-term return variability of portfolio strategies constructed using market value and book-to-price variables. The volatility of the size and value premiums suggests that a consistent bet to a certain investment philosophy or style might not be the ideal investment choice. The thesis explores the feasibility of style rotation strategies after taking account different levels of forecasting skill and transaction costs and tests out-of-sample a model that utilises mainly macroeconomic factors to predict the next months’ size and value premium. Finally, the thesis analyse the volatility characteristics of style portfolios and proposes volatility specifications to predict future variances at different horizons