Asset pricing without garbage

This paper provides an explanation why garbage as a measure of consumption implies a several times lower coefficient of relative risk aversion in the consumption-based asset pricing model than consumption based on the official National Income and Product Ac- counts (NIPA): Unlike garbage, NIPA consumption is filtered to mitigate measurement error. I apply a structural model of the filtering process, which allows to revoke the filter inherent in NIPA consumption. "Unfiltered NIPA consumption" performs as well as garbage in explaining the equity premium and risk-free rate puzzle. Furthermore, I find that two other popular NIPA-based measures, three-year and fourth-quarter NIPA consumption, are related to unfiltered NIPA consumption. Both can be viewed as ad hoc unfilter rules

Downside risk optimization in securitized real estate markets

Optimization of international securitized real estate portfolios has been a key topic for several decades. However, most previous analysis has focused on regional diversification by applying the traditional mean-variance (MV) framework suggested by Markowitz (1952) even if the limitations of this approach are well-known. Thus, we focus on a more suitable and appealing downside risk (DR) framework suggested by Estrada (2008), which applies a similar optimization algorithm as the MV framework. The analysis covers the eight largest securitized real estate markets from January 1990 to December 2009 and thus captures a more global perspective. The main findings are as follows: first, the return distributions are non-normally distributed and negatively skewed. Second, optimal portfolio weights differ substantially between the MV and DR approach. Third, portfolio weights are shifted from the U.S. and Australian market to the Dutch and the French market when applying the DR framework instead of the MV framework. Fourth, the dominance of the DR framework is well-documented by comparing out-of-sample performance. The empirical results are remarkable and emphasize the practical merit of the presented DR framework for investors and portfolio managers

Return and risk of human capital contracts

Human capital contracts give private investors the right to a share of students' future earnings in return for a financial contribution during their studies. Although still rarely used, human capital contracts could not only help to complement limited public funding for higher education but might also be an alternative to traditional financial assets. Using a dataset covering 1% of German households for the period 1995-2009, we analyse the return and risk properties that can be expected from human capital contracts. We find that funds of human capital contracts provide low risk exposures to stocks and bonds. As a result, risk-adjusted returns of funds of human capital contracts are significantly positive under fairly weak conditions. Thus, human capital contracts potentially offer large diversification benefits for investors and might be a way to improve the state's educational budget

Understanding and harvesting expected returns of asset classes, investment styles, and risk factors

This thesis contains four papers in finance

International diversification benefits with foreign exchange investment styles

This paper provides a comprehensive analysis of portfolio choice with popular foreign exchange (FX) investment styles such as carry trades and strategies commonly known as FX momentum, and FX value. We investigate if diversification benefits can be achieved by style investing in FX markets relative to a benchmark allocation consisting of U.S. bonds, U.S. stocks, and international stocks. Overall, our results suggest that there are significant improvements in international portfolio diversification due to style-based investing in FX markets (both in the statistical, and most importantly, in the economic sense). These results prevail for the most important investment styles after accounting for transaction costs due to re-balancing of currency positions, and also hold in out-of-sample tests. Moreover, these gains do not only apply to a mean-variance investor but we also show that international portfolios augmented by FX investment styles are superior in terms of second and third order stochastic dominance. Thus, even an investor who dislikes negatively skewed return distributions would prefer a portfolio augmented by FX investment styles compared to the benchmark

GDP mimicking portfolios and the cross-section of stock returns

The components of GDP (residential investment, durables, nondurables, equipment and software, and business structures) display a pronounced lead-lag structure. We investigate the implications of this lead-lag structure for the cross-section of asset returns. We find that the leading GDP components perform well in explaining the returns of 25 size and book-to-market portfolios and do reasonably well in explaining the returns of 10 momentum portfolios. The lagging components do a poor job at explaining the returns of 25 size and book-to-market portfolios but explain the return of momentum portfolios very well. A three-factor model with the market risk premium, one leading and one lagging GDP component compares very favorably with the Carhart four-factor model in jointly explaining the returns on 25 size/book-to-market portfolios, 10 momentum portfolios and 30 industry portfolios

International diversification with securitized real estate and the veiling glare from currency risk

This paper analyzes diversification benefits from international securitized real estate in a mixed-asset context. We apply regression-based mean-variance efficiency tests, conditional on currency-unhedged and fully hedged portfolios to account for foreign exchange risk exposure. From the perspective of a US investor, it is shown that first, international diversification is superior to a US mixed-asset portfolio, second, adding international real estate to an already internationally diversified stock and bond portfolio results in a further significant improvement of the risk-return trade-off and, third, considering unhedged international assets could lead to biased asset allocation decisions not realizing the true diversification benefits from international assets. Our in-sample results are quite robust in out-of-sample analysis and when investment frictions like short selling constraints are introduced

The anatomy of public and private real estate return premia

Market-wide, stock market specific, and real estate market specific risk – what kind of risk and to which extent drives the returns of listed real estate? Based on a structural asset pricing model calibrated to the empirical data in the U.S., we show that at least two thirds of the risk premium of listed real estate are driven by the same factors as direct real estate. Our results shed new light on the risk-characteristics of listed real estate returns and are of high interest for academics, regulators, and portfolio managers alike

International Diversification Benefits with Foreign Exchange Investment Styles

This paper provides a comprehensive analysis of portfolio choice with popular foreign exchange (FX) investment styles such as carry trades and strategies commonly known as FX momentum, and FX value. We investigate if diversification benefits can be achieved by style investing in FX markets relative to a benchmark allocation consisting of U.S. bonds, U.S. stocks, and international stocks. Overall, our results suggest that there are significant improvements in international portfolio diversification due to stylebased investing in FX markets (both in the statistical, and most importantly, in the economic sense). These results prevail for the most important investment styles after accounting for transaction costs due to re-balancing of currency positions, and also hold in out-of-sample tests. Moreover, these gains do not only apply to a mean-variance investor but we also show that international portfolios augmented by FX investment styles are superior in terms of second and third order stochastic dominance. Thus, even an investor who dislikes negatively skewed return distributions would prefer a portfolio augmented by FX investment styles compared to the benchmark.International Diversification, Foreign Exchange Speculation and Hedging, Carry Trades, Stochastic Dominance, Investment Styles