Andre Guettler

On Portfolio Optimization: Imposing the Right Constraints

We reassess the recent finding that no established portfolio strategy outperforms the naively diversified portfolio, 1/N, by developing a constrained minimum-variance portfolio strategy on a shrinkage theory based framework. Our results show that our constrained minimum-variance portfolio yields significantly lower out-of-sample variances than many established minimum-variance portfolio strategies. Further, we observe that our portfolio strategy achieves higher Sharpe ratios than 1/N, amounting to an average Sharpe ratio increase of 32.5% across our six empirical datasets. We find that our constrained minimum-variance strategy is the only strategy that achieves the goal of improving the Sharpe ratio of 1/N consistently and significantly. At the same time, our developed portfolio strategy achieves a comparatively low turnover and exhibits no excessive short interest.

Public Bank Guarantees and Allocative Efficiency

We use a natural experiment and matched bank/firm data to identify the effects of bank guarantees on allocative efficiency. We find that with guarantees in place unproductive firms invest more and maintain higher rates of sales growth. Moreover, firms produce less productively. Firms also survive longer in banks’ portfolios and those that enter guaranteed banks’ portfolios are less productive. Finally, we observe fewer economy-wide firm exits and bankruptcy filings in the presence of guarantees. Overall, the results are consistent with the idea that guaranteed banks keep unproductive firms in business for too long and prevent their exit from the market.

Financial Incentives and Loan Officer Behavior: Multitasking and Allocation of Effort under an Incomplete Contract

In this paper we investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance versus a fixed wage unrelated to performance. We study detailed transaction information for more than 45,000 loans issued by 240 loan officers of a large commercial bank in Europe. We examine the three main activities that loan officers perform: monitoring, originating, and screening. We find that when the performance of their portfolio deteriorates, loan officers increase their effort to monitor existing borrowers, reduce loan origination, and approve a higher fraction of loan applications. These loans, however, are of above-average quality. Consistent with the theoretical literature on multitasking in incomplete contracts, we show that loan officers neglect activities that are not directly rewarded under the contract, but are in the interest of the bank. In addition, while the response by loan officers constitutes a rational response to a time allocation problem, their reaction to incentives appears myopic in other dimensions.

The Use of Credit Default Swaps by U.S. Fixed-Income Mutual Funds

We examine the use of credit default swaps (CDS) in the U.S. mutual fund industry. We find that among the largest 100 corporate bond funds the use of CDS has increased from 20% in 2004 to 60% in 2008. Among CDS users, the average size of CDS positions (measured by their notional values) has increased from 2% to almost 14% of a fund’s net asset value. Some funds exceed this level by a wide margin. CDS are predominantly used to increase a fund’s exposure to credit risks rather than to hedge credit risk. Consistent with fund tournaments, underperforming funds use multi-name CDS to increase their credit risk exposures. Finally, funds that use CDS underperform funds that do not use CDS. Part of this underperformance is caused by poor market timing.