Ashraf Al Zaman

Real Estate for the Long Term: The Effect of Return Predictability on Long-Horizon Allocations

We examine how the predictability of real estate returns affects the risk of, and optimal allocations to, real estate for investors of differing investment horizons. Returns to direct real estate are mean reverting, and risk decreases with horizon. This is driven by a tendency for property transaction prices to overshoot inflation. Mean reversion in real estate returns is weaker than that of equities, resulting in real estate having similar risk to equities for long-term investors. However, optimal portfolios have large allocations to direct real estate at all horizons, and the allocation increases with horizon. Finally, we find that real estate investment trusts are a redundant asset class for investors with access to direct real estate as an asset class, but they do have a role in optimal allocations when direct property investment is not feasible.

Management quality and the cost of debt: Does management matter to lenders?

This paper investigates the effect of organizational capital, typified by various management practices within a firm, on the cost of external debt financing. Using a sample of medium-sized manufacturing firms in the US, we find that better management practices enhance a firm’s external financing capacity by lowering the firm’s cost of bank loans. We do not find any evidence that the lower loan cost of a high-quality-management firm is associated with more restrictive non-price contract terms such as greater collateral requirements and stricter covenants. These results suggest that banks explicitly take into account the risk arising from poor management practices when pricing and designing debt contracts.

Tax-Adjusted Portfolio Optimization and Asset Location: Extensions and Synthesis

Models developed in a pretax framework do not necessarily apply in an after-tax framework, and this notion certainly applies to portfolio optimization. This article derives generalized tax adjustments to return and volatility inputs in an after-tax portfolio optimization algorithm. It extends the literature by incorporating an asset’s cost basis, addressing a broader array of taxable entities, and deriving expressions for off-diagonal terms in the covariance matrix. They develop a comprehensive framework that distinguishes between tax-adjustments predicated on pretax market values and after-tax values. The distinction is important so that portfolio managers can avoid inadvertently blending two inconsistent approaches.

Risk-Sharing Implications for Roth IRA Conversions: Fact and Fiction

We investigate the risk-sharing implications of taxation associated with the option to convert a traditional IRA to Roth IRA. Although the conversion option may create value for savers by potentially reducing their tax burdens, the risk profile of their holdings may change. Delaying payment of the conversion tax creates a leveraged equity position for the taxpayer. We show that the conversion decision depends on the dynamics of the underlying asset, including volatility and its path through time. Moreover, how asset dynamics affect the ultimate payoff depends on the financing source for the conversion tax payment. These factors render some conventional wisdom around conversion unreliable.

Supply-Chain Flexibility and the Cost of Debt: Evidence from Uncertainty Shocks

Using comprehensive bank-loan contract information, we show that the power of a firm relative to its suppliers eases its terms of bank financing, specifically through lower loan prices and less restrictive non-price contract terms. Our results are robust to controlling for product-market competition. Supply chain power enables the firm to achieve a greater level of control over its inventory, constituting a significant portion of the reduction in its overall loan cost. We argue that it is important to consider supply-chain related issues when analyzing the external-financing capacity of firms.

Politics and Stock Returns: A Rationalization

In this study, we find some evidence in favor of systematic risk being priced in the cross-section of stock returns when the effects of presidential cycles and political environments are taken into account. During Democratic presidencies or harmonious political environments, beta has a positive relation to stock returns, but is negatively related to returns during Republican presidencies or in gridlock periods. We find that both the presidential puzzle and the harmony premium can be rationalized when the effects of politics on the beta-return relation are taken into account.

Cash Holdings, Market Frictions and Monetary Policy: An Investigation of Increase in Cash Holdings

We investigate the secular increase in the corporate cash holding over the period 1980-2006. We show that along with firm characteristic–related variables, monetary policy and banking structure have a significant bearing on corporate cash holdings, as they determine the opportunity cost of holding cash as well as access to cash. Specifically, we establish that the need to hold cash was complemented by the ability to hold cash during the given period due to low opportunity cost. We also investigate the role of cash as collateral for financially constrained firms. Our findings allow us to provide insight into the cross-sectional variation.

Taking a Closer Look at the RRSP and TFSA

The Tax-Free Savings Account (TFSA) is the new savings vehicle proposed under the 2008 federal budget. Most existing analyses find the TFSA to be comparable to the Registered Retirement Savings Plan (RRSP) as a retirement savings vehicle. However, given Canada’s progressive tax rates and the specific attributes of each account, such as the mandatory withdrawal provision of the RRSP, the two vehicles are not necessarily equally advantageous for all savers. A careful consideration of the vehicles’ unique attributes shows that different savers with varying income levels, contribution levels, and savings goals (such as making bequests) may benefit differently from these vehicles.