Jose L. B. Fernandes

Risk premium: insights over the threshold

The aim of this article is 2-fold: first to test the adequacy of Pareto distributions to describe the tail of financial returns in emerging and developed markets, and second to study the possible correlation between stock market indices observed returns and returns extreme distributional characteristics measured by Value at Risk and Expected Shortfall. We test the empirical model using daily data from 41 countries, in the period from 1995 to 2005. The findings support the adequacy of Pareto distributions and the use of a log linear regression estimation of their parameters, as an alternative for the usually employed Hills estimator. We also report a significant relationship between extreme distributional characteristics and observed returns, especially for developed countries.

Behavioral Finance: A Study of Affect Heuristic and Anchoring in Decision Making of Individual Investors

The objective of this article is to investigate the presence of affect and anchoring biases in the financial decision making of individual investors. Another parallel objective is to verify whether the gender factor (male and female) or financial knowledge interfere with the presence of these biases. Considering the results of an innovative experiment, we found support to the existence of such biases. It was verified that there was no significant difference regarding men and women with respect to being attached, anchored or attached and anchored to their investments. The women in this sample were slightly more anchored. Finally, it was observed that the knowledge factor interfered marginally in affect, in addition to partially attenuating the anchoring bias.

The Benefits of International Portfolio Diversification

Diversification is one of the main pillars of finance theory. However, its benefits for a conservative investor have been put in check recently with the financial crisis whether it really adds value to the investment profile. The objective of this study is to evaluate if the inclusion of new asset classes add value to a traditional conservative portfolio of USD and EUR bonds. To reach this goal we take into account several asset classes from equities to commodities and generate what would be the efficient frontier under both the Markowitz and the resampling approaches. We also evaluate the effect of the chosen numeraire in the analysis. Our results indicate that the benefits of diversification are higher for less risk averse investors and the choice of the numeraire has a dramatic effect in the portfolio optimization problem and so this is one of the main decisions the investor should care about.

Professional Portfolio Managers - a Setting for Momentum Strategies

Most real world market participants are professional portfolio managers (PPM), which means that they are not managing their own money, but rather managing money for other people (e.g. mutual funds, pension funds). This situation generates an agency feature which has relevant consequences, as investors lacking specialized knowledge may evaluate the PPM just based on his past performance (Performance Based Evaluation - PBE). The objective of this paper is to extend the analysis of the PPMs context inferring the effectiveness of feedback trading in this setting and so describing a source of markets inefficiency. In this sense, we propose a model which considers that professional investment is conducted by a relatively small number of highly specialized PPM using other peoples capital. In a deductive way, we reach four propositions which justify the effectiveness of momentum strategies.

Hidden Risks in Mean-Variance Optimization: An Integrated-Risk Asset Allocation Proposal

The traditional mean—variance asset allocation approach (Markowitz 1952) considers the volatility of returns as the only risk factor. However, investors are usually concerned about other types of risk or negative statistical properties of returns. For instance, investors usually care about credit and liquidity risks, and the skewness and kurtosis of returns. Thus, there is a risk premium embedded in their returns to compensate for additional risk taking. If those risk premia are not taken into account in the analysis, the results of the model tend to be distorted, with portfolios carrying these hidden risks dominating the risk-free portfolios. Moreover, the resulting portfolios for the traditional model tend to be badly behaved due to the overconfidence on the risk/return estimation. Black and Litterman (1992) realize that quantitative asset allocation models have not played the important role they should in global portfolio management, partly due to the previous problems.

How Do Prior Outcomes Affect Risk Taking Behavior? A Cross-Country Experimental Analysis

Recent literature has advocated that risk-taking behavior is influenced by prior monetary gains and losses. On one hand, after perceiving monetary gains, people are willing to take more risk (house-money effect). Another stream of the literature, based on prospect theory and loss aversion, suggests that people are risk averse/seeking in the gain/loss domain. The objective of this paper is twofold: first to clarify the previous contradiction and second to verify the existence of myopic loss aversion across countries. We found that loss aversion is the dominant effect and also report the existence of myopic loss aversion across countries.

Investment Horizon and Efficient Frontier

This paper verified the impact of the investment horizon in the allocation of an optimized portfolio. To do so, we generated efficient frontiers from a group of diversified global asset classes considering time series of returns of the past 10 years. It was possible to prove that the investment horizon impacts the composition of optimal portfolios for different risk levels. In the analysis of the differences in the allocations of portfolios it was revealed a greater disparity in asset allocations in the intermediate to high levels of risk, thus giving support to the effect of the investment horizon in the definition of an optimal portfolio.

Presentation Format and Individual Financial Decisions

This study aimed to verify if the presentation format influences the individual financial decisions. It was also checked whether men and women differ as to the presentation format responses and if financial literacy diminishes this effect. The methodology was an experiment to measure the consistency of responses in similar investment scenarios applied in a group of 106 individuals. The results show that around 70% of the responses were considered inconsistent. Moreover, women were more biased than men and the financial literacy decreased the effect of the presentation format.

Behavioral Finance: The Aversion to Uncertainty Bias in Individual Financial Decisions

This research verifies the existence of the aversion to uncertainty bias in individual financial decisions. It also evaluates the effects of gender and knowledge in this bias. We considered a sample of 80 undergraduate management students from Universidade Catolica de Brasilia. The results supported the existence of the uncertainty bias amongst individuals facing financial decisions. Contrasting previous studies, men presented greater uncertainty bias than women. The students with higher financial knowledge presented lesser uncertainty bias when compared to the ones with reduced knowledge. This last result supports the classification of the aversion to uncertainty as cognitive and not emotional bias.

Information or Noise, A Study on the Accuracy of Analysts’ Forecasts in Brazil

This paper evaluates the accuracy of financial analysts’ forecasts. These predictions are very important since they are used by investors and administrators during the decision making process. We address the quality of the forecasts by comparing them to the actual numbers, using the root mean squared error (RMSE) as the accuracy measure. The data used in this research is provided by the Central Bank of Brazil in the weekly survey with the market analysts: Focus Report. Our results support the hypothesis that analysts’ forecasts are less accurate the further they are away from the date of release of the actual numbers and there is some level of information in some classes of economic indices forecasts which could be used by investors.