Kanshukan Rajaratnam

Testing market efficiency on the Johannesburg Stock Exchange using the overlapping serial test

It has been suggested that stock exchanges may be tested for market efficiency by using tests for assessing random number generators. This paper uses such a test to assess the efficiency of small, mid and large cap indices on the Johannesburg Stock Exchange, while making adjustments for thin trading which occurs during the sample period. The efficiency of these indices is examined using individual share level data as well as index level data over a stable period and a period containing the 2008 financial crisis. This study finds evidence suggesting that small cap stocks exhibit a high degree of non-randomness in price movements. Some inefficiencies also appear to be present in mid and large cap stocks, however to a much lesser extent, with large cap stocks exhibiting higher levels of efficiency. Many of the stocks investigated appear to exhibit lower levels of efficiency during the crisis period. This may be a result of increased irrationality during periods of uncertainty.

Energy-efficient homes and mortgage risk: crossing the chasm at last?

A topic of recent interest is energy-efficient houses. In the last twenty years, the US market has witnessed growth in the adoption of energy efficiency via various building technologies, design schemes, and eco-labels by developers, homebuilders, and homebuyers. Although housing and real estate scholars have begun explorations of the factors associated with the diffusion of energy efficiency, the subject has yet to be explored from the perspective of a critical stakeholder—the mortgage lender. This paper distinguishes itself from the extant literature in several ways. First, using a diffusion of innovation intellectual framework, the authors explore the role of the lender as an innovation gatekeeper. Second, as a review article, the authors summarize several key papers from the underwriting, credit scoring, and finance literature to help frame a number of market frictions that could mute further diffusion of energy efficiency in housing. Finally, the authors analyze these frictions and offer both market and public policy suggestions that may help overcome these frictions and increase opportunities for both private competitive advantage and market transparency.

A study of total beta specification through symmetric regression: the case of the Johannesburg Stock Exchange

A topic of recent interest is risk management in equity investments from emerging markets. One traditional measure for systematic risk of an asset is beta, which is constructed through ordinary least squares (OLS) regression between historical returns on an individual asset and an index representing the overall market. OLS regression assumes all the error lies within the asset returns. Tofallis (Eur J Oper Res 187(3):1358–1367, 2008) made the case for constructing a systematic risk measure through symmetric regression, where error is assumed to be present in the returns of both the asset and the index. In this paper, we construct a systematic risk measure using symmetric regression for the case of the Johannesburg Stock Exchange (JSE). This paper makes the case that the so-called ‘total beta’ parameter provides a more realistic and stable estimator for market-related risk and return. The total beta estimate, explicitly allowing for error in both variables, is less likely to underestimate the magnitude of the beta parameter.

Loan origination decisions using a multinomial scorecard

This paper explores the case of a consumer loan portfolio manager incorporating the output of a multinomial classifier in the acquisition decision process. We suppose the portfolio manager has access to a pool of applicants and is required to make an accept/reject decision on each applicant. We assume each applicant’s characteristics are used as inputs into the classifier with the output score used to aid in the decision making. Past literature on consumer lending decisions considered the case of a portfolio manager with access to a binomial classifier. For the case of a portfolio manager with a multinomial classifier, we show an efficient policy may be achieved through transforming the score and applying a single cutoff-score strategy on the new score.

Regulatory capital decisions in the Context of consumer loan portfolios

A topic of interest in recent literature is regulatory capital requirements for consumer loan portfolios. Banks are required to hold regulatory capital for unexpected losses, while expected losses are to be covered by either provisions or future income. In this paper, we show the set of efficient operating points in the market share and profit space for a portfolio manager operating under Basel II capital requirement and under capital constraints are a union of single-cutoff-score and double-cutoff-score operating points. For a portfolio manager to increase market-share beyond the maximum allowable under a single-cutoff score policy (eg, with binding capital constraints) requires granting loans to higher than optimal risk applicants. We show this result in greater portfolio risk but without an increase in regulatory capital requirement amount. The increase in forecasted losses is assumed to be absorbed by provisions or future margin income. Given portfolio managers take on higher risk under the same regulatory capital amount, our findings call for greater focus on provision amounts and future margin income under the supervisory review pillar of Basel II. This research raises the issue of whether the design of the regulatory formula for consumer loan portfolios is flawed.

Inference of Aggregational Gaussianity in Asset Returns Exhibiting a Paretian-distribution

Abstract Aggregational Gaussianity (AG) has long been considered a stylized fact of empirical asset return distributions. This research links existing work on the stable-Paretian Hypothesis with the Aggregational Gaussianity hypothesis and notes that the two are incompatible. We use simulation to show that under certain conditions, AG can be falsely inferred to hold in a data set exhibiting the stable-Paretian distribution.

Cornier Creepier Corporate Creditor: A Theoretical Model for the Term Structure of Corporate Credit Based on Competitive Advantage

We model the term structure of Corporate Credit based on Competitive Advantage. Our approach dispenses with the volatility based Geometric Brownian Motion prevalent in most structural-form models. Instead we consider the competitive advantage enjoyed by a firm as the central tenet of our model and capture its eventual demise in a probabilistic manner. We believe that this is the first time a formal link is being established between a firm’s competitive advantage and its term structure, although it seems natural that these two factors are related. Our simple model overcomes some of the well-known shortcomings of structural-form models and explains the credit premium puzzle reasonably well.

Corny Creepy Corporate Credit: A Novel Model for the Term Structure of Corporate Credit Based on Competitive Advantage

We present a novel model for the term structure of Corporate Credit based on Competitive Advantage. Our approach dispenses with the volatility based Geometric Brownian Motion that is prevalent in most structural-form firm models. Instead we consider the competitive advantage enjoyed by a firm as the central tenet of our model and capture the eventual demise of this competitive advantage in a probabilistic manner. As far as we are aware, this is the first time a formal link is being established between a firm’s competitive advantage and the term structure of its debt, although it seems natural that these two factors are related. Our simple intuitive model overcomes some of the well-known shortcomings of structural form models (such as complexity, limited tractability, the under-prediction of credit spreads for lower maturity and the under-prediction of spreads for certain grades of debt).

Mauling Mr. Market: Valuing Equity Capital of Businesses by Long-Term Value-Investors

We present a novel asset pricing model that captures the investment wisdom of the long-term value-investors Benjamin Graham and Warren Buffett. Taking a longer term view of business prospects and business risks, we explicitly consider the time period in which a business enjoys a competitive advantage over its peers as the central tenet of our model and capture the eventual demise of this competitive advantage in a probabilistic manner. Assuming that our investor has log utility, our model answers the question of capital allocation in a two-asset scenario. The model does not enforce the Efficient Market Hypothesis and is shown to explain some well-known empirical studies on stock returns.

Murdering Mr. Market: An Equity Valuation and Capital Allocation Model for Long-Term Value-Investors

We present an equity valuation model that is in the spirit of the long-term value-investors Benjamin Graham and Warren Buffett. Taking a longer term view of business prospects and business risks, we explicitly consider Schumpeter’s forces of creative destruction as the central tenet of our model and capture its effect in a probabilistic manner. Assuming that our investor has log utility, we show that our valuation model answers the question of how much capital to allocate. Unlike CAPM, our model does not enforce the Efficient Market Hypothesis and qualitatively explains some well-known empirical studies on stock returns in existing literature.