Maximilian Wimmer

Tri-criterion inverse portfolio optimization with application to socially responsible mutual funds

We present a framework for inverse optimization in a Markowitz portfolio model that is extended to include a third criterion. The third criterion causes the traditional nondominated frontier to become a surface. Until recently, it had not been possible to compute such a surface. But by using a new method that is able to generate the nondominated surfaces of tri-criterion portfolio selection problems, we are able to compute via inverse optimization the implied risk tolerances of given funds that pursue an additional objective beyond risk and return. In applying this capability to a broad sample of conventional and socially responsible (SR) mutual funds, we find that there appears to be no significant evidence that social responsibility issues, after the screening stage, are further taken into account in the asset allocation process, which is a result that is likely to be different from what many SR investors would expect.

The Effect of the Japan 2011 Disaster on Nuclear and Alternative Energy Stocks Worldwide: An Event Study

This event study investigates the impact of the Japanese nuclear disaster in Fukushima-Daiichi on the daily stock prices of French, German, Japanese, and U.S. nuclear utility and alternative energy firms. Hypotheses regarding the (cumulative) abnormal returns based on a three-factor model are analyzed through joint tests by multivariate regression models and bootstrapping. Our results show significant abnormal returns for Japanese nuclear utility firms during the one-week event window and the subsequent four-week post-event window. Furthermore, while French and German nuclear utility and alternative energy stocks exhibit significant abnormal returns during the event window, we cannot confirm abnormal returns for U.S. stocks.

Computing the Nondominated Surface in Tri-Criterion Portfolio Selection

Computing the nondominated set of a multiple objective mathematical program has long been a topic in multiple criteria decision making. In this paper, motivated by the desire to extend Markowitz portfolio selection to an additional linear criterion dividends, liquidity, sustainability, etc., we demonstrate an exact method for computing the nondominated set of a tri-criterion program that is all linear except for the fact that one of its objectives is to minimize a convex quadratic function. With the nondominated set of the resulting quad-lin-lin program being a surface composed of curved platelets, a multiparametric algorithm is devised for computing the platelets so that they can be graphed precisely. In this way, graphs of the tri-criterion nondominated surface can be displayed so that, as in traditional portfolio selection, a most preferred portfolio can be selected while in full view of all other contenders for optimality. Finally, by giving an example for socially responsible investors, we demonstrate that our algorithm can outperform standard portfolio strategies for multicriterial decision makers.

Temperature Models for Pricing Weather Derivatives

We present four models for predicting temperatures that can be used for pricing weather derivatives. Three of the models have been suggested in previous literature, and we propose another model that uses splines to remove trend and seasonality effects from temperature time series in a flexible way. Using historical temperature data from 35 weather stations across the United States, we test the performance of the models by evaluating virtual heating degree days (HDD) and cooling degree days (CDD) contracts. We find that all models perform better when predicting HDD indices than predicting CDD indices. However, all models based on a daily simulation approach significantly underestimate the variance of the errors.

Tri-criterion modeling for constructing more-sustainable mutual funds

One of the most important factors shaping world outcomes is where investment dollars are placed. In this regard, there is the rapidly growing area called sustainable investing where environmental, social, and corporate governance (ESG) measures are taken into account. With people interested in this type of investing rarely able to gain exposure to the area other than through a mutual fund, we study a cross section of U.S. mutual funds to assess the extent to which ESG measures are embedded in their portfolios. Our methodology makes heavy use of points on the nondominated surfaces of many tri-criterion portfolio selection problems in which sustainability is modeled, after risk and return, as a third criterion. With the mutual funds acting as a filter, the question is: How effective is the sustainable mutual fund industry in carrying out its charge? Our findings are that the industry has substantial leeway to increase the sustainability quotients of its portfolios at even no cost to risk and return, thus implying that the funds are unnecessarily falling short on the reasons why investors are investing in these funds in the first place.

Patience pays off – corporate social responsibility and long-term stock returns

ABSTRACT This paper presents new evidence on the implications of corporate social responsibility (CSR) on stock returns. By implementing a long-term focus as well as using subdivided measures for CSR, we cater to the intangible nature and the heterogeneity of CSR activities. We use a novel classification of these activities into nine areas, each belonging to one of the standard environment, social, and governance (ESG) dimensions. Using cross-sectional return regressions and buy-and-hold abnormal returns, we find that firms with strong CSR significantly outperform firms with weak CSR in the mid and long run in certain areas. Firm returns increase up to 3.8% with respect to a one-standard-deviation increase of the CSR rating. In a two-stage least squares (2SLS) approach we verify that the main economic channel for the appreciation of strong CSR stocks is unexpected additional cash flows. The results are relevant for assessing the efficiency of CSR, and have broader implications for asset managers who can expect abnormal returns by investing in firms that exhibit a high CSR in the respective scores and holding the stocks for a longer period.

Incorporating single and multiple losses in operational risk: a multi-period perspective

Operational disruptions can have serious repercussions for firms over extended periods of time. In this work, we develop a multi-period model of operational risk. We define the loss process of operational disruptions as a sum of events triggering single and multiple losses. We empirically validate our approach using an extensive dataset of operational disruptions experienced by firms from the financial services and manufacturing industry sectors. The results of our simulations point out that operational risk is significantly underestimated if the events leading to multiple losses are not accounted for in the firms’ long-term capital planning.

Patience Pays Off - Financial Long-Term Benefits of Sustainable Management Decisions

This paper quantifies the long-term financial effects of strong (weak) corporate social performance (CSP). We contribute to the literature by seeking such effects on a broad range, i.e. different CSP dimensions which are depicted by so-called ESGEc scores - an acronym for environment, social, governance, and economic - and for 18 sub-scores of these four dimensions. Our central strategy is to analyze the time structure of abnormal firm returns dependent on CSP rating data. We find positive mid- and long-term effects in all four dimensions of up to 6.82% abnormal return with respect to a change from the lowest to the highest possible ESGEc score. These effects are robust to controlling for common risk factors, accounting data, and industry fixed effects. We identify market inefficiencies for certain sub-scores and verify that the economic channel for the appreciation of strong CSP stocks are both additional cash flows and additional demand during our sample period. Thus, investments in firms with a high CSP are profitable in the long run.

Where and When Does It Pay to Be Good? A Global Long-Term Analysis of ESG Investing

This paper explores the long-term performance of stocks with high corporate social performance (CSP), measured by so-called ESG scores depicting the environmental (E), social (S), and governance (G) dimension. We investigate the buy-and-hold abnormal returns of a long/short investment strategy including the top and low 20% stocks with respect to each of the ESG dimensions. The results of the bootstrap tests in a world-wide perspective indicate that financial markets are not capable to price different levels of CSP in the short run and in particular in the long run properly. The zero investment strategy produces significantly positive abnormal returns up to 20% in North America and Europe in a five year period. We also identify regional differences, for instance, a high social score does not pay in Japan and strong corporate governance yields significantly negative abnormal returns in Asia Pacific.

Is socially responsible investing just screening

This paper presents the results of an empirical study concerning conventional and socially responsible mutual funds.We apply a sophisticated operations research algorithm embedded in inverse portfolio optimization on financial market data, ESG-scores and CRSP fund data. Due to our results we cannot find strong evidence of differences between conventional and socially responsible mutual funds. In particular, the calculated risk tolerance parameters describing the real portfolio composition best show that socially responsible mutual funds may be even less concerned about the ESG-scores in the preference functional than conventional funds.