Nico van der Wijst

Default Probabilities in a Corporate Bank Portfolio: A Logistic Model Approach

Anaysis and management of credit risk has taken on an increased importance in recent years. New regulations force banks and other financial institutions to make a credible effort to chart and manage risk associated with their client portfolio. Increased competation in the financial market has also improved the motivation of monitoring the risk/reward relationship on various clients. This article present a method of estimating default probabilities for a retail bank portfolio. The analysis is based on a logistic regression model where financial variables as well as other firm characteristics affect the default probability.

Optimal portfolio selection and dynamic benchmark tracking

Abstract This paper analyzes different approaches to portfolio selection when the requirement to portfolio performance is formulated relative to a given benchmark. For example, it may be desirable to track a market index as closely as possible. We develop several portfolio selection algorithms based on different perceptions of risk and different risk/target measures, ranging from the traditional variance to the more modern value-at-risk. In a dynamic setting we address the issue of optimal portfolio rebalancing. We develop an algorithm for determining whether or not to rebalance a given portfolio, based on transaction costs and new information about market conditions. Our approaches are tested on a set of stock data from the Oslo stock exchange.

The financial structure of nonlisted firms

This article presents an analysis of how Norwegian nonlisted firms are financed. Using a unique database covering all limited liability firms in Norway, both the size (leverage) and composition (maturity structure) of debt are investigated. The empirical evidence provides support for the effects of taxes, asymmetric information and size suggested in the theoretical literature and rejects the effects of agency costs and the pecking order theory. It also shows that the capital structure choice in these firms is not made in a fundamentally different way than in large firms.

A new approach to firm evaluation

In this paper, a method is developed to evaluate firms on the basis of the risks they face. In accordance with the multi-factor method, risk is represented as a vector of sensitivities to unexpected changes of risk factors. Subsequently, the sensitivities themselves are related to firm characteristics.In addition, an application of the method to interfirm comparison is presented. This application is illustrated by a numerical example based on estimates concerning real data. Apart from this application, some other possible future applications are mentioned. Finally, some decision support tools are presented which may enhance the usefulness of the method in practice.

The Application of the Multi-Factor Model in the Analysis of Corporate Failure

This paper describes an application of the multi-factor model to the analysis and prediction of corporate failure. The multi-factor model differs from the more usual methods of failure prediction because failure is conditioned on the values of a series of exogenous risk factors rather than on a series of “internal” financial ratio’s. Moreover, the multi-factor model is not primarily aimed at classifying firms in categories, but at modelling the influences of exogenous riskfactors, through sensitivities, on the firm’s cash flow generating process. The paper presents the general multi-factormodel and the conditional failure prediction model as bell as the possibilities to apply the model.

A Cautionary Note on the Pricing of Ethics

Ethical or socially responsible investing (SRI) has become a popular feature of modern portfolio management. This cautionary note evaluates SRI under different assumptions regarding market efficiency and ethical preferences. SRI appears to be difficult to combine with active investment strategies, as an informationally inefficient market may give rise to ethical illusions. The most consistent way to implement SRI seems to be to hold a market portfolio based on an ethical subset of the investment universe.

Firm Finance and Growth: An Empirical Analysis

This paper presents a discussion and empirical analysis of the effects of growth on financial structure. The analysis uses the concept of sustainable growth as well as Myers’ pecking order theory and spline functions in LSDV regressions.

Analyzing risk and performance using the multi-factor concept

textabstractIn this paper, we present a new model to analyze the risk and the expected level of firm performance. This model is based on the multi-factor approach to risk, in which unexpected performance is explained through sensitivities to unexpected changes of risk factors. Instead of using the multi-factor approach for the analysis of security portfolios, it is used to analyze performance measures of firms. In this paper the multi-factor approach is not only used to analyze risk, but also to analyze the expected level of performance. Furthermore, it is analyzed how instruments, as for instance projects, can be used to change the risk and the expected level of performance. An illustrative application in the field of finance is presented, although the model can also be applied in other areas.

Default Risk and its Greeks under an Objective Probability Measure

This paper investigates default probabilities and their comparative statics (default Greeks) in the Black and Scholes, Merton framework, using the objective or real probability measure. First we show how a risk neutral default probability can be transformed into an objective probability. The difference between the two is analysed numerically. Risk neutral probabilities appear to be accurate only when they are not useful, and to be too inaccurate for normal credit risk management. Several sensitivity measures for default probability are derived. Default probability is shown to decrease with the value and the drift of assets and to increase with asset volatility, while debt maturity has an ambigous effect. The approach in this paper facilitates the use of the BSM framework for risk management purposes and provides a theoretical basis for empirical analyses of default probability.

Teaching Measure Transformation in Option Pricing with a Loaded Die

We argue that students can be introduced to the counter-intuitive concept of probability measure transformation by applying it to gambling games with a die. The effect of loading a die on the odds of a simple game is readily understood by students and transformed probabilities can easily be calculated. More complex transformations can be obtained with the solver of a spreadsheet program. They can be expressed in measure transformation functions that give an intuitive understanding of the Radon-Nikodym derivative used in risk neutral valuation. The connection with option pricing is made by placing a die game in a simple but general pricing framework. The die loading analogy may be of use to instructors teaching risk neutral valuation or probability measure transformation.