Roger J. Bowden

An Asymmetry Generator for Error-Correction Mechanisms, with Application to Bank Mortgage-Rate Dynamics

Empirical evidence supports asymmetries in the adjustment of prices, interest rates, and other economic variables. The asymmetry hypothesis, however, is often procedurally difficult to set up and test. This article shows that a wide variety of such mechanisms can be nested within an asymmetry generator, which represents the interactions between the disequilibrium term of an error-correction mechanism and an ancillary driver process. The asymmetry hypothesis can then be tested in a straightforward extension of linear statistical methods. The methods are applied to 10 years of monthly New Zealand mortgage-rate data.

The generalized value at risk admissible set: constraint consistency and portfolio outcomes

Generalized value at risk (GVaR) adds a conditional value at risk or censored mean lower bound to the standard value at risk and considers portfolio optimization problems in the presence of both constraints. For normal distributions the censored mean is synonymous with the statistical hazard function, but this is not true for fat-tailed distributions. The latter turn out to imply much tighter bounds for the admissible portfolio set and indeed for the logistic, an upper bound for the portfolio variance that yields a simple portfolio choice rule. The choice theory in GVaR is in general not consistent with classic Von Neumann–Morgenstern utility functions for money. A re-specification is suggested to make it so that gives a clearer picture of the economic role of the respective constraints. This can be used analytically to explore the choice of portfolio hedges.

The ordered mean difference as a portfolio performance measure

Abstract The ordered mean difference (OMD) function is a running mean of the difference between returns on a given fund or security and a benchmark such as the market portfolio, ordered by values of the benchmark. The expectation of this function, conditional on the observed series of benchmark returns, can be used as a portfolio performance measure. Such a formulation is the financial counterpart of the equivalent variation of welfare economics, which in the present context can be regarded as the resource rental value of the managers market timing ability. The conditional ordered mean difference (COMD) is related to a number of recent approaches to the principles of performance measurement. It can be estimated either by using the OMD as a non-parametric estimate, or else by fitting the conditional expectation by least squares.

The zero-capital approach to portfolio enhancement and overlay management

Abstract Both active and passive portfolio enhancement can be analysed within a zero-capital framework, wherein enhancement exposures are reported as an additional or secondary portfolio requiring zero capital. This enables an identification of the economic value added by the enhancement, using two complementary approaches. The first is based on traditional beta analysis, which is useful in identifying the direction and magnitude of exposures. The second is non-parametric in nature and plots ordered mean difference schedules for the enhancement against the base portfolio. This enables risk profiling where the manager can match the likely range of his or her own risk preferences against the empirical history of the relationship, so that explicit risk premiums do not have to be utilized. The empirical illustration exhibits asymmetries in the effectiveness of currency overlay.

McHouse prices, capital hoovering, and real exchange rate exposures

House prices are both cause and effect of the real exchange rate. In the form of implied rentals or service prices, they are a good proxy for non tradables prices, which in turn are signs of generalised expenditure inflation and hence underlying real exchange rate pressures. The causal impact is because rising house prices suck in offshore funding, markedly so in recent times, creating a capital account driven nominal exchange rate. The hoovering effect is responsive to interest rate differentials, leading to a more focused view of the role of uncovered interest parity, as an offshore response to internally generated demand for funds rather than externally generated hot money chasing spot rate margins. The overall result is likely to be chronic macroeconomic instability over the inter run, creating challenges for corporate risk management, monetary control and industrial policy.

Which Are the World's Wobblier Currencies? Reference Exchange Rates and Their Variation

Measuring country exchange rates relative to a common reference basket results in a set of no-arbitrage prices, unlike trade-weighted indexes, the usual method of comparing country exchange rate histories. The reference basket is analogous to a portfolio, and its choice can be resolved by drawing on required economic interpretations or uses. We use currency reference rates to examine the historical variability of different currencies over designated cyclical bands. The temporal decompositions used are those provided by wavelet analysis, which is light on maintained assumptions about data generating processes. Some countries, notably Japan and New Zealand do exhibit a powerful but irregular medium term cycle, while others are much more stable. Implications are briefly examined for investment, hedging, monetary policy and common currency studies.

Asymmetry and Performance Metrics for Equity Returns

An assumption of symmetric asset returns, together with globally risk averse utility functions, is unappealing for fund managers and other activist investors, whose preferences switch between risk aversion on the downside and risk seeking on the upside. A performance return criterion is originated that is more consistent with the implicit Friedman-Savage utility ordering. Adapted from recent developments in the income distribution literature, the proposed metric weights the lower versus upper conditional expected returns, while a dual spread or dispersion metric also exists. The resulting performance metric is easy to compute. A point of departure is taken as the conventional Sharpe performance ratio, and the contrasts are illustrated with an empirical example.

Quality Signalling and Ratings Credibility: Regulatory Reform for the Ratings Industry

Financial regulators can enhance the credibility of credit ratings if agencies are offered a registration facility that sequesters part of their fee as a performance bond over a designated maturity. The margin can be responsive to the rating, the defined credit event, and the registration maturity. Agencies can signal their private information by choosing whether or not to register and stake part of their fee. The value of the registration real option determines the amount that is spent by the issuer on the incremental quality of research required. The framework can also inform margin and penalty setting by regulators; while an ex ante choice to register is a potential defence in professional liability litigation.

Instrument Insufficiency and Economic Stabilisation

Recently concerns have been raised in New Zealand about the effectiveness of monetary policy in controlling inflation while avoiding damage to the economy from high exchange rates. This review examines the basis for concern and identifies the problem as a failure in the primary instrument, namely the Reserve Banks official cash rate, to adequately impact further along the term structure curve, which has become the more sensitive area for aggregate demand. Direct control over expenditure is therefore weak, and too much leeway is left to the housing and other asset markets to sustain demand in the economy. Globalisation of credit availability and financial technology have helped to blunt the policy instrument in this respect, shifting the adjustment burden on to the exchange rate. Deft management of interest and currency expectations can help, but the problem may require closer coordination and cooperation between monetary and fiscal policy, restoring a stabilisation role for the latter.