The paper proposes using modified duration in calculating the proper risk-adjusted discount rate (RADR) to account for downside risk scenarios in capital budgeting.
Abstract
Purpose
The paper proposes using modified duration in calculating the proper risk-adjusted discount rate (RADR) to account for downside risk scenarios in capital budgeting.
Design/methodology/approach
The paper shows how to use modified duration to summarize in a single number the bidimensional information about the inflows and terms in which they are charged in the use of the RADR. If a short modified duration characterizes the project, that is, the most relevant inflows are charged in short times, then discounting at RADR has mild effects on net present value (NPV). Else, if a long modified duration characterizes the project, discounting at RADR may have severe effects on NPV. The study proves that RADR's effectiveness increases with the project's modified duration.
Findings
The study builds a bridge between the regular NPV method used in academia and the RADR method used in the managerial context by identifying the proper RADR that leads the same NPV risk-adjustments, whichever method is used by including modified duration into the analysis.
Practical implications
The results show how to select the proper RADR by reducing the subjectivity and increasing financial precision based on modified duration, thus providing an alternative to the norm. Simulations are used to make sensitivity analysis more effective and spotlight the main drivers in the risk-adjustments providing robust results.
Originality/value
This paper fulfils the gap between the RADR method and the expected net present value method by providing simple relations between the characteristic parameters.
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DIRK TASCHE and LUISA TIBILETTI
Incremental value at risk (IVaR) is becoming a standard tool to identify investment strategies that enhance risk‐adjusted returns. Recently, practice‐oriented research has focused…
Abstract
Incremental value at risk (IVaR) is becoming a standard tool to identify investment strategies that enhance risk‐adjusted returns. Recently, practice‐oriented research has focused applying IVaR to hedging and speculating with options and risk reduction. IVaR approximation methods provide easily applied preliminary guidelines for risk allocation. This article examines two such approaches.
Marta Cardin, Bennett Eisenberg and Luisa Tibiletti
Shalit and Yitzhaki presented the mean‐extended Gini (MEG) as a workable alternative to the Markowitz mean‐variance approach in 1984. Since then, the challenge has been to extend…
Abstract
Purpose
Shalit and Yitzhaki presented the mean‐extended Gini (MEG) as a workable alternative to the Markowitz mean‐variance approach in 1984. Since then, the challenge has been to extend the MEG approach. The purpose of this paper is to propose a generalization of the MEG approach for making customized optimal asset allocation to control both down‐performance and/or up‐performance.
Design/methodology/approach
The MEG approach is used to make strategical allocation tailored to the investor risk aversion and gain propensity measured by characteristic parameters of the extended Gini measures.
Findings
The authors set up two optimization problems: the former focused on controlling the risk, the latter on emphasizing the potential gains. Sufficient conditions such that the efficient MEG‐risk frontier coincides with the inefficient MEG‐gain frontier are stated. In the realistic scenarios that portfolios have asymmetrical distributions and/or the investor profile is very conservative or very aggressive, the desirable occurrence that a portfolio is optimal under both optimizations may occur.
Originality/value
The main contribution of this research is to have pointed out that optimal allocation must be tailored to both the investor's risk and gain profile; and, that the optimality may be not preserved if the investor's risk‐gain profile changes. So, the statement “optimal allocation” should be reworded as “optimal allocation personalized to the investor's risk‐aversion and gain‐propensity”.
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Martin Eling, Simone Farinelli, Damiano Rossello and Luisa Tibiletti
Recent literature discusses the persistence of skewness and tail risk in hedge fund returns. The aim of this paper is to suggest an alternative skewness measure, Azzalini's…
Abstract
Purpose
Recent literature discusses the persistence of skewness and tail risk in hedge fund returns. The aim of this paper is to suggest an alternative skewness measure, Azzalini's skewness parameter delta, which is derived as the normalized shape parameter from the skew‐normal distribution. The paper seeks to analyze the characteristics of this skewness measure compared with other indicators of skewness and to employ it in some typical risk and performance measurements.
Design/methodology/approach
The paper first provides an overview of the skew‐normal distribution and its mathematical formulation. Then it presents some empirical estimations of the skew‐normal distribution for hedge fund returns and discusses the characteristics of using delta with respect to classical skewness coefficients. Finally, it illustrates how delta can be used in risk management and in a performance measurement context.
Findings
The results highlight the advantages of Azzalini's skewness parameter delta, especially with regard to its interpretation. Delta has a limpid financial interpretation as a skewness shock on normally distributed returns. The paper also derives some important characteristics of delta, including that it is more stable than other measures of skewness and inversely related to popular risk measures such as the value‐at‐risk (VaR) and the conditional value‐at‐risk (CVaR).
Originality/value
The contribution of the paper is to apply the skew‐normal distribution to a large sample of hedge fund returns. It also illustrates that using Azzalini's skewness parameter delta as a skewness measure has some advantages over classical skewness coefficients. The use of the skew‐normal and related distributions is a relatively new, but growing, field in finance and not much has been published on the topic. Skewness itself, however, has been the subject of a great deal of research. Therefore, the results contribute to three fields of research: skewed distributions, risk measurement, and hedge fund performance.
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Ahmed Hassanein and Mohamed Elmaghrabi
This study tests the proprietary cost of reporting sustainability practices. It explores how market competition impacts the reporting of corporate sustainability information…
Abstract
Purpose
This study tests the proprietary cost of reporting sustainability practices. It explores how market competition impacts the reporting of corporate sustainability information. Further, it examines whether the influence of market competition on sustainability reporting is affected by firm size.
Design/methodology/approach
It uses two samples of the UK FTSE 350 and German Frankfurt CDAX nonfinancial firms from 2010 to 2023. The sustainability reporting scores for UK and German firms are their Environmental, Social and Governance (ESG) disclosure scores based on the Bloomberg disclosure index. The Herfindahl–Hirschman index has been utilized to measure a firm’s degree of market competition.
Findings
The results reveal that reporting sustainability practices is a negative function of the degree of market competition. Specifically, companies in highly competitive industries disclose less information about their sustainability practices, suggesting that firms view sustainability reporting as a potential source of competitive disadvantage and, therefore, choose to limit such disclosures to maintain a strategic advantage over rivals. Further, the findings reveal a negative impact of market competition on sustainability reporting among small firms. However, this effect is weak or absent among medium and large firms. The results are more observable in the liberal market economy (i.e. the UK) than in the coordinated market economy (i.e. Germany).
Practical implications
It provides implications for policymakers and market participants to advocate for more significant policies that promote transparency and encourage companies to report their sustainability practices and performance, especially companies in highly competitive industries.
Originality/value
It provides the first evidence of how market competition influences corporate sustainability reporting, adding a deeper insight into another non-financial dimension of sustainability reporting. Likewise, it reflects the varying priorities of companies of different sizes in managing both competition and sustainability reporting. Besides, it is the first to explore this nexus in two distinct jurisdictions: the UK and Germany.