With the introduction of the international accounting standards in Europe and dissemination of LD... more With the introduction of the international accounting standards in Europe and dissemination of LDI (Liability Driven Investment) as a new investment standard, the investor demand for super-long end has been rising also in Japan. Under these circumstances, it is required that the Japanese government, as the supplier of the Japanese Government Bond (“JGB”), a unique yen-denominated risk-free asset, establishes a system in which new ultra-long-term bonds such as 40-year JGB can be issued flexibly. Such issues will contribute to the development of bond market and ALM (Asset Liability Management) of financial institutions. On the other hand, proper attention should be paid to setting “appropriate conditions” for the issuance of new maturity government bonds without a secondary market so that neither investors nor taxpayers may be left in a disadvantageous position. Thus, the establishment of an interest rate estimation model is required for setting out such “appropriate conditions.” For ...
Welcome to edition 51 of the Capco Institute Journal of Financial Transformation. The global weal... more Welcome to edition 51 of the Capco Institute Journal of Financial Transformation. The global wealth and asset management industry faces clear challenges, and a growing call for innovation and transformation. Increased competition, generational shifts in client demographics, and growing geopolitical uncertainty, mean that the sector needs to focus on the new technologies and practices that will position for success, at speed. There is no doubt that technology will be at the forefront of a responsive and effective wealth and asset management sector in 2020 and beyond. The shift to digitization, in particular, will see the speeding up of regulatory protocols, customer knowledge building, and the onboarding process, all of which will vastly improve the client experience. This edition of the Journal will focus closely on such digital disruption and evolving technological innovation. You will also find papers that examine human capital practices and new ways of working, regulatory trends, and what sustainability and responsible investment can look like via environmental, social and corporate governance.
Well thank you very much. I greatly appreciate the opportunity to speak to you today and for your... more Well thank you very much. I greatly appreciate the opportunity to speak to you today and for your taking the time to do so. As an introduction, the topic for today is looking at connectedness in the financial system, and I'll talk about a specific way that connectedness is defined in this context, and we'll talk about developing a new and better way to measure the degree of connectedness in the institution in a useful way, with respect to credit risk in particular, and how we might look at all that information and convey it in a fashion that we might be able to monitor, or at least get better information or insights, into potential systemic events. Macro financial risk propagation is a big issue for governments and financial stability, but it also is important in the private sector, particularly for very large asset managers. Managers that have very large asset pools, are too large to actually get out of harm's way, and so like the rest of us, they have to be prepared to deal with large market shocks-instead of simply trying to get away from them. The crisis of 2008 and 2009 was centered on credit risk involving money markets as well, but it was essentially a credit risk issue. The ongoing European debt crisis is, at least in my mind, not yet fully resolved-that also is an issue of credit. So the substantive issue for my remarks is going to be on credit. What I want to deal with is to look at how the propagation of credit risk among financial institutions and sovereigns is related to how connected they are, and in the process develop tools for measuring the connectedness and its dynamic changes. As you'll see from the numbers and the pictures, mostly pictures, the degree of connectedness among institutions and sovereigns is not constant or even approximately so through time. It changes quite substantially and dynamically. A last point, this is work that I've done with five other co-authors; they are not to be held accountable for my bringing it here. The scientific paper is not yet finished. There was an earlier paper describing it but I'm bringing it to you because I, as well as my co-authors, believe
The Journal of Alternative Investments, May 21, 2021
This article provides a robust and practical framework for assessing performance fees. The fee va... more This article provides a robust and practical framework for assessing performance fees. The fee valuation uses standard option pricing models and therefore does not require any expected return or alpha estimate. These features make the framework easy to use, robust, and widely applicable to a variety of fee structures in practice. The authors discuss the incentive impact of performance fees and caution against the unintended consequences for manager behaviors. These implications are especially relevant today, as systematic investing is on the rise and asset owners are increasingly interested in the adoption of performance fees across a broader range of investment styles. TOPICS: Derivatives, options, manager selection, performance measurement Key Findings ▪ This article provides a practical framework for assessing performance fees based on standard option pricing models. The fee valuation does not require any expected return or alpha estimate, making this framework transparent, robust, and widely applicable. ▪ Using the framework, the authors show the incentive impact of performance fees and caution against the unintended consequences for manager behaviors. ▪ The article discusses the implications of performance fees in the context of systematic investing. This discussion is especially relevant today as asset owners are increasingly interested in the broader adoption of performance fee structures beyond traditional alternative investments.
at a conference on pensions sponsored by BNP Paribas. Some events that have occurred since that t... more at a conference on pensions sponsored by BNP Paribas. Some events that have occurred since that time are reflected in the footnotes that have been appended to the talk. 1. IBM's recent announcement of its shift to a DC plan could turn out to be a watershed event that precipitates the unraveling of the DB system. If healthy and employee-centric companies are getting rid of DB plans even for existing employees, what kind of companies are going to pay ever larger premiums to remain part of the system insured by the Pension Benefit Guaranty Corporation? 2. One notable difference between U.S. and U.K. companies is that the latter provide workers with inflation-indexed benefits, and such benefits can be immunized with inflation-linked "Gilts.
will try my hand at suggesting some fruitful directions for putting existing finance theory into ... more will try my hand at suggesting some fruitful directions for putting existing finance theory into investment management practice. I will take the perspective of the client, or customer, and explore a set of asset management issues for three groups-households, corporations (in particular, pension funds), and endowment funds. My intent is to build on and extend the existing intellectual foundation of our investment practice These issues are inextricably connected to four horizons-the long run, the decision horizon, the planning horizon, and the planning subhorizons. The long run is a series of short runs linked to the faraway objective. There are essentially three fundamental time horizons. The shortest is the trading horizon-the shortest length of time in which you can carry out or revise a transaction. Depending on the type of market, it could be virtually continuous (24 hours a day) or once a day. But the horizon is not chosen by the investor or the investor's agent; it is institutionally set. The second-shortest horizon is the decision horizon-the length of time between deciding to revise a portfolio and executing the decision. It may be similar in length to the trading horizon or somewhat longer, such as a week or even a month. But realistically, it will not be, say, five years. No one is going to lock in a decision for five years without any way to revise it. The longest time frame is the planning horizon-the length of time over which things matter to the decision maker. It can be quite long-60 years, 70 years, or in some cases, if the investor is interested in passing wealth to future generations, of indefinite duration. And in addition, there are planning subhorizons-horizons that relate to targeted concerns. For example, within overall lifetime planning, investors may find it convenient to focus on the retirement component of the life cycle, and the length of time until retirement is thus a planning subhorizon, as is the time spent in retirement.
AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL' BY ROBERT C. MERTON An intertemporal model for the ... more AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL' BY ROBERT C. MERTON An intertemporal model for the capital market is deduced from the portfolio selection behavior by an arbitrary number of investors who aot so as to maximize the expected utility of lifetime consumption and who can trade continuously in time. Explicit demand functions for assets are derived, and it is shown that, unlike the one-period model, current demands are affected by the possibility of uncertain changes in future investment opportunities. After aggregating demands and requiring market clearing, the equilibrium relationships among expected returns are derived, and contrary to the classical capital asset pricing model, expected returns on risky assets may differ from the riskless rate even when they have no systematic or market risk.
AUTHOR'S PREFACE Over the years it has been suggested that I bring out some collected papers... more AUTHOR'S PREFACE Over the years it has been suggested that I bring out some collected papers. As the supply of my reprints has become more and more ex-hausted, I have in principle become more and more impressed with the force of this argument. But I have always felt ...
MASSACHUSETTB INSTITUTE OF TECHNOLOGY 'Because this derivation parallels Samuelson's derivation o... more MASSACHUSETTB INSTITUTE OF TECHNOLOGY 'Because this derivation parallels Samuelson's derivation of the Per Capita Consumption Tumpike Theorem [61, I have tried to keep the same notation. As is usual for continuous models, new people are assumed to work from the time they are born (into the labor force). There are various other alternative expressions one might care to maximize instead of the utility of per capita consumption. One such variate, the Bentham-Lemer criterion, is explored later.
A general formula is derived for the price of a security whose value under specified conditions i... more A general formula is derived for the price of a security whose value under specified conditions is a known function of the value of another security. Although the formula can be derived using the arbitrage technique of Black and Scholes, the alternative approach of continuoustime portfolio strategies is used instead. This alternative derivation allows the resolution of some controversies surrounding the Black and Scholes methodology. Specifically, it is demonstrated that the derived pricing formula must be continuous with continuous first derivatives, and that there is not a 'pre-selection bias' in the choice of independent variables used in the formula. Finally, the alternative derivation provides a direct proof of the Modigliani-Miller theorem even when there is a positive probability of bankruptcy. *The paper is a substantial revision of parts of Merton (1976) presented in seminars at Yale and Brown Universities in April 1976 and at the EIASM Workshop in Management Science, Bergamo, Italy ,in October 1976. I thank the oarticioants for their helpful comments. Aid from the National Science Foundation is gratefully acknowledged. My thanks to the referee for editorial suggestions. 'For references to the mathematics of diffusion processes and their applications in economics, see the bibliographies in Merton (1971) and (1973b). ?See Merton (1973a) and (1975).
With the introduction of the international accounting standards in Europe and dissemination of LD... more With the introduction of the international accounting standards in Europe and dissemination of LDI (Liability Driven Investment) as a new investment standard, the investor demand for super-long end has been rising also in Japan. Under these circumstances, it is required that the Japanese government, as the supplier of the Japanese Government Bond (“JGB”), a unique yen-denominated risk-free asset, establishes a system in which new ultra-long-term bonds such as 40-year JGB can be issued flexibly. Such issues will contribute to the development of bond market and ALM (Asset Liability Management) of financial institutions. On the other hand, proper attention should be paid to setting “appropriate conditions” for the issuance of new maturity government bonds without a secondary market so that neither investors nor taxpayers may be left in a disadvantageous position. Thus, the establishment of an interest rate estimation model is required for setting out such “appropriate conditions.” For ...
Welcome to edition 51 of the Capco Institute Journal of Financial Transformation. The global weal... more Welcome to edition 51 of the Capco Institute Journal of Financial Transformation. The global wealth and asset management industry faces clear challenges, and a growing call for innovation and transformation. Increased competition, generational shifts in client demographics, and growing geopolitical uncertainty, mean that the sector needs to focus on the new technologies and practices that will position for success, at speed. There is no doubt that technology will be at the forefront of a responsive and effective wealth and asset management sector in 2020 and beyond. The shift to digitization, in particular, will see the speeding up of regulatory protocols, customer knowledge building, and the onboarding process, all of which will vastly improve the client experience. This edition of the Journal will focus closely on such digital disruption and evolving technological innovation. You will also find papers that examine human capital practices and new ways of working, regulatory trends, and what sustainability and responsible investment can look like via environmental, social and corporate governance.
Well thank you very much. I greatly appreciate the opportunity to speak to you today and for your... more Well thank you very much. I greatly appreciate the opportunity to speak to you today and for your taking the time to do so. As an introduction, the topic for today is looking at connectedness in the financial system, and I'll talk about a specific way that connectedness is defined in this context, and we'll talk about developing a new and better way to measure the degree of connectedness in the institution in a useful way, with respect to credit risk in particular, and how we might look at all that information and convey it in a fashion that we might be able to monitor, or at least get better information or insights, into potential systemic events. Macro financial risk propagation is a big issue for governments and financial stability, but it also is important in the private sector, particularly for very large asset managers. Managers that have very large asset pools, are too large to actually get out of harm's way, and so like the rest of us, they have to be prepared to deal with large market shocks-instead of simply trying to get away from them. The crisis of 2008 and 2009 was centered on credit risk involving money markets as well, but it was essentially a credit risk issue. The ongoing European debt crisis is, at least in my mind, not yet fully resolved-that also is an issue of credit. So the substantive issue for my remarks is going to be on credit. What I want to deal with is to look at how the propagation of credit risk among financial institutions and sovereigns is related to how connected they are, and in the process develop tools for measuring the connectedness and its dynamic changes. As you'll see from the numbers and the pictures, mostly pictures, the degree of connectedness among institutions and sovereigns is not constant or even approximately so through time. It changes quite substantially and dynamically. A last point, this is work that I've done with five other co-authors; they are not to be held accountable for my bringing it here. The scientific paper is not yet finished. There was an earlier paper describing it but I'm bringing it to you because I, as well as my co-authors, believe
The Journal of Alternative Investments, May 21, 2021
This article provides a robust and practical framework for assessing performance fees. The fee va... more This article provides a robust and practical framework for assessing performance fees. The fee valuation uses standard option pricing models and therefore does not require any expected return or alpha estimate. These features make the framework easy to use, robust, and widely applicable to a variety of fee structures in practice. The authors discuss the incentive impact of performance fees and caution against the unintended consequences for manager behaviors. These implications are especially relevant today, as systematic investing is on the rise and asset owners are increasingly interested in the adoption of performance fees across a broader range of investment styles. TOPICS: Derivatives, options, manager selection, performance measurement Key Findings ▪ This article provides a practical framework for assessing performance fees based on standard option pricing models. The fee valuation does not require any expected return or alpha estimate, making this framework transparent, robust, and widely applicable. ▪ Using the framework, the authors show the incentive impact of performance fees and caution against the unintended consequences for manager behaviors. ▪ The article discusses the implications of performance fees in the context of systematic investing. This discussion is especially relevant today as asset owners are increasingly interested in the broader adoption of performance fee structures beyond traditional alternative investments.
at a conference on pensions sponsored by BNP Paribas. Some events that have occurred since that t... more at a conference on pensions sponsored by BNP Paribas. Some events that have occurred since that time are reflected in the footnotes that have been appended to the talk. 1. IBM's recent announcement of its shift to a DC plan could turn out to be a watershed event that precipitates the unraveling of the DB system. If healthy and employee-centric companies are getting rid of DB plans even for existing employees, what kind of companies are going to pay ever larger premiums to remain part of the system insured by the Pension Benefit Guaranty Corporation? 2. One notable difference between U.S. and U.K. companies is that the latter provide workers with inflation-indexed benefits, and such benefits can be immunized with inflation-linked "Gilts.
will try my hand at suggesting some fruitful directions for putting existing finance theory into ... more will try my hand at suggesting some fruitful directions for putting existing finance theory into investment management practice. I will take the perspective of the client, or customer, and explore a set of asset management issues for three groups-households, corporations (in particular, pension funds), and endowment funds. My intent is to build on and extend the existing intellectual foundation of our investment practice These issues are inextricably connected to four horizons-the long run, the decision horizon, the planning horizon, and the planning subhorizons. The long run is a series of short runs linked to the faraway objective. There are essentially three fundamental time horizons. The shortest is the trading horizon-the shortest length of time in which you can carry out or revise a transaction. Depending on the type of market, it could be virtually continuous (24 hours a day) or once a day. But the horizon is not chosen by the investor or the investor's agent; it is institutionally set. The second-shortest horizon is the decision horizon-the length of time between deciding to revise a portfolio and executing the decision. It may be similar in length to the trading horizon or somewhat longer, such as a week or even a month. But realistically, it will not be, say, five years. No one is going to lock in a decision for five years without any way to revise it. The longest time frame is the planning horizon-the length of time over which things matter to the decision maker. It can be quite long-60 years, 70 years, or in some cases, if the investor is interested in passing wealth to future generations, of indefinite duration. And in addition, there are planning subhorizons-horizons that relate to targeted concerns. For example, within overall lifetime planning, investors may find it convenient to focus on the retirement component of the life cycle, and the length of time until retirement is thus a planning subhorizon, as is the time spent in retirement.
AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL' BY ROBERT C. MERTON An intertemporal model for the ... more AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL' BY ROBERT C. MERTON An intertemporal model for the capital market is deduced from the portfolio selection behavior by an arbitrary number of investors who aot so as to maximize the expected utility of lifetime consumption and who can trade continuously in time. Explicit demand functions for assets are derived, and it is shown that, unlike the one-period model, current demands are affected by the possibility of uncertain changes in future investment opportunities. After aggregating demands and requiring market clearing, the equilibrium relationships among expected returns are derived, and contrary to the classical capital asset pricing model, expected returns on risky assets may differ from the riskless rate even when they have no systematic or market risk.
AUTHOR'S PREFACE Over the years it has been suggested that I bring out some collected papers... more AUTHOR'S PREFACE Over the years it has been suggested that I bring out some collected papers. As the supply of my reprints has become more and more ex-hausted, I have in principle become more and more impressed with the force of this argument. But I have always felt ...
MASSACHUSETTB INSTITUTE OF TECHNOLOGY 'Because this derivation parallels Samuelson's derivation o... more MASSACHUSETTB INSTITUTE OF TECHNOLOGY 'Because this derivation parallels Samuelson's derivation of the Per Capita Consumption Tumpike Theorem [61, I have tried to keep the same notation. As is usual for continuous models, new people are assumed to work from the time they are born (into the labor force). There are various other alternative expressions one might care to maximize instead of the utility of per capita consumption. One such variate, the Bentham-Lemer criterion, is explored later.
A general formula is derived for the price of a security whose value under specified conditions i... more A general formula is derived for the price of a security whose value under specified conditions is a known function of the value of another security. Although the formula can be derived using the arbitrage technique of Black and Scholes, the alternative approach of continuoustime portfolio strategies is used instead. This alternative derivation allows the resolution of some controversies surrounding the Black and Scholes methodology. Specifically, it is demonstrated that the derived pricing formula must be continuous with continuous first derivatives, and that there is not a 'pre-selection bias' in the choice of independent variables used in the formula. Finally, the alternative derivation provides a direct proof of the Modigliani-Miller theorem even when there is a positive probability of bankruptcy. *The paper is a substantial revision of parts of Merton (1976) presented in seminars at Yale and Brown Universities in April 1976 and at the EIASM Workshop in Management Science, Bergamo, Italy ,in October 1976. I thank the oarticioants for their helpful comments. Aid from the National Science Foundation is gratefully acknowledged. My thanks to the referee for editorial suggestions. 'For references to the mathematics of diffusion processes and their applications in economics, see the bibliographies in Merton (1971) and (1973b). ?See Merton (1973a) and (1975).
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Papers by Robert Merton