Optimal Portfolio Choice with Estimation Risk: No Risk-Free Asset Case

We propose an optimal combining strategy to mitigate estimation risk for the popular mean-variance portfolio choice problem in the case without a risk-free asset. We find that our strategy performs well in general, and it can be applied to known estimated rules and the resulting new rules outperform the original ones. We further obtain the exact distribution of the out-of-sample returns and explicit expressions of the expected out-of-sample utilities of the combining strategy, providing not only a fast and accurate way of evaluating the performance, but also analytical insights into the portfolio construction. This paper was accepted by Tyler Shumway, finance.

Growth Matters: Disclosure and Risk Premium

Theoretical work generally predicts a negative association between disclosure and risk premium, where additional disclosure reduces estimation risk or information asymmetry. However, empirical studies frequently report mixed results. Recent theoretical studies suggest that the association between disclosure and risk premium is not necessarily always negative, and could be positive (or less negative). For example, Dutta and Nezlobin (2017) show that disclosure can be associated with higher risk premium when conditioned on firms' growth rates. Similarly, Johnstone (2016) shows that higher signal quality can lead to higher risk premium. Motivated by these studies, we re-examine the association between disclosure and risk premium, conditional on growth. Using various proxies for risk premium, disclosure, and growth, we provide robust evidence that while the unconditional association between disclosure and risk premium is ambiguous, the conditional association is negative for lower growth firms but is less negative (or positive) for higher growth firms.

Fair Value Complexity and the Audit Risk

This paper checks if the auditors in an emergent context, where the fair value (FV) concept, its implementation and audit are relatively new, are aware of the estimation risk induced by the valuation process (the FV provider and FV disclosure), depending on the quality of internal control (IC). An experiment was applied to a group of auditors and master students, using two elements pertaining to FV reporting: “Valuation attributes and sensitivity of data”, respectively “Methods, assumptions and model”. This experiment revealed that: (1) FV audit risk is lower when the estimation is made by an external, instead of an internal valuator; (2) the master’s students, compared to more experienced professional auditors, manifest an overconfidence in the external Valuation Report in terms of valuation attributes, data availability and solutions adopted to test the sensitivity of value; (3) the audit risk is lower when the valuator is external and hence the auditors verify in detail the information provided in the Valuation Report as inputs and methods applied; (4) when IC is strong as quality, the verification of methods, assumptions and model induces for auditors a higher risk than the other FV disclosed component, valuation attributes and sensitivity of data, in the case of management estimation.

Organisation of running events – reducing exclusions and improving the quality of life

Physical activity is a basic factor of human development – it brings satisfaction, vitality, energy, has a therapeutic dimension and affects the quality of life. Among the large group of amateur athletes, there are people vulnerable to social exclusions related to disabilities, psychological dysfunctions, sex and social status. For these people sport is a cure for loneliness and lack of self-confidence, as well as it positively affects their motivation to overcome barriers, which is reflected in other spheres of their lives. One sport that in particular integrates different social groups is running, as confirmed by the growing number of amateur runners, training activities dedicated to them and running events organised for them. However, it is important that organisers of such events ensure the safety of participants and take care of their satisfaction and comfort by holistic planning of all organisational activities. The study hypothesised that factors concerning the safety, comfort and satisfaction of participants play a vital role in organising running events. The aim of the article was to identify and assess the risk of organising running competitions for amateurs in the context of ensuring safety and satisfaction for all participants of the event. In particular, the author noted the risk factors of a social nature, conducive to integration, associated with countering exclusions. The paper presents test results for national competitions involving 21 and 42 km runs. The identification of risk factors was performed by 10 experts (the Delphi method) and 27 representatives of 7 running events organised in Poland (2017–2018) (risk estimate, a questionnaire) took part in the risk estimation. Risk estimation was carried out on the basis of average (effect and probability). The results of the study provide unequivocal information about the spheres of organising sporting events which in the highest degree can affect the safety and comfort of their participants and the perception of the competition itself. Among the key risks there were: inadequate financial and organisational resources, route capacity, or technical problems. Moreover, the paper includes an attempt to discuss results of other research.

A value-at-risk approach to mis-estimation risk

Parametric mortality models permit detailed analysis of risk factors for actuarial work. However, finite data volumes lead to uncertainty over parameter estimates, which in turn gives rise to mis-estimation risk of financial liabilities. Mis-estimation risk can be assessed on a run-off basis by valuing the liabilities with alternative parameter vectors consistent with the covariance matrix. This run-off approach is especially suitable for tasks like pricing portfolio transactions, such as bulk annuities, longevity swaps or reinsurance treaties. However, a run-off approach does not fully meet the requirements of regulatory regimes that view capital requirements through the prism of a finite horizon, such as Solvency II’s one-year approach. This paper presents a methodology for viewing mis-estimation risk over a fixed time frame, and results are given for a specimen portfolio. As expected, we find that time-limited mis-estimation capital requirements increase as the horizon is lengthened or the discount rate is reduced. However, we find that much of the so-called mis-estimation risk in a one-year value-at-risk assessment can actually be driven by idiosyncratic variation, rather than parameter uncertainty. This counter-intuitive result stems from trying to view a long-term risk through a short-term window. As a result, value-at-risk mis-estimation reserves are strongly correlated with idiosyncratic risk. We also find that parsimonious models tend to produce lower mis-estimation risk than less-parsimonious ones.