Class Notes (808,380)
Canada (493,170)
MIS 4500 (31)

Chapter 25.docx

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University of Manitoba
Management Info. Systems
MIS 4500
Pourang Irani

Chapter 25: Dreaming with BRICs: the Path to 2050 BRICs have larger US$GDP than G6 in less than 40 yrs; currently only 15% Have less capital, so higher returns on capital, resulting in higher growth of capital stock Technological catch up. Countries grow richer on back of appreciating currencies; convergence to PPP. GDP Growth: growth in employment; growth in capital stock; technical progress/TFP.  Maybe lower convergence in India and Brazil than Russia and China b/c lower education levels and poorer infrastructure  Maybe 1/3 of increase in US$GDP of BRICs from rising currencies and 2/3s from faster growth Conditions for growth:  Robert Barro: o Higher schooling o Higher life expectancy o Lower fertility o Lower gov’t consumption o Better maintenance of rule of law o Lower inflation o Improvements in terms of trade  Macro stability: price stability (fiscal deficit reduction, tighter monetary policy, exchange-rate realignment)  Institutions: efficient legal system, functioning markets, health and education systems, financial institutions and gov’t bureaucracy  Openness: trade and fdi  Education: skilled workers Strategic Asset Allocation: establish exposures to IPS-permissible asset classes by integrating investor’s return objectives, risk tolerance, and investment constraints w/ long-run capital market expectations.  result is the Policy Portfolio  In long run, diversified portfolio’s mean returns are reliably related to systematic risk exposures.  Strategic asset allocation specifies investor’s desired exposures to systematic risk.  b/c investors in aggregate are the market and costs do not net out across investors, return on avg actively managed dollar should be less than return on avg passively managed dollar after costs Tactical asset allocation (TAA): short-term adjustments to asset-class weights based on short- term expected relative performance among asset classes.  creates active risk Asset-Only (AO) vs. Asset/Liability Management (ALM):  ALM: explicitly modeling liabilities (and quasi-liabilities) and adopting optimal asset allocation in relationship to funding liabilities; concern for net returns and risk o Cash flow matching: exact matching: use bonds to match liabilities and quasi- liabilities o Immunization: structures investments in bonds to match (offset) weighted-avg duration of liabilities  riskier than cash flow matching as duration is first-order approximation of interest rate risk o favored by:  investor w/ below-avg risk tolerance  if have high penalties for not meeting liabilities  if market value of liabilities interest rate sensitive  if risk taken in investment portfolio limits investor’s ability to profitably take risk in other activities  if legal and regulatory reqs and incentives favor holding fixed-income securities  if tax incentives favor holding fixed-income securities  AO: no explicit liability modeling; concern for absolute return and risk o Black-Litterman model: take global market-value-weighted asset allocation (Market equilibrium portfolio) as default and then incorporate deviate from weights reflecting views on asset classes’ expected returns and strength of views Dynamic vs. Static approach:  dynamic: link optimal investment decisions to all future time periods  static: do not consider links b/w optimal decisions at different time periods Risk objectives:  Investor’s expected utility for asset mix: m  E(R m  0.005 R A m ; E is expected return 2 for mix; R is investor’s risk aversion (1 to 10?); σ is variance of return for mix  shortfall risk: risk that fall below minimum during time  downside risk: risk relating to losses or worse than expected outcomes only (also semivariance and target semivariance)  Roy’s safety-first criterion: optimal portfolio minimizes probability over stated time E(R )P R L horizon that portfolio return will fall below some threshold level:FRatio   P  could specify maximum probability of not meeting a return threshold Behavioral Influences on Asset Allocation:  loss aversion: worry about avoiding losses more than gains; risk-seekers when faced w/ losses (could use shortfall risk criterion or ALM)  Mental accounting: associate different level of risk tolerance depending on mental account  regret avoidance: may promote diversification; may limit divergence from peers’ avg asset allocation Selection of Asset Classes:  Criteria for specifying asset classes: o 1. assets w/i asset class should be relatively homogenous o 2. asset class should be mutually exclusive o 3. asset classes should be diversifying o 4. asset classes as group should make up preponderance of world investable wealth o 5. asset class should have capacity to absorb significant fraction of investor’s portfolio w/o seriously affecting portfolio’s liquidity  Traditional asset classes: o domestic common equity o domestic fixed income o non-domestic (international) common equity (maybe developed-emerging distinction) o non-domestic fixed income (maybe developed-emerging distinction) o real estate (maybe including other alternative investments) o cash and cash equivalents o (consider also tax concerns)  E(R ) R  o test for adding asset class: E(R new) R F   p FCorr(R new,R p  new   p  o also consider following for whether to add international assets:  currency risk  increased correlations in times of stress  emerging market concerns o alternative assets: heterogeneous; high diligence costs Steps in Asset Allocation:  asset allocation review: o (AO is special case where liabilities equal 0) Capital Market Conditions Investor’s Assets, Liabilities, Net Worth, and Risk Attitudes | | Prediction procedure Investor’s Risk Tolerance Function | | Expected Returns, Risk, and Correlations Investor’s Risk Tolerance | | Optimizer | Investor’s Asset Mix | Returns | (back to top) Optimization:  mean-variance approach o identify efficient frontier (part of minimum variance frontier bordered on the bottom by global minimum variance portfolio) o mean-variance optimization (MVO):  unconstrained MVF: asset-class weights sum to 1. (allows for short positions)  sign-constrained MVF: no short-positions
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