Szafarz A., Brière M. (2015), Does Commercial Microfinance Belong to the Financial Sector? Lessons from the Stock Market, World Development, 67, p. 110â125
This paper is the first to draw a global picture of worldwide microfinance equity by taking full advantage of daily quoted prices. We revisit previous findings showing that investors should consider microfinance as a self-standing sector. Our results are threefold. First, microfinance has become less risky and more closely correlated with the financial sector. This convergence is associated with a decline in the proportion of women borrowers. Second, microfinance and finance shares have equivalent currency exposure. Last, introducing a self-standing microfinance sector presents few diversification benefits. This paper confirms that microfinance has changed dramatically during the last decade.
Brière M., Bodie Z. (2014), Optimal Asset Allocation For Sovereign Wealth Funds: Theory And Practice, Bankers, markets & investors, 128, p. 49-54
This paper addresses management of sovereign wealth from the perspective of the theory of contingent claims. Starting with the sovereign's balance sheet, we frame sovereign fund management as an asset-liability management (ALM) problem, covering all public entities and taking explicit account of all sources of risks affecting government resources and expenditures. Real-life SWFs asset allocations differ strongly from theoretical ones. Financial management of the sovereign balance sheet is hampered by a lack of aggregate data, which compromises the coordination of sovereign wealth management with fiscal policy, monetary policy and public debt management. In this framework, we suggest institutional arrangements that could overcome this obstacle and enable efficient coordination.
Brière M., Bodie Z. (2014), Sovereign Wealth and Risk Management: A Framework for Optimal Asset Allocation of Sovereign Wealth, Journal Of Investment Management, 12, 1
This paper sets out an analytical framework for optimal asset allocation of sovereign wealth, based on the theory of contingent claims analysis applied to the sovereigns economic balance sheet. A country solves an asset-liability management problem involving its sources of income and its expenditures. We derive analytically the optimal asset allocation of sovereign wealth, taking explicit account of all sources of risks affecting the sovereigns balance sheet. The optimal composition of sovereign wealth should involve a performance-seeking portfolio and three hedging demand terms for the variability of the fiscal surplus and external and domestic debt. A real-life application of our model in the case of Chile shows that its sovereign investment is under-diversified.
Signori O., Brière M. (2013), La couverture du risque inflationniste dans les économies en développement, Research in International Business and Finance, 27, 1, p. 209-222
Les chocs sur l'inflation représentent un important danger pour les économies en développement et sont généralement difficiles à couvrir. Ce papier examine l'allocation d'actifs optimale pour un investisseur brésilien, cherchant à couvrir le risque inflationniste sur différents horizons, variant de 1 à 30 ans. En utilisant une spécification autoregressive vectorielle pour modéliser les dépendances inter-temporelles entre variables économiques et financières, nous mesurons les propriétés de couverture contre l'inflation des investissements nationaux et étrangers et procédons à une optimisation du portefeuille. Nos résultats montrent que les devises étrangères complètent très efficacement les actifs traditionnels lorsqu'on cherche à couvrir le portefeuille contre l'inflation: environ 70% du portefeuille devrait être dédié aux actifs domestiques (actions, obligations indexées sur l'inflation et les obligations nominales), alors que 30% devrait être investi dans des devises étrangères, plus spécifiquement en dollar et euro.
Inflation shocks are one of the pitfalls of developing economies and are usually difficult to hedge. This paper examines the optimal strategic asset allocation for a Brazilian investor seeking to hedge inflation risk at different horizons, ranging from one to 30 years. Using a vector-autoregressive specification to model inter-temporal dependency across variables, we measure the inflation hedging properties of domestic and foreign investments and carry out a portfolio optimisation. Our results show that foreign currencies complement traditional assets very efficiently when hedging a portfolio against inflation : around 70% of the portfolio should be dedicated to domestic assets (equities, inflation-linked (IL) bonds and nominal bonds), whereas 30% should be invested in foreign currencies, especially the US dollar and the euro.
Szafarz A., Oosterlinck K., Mignon V., Drut B., Brière M. (2013), Is the Market Portfolio Efficient? A New Test of Mean-Variance Efficiency when all Assets are Risky, Finance, 34, 1, p. 7-41
L'efficience du portefeuille de marché demeure une question controversée. Cet article propose un nouveau test d'efficience moyenne-variance dans un cadre réaliste comprenant uniquement des actifs risqués. Ce test est basé sur la « distance verticale » d'un portefeuille à la frontière efficiente. Nos simulations de Monte Carlo montrent que notre test est plus performant que les tests d'efficience moyenne-variance antérieurs en grand échantillon, la taille du test vertical étant en effet plus faible que celle associée aux autres tests, pour une puissance comparable. L'application au marché boursier américain met en outre en évidence l'inefficience du portefeuille de marché.
The market portfolio efficiency remains controversial. This paper develops a new test of portfolio mean-variance efficiency relying on the realistic assumption that all assets are risky. The test is based on the vertical distance of a portfolio from the efficient frontier. Monte Carlo simulations show that our test outperforms the previous mean-variance efficiency tests for large samples since it produces smaller size distortions for comparable power. Our empirical application to the U.S. equity market highlights that the market portfolio is not mean-variance efficient, and so invalidates the zero-beta CAPM.
Aglietta M., Brière M., Rigot S., Signori O. (2012), Rehabilitating the Role of Active Management for Pension Funds, Journal of Banking & Finance, 36, 9, p. 2565-2574
Pension fund return s can be decomposed into different sources, including market movements, asset allo-cation policy, and active portfolio management. We use a unique database covering the asset allocations of US defined-benefit pension funds for the perio d 1990-2008, and we test the role of each factor in explaining their return s. Our results shed new light on pension funds' sources of performance. While the previous literature emphasized that policy allocation accounts for the bulk of returns, leaving little room for active management, we show that taking explicit account of market movement can change the results significantly. Although active management plays a minor role in global asset allocat ion, its role is predominant in explaining returns to individual asset classes, whether traditional or alternative. This paper rehabilitates the contribution of active managem ent as a source of performance for pension funds, at least at the asset class level.
Signori O., Brière M. (2012), Inflation-Hedging Portfolios : Economic Regimes Matter, Journal of Portfolio Management, 38, 4, p. 43-58
The exceptional rise in government deficits following the subprime crisis, the recent commodity price spikes and the increase in inflation volatility have revived the debate on medium to long-term resurgence of inflation. Using a vector-autoregressive model, this paper investigates the relationships between asset returns and inflation and the optimal strategic asset allocation for investors seeking to hedge inflation risk in two different types of macroeconomic regimes. In a volatile macroeconomic environment marked by countercyclical supply shocks, cash, inflation-linked bonds and precious metals play an essential role, while in a more stable environment ("Great Moderation") with procyclical demand shocks, cash and nominal bonds play the most significant role, followed by precious metals, real estate and equities. An ambitious investor in terms of required real returns should have a larger weighting in equities, real estate and precious metals.
Signori O., Malongo H., Fermanian J-D., Brière M. (2012), Volatility Strategies for Global and Country Specific European Investors, Bankers, markets & investors, 121, p. 17-29
Adding volatility exposure to an equity portfolio offers interesting opportunities for long-term investors. This article discusses the advantages of adding a long volatility strategy for a protection to a global European equity portfolio and to specific equity portfolios based in "core" or "peripheral" countries within the euro zone. A European investor today has the choice of investing in US or European equity volatility. We check whether a long volatility strategy based on VSTOXX futures is better than a strategy based on VIX futures. The benefit of using volatility strategies as a hedge for equities is shown through a Mean/Modified-CVaR portfolio optimization. We find that long volatility strategies offer valuable protection to all European equity investors. A long volatility strategy based on VSTOXX futures offers better protection than a similar one based on VIX futures. It reduces the risk of an equity portfolio more significantly, while providing more attractive returns. For specific European investors, and despite major differences in local European equity markets, our long volatility strategy shows a certain homogeneity and provides efficient protection, whatever the country.
Szafarz A., Chapelle A., Brière M. (2012), No contagion, only globalization and flight to quality, Journal of International Money and Finance, 31, 6, p. 1729-1744
In this article, tests for globalization and contagion are separated using an ex ante definition of crises, and contagion tests are neutralized with respect to globalization effects. A large database is constructed to study the stability of correlation matrices for four asset classes : equities, government bonds, and corporate bonds - investment grade and high yield - in four geographical zones. Overall, the results confirm the instability of correlations and point to a combination of globalization and flight to quality, while emphasizing that contagion on the equity markets appears as an artifact due to globalization.
Brière M., Ang A., Signori O. (2012), Inflation and Individual Equities, Financial Analysts Journal, 68, 4, p. 36-55
We study the inflation hedging ability of individual stocks. While the poor inflation hedging ability of the aggregate stock market has long been documented, there is considerable heterogeneity in how individual stock returns covary with inflation. Stocks with good inflation-hedging abilities since 1990 have had higher returns, on average, than stocks with low inflation betas and tend to be drawn from the Oil and Gas and Technology sectors. However, we show that the time variation of stock inflation betas is substantial. This makes it difficult to construct portfolios of stocks that are good inflation hedges out of sample. This is true for portfolios constructed on past inflation betas, sector portfolios, and portfolios constructed from high-paying dividend stocks.
Bodie Z., Brière M. (2011), Financing Future Growth : the Need for Financial Innovations, OECD journal : Financial market trends, 1, p. 4
Attracting long-term investors from the private sector or in public-private partnerships for stable long-term investment in the innovative sectors and industries needed to generate sustained growth is crucial. Long-term investors want assets that generate regular cash flows, often linked to inflation. While equities seem today less appropriate for long-term investors' needs, particularly in the context of the recent regulatory changes, inflation-linked bonds, very-long dated conventional bonds, project bonds or specific derivatives better meet their requirements. It seems highly likely that the expansion and increasing regulation of long-term investors in both developed and emerging countries will trigger the development of new financial instruments compatible with long-term investment. While long-term investors are the natural sources of growth financing, they are not necessarily capable of assuming all the associated risks. Establishing and/or developing national or supranational institutions that can partly assume or at least structure some of these risks and thus offer end-investors the products they need is therefore essential. Strict regulation of the new markets arising from this process will also be vital.
Brière M., Burgues A., Signori O. (2010), Volatility Exposure for Strategic Asset Allocation, Journal of Portfolio Management, 36, 3, p. 105-16
The authors examine the advantages of incorporating strategic exposure to equity volatility into the investment opportunity set of a long-term equity investor. They consider two standard volatility investments: implied volatility and volatility risk premium strategies. An analytical framework, which offers pragmatic solutions for long-term investors who seek exposure to volatility, is used to calibrate and assess the risk-return profiles of portfolios. The benefit of volatility exposure for a conventional portfolio is shown through a mean-modified value at risk portfolio optimization. A pure volatility investment makes it possible to partially hedge downside equity risk and thus reduce the risk profile of a portfolio, while an investment in the volatility risk premium substantially increases returns for a given level of risk. A well-calibrated combination of the two strategies enhances both the absolute and risk-adjusted returns of a portfolio.
Brière M., Signori O. (2009), Do Inflation-Linked Bonds Still Diversify ?, European Financial Management, 15, 2, p. 279-297
The diversifying power of inflation-linked (IL) bonds relative to traditional asset classes has changed significantly. In this paper, we study the dynamics of conditional volatilities and correlations for three asset classes, IL bonds, nominal bonds, and equities, in the USA and Europe. Using a DCC-MVGARCH for the period 1997-2007, we highlight the change that took place in 2003. Although IL bonds once had definite diversification power, they are now highly correlated with nominal bonds and have reached similar volatility levels. As a result, the two asset classes are practically substitutable. This seems to be due to more stable inflation expectations and to a more liquid IL bond market. Although diversification was a valuable reason for introducing IL bonds in a global portfolio before 2003, this is no longer the case. Dynamic portfolio optimisation using our estimates of conditional correlations and volatilities clearly demonstrates that the optimal weight of IL bonds in a portfolio decreased sharply in 2003 in favour of nominal bonds and equities.
Topeglo K., Brière M., Signori O. (2008), Bond market "conundrum" : new factors to explain long-term interest rates ?, Banque & marchés, 8, 92, p. 51-68
Entre 2004 et 2006, alors que la banque centrale américaine a augmenté ses taux directeurs à chaque meeting, les taux longs sont restés étonnamment stables, au point d'être qualifiés d'« énigme » par A. Greenspan. Nous comparons le niveau des taux longs à leur niveau théorique déterminé grâce à un modèle fondamental, et montrons que l'anomalie a été en moyenne de 40 bp. Deux types d'explications ont été invoqués: le changement d'attitude des investisseurs vis-à-vis du risque, et l'intensification des flux d'achat de Bons du Trésor. Nous montrons que si ces variables peuvent en théorie être responsables du déclin de la prime de risque obligataire, elles expliquent en pratique moins de la moitié de l'anomalie. Leur influence croissante justifie cependant d'en tenir compte pour une analyse prospective des taux longs.
Interest rates behaved highly atypically from 2004 to 2006. While the US central bank raised its policy rate at every meeting, long-term interest rates remained so remarkably stable that former Fed Chairman Alan Greenspan described their behaviour as a "conundrum". Comparing long-term rates to their theoretical level based on fundamental valuation models, we show that the anomaly was on average 40 bps. Various explanations have been put forward for this, including investors' changed attitude to risk, and the rise in US Treasury purchases by different categories of buyers. We show that, while these variables could theoretically be responsible for the decline in bond risk premiums, they explain less than half of the anomaly when incorporated into a fundamental model of bond yields. However, their recent changing influence could justify their being used for a prospective analysis of bond yields.
Szafarz A., Brière M. (2008), Crisis-Robust Bond Portfolios, The Journal of Fixed Income, 18, 2, p. 57-70
Brière M. (2012), Managing Commodity Risk : Can Sovereign Funds Help ?, in Samama F., Bolton P., Stiglitz J. (eds), Sovereign Wealth Funds and Long Term Investing, New York, Columbia University Press, p. 196-203
A number of countries have recently responded to high and volatile commodity prices by setting up commodity funds. In several cases, these funds have proved effective in stabilising government spending and boosting savings, but on the whole they have unfortunately not achieved the hoped-for results. In many cases, resources initially allocated to sovereign funds were later commandeered by the government and ultimately squandered. In this paper we review past experiences with commodity funds and discuss incentives that can be used to ensure that commodity risk is managed with greater efficiency and that funds are more autonomous, a vital prerequisite to meeting their original aims.
Brière M. (2011), Managing commodity price volatility, in Bolton P., Samama F., Stiglitz J. (eds), Sovereign Wealth Funds and Long Term Investing, New York, Columbia University Press, p. 188-191
Burgues A., Signori O., Brière M. (2009), Volatility as an Asset Class for Long-Term Investors, in Berkelaar A., Coche J., Nyholm K. (eds), Interest Rate Models, Asset Allocation and Quantitative Techniques for Central Banks and Sovereign Wealth Funds, Basingstoke, Palgrave McMillan, p. 265-280
This work shows how long-term investors can benefit from adding volatility as an asset class to their portfolio. Two types of "structural" exposure - long implied volatility and long volatility risk premium - are now simple to implement. Implied volatility exposure can be used to significantly reduce the risk profile of the portfolio, and especially extreme risks. Adding a volatility risk premium investment is less appealing : it substantially increases returns for a given level of risk, but at the cost of higher extreme risks. However a combination of the two volatility strategies is very attractive, thanks to fairly effective reciprocal hedging during periods of market stress. It delivers enhanced absolute and risk-adjusted returns, with smaller extreme risks than a traditional portfolio. Over the long term, volatility strategies make it possible to build portfolios that are more efficient than a pure-bond or equity/bond investment.
Ielpo F., Brière M. (2008), Yield Curve Reaction to Macroeconomic News in Europe : Disentangling the US Influence, in Stavárek D., Poloucek S. (eds), Consequences of the European monetary integration on financial systems, Newcastle, Cambridge Scholars, p. 111-135
This paper analyses the response of the euro yield curve to macroeconomic and monetary policy announcements. We present a new methodology for estimating the reaction of the euro swap curve to economic news in a data-rich environment. Given the sharp degree of interdependence between euro and US rates, we propose to use the factors of the US yield curve to disentangle the daily variations in euro rates stemming from US influence and the changes resulting from European news. We highlight the importance of taking the influence of the US yield curve into account. For some of the major announcements, results differ appreciably, depending on whether this influence is integrated. We then investigate the shape of the euro term structure reaction to a range of news types, measuring which are the most important economic releases for euro financial markets. In most instances, the curve's reaction is hump shaped, with the most significant reactions concentrated in intermediate maturities. Finally, we provide a hierarchy of the economic figures that have the strongest impact on each maturity, and show the differences in important news for the short and long end of the curve.
Brière M. (2006), Représentations conventionnelles sur les marchés de taux, in Eymard-Duvernay F. (dir.), L'économie des conventions, méthodes et résultats. Tome 2. Développements, Paris, la Découverte, p. 177-191
Brière M., Boon L-N., Rigot S. (2014), Does Regulation Matter? Riskiness and Procyclicality of Pension Asset Allocation, 31st International French Finance Association Conference, AFFI 2014, Aix-en-Provence, France
In this paper, we investigate the relative importance of drivers to pension funds' asset allocation choices. We specifically test if the contrast between regulatory approaches of public and private Defined Benefits (DB) pension funds in the US, Canada and the Netherlands have an impact on the riskiness and procyclicality of their asset allocation. Derived from panel data analysis of a unique database comprising of more than 800 pension funds' detailed asset allocations, our results underscore the economic importance of regulation in the funds' asset allocation choices, relative to institutional and individual funds' characteristics. In particular, quantitative risk-based capital requirements, and to a lesser extent valuation and funding requirements (i.e., the choice of the liability discount rate) or the presence of quantitative investment restrictions, induce pension funds to significantly decrease their asset allocation to risky assets, especially to equities. Allocation to alternatives, which are comparatively treated quite favorably by solvency standards, is higher in the presence of risk-based capital requirements. Contrary to popular conviction that regulatory mechanisms encourage procyclical asset allocation, we find that funds subject to risk-based capital requirements were likely to be less procyclical during the last crisis - an outcome possibly tempered by temporary regulatory slackening in response to the crisis.
Boon L-N., Brière M., Gresse C., Werker B. (2013), Regulatory Environment and Pension Investment Performance, 11th Workshop on Pension, Insurance and Savings, Paris, France
Using the most comprehensive publicly available data to-date, we study the effect of three aspects of pension regulation (namely quantitative investment restrictions, minimum return or benefit guarantee, and the type of supervising authority) on risk-adjusted funded pension performance in 27 countries. Regulatory strictness' influence on the Sharpe ratio of investment return depends on a country's level of economic development. In emerging market economies, existence of quantitative investment restrictions across asset classes adversely affects risk-adjusted returns. This impact is more severe if higher investment limits are imposed on equities and foreign assets, as opposed to on bonds. Having a minimum benefit or return guarantee, as well as having a specialized supervising authority has no statistically significant effect on the risk-adjusted returns regardless of economic development.
Bodie Z., Brière M. (2011), Sovereign Wealth and Risk Management. A New Framework for Optimal Asset Allocation of Sovereign Wealth, 30th International French Finance Association Conference, Lyon, France
This paper sets out a new analytical framework for optimal asset allocation of sovereign wealth, based on the theory of contingent claim ana lysis (CCA) applied to the sovereign's economic balance sheet. A country solves an asset-l iability management (ALM) problem between its sources of income and its expenditures. We derive analytically the optimal asset allocation of sovereign wealth, taking explic it account of all sources of risks affecting the sovereign's balance sheet. The optima l composition of sovereign wealth should involve a performance-seeking portfolio and three hedging demand terms for the variability of the fiscal surplus, and external and domestic debt. Our results provide guidance for sovereign wealth management, particula rly with respect to sovereign wealth funds and foreign exchange reserves. A real-life ap plication of our model in the case of Chile shows that at least 60% of the Chilean asset allocation should be dedicated to emerging bonds, developed and emerging equities. Ch ile's current sovereign investment is under-diversified.
Brière M., Signori O. (2009), Inflation-hedging Portfolios in Different Regimes, Portfolio and risk management for central banks and sovereign wealth funds, Basel, Suisse
The unconventional monetary policies implemented in the wake of the subprime crisis and the recent increase in inflation volatility have revived the debate on medium to long-term resurgence of inflation. This paper presents the optimal strategic asset allocation for investors seeking to hedge inflation risk. Using a vector-autoregressive model, we investigate the optimal choice for an investor with a fixed target real return at different horizons, with shortfall probability constraint. We show that the strategic allocation differs sharply across regimes. In a volatile macroeconomic environment, inflation-linked bonds, equities, commodities and real estate play an essential role. In a stable environment ("Great Moderation"), nominal bonds play the most significant role, with equities and commodities. An ambitious investor in terms of required real return should have a larger weighting in risky assets, especially commodities.
Viala J-R., Boulier J-F., Brière M. (2007), Do Leveraged Credit Derivatives Modify Credit Allocation ?, EDHEC Symposium « Risk and Asset Management », Nice, France
This paper examines how credit derivatives have changed the construction of an efficient portfolio. Credit derivatives provide a way of gaining exposure to credit risk alone, to the exclusion of interest rate risk. They also permit a relatively easy use of leverage. We examine two types of allocation : the first is a conventional investment in government bonds, corporate bonds (investment grade and high yield) and equities in the United States; the second replaces corporate bonds with credit derivatives, which may also be leveraged. We look at past data on returns, risk and correlations of these investments, and we show that the credit risk component seems to have a strongly diversifying effect relative to the traditional asset classes, i.e. equities and government bonds. We then compute efficient frontiers within a standard mean- variance framework. The results show the advantages of credit derivatives for portfolio diversification, and the usefulness of leveraging this investment to extend the limits of the efficient frontier.
Boon L-N., Brière M., Gresse C., Werker B. (2014), Pension Regulation and Investment Performance: Rule-Based vs. Risk-Based, SSRN Working Paper Series, 12 p.
We investigate the relationship between rule-based versus risk-based regulatory choices in different countries and the real investment performance of their pension funds. Pension systems in countries with more mature risk-based regulatory regimes tend to demonstrate superior investment performance. The benefit of implementing risk-based regulation is more pronounced in countries with low regulatory quality. The core of rule-based regulations, i.e., quantitative investment limits, has no significant impact on the Sharpe ratio of pension investment returns.
Szafarz A., Brière M. (2011), Investment in Microfinance Equity : Risk, Return, and Diversification Benefits, CEB Working Paper, Bruxelles, Université Libre de Bruxelles, 42
This paper takes full advantage of daily quoted prices of microfinance stocks from their issuance, and draws a global picture of worldwide microfinance equity from the viewpoint of a profit-oriented investor. We construct microfinance country equity indices and an international global microfinance index. We analyse the changes in these indices, which we assess in reference to comparable indices for the financial sector and also to national indices. Our findings show that microfinance has resumed its close correlation with the financial sector since 2001. In terms of risk exposure, estimations of the Capital Asset Pricing Model demonstrate that microfinance shares exhibit higher market beta than conventional financial institutions, and have equivalent currency exposure. We also examine whether adding microfinance to international asset portfolios improves the investor's risk-return performance. While the inclusion of microfinance equity has indeed been a major source of diversification in the 1990s, its impact has diminished in recent years. Still, optimal portfolios invested in countries where microfinance equity is available may contain up to 20% of stocks from MFIs.
Drut B., Brière M. (2009), The Revenge of Purchasing Power Parity on Carry Trades during Crises, CEB Working Paper, Bruxelles, ULB : Universite Libre de Bruxelles, 27
Empirical evidence shows that fundamental models have produced disappointing results over the past 20 years while carry trade strategies have performed superbly. But the real picture is much more complex. In fact, the track records of both strategies have varied considerably. This article shows that they have actually alternated between periods of profitability and underperformance. It also shows that when carry trade strategies perform well, fundamental strategies do poorly, and vice versa. Crises appear to play a significant role in the alternation of investment styles on currency markets. In contrast to carry trades, fundamental strategies perform remarkably well in crises. A portfolio that rotates between these two types of strategies, based on a risk aversion indicator such as implied equity volatility, would substantially outperform a pure carry trade strategy and would be robust to crises.