Market Insights

Opinions and analysis pertaining to current market events
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Kenny Polcari, NYIF faculty, provides daily insights on the day’s action that ends with a recipe to serve the mood of the markets.

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Schools Brief

Clear, concise explanations of concepts, policy, regulation and emerging trends
In Brief

Coupling of Market Risk, Credit Risk & Liquidity Risk

The main risks of any financial product are market risk, credit risk, and liquidity risk. When we reference credit risk, we are including both market-based credit risk, where widening of credit spreads is indicative of credit quality deterioration, as well as counterparty credit risk. This may be caused by the loss in the market value of the portfolio holdings or market illiquidity. Similarly, liquidity risk includes the funding liquidity as well as the market liquidity of different asset classes. In general, these risks are treated separately as if they are totally Independent of each other. That assumption is untrue as any loss in market value impacts both funding costs as well as credit quality loss. Similarly, any loss in liquidity can impact the credit performance risk as well as the market prices of an asset. If we measure the market, credit, and liquidity risk separately, this risk can be significantly understated as the coupling can be highly non-linear, thus increasing the losses several orders of magnitude.

Quant Corner

NYIF Faculty Research
Securitization cause subprime
In Depth

Did Securitization cause the Subprime Crisis?

This paper develops a continuous time, contingent claims model of mortgage valuation with strategic behavior to show that securitized mortgages are characterized by significantly higher loan to value ratios than mortgages held on the balance sheet of the originator. Higher loan to value ratios for securitized mortgages do not necessarily constitute evidence that securitization encourages risky lending.

Analysis

Setting Residual Values: The Impact on Rates of Return for Buyout Funds

We conduct a study dedicated principally to older leveraged buyout funds that have had the opportunity for multiple portfolio company liquidations, or have been fully liquidated. Examining 186 funds in the vintage years from 2000 to 2007 with complete cash flow data from the Preqin database, we find that 61% beat the S&P 500 plus 3% ( a common benchmark), and 39% did not. Funds originated during the boom years (2005 to 2007) are less successful, with 41 % beating the benchmark to date, and 59% falling short. Thus, we find that funds from the earlier vintage years have better performance relative to broad equity market benchmarks than the later years. The later vintage year funds have larger RVPIs than the early vintage year funds, most of which had been fully liquidated. In addition, we find that moderately-liquidated funds tend to have worse results than mostly-liquidated funds. Lastly, in examining a group of fund families with three or more funds, we find no strong evidence of consistency.

Analysis

Alternative Assets Evolve

Equities in U.S. defined benefit plan portfolios were pared down to 43% of total assets, on average, from over 60% in the era before the PPA, according to analysts at CEM Benchmarking in Toronto. An insightful June report studied 200 U.S. DB plans, with aggregate assets of over $3 trillion, from 1998 through 2014. “We looked at both costs and returns, to answer the question: ‘Did we get what we paid for?’” notes senior research analyst Alex Beath. In addition to the scaling back of equities, the report chronicles rapid growth in hedge funds and private equity, and a smaller increase in direct real estate. Over the study period, Beath found that, on average, real estate and private equity both delivered respectable returns—albeit at high volatility—but that hedge funds were a disappointment.
Source: CEM Benchmarking, "Asset Allocation and Fund Performance of Defined Benefit Pension Funds in the United States, 1998-2014"

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