Tuesday, November 24, 2015

Between First and Second-Order Stochastic Dominance

Read the working paper
INSEAD Working Paper 2015/93/DSC revised version of 2015/55/DSC

We develop a continuum of stochastic dominance rules, covering preferences from first to second-order stochastic dominance. The motivation for such a continuum is that while decision makers have preference for \more is better," they are mostly risk averse but cannot assert that they would dislike any risk. For example, situations with targets, aspiration levels, and local convexities in induced utility functions in sequential decision problems may lead to preferences for some risks. We relate our continuum of stochastic dominance rules to utility classes, the corresponding integral conditions, and probability transfers, and discuss the usefulness of these interpretations. Several examples involving, e.g., finite-crossing cumulative distribution functions, location-scale families, and induced utility illustrate the implementation of the framework developed here. Finally, we extend our results to a combined order including convex (risk-taking) stochastic dominance.

A Survey of Forecasting and Uncertainty

A Survey of Forecasting and Uncertainty, Risk and Decision Analysis (forthcoming)

The origins of forecasting can be traced back to the beginning of human civilization with attempts to predict the weather, although forecasting as a field first appeared in the 1940s and attracted more followers from the early 1950s, when the need for predictions emerged in different fields of endeavor. It expanded considerably in the 1960s and 1970s when benefits were ascertained and computers were employed to perform the tedious calculations required. But initial successes in the fields of economics and business were first moderated and later reversed, with reality checks, first during the 1973/74 energy crisis, afterwards during the prolonged economic stagflation of the late 1970s and early 1980s and further deteriorated during the severe 2007/8 global financial crisis. The initial, optimistic expectations that social sciences will (using powerful computers and sophisticated models) replicate the predictive accuracy of hard ones were repeatedly shattered. This has left diverse fields like economics, management, political and human sciences and even worse medicine with no objective evidence of successful, accurate predictions, casting doubts to their “scientific” vigor. At the same time, weather forecasting achieved success for immediate term predictions improving its accuracy and reliability over time. This paper starts with a historical overview of non-superstition based forecasting as it is practiced in different areas and surveys their predictive accuracy, highlighting their successes, identifying their failures and explaining the reasons involved. Consequently, it argues for a new, pragmatic approach where the emphasis must shift from forecasting to assessing uncertainty, as realistically as possible, evaluating its implications to risk and exploring ways to prepare to face it. It expands Rumsfeld’s classification to four quadrants (Known/Knowns, Unknown/Knowns, Known/Unknowns and Unknown/Unknowns) in order to explore the full range of predictions and associated uncertainties and consider the implications and risks involved. Finally, there is a concluding section summarizing the findings and providing some suggestions for future research aimed at turning forecasting into an interdisciplinary field increasing its value and usefulness.

Monday, November 23, 2015

Corporate Governance and Boards, System and Behaviour, Developing Board Effectiveness in Malaysia

VAN de LOO Erik , KAMARUDIN Maszuin, WINTER Jaap 
Corporate Governance and Boards, System and Behaviour, Developing Board Effectiveness in Malaysia, Universiti Tun Abdul Razak (UNIRAZAK) (2015) 246 p.

The Board of Directors is a high impact entity. It represents the highest authority and the ultimate leadership of organizations and institutions. The recent series of financial and economic crises situations have deeply challenged traditional ways of perceiving and dealing with risks. As a consequence, expectations and pressure have increased that “Boards deliver”.

One cannot “fix” this by merely imposing more rules and regulations. Boards will also need to behave differently. This book strongly advocates a multi-disciplinary focus on corporate governance and boards, on the interaction between system and behavior. It provides a series of new concepts and frameworks that help to open the black box of board reality, like Board on Task, Board GPS and The Matrix of Board Interaction.

Boards are about the interaction between executives and non-executives. One should not only focus on traps and derailment factors, it is equally important to identify positive core conditions for evaluating and developing boards: creating reflective space, building trust, humility and the courage to speak the truth.

This book also aims to compare and learn from corporate governance and board practices across Malaysia and other countries around the world. It describes the development of the governance landscape in Malaysia and the challenges boards face today. This is also based on a series of interviews with Malaysian Chairmen, Directors and Corporate Governance policy makers as well as on a pilot study on aspects of the practice of board evaluation in Malaysia.

Friday, November 20, 2015

Investor Sentiment and Mutual Fund Strategies

MASSA Massimo, YADAV Vijay
Access the publisher's website Journal of Financial and Quantitative Analysis 50, 4 (2015) 699-727

We show that mutual funds employ portfolio strategies based on market sentiment. We build a proxy for the degree of a fund’s sentiment beta (or FSB). The low FSB funds outperform high FSB funds, even after controlling for standard risk factors and fund characteristics. This effect is sizable and delivers a net-of-risk performance of 3.8% per year. Funds with lower FSB follow more idiosyncratic strategies, suggesting that FSB is deliberate active choice of the fund manager. A sentiment contrarian strategy leads to high flows due to its superior performance, whereas a sentiment catering strategy fails to attract significant investor flows.

Thursday, November 19, 2015

The Business School: Serving Mammon or the University

GAUTSCHI David, STORY Jonathan
Read the working paper
INSEAD Working Paper 2015/92/EPS

What are business schools to do? For slightly more than a century, there has been a protracted debate about the business school in the university. We argue that business schools have a special responsibility to advance understanding of business context and how it evolves. In so doing the business school naturally establishes itself as both a legitimate academic unit of the university and as a purveyor of value to the constituencies it serves as a professional school.