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Research Papers

Our experts have published extensively in peer-reviewed journals. Pre-publication versions of these papers plus other working papers are available below.

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Robust Portfolio Optimization with VaR Adjusted Sharpe Ratio

By: Geng Deng, Tim Dulaney, Craig McCann, and Olivia Wang (Nov 2013)

Published in the Journal of Asset Management, 14(5):293-305, 2013.

We propose a robust portfolio optimization approach based on Value-at-Risk (VaR) adjusted Sharpe ratios. Traditional Sharpe ratio estimates using a limited series of historical returns are subject to estimation errors. Portfolio optimization based on traditional Sharpe ratios ignores this uncertainty and, as a result, is not robust. In this paper, we propose a robust portfolio optimization model that selects the portfolio with the largest worse-case-scenario Sharpe ratio within a given confidence interval. We show that this framework is equivalent to maximizing the Sharpe ratio reduced by a quantity proportional to the standard deviation in the Sharpe ratio estimator. We highlight the relationship between the VaR-adjusted Sharpe ratios and other modified Sharpe ratios proposed in the literature. In addition, we present both numerical and empirical results comparing optimal portfolios generated by the approach advocated here with those generated by both the traditional and the alternative optimization approaches.

Are VIX Futures ETPs Effective Hedges?

By: Geng Deng, Craig McCann, and Olivia Wang (Jun 2012)

Published in The Journal of Index Investing, Winter 2012, Vol. 3, No. 3, pp. 35-48.

Exchange-traded products (ETPs) linked to futures contracts on the CBOE S&P 500 Volatility Index (VIX) have grown in volume and assets under management in recent years, in part because of their perceived potential to hedge against stock market losses.

In this paper we study whether VIX-related ETPs can effectively hedge a portfolio of stocks. We find that while the VIX increases when large stock market losses occur, ETPs which track short term VIX futures indices are not effective hedges for stock portfolios because of the negative roll yield accumulated by such futures-based ETPs. ETPs which track medium term VIX futures indices suffer less from negative roll yield and thus appear somewhat better hedges for stock portfolios. Our findings cast doubt on the potential diversification benefit from holding ETPs linked to VIX futures contracts.

We also study the effectiveness of VIX ETPs in hedging Leveraged ETFs (LETFs) in which rebalancing effects lead to significant losses for buy-and-hold investors during periods of high volatility. We find that VIX futures ETPs are usually not effective hedges for LETFs.

CLOs, Warehousing, and Banc of America's Undisclosed Losses

By: Tim Husson, Craig McCann, and Olivia Wang (Jan 2012)

Collateralized Loan Obligations (CLOs) are issued by trusts which in turn invest the proceeds from issuing the CLO securities in portfolios of bank loans. This note explains the conflicts of interest created when an investment bank accumulates loans for potential securitization prior to the issuance of a CLO through a practice known as 'warehousing.' Warehousing appears to have resulted in some CLO trusts issuing securities without disclosing to investors that the securities had lost almost all their value because the CLO trust was committed to paying substantially more than the market value of the warehoused loans.

We provide two examples of such problematic CLO offerings in which Banc of America appears to have transferred at least $35 million of losses to investors in July 2007 and which ultimately led to approximately $150 million in losses in just these two CLOs. $35 million of those $150 million in losses occurred before Banc of America sold the securities to investors and only $115 million occurred after investors bought the CLO securities. The problem we identify is more widespread than Banc of America and broader than CLOs.

The Private Placement Memoranda for the products mentioned in the paper:
- Bryn Mawr II PPM
- Symphony IV PPM

The LCM VII Marketing Deck and the LCM Trustee Reports which document the decline in the value of the LCM VII loans before July 31, 2007 are available to read.

News Article:
- American Banker - B of A Subpoenaed by Massachusetts Over CLOs by Allison Bisbey
- The New York Times, February 5, 2012 - A Wipeout That Didn't Have to Happen

Recent Award:
- Hayes v Banc of America Securities - $1.4 million CLO Award

3 Results