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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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Displaying 10 out of 19 results

Impact of Zoom on FINRA Claimants

By: Craig McCann, Chuan Qin (Jan 2021)

SLCG presents a new study on the impacts that Zoom and other virtual meeting platforms have on the process of FINRA hearings, citing evidence that the newly updated process has a negative effect on those who are claiming.

Craig McCann's NASAA 2015 Presentation, Investments Through Time

By: Craig McCann (Sep 2015)

Investments Through Time: The Evolution of Investment Products and How They are Sold.

Securities-Based Lending

By: Paul Meyer (Jun 2015)

A perfect storm of soaring equity values and historically low interest rates has sparked a borrowing binge among securities investors. Securities-based loans ("SBLs") are a very attractive product for the broker-dealers who market them. However, SBLs impose substantial risks on borrowers. These risks are easy to overlook in a buoyant market but will eventually wreak havoc on the financial wellbeing of investors who are not prepared to withstand the next bear market. In this paper, Paul Meyer reviews the types of lending in which broker-dealers engage, describes how SBLs are regulated and marketed, and points out the considerable risks borne by a customer who borrows against his savings.

The Fall of Willow

By: Geng Deng and Craig McCann (Mar 2014)

Published in the PIABA Bar Journal, 21 (1): 71-90, 2014.

From May 8, 2000 until June 30, 2007, the UBS Willow Fund was invested in distressed obligations with offsetting but smaller cash and synthetic short debt positions through credit default swaps (CDS). After June 2007 the Fund dramatically increased its purchases of CDS and became massively short distressed debt. Investors in the Fund lost $278.4 million during this second period from June 2007 to December 2012 and the Willow Fund was liquidated in 2013.

The Willow Fund understated the risk of its CDS portfolio and did not disclose the dramatic increase in the Fund's risks. In fact, the Willow Fund stopped reporting the CDS premiums it paid as a line item expense and thereafter bundled them with realized and unrealized gains on losses on its overall securities and derivatives portfolio making it nearly impossible for investors to discern the impact of the Fund's change in strategy and dramatic increase in risk. Investors in the Willow Fund suffered losses of between $351 million and $419 million compared to diversified portfolios of junks bonds while UBS made over $100 million selling and managing the Fund.

Modeling a Risk-Based Criterion for a Portfolio with Options

By: Geng Deng, Tim Dulaney, and Craig McCann (Dec 2013)

Published in the Journal of Risk, Vol. 16, No. 6.

The presence of options in a portfolio fundamentally alters the portfolio's risk and return profiles when compared to an all equity portfolio. In this paper, we advocate modeling a risk-based criterion for optioned portfolio selection and rebalancing problems. The criterion is inspired by Chicago Mercantile Exchange's risk-based margining system which sets the collateralization requirements on margin accounts. The margin criterion computes the losses expected at the portfolio level using expected stock price and volatility variations, and is itself an optimization problem. Our contribution is to remodel the criterion as a quadratic programming subproblem of the main portfolio optimization problem using option Greeks. We also extend the margin subproblem to a continuous domain. The quadratic programming problems thus designed can be solved numerically or in closed-form with high efficiency, greatly facilitating the main portfolio selection problem. We present two extended practical examples of the application of our approach to obtain optimal portfolios with options. These examples include a study of liquidity effects (bid/ask spreads and limited order sizes) and sensitivity to changing market conditions. Our analysis shows that the approach advocated here is more stable and more efficient than discrete approaches to portfolio selection.

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.

Optimizing Portfolio Liquidation Under Risk-Based Margin Requirements

By: Geng Deng, Tim Dulaney, and Craig McCann (Apr 2012)

Published in the Journal of Finance and Investment Analysis, 2(1): 121-153, 2013.

This paper addresses a situation wherein a retail investor must liquidate positions in her portfolio -- consisting of assets and European options on those assets -- to meet a margin call and wishes to do so with the least disruption to her portfolio. We address the problem by first generalizing the usual risk-based haircuts methodology of determining the portfolio margin requirement given the current positions of a portfolio. We derive first and second-order analytic estimates for the margin requirements given the positions. Given this generalization, we determine the liquidation strategy that minimizes the total positions liquidated and meets the margin requirement. We implement the strategy on example portfolios and show advantages over traditional piece-wise liquidation approaches. The analytic approach outlined here is more general than the margin context discussed. Our approach is applicable whenever an investor is attempting to maximize the impact of their capital subject to leverage limits and so has obviously applications to the hedge fund industry.

Valuing Partial Interests in Trusts

By: Geng Deng, Tim Husson, and Craig McCann (Dec 2011)

The financial interests of a trust's beneficiaries are often diametrically opposed and conflict among trust beneficiaries is common. Although applicable law requires that trustees adhere to lofty standards of 'good faith' and 'fair dealing' they must make tangible, specific decisions, and sometimes under circumstances in which the settlor's expectations regarding investments and distributions as set forth in the trust document are unclear. Traditional methods for valuing partial interests in trusts offer insufficient guidance to courts in assessing the prudent investor standard, as they often disregard many of the important factors which go into investment decisions--notably, the allocations to different asset classes.

In this paper, we develop a valuation methodology based on Monte Carlo Simulation techniques which allows for economically feasible ex ante valuation of partial interests in trusts. The MCS technique is widely used in modern finance and economics, and is especially useful for valuing partial interests because it can incorporate mortality risk, portfolio asset allocation, varying distributions and the discretionary sale of the trust's assets to fund distributions. We explain how the MCS method can incorporate a variety of assumptions about the income beneficiary's mortality and the trustee's decisions, and show how these factors affect the valuation of partial interests.

What Does a Mutual Fund's Term Tell Investors?

By: Geng Deng, Craig McCann, and Edward O'Neal (Apr 2010)

Published in the Journal of Investing, Summer 2011, Vol. 20, No 2: pp. 50-57.

In a previous article, we highlighted a flaw in the average credit quality statistic frequently reported by bond mutual funds. That statistic understates the credit risk in bond portfolios if the portfolios contain bonds of disperse credit ratings. In this article we address a similar problem with bond mutual funds' reporting of the average term of their portfolios. The somewhat ambiguous nature of this statistic provides an opportunity for portfolio managers to significantly increase the funds' risks, credit risk in particular, by holding very long-term bonds while claiming to expose investors to only the risks of very short-term bonds.

Morningstar uses a fund-provided statistic - the average effective duration - to classify funds as ultra short, short, intermediate or long-term. Funds have figured out how to hold long-term bond portfolios yet be classified as ultra short-term and short-term bond funds. We show that extraordinary losses suffered by these funds in 2008 can be explained by the how much the bond funds' unadulterated weighted average maturity exceeded the maturities typically expected in short-term bond funds.

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