THE LATEST NEWS FROM THE ICF

Special Guest Lecture by Rakesh Mohan

Rakesh Mohan, Deputy Governor, The Reserve Bank of India, Mumbai, To Speak at SOM

Rakesh Mohan, Deputy Governor of the Reserve Bank of India at Mumbai, will speak at a special guest lecture on Monday, December 3, 2007, at Luce Hall Auditorium, 34 Hillhouse Avenue, at 4:00 p.m. Mr. Mohan will present, "India's Financial Sector Reforms: Fostering Growth While Containing Risk." Additionally, Mr. Mohan will be available , by appointment only, throughout the day, for one-on-one meetings. Please contact Peter Rondina at 432-3630, to make an appointment to meet Mr. Mohan. This special lecture is sponsored by The South Asia Studies Council, the International Center for Finance, and the Center for the Study of Globalization.

Bob Shiller on the Housing Market

WNPR "Where We Live" Interview with Bob Shiller

HARTFORD, CT (2007-10-18) The disaster of sub-prime lending has helped to put a hole in the once rapidly expanding housing market. So now, is your home still an investment or just a place to live? The number of foreclosures on homes in Connecticut, and surrounding states has gone way up, in part because of adjusting rates on low-interest loans, that have many homeowners paying more than they can afford. But even for those not directly hit by the sub-prime crisis, it's clear that home ownership isn't as lucrative as it once was. Bob Shiller, a Yale Economist and housing expert will join us to take your questions about the changing housing market and what to expect. Listen to Bob's interview here

New Book by ICF Fellow Frank Fabozzi

Introduction to Structured Finance Book Review by Riskbook.com

"Introduction to Structured Finance," by Frank Fabozzi, H. Davis, and M. Choudhry, published by John Wiley and Sons, receives great review from Riskbook.com

Structured finance is one of those elusive terms that mean different things to different people. With this wonderful book, authors Fabozzi, Davis and Choudhry first explore the boundaries of what is and is not considered to be structured finance. A simple definition would be that structured finance is any form of non-traditional financing, but this begs the question of where to draw the line between traditional and non-traditional. Certainly, most people wouldn't consider a vanilla swap to be structured finance! Structured finance might be described in terms of techniques that are commonly employed—securitization, derivatives, special purpose vehicles (SPVs), leasing, project finance, etc. The authors explore this and other approaches to, if not defining structured finance, at least clarifying its boundaries.

Embracing a broad conception of structured finance, the authors then set out to describe the many facets of their conception. Chapters are devoted to credit derivatives, securitization, structured notes, leasing, project finance and more. There are thirteen chapters in all, and almost a hundred pages of appendices, which mostly dissect a number of actual structured finance deals.

Top Ten Technical Books for 2006

Financial Engineering News, by Richard Norgate, Ph.D., FEN Book Review Editor.

"Financial Modeling of the Equity: CAPM to Cointegration," by Frank Fabozzi, Petter Kolm, and Sergio Focardi, published by John Wiley and Sons, named one of the "Top Ten Technical Books for 2006" by Financial Engineering News.

This book provides an extensive overview of the models used for measuring equity risk, and presents all the major approaches to single-period return analysis, including modeling, estimation, and optimization issues. Mr. Norgate states, "This book represents an excellent summary of the method in place within equity modeling."

Frank Fabozzi is the Frederick Frank Adjunct Professor of Finance and an ICF Fellow at the Yale School of Management. He has authored numerous books on financial engineering and specializes in investment management and structured finance. An recent, exclusive interview with Frank can be found in the Financial Engineering News, FEN 45.

Petter is a graduate student in finance at the Yale School of Management and a financial consultant in New York City. Previously, he worked in the Quantitative Strategies Group of Goldman Sachs Asset Management, where he developed quantitative investment models and strategies.

Sergio M. Focardi (Paris, France) is a founding partner of the Paris-based consulting firm, The Intertek Group.

Illuminating 'Closet Indexes'

The Wall Street Journal, by Tom Lauricella.

"Are your mutual-fund managers earning their keep?"

A complaint lodged against many managers of funds that invest in stocks is that they collect big fees for doing little more than basing their stock picks on the market index -- say, the Standard & Poor's 500-stock index -- against which their fund's performance is measured. There is even a term for this behavior: closet indexing. "

For investors, there hasn't been an easy way to tell if a fund falls into this category. Now a pair of Yale University professors have developed a simple way of measuring to what degree a fund's holdings are actively managed, as opposed to passively mirroring an index. It also turns out that -- at least according to the research -- the measure could be a useful predictor of performance. The measure, created by Antti Petajisto and Martijn Cremers from the Yale School of Management, takes a simple approach. Called the "active share" of a portfolio, it matches the holdings reported by a fund in U.S. Securities and Exchange Commission filings against the components of an index, and then measures the percentage of overlap. For example, if General Electric and Exxon Mobil each account for 4% of an index, and a fund had a portfolio exactly mirroring the index except it had 8% in GE and nothing in Exxon, its active share would be 4%. The more a portfolio differs from an index, the higher the active share percentage.

The study found that the average fund using the S&P 500 as a benchmark (generally, funds investing in large-company stocks) has an average active-share percentage of 66%. In other words, the average large-company stock fund had a portfolio that was 66% different than the benchmark and the rest essentially mirrored the index. The study, which examined data from 1980 through 2003, found an increase in funds that could be described as closet indexing during the 1990s. Closet index funds (generally those with active share in the 20% to 60% range) contained about 30% of all assets in 2003, up from practially no assets in the 1980s.

One reason investors should care: Actively managed funds charge higher fees, on average, than index funds. After all, the idea is that you are paying a premium for the talents of a skilled stock picker -- not just someone mirroring a stock index.

A globe-trotting history of modern finance BOOK REVIEW THE ORIGINS OF VALUE: Stephen Fidler on an edifying account of financial markets, from pawnshops in seventh-century China to the first stock exchange in Holland

STEPHEN FIDLER, Financial Times (London, England), 27 December, 2005

"Loans, bets and trades. These three words, more or less, encapsulate all transactions in the world's financial markets. Raw computing power in the past 20 years has pushed modern finance to levels of sophistication that make it hard for laymen to grasp. But understand these building blocks and you understand, at root, what financial markets are about.

Bets are contingent claims in which one side pays the other depending on the outcome of a future event. They also seem to have emerged in Mesopotamia but were developed in 17th-century Holland, where a market developed in options on shares. Insurance and all types of risk hedging are, in essence, bets.

This academic but beautifully produced and revealing book casts light on where, when and why these concepts first emerged and how they developed.

The book does not argue that concepts developed in one place necessarily influenced the subsequent development of similar financial instruments. But it roams around the world from China - where pawnshops, noted in the seventh century, were almost the only private financial institutions before the 19th century - to Italy, where the beginnings of modern state finance emerged, and beyond to the US and Africa.

The authors have also uncovered some fascinating historical footnotes, including a financial instrument that has been paying interest since it was issued in the 17th century: the oldest live security in the modern capital markets.

That perpetual security was a bond issued by one of Holland's many water boards, responsible for a 33.5km stretch of dyke. It has paid interest in Carolus guilders, Flemish pounds, guilders and now, since one of the authors presented the coupons to a successor company, in euros.

The book also describes how speculators moved in to benefit from anomalies that emerged in the market for annuities in the 1830s - which the British government used to finance itself. In return for an up-front sum, the government would pay an annual amount until the person specified in the contract died."

Martin Shubik's book republished as a classic

ICF Fellow(s) included in the article: Shubik, Martin

Martin's Shubik's Aggressive Conservative Investor has been republished. Click here for more details

BIG IDEAS

Elizabeth Fry, CFO, 1 February, 2005
ICF Fellow(s) included in the article: Goetzmann, William

"The world of corporate finance is always open to new ideas, but such ideas rarely strike at the very assumptions underpin-ning what we know - or think we know - about the subject.

Our conversations with seven leading finance academics from the United States and Britain reveals that a once small and much-maligned branch of corporate finance theory - behavioural finance, which holds that systemic psychological biases cause problems with asset pricing - has become mainstream.

Goetzmann is credited with an important contribution in the area of funds management, having developed a performance measure he says cannot be manipulated.

The measure is a ranking system based on investor preferences for risk and return, which Goetzmann claims is superior to the method fund managers usually use to evaluate their performance (the Sharpe Ratio, a quantitative index of performance that looks at the return per unit of risk).

"When we tested our method against the Sharpe Ratio, we found the Sharpe Ratio performs poorly when returns have skewed distributions," Goetzmann says. "While the Sharpe Ratio is a useful measure of performance, you can manipulate it by smoothing returns and using options. Because of this, fund managers may appear as though they are generating high returns when all they are really doing is taking big risks." Under his measure, fund managers will be penalised for such practices.

Goetzmann says there is only one unambiguous way to see if funds are performing, and that is to measure the risks and returns in the context of what investors want.

Assume, for example, that investors can choose between a fund that has a 15% return and 30% risk, and another fund with a 10% return and a 12% risk. Which would they prefer? For Goetzmann, the trade-off that investors make will be based on their attitude towards risk and return.

"They may like 1% return more than they hate 1% risk, or they might not be able to take on extra risk no matter how much greater the return. This method is a way of specifying those investor preferences," Goetzmann says."

Read the full article here

Hedge funds: Prof puts Yale at center of hedge fund universe; School works with top-flight academics, industry groups on major research projects

Christine Williamson, Pensions & Investments, 24 January, 2005
ICF Fellow(s) included in the article: Goetzmann, William

"Industry insiders are in on a well-kept secret: Yale University is a hotbed of hedge fund research.

That's because of the efforts during the past decade of a self-named "missionary for hedge funds," William N. Goetzmann, the Edwin J. Beinecke Professor of Finance and Management and director of the International Center for Finance at the Yale School of Management. He also is a power behind the center's Hedge Fund Research Initiative.

The idea from the beginning has been to pair Yale faculty with other academics and industry practitioners to conduct cutting-edge research on hedge fund management. Seven Yale faculty members, including Mr. Goetzmann, Roger G. Ibbotson, Jonathan E. Ingersoll Jr. and Judith Chevalier, work with participating scholars from Massachusetts Institute of Technology, the Stern School of New York University, Boston College, the University of Illinois, Case Western Reserve University and others, as well as with hedge fund managers. In addition, David F. Swensen, chief investment officer, and Dean Takahashi, senior director-investments, of the Yale Investments Office, which manages the university's nearly $13 billion endowment, also are participating researchers at the HFRI.

His efforts have resulted in partnerships between academics and practitioners that have borne well-read fruit. Of the 14 research papers listed on the HFRI website- http://icf.som.yale.edu/research/ hedgefund.html - the paper "Illiquid Alternative Asset Fund Modeling'' by Seth Alexander and Mr. Takahashi has been downloaded more than 10,000 times. Another paper has been downloaded 7,000 times, Mr. Goetzmann said.

While the Yale hedge fund think tank won't accept research "commissions'' from the money management industry, because it wants to preserve its independence, Mr. Goetzmann said HFRI scholars do have a lot of interaction with hedge fund managers.

These conversations tend to be mutually beneficial and spark new research ideas. In fact, about 50% of the center's research concepts to date have been sparked by practitioners' ideas, Mr. Goetzmann said."

Following the herd could cost you dear: BEHAVIOURAL FINANCE: Alexander Jolliffe looks at a school of thought that says investors keep on making the same expensive mistakes.

Alexander Jolliffe, The Financial Times (London Edition), 29 January, 2005
ICF Fellow(s) included in the article: Barberis, Nicholas

"For investors who bought technology funds during the internet boom, only to see their value halve when the bubble burst, studying "behavioural finance", the analysis of irrational investor behaviour, could pay big dividends.

Behavioural finance contrasts with the traditional argument that markets are "efficient" - that is, that share prices reflect publicly available information. According to this traditional school of thought, it is difficult to outwit the market as this means getting information before everyone else. But a growing number of academics are starting to disagree with this long-held view.

Professor Nick Barberis, a professor of finance at Yale School of Management, says: "Don't trade too often. Retail investors would do a lot better if they traded less. Their trading takes a lot away from their net returns because of transaction costs (the money you pay to stockbrokers or fund managers to buy or sell shares and funds)."

For psychological reasons, people tend to hang on to prior losers. But this only worsens their portfolio performance because prior losers tend to keep losing," says Professor Barberis whose research has focussed on behavioural finance.

He adds that psychological factors stop investors from diversifying their portfolios enough. For example, they often invest only in domestic stock markets, or invest too heavily in their employers' shares - although they already depend on employers for salaries and in many cases pensions as well."

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