Edhec-Risk Institute NWL
June, 2018

Editorial
Vincent Milhau

Individuals need flexicurity in retirement solutions
At EDHEC-Risk Institute, we believe that individuals should not have to choose between security and flexibility. Improved forms of target date funds, which rely on goal-based investment principles applied to the retirement problem, can be promoted by the asset management industry to help individuals and households secure minimum levels of replacement income while generating upside exposure in the context of liquid and reversible investment products. In May 2018, EDHEC-Risk and the Operations Research and Financial Engineering (ORFE) Department of Princeton University launched a series of Goal-Based Investing Indices to help demonstrate the value of mass-customised goal-based investing strategies applied to the retirement problem. More...


Table of Contents

6. News
7. Events

FEATURE

Applying Goal-Based Investing Principles to the Retirement Problem
A major global pension crisis is threatening the two main pillars of pension systems, due to a combination of increasing demographic imbalances and decreasing economic productivity growth. In parallel, defined-benefit arrangements, which used to be dominant among occupational pension schemes, are progressively being closed and replaced by defined-contribution arrangements for new workers. Mathematically, the retirement investing problem can be laid out as follows: maximise the probability of reaching a target level of replacement income in retirement, while securing a minimum level. This problem can be solved by standard probabilistic techniques, but the theoretically optimal approach would not be implementable because it would require unreasonably high levels of leverage as well as continuous trading. More...


INTERVIEW
Prof Mulvey_Suri_Martellini

"Individuals are increasingly responsible for their own saving and investment decisions" - an interview with John Mulvey, Anil Suri and Lionel Martellini
In this month's interview, John Mulvey, Professor of Operations Research and Financial Engineering (ORFE) Department at Princeton University, Anil Suri, Managing Director and Head of Portfolio Analytics & the Innovation Development Center at Merrill Lynch Wealth Management and Lionel Martellini, Professor of Finance at EDHEC Business School and Director of EDHEC-Risk Institute, discuss the newly-launched EDHEC-Princeton goal-based investing indices, based on academic research that was supported by Merrill Lynch Wealth Management. They reflect on their long-term relationship, explain how it led to this new joint initiative and discuss the goals and usefulness of the indices. More...


Industry Analysis

IMR: Individual Investment Processes for the 21st Century
For the most part, private individuals have come a poor second in terms of the attention paid to their problems by the asset management industry. The solutions put forward in the two in-depth academic studies conducted by EDHEC-Risk Institute, summarised in the preceding two articles, go a long way to redressing the balance. These solutions, if adopted by the industry as is needed, will put individuals closer to par with leading institutional investors, with respect to the techniques and advice available for their specific needs. More...

P&I: Applying Goal-Based Investing to the Retirement Issue
Financing consumption in retirement has arguably become the greatest challenge for most individuals following a number of important changes, including the weakening state pension systems and the shift from defined-benefit to defined-contribution schemes in the corporate world that has left individuals more exposed to retirement risks. With the need to supplement retirement savings via voluntary contributions, individuals are increasingly responsible for their own savings and investment decisions. This global trend poses substantial challenges as individual investors not only suffer from behavioral limitations, but also typically lack the expertise needed to make educated investment decisions. More...

P&I: Maximizing the Benefits of Factor Investing
In this article drawn from the Amundi "ETF, Indexing and Smart Beta Investment Strategies" research chair at EDHEC-Risk Institute, we clarify the various possible definitions of factors that are relevant in investment practice and develop a framework for allocating to factors in two main contexts, namely allocation decisions at the asset class level, and benchmarking decisions within a given class. It is possible to use factor indexes as building blocks and to diversify risk across underlying factors, or to seek to exploit knowledge of economic regimes to design portfolios that react to changes in market conditions. More...


Research Publications
Journal of Financial and Quantitative Analysis

Staying on Top of the Curve: A Cascade Model of Term Structure Dynamics, with Laurent Calvet
This paper specifies term structure dynamics by a recursive cascade of heterogeneously persistent factors. The cascade naturally orders economic shocks by their adjustment speeds, and generates smooth interest-rate curves in closed form. For a class of specifications, the number of parameters is invariant to the size of the state space, and the term structure converges to a stochastic limit as the state dimension goes to infinity. High-dimensional specifications fit observed term structure almost perfectly, match the observed low correlation between movements in different maturities, and produce stable interest-rate forecasts that outperform lower-dimensional specifications. More...

The Journal of Corporate Finance

Capital Structure Decisions and the Optimal Design of Corporate Market Debt Programs with Lionel Martellini and Vincent Milhau
This paper provides a joint quantitative analysis of capital structure decisions (debt versus equity) and debt structure decisions (fixed-rate debt versus floating-rate debt or inflation-linked debt) in a continuous-time setting. We show that optimizing the debt structure has an impact on capital structure decisions, and leads to increases in leverage ratios compared to a pure fixed-rate debt program. We also find that for realistic parameter values, jointly optimizing the debt and capital structures generates a significant increase in firm value with respect to a situation where only the capital structure is optimized. More...

Quantitative Finance

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction, with Nikolaos Tessaromatis
Agent-based models are used widely in the social and natural sciences. There is less usage in economics. Cheap computing power, big data and the disappointing performance of mainstream economic modelling, could provide the necessary impetus for wider acceptance within the economic profession. If not, ABMs might still be a promising alternative to standard models in periods characterised by instability and complexity. Richard Bookstaber’s book is an excellent treatise, in simple non-mathematical terms, of an alternative approach to the neoclassical economic paradigm that should be read by risk managers and policy officials. More...

Journal of Economic Dynamics and Control

Local volatility and the recovery rate of credit default swaps, with Jeroen Jansen, Frank Fabozzi
Credit default swap (CDS) spreads can only be decomposed into the probability of default and the loss-given-default by imposing some structure. Employing a hybrid binomial tree for equities and a recovery function, Das and Hanouna (2009) obtain accurate estimates for CDS spreads by fitting the model to historical equity volatilities. We extend their approach by including the full implied volatility surface, developing an implied binomial tree with a jump to default based on extending the Derman and Kani (1994) tree. More...


IN VIDEO

"Bond Portfolio Optimization" - with Professor Lionel Martellini and Nathalie Pistre Head of Quantitative Research, Support and Development at Ostrum Asset Management. This video discusses advanced methods for efficient portfolio construction in bond market and fixed income portfolio construction with active views.

"Introducing the EDHEC Bond Risk Premium Monitor" - with Riccardo Rebonato, Professor of Finance at EDHEC Business School. He introduces a tool to derive a state-of-the-art estimation of the risk premia in bond markets using market and monetary policy information. The EDHEC-Risk Premium Monitor was launched in September 2017.

Bond Portfolio Optimization by Lionel Martellini and Nathalie

Introducing the EDHEC Bond Risk Premium Monitor by Riccardo Rebonato

Learn more in video by subscribing to our YouTube channel.


News
Multi asset investment products and solutions seminar

Multi-Asset Investment Products and Solutions Seminar, July 2018
The aim of this seminar is to equip participants with practical tools to improve asset allocation and risk management decision processes, and to implement novel investment management approaches. Emphasis will be put on real world examples of application and the development of problem solving skills using Excel-based portfolio simulation tools. More...

Lionel Martellini

Lionel Martellini presented EDHEC-Risk activities and research programmes at a conference on the topic "Paris, a Leading European Research Center in Asset Management", organised by AFG
Lionel Martellini, Director, EDHEC-Risk Institute, was invited to participate as a panelist on the theme "Three Examples of Successful Research Programs, conducted with Leading Asset Managers" at the French Embassy in London at a conference organised by AFG - Association Française de la Gestion financière, on 29 May, 2018. More...

Kati Eriksson

Kati Eriksson, Head of Investments, Aalto University Endowment appointed as a new member of EDHEC-Risk Institute's international advisory board
EDHEC-Risk Institute is pleased to announce that Kati Eriksson has joined its international advisory board, whose role is to consult on the relevance and goals of the different research programmes proposals presented by the centre and to evaluate research outcomes with respect to their potential impact on industry practices. More...

2nd edition of the rotating conference series

A great success for the State of the Art in Robo-Advising Systems: Financial Technologies for Enhanced Social Security Conference with over 200 professionals at the Millenium Hotel in Seoul
This event was the 2nd edition of the rotating conference series, assessing again the successful collaboration of EDHEC-Risk Institute, KAIST (Korea), Princeton (USA), and Tsinghua (China) Universities. More...


EVENTS

Keynote Speech by Lionel Martellini at the Amundi World Investment Forum, Paris, 29 June 2018

Multi-Asset Investment Products and Solutions Seminar, Yale SOM, July 2018

EDHEC-Risk's International Advisory Board Annual Meeting, Beaulieu sur Mer, 5 October, 2018


Press Review

EDHEC-Risk Institute has been cited widely in the business and industry press. A selection of articles may be found below.


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About EDHEC-Risk Institute:

Established in 2001, EDHEC-Risk Institute has become the premier academic centre for industry-relevant financial research. In partnership with large financial institutions, its team of close to 30 permanent professors, engineers, and support staff, and 39 research associates and affiliate professors, implements 7 research programmes and 6 research chairs, industrial partnerships and private research projects focusing on asset allocation and risk management and has developed an ambitious portfolio of research and educational initiatives in the domain of investment solutions for institutional and individual investors.

EDHEC-Risk Institute
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E-mail: research@edhec-risk.com
Telephone: +33 493 187 887
Web: https://risk.edhec.edu

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