Systematic risk

In finance and economics, systematic risk (in economics often called aggregate risk or undiversifiable risk) is vulnerability to events which affect aggregate outcomes such as broad market returns, total economy-wide resource holdings, or aggregate income. In many contexts, events like earthquakes, epidemics and major weather catastrophes pose aggregate risks that affect not only the distribution but also the total amount of resources. That is why it is also known as contingent risk, unplanned risk or risk events. If every possible outcome of a stochastic economic process is characterized by the same aggregate result (but potentially different distributional outcomes), the process then has no aggregate risk. Properties Systematic or aggregate risk arises from market structure or dynamics which produce shocks or uncertainty faced by all agents in the market; such shocks could arise from government policy, international economic forces, or acts of nature. In contrast, specif

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Optimal Capital and Risk Allocations for Law-and Cash-Invariant Convex Functions

Damir Filipovic, Gregor Svindland

In this paper we provide the complete solution to the existence and characterization problem of optimal capital and risk allocations for not necessarily monotone, law-invariant convex risk measures on the model space Lp, for any p ε [1;∞]. Our main result says that the capital and risk allocation problem always admits a solution via contracts whose payoffs are defined as increasing Lipschitz continuous functions of the aggregate risk.

Springer Verlag2008

Real options and risk aversion

Julien Hugonnier, Erwan Morellec

In the standard real options approach to investment under uncertainty, agents formulate optimal policies under the assumptions of risk neutrality or complete financial markets. Although these assumptions are crucial to the implications of the approach, they are not particularly relevant to most real world environments where agents face incomplete markets and are exposed to undiversifiable risks. In this chapter we extend the real options approach to incorporate risk aversion for a general class of utility functions. We show that risk aversion provides an incentive for the investor to delay investment and leads to a significant erosion in project values.

2012

Corporate control and real investment in incomplete markets

Julien Hugonnier, Erwan Morellec

In the standard real options approach to investment under uncertainty, agents formulate optimal policies under the assumptions of risk neutrality or perfect capital markets. However, in most situations, corporate executives face incomplete markets either because they receive compensation packages that restrict their portfolios or because cash flows from the firm’s investment opportunities are not spanned by those of existing assets. The present paper examines the impact of managerial risk aversion on investment decisions when the manager is exposed to idiosyncratic risk and faces the risk of a control challenge. In the paper, the investment policy selected by the manager reflects a trade-off between his incentives to reduce risk and the need to ensure sufficient efficiency to prevent control challenges. The analysis demonstrates that risk aversion induces the manager to speed up investment, leading to a significant erosion of the value of the option to wait.

2007

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