Recent Research: Highlights from July 2014
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"Going for Broke: Restructuring Distressed Debt Portfolios"
The Journal of Fixed Income (Summer 2014)
Sanjiv R. Das and Seoyoung Kim
This article discusses how to restructure a portfolio of distressed debt and what the gains are from doing so, and attributes these gains to restructuring and portfolio effects. This is an interesting and novel problem in fixed-income portfolio management that has received scant modeling attention. We show that debt restructuring is Pareto improving and lucrative for borrowers, lenders, and investors in distressed debt. First, the methodological contribution of the paper is a parsimonious model for the pricing and optimal restructuring of distressed debt, i.e., loans that are under-collateralized and are at risk of borrower default, where willingness to pay and ability to pay are at issue. Distressed-debt investing is a unique portfolio problem in that a) it requires optimization over all moments, not just mean and variance, and b) with debt restructuring, the investor can endogenously alter the return distribution of the candidate securities before subjecting them to portfolio construction. Second, economically, we show that post-restructuring return distributions of distressed debt portfolios are attractive to fixed-income investors, with risk-adjusted certainty equivalent yield pickups in the hundreds of basis points, suggesting the need for more efficient markets for distressed debt, and shedding light on the current policy debate regarding the use of eminent domain in mitigating real estate foreclosures.
"The Little Problem of Longevity: Searching for Answers to Uncertainty"
The Journal of Alternative Investments (Summer 2014)
This article examines historical and future trends in life expectancy across the world. The expected increases in longevity could have significant implications for the structure of pension systems in the future. Individuals, businesses, and governments have already responded to these expected increases—for example, by working longer, closing defined-benefit pension schemes, or introducing parametric reforms to state pension systems—and are likely to make further changes in the future. However, future longevity trends are uncertain, making it more difficult not only to allocate longevity risk efficiently and fairly across different economic but also to guarantee the sustainability of the system overall. Now, innovative solutions to this challenge are being developed by the capital markets and others.
"What Makes an Exchange a Unique Institution? A Commentary"
The Journal of Trading (Summer 2014)
In this response to an article in the Winter 2014 issue of The Journal of Trading, the uniqueness of exchanges is examined, beginning with a review of previously published commentary on the subject. National securities exchanges are unique in that they operate simultaneously as market participants and self-regulatory organizations. The implications of operating under the doctrine of regulatory immunity as a for-profit participant are discussed in the context of NASDAQ’s Benchmark Orders and the Facebook initial public offering.