/Type /Font /XHeight 447 Further empirical work might shed more light on this issue if and where new data can be obtained. In general, all models discussed here have characteristics that make them more or less suited to one economic environment versus another. $ \ldots $ he wants to know sets of values that will be attained by a given decision rule $ F $ under a set of transition laws.. For example, one may assume that a linear regression model has normal errors, so the question may be how sensitivity is the Ordinary Least Squares (OLS) estimator to the assumption of normality. One source for the validation sample is based on regime shifts. HHI = logarithm of Herfindahl Index; DCPC = logarithm of the domestic credit to the private sector as a percent of GDP; sovereign = sovereign lending rate. It is interesting to note that the t-statistic is similar to a ratio widely used by the managed funds industry, the Sharpe ratio – Equation (10.13). /MaxWidth 2000 Economic theory itself does not tell which idealizations are truly fatal or harmful for the result and which are not. It turns out that, for all the window lengths, the three indicators of market condition have the right sign and are statistically strongly significant, confirming in this the previous results obtained with the wide window. (2008) and Moosa (2011). Syndicated investors almost invariably used the same securities as those used by the investors that provided these data. << First of all, while the size of the conditional volatility does depend upon the window's size, the time series behavior of the conditional volatility is more or less the same as shown in Figure 6.3. Keane and Moffitt (1998) estimated a model of labor supply and welfare program participation using data after federal legislation (OBRA 1981) that significantly changed the program rules. 541 0 0 0 0 0 0 1000 0 0 0 0 0 0 0 0 x��Zˎ����Wԑ ��|7ii-+k%H;�|�9�Բ�6����{�!���~��؀���v�YY���������]��*��pWn�Q�0�\��qU���z熫Ϯ�O��IX啻���ネ]���n��x������[L�F��ل�� ��/�o�=Ņ�����>�z�D�7_�������U�o�w�|��_��8�\�o� #�^����S���o���*I������/eAIS"Z���,sV ��>��Ƙ$�߿��eZ^���0ʜ���e�~����^`�4�7������e��nh6EA=l��y^�^Zmc��W��7���� �d�Vv�.itf>���8 �p3��iU��I�u� \����O"���.�i��k�1���HJM6[��ax�5?5,Ө�o�3ɰ�q�-�Z���1����@�$���$,��u�Y�ء��r �1X81���`30� ���Q/o�( Robustness refers to the ability of a model to estimate the cost of capital reliably even when different economic conditions may influence its inputs and implementation, or when the model's assumptions are not fully satisfied. Its popularity is due in part to its simplicity as well as its intuitive appeal. But which assumptions and how many are rarely specified. In general, a system … Heavy-Tailed Distributions and Robustness in Economics and Finance. /Encoding /WinAnsiEncoding 2. They used the model to predict behavior prior to that policy change. Figure 6.3. We nevertheless outline a number of suggestions for future work. /FontName /TimesNewRomanPSMT /LastChar 122 Nevertheless, it is interesting to note that formal tests generally reject DCDP models. << 3. We argued that both themes yielded similar predictions which were supported in the data. /AvgWidth 479 /Type /Font Sharpe defined the difference between the return on a risky asset and the risk-free return on another secure asset as a good measure of the reward and the variance of the return on the asset as being an appropriate measure of risk. The economic intuition of this result stems from the fact that we are studying a market equilibrium ag- ... we derive robust comparative static results with respect to changes in the discount factor, borrowing limits, the parameters of the utility function ðe.g., the level of risk aversionÞ, and the parameters of … ‎This book focuses on general frameworks for modeling heavy-tailed distributions in economics, finance, econometrics, statistics, risk management and insurance. Specifically, if p and p∗ are related by the long-run relation: and if they are cointegrated such that εt∼I(0), then equation (6) is misspecified and the correctly specified model is an error correction model of the form: where θ is the coefficient on the error correction term, which should be significantly negative for the model to be valid. We have no reason to believe the variables considered in this chapter are incomplete, although more detailed data and/or a greater volume of data could shed further light on the issues raised. This procedure is applied to two cases in which the US is the domestic market: one producing a highly effective hedge (against the UK) and another producing a less effective hedge (against Japan). 250 278 500 500 500 500 500 500 500 500 500 500 278 278 0 564 /BaseFont /TimesNewRomanPS-ItalicMT We controlled for a very large number of different firm-specific and private investor-specific characteristics, market conditions, and institutional factors. We present both impulse response functions (IRFs),21 which present the response of each variable to its own innovation and to the innovations of the other variables, as well as variance decompositions (VDCs), which show the percentage of the forecast error variance of one variable that is explained by the same and other variables within the panel-VAR. Using only the control villages, they estimated a behavioral model of parental decisions about child schooling and work, as well as family fertility. /FontDescriptor 7 0 R To evaluate the robustness of our results, we use the Student t-statistic which is generally accepted by academics and practitioners to test the hypothesis that the returns generated by technical analysis are zero. 3 0 obj Nor will non-rejected models necessarily outperform rejected models in terms of their (context-specific) predictive accuracy. endobj It is most likely that preplanned exits influence portfolio size per manager, which could be the subject of a new and different paper; but our data comprise 35 venture capital funds, and it is therefore not possible to fully consider this issue. These models are always based on various idealizations and abstractions, which make at … We do not know the “true” model of the cost of capital, so it is useful to consider evidence from all reasonable models, while recognizing their strengths and weaknesses and paying close attention to how they were implemented. It is not only about the use of an error correction model as opposed to a first-difference model, as various other model specifications have been suggested to estimate the hedge ratio. The results are gathered in Table 6.4 and Figure 6.3. /StemV 77 A much smaller negative effect is observed in the case of the Herfindahl Index. Our “robust” decision maker wants to know how well a given rule will work when he does not know a single transition law $ \ldots $. Aims to bridge the gap between economic modeling and the statistical modeling techniques that have been developed for observed real-world heavy-tailed risk distributions. Only the signs of the residuals matter in determining the quantile regression estimates, and thus outlying responses influence the fit in so far as they are either above or below the fitted hyperplane, but how far above or below is irrelevant. Various attempts have been made to design a modifiedmeasure to overcome this shortcoming, but as to date such proposals have been unable to retain the simplicity of the t-statistic and the Sharpe ratio, which has impeded their acceptance and implementation. Bente Villadsen, ... A. Lawrence Kolbe, in Risk and Return for Regulated Industries, 2017. Table 11. The validity of the model was then assessed according to how well it could forecast (predict) the behavior of households in the treatment villages.162. A common exercise in empirical studies is a “robustness check”, where the researcher examines how certain “core” regression coefficient estimates behave when the regression specification is modified by adding or removing regressors. Lumsdaine et al. Turning to the VDCs results (Table 12), we observe that 1.4% of alpha’s forecast error variance after 20 years is explained by Herfindahl Index’s disturbances and another 1.4% by disturbances of the domestic credit ratio. It can be defined as: with N number of (daily) observations, R the average (daily) rule returns and σR the standard deviation of (daily) rule returns. << Robustness definition at Dictionary.com, a free online dictionary with pronunciation, synonyms and translation. 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 /XHeight 454 A separate, though related, issue is how the regulator should respond when the true underlying cost of capital enters a volatile period, for example, following the recent financial crisis. Thus the nonlinear error correction model corresponding to the cointegrating regression (31) is: where A(L) and B(L) are lag polynomials. The estimation results are presented in Table 6, which reports the estimated value of the hedge ratio, its t statistic, and the coefficient of determination. A common exercise in empirical studies is a “robustness check”, where the researcher examines how certain “core” regression coefficient estimates behave when the regression specification is modified by adding or removing regressors. $ \ldots $ he wants to know sets of values that will be attained by a given decision rule $ F $ under a set of transition laws.. As advocated by previous literature, this length may be of importance. stream Keane and Wolpin (2007) estimated a model of welfare participation, schooling, labor supply, marriage and fertility on a sample of women from five US states and validated the model based on a forecast of those behaviors on a sixth state. 500 500 500 500 333 389 278 500 500 722 500 500 444 0 200 0 /Producer (PDF-XChange 3.60.0121 \(Windows XP\)) When adding the lag of the conditional volatility, the findings are slightly less clear cut. Examples are pervasive, appearing in almost every area of applied econometrics. 0 0 444 0 0 0 444 0 0 0 0 444]>> For exam-ple, of the 98 papers published in The American Economic Review during 2009, 76 involve some data analysis. 2, we observe that the effect of a one standard deviation shock of the supervision index on alpha is positive. /FirstChar 32 Table 6.4. Note: Figure presents impulse response functions (IRFs), which show the response of a variable of interest to a shock of one plus/minus standard deviation of the same variable or another variable within the panel-VAR. /Subtype /TrueType /ItalicAngle -16.399 The effect of a one standard deviation shock of the Fraser regulation index on alpha is negative; the same applies for the z-score variable.22 Table 11 presents VDCs and reports the total effect accumulated over 10 and 20 years. 0 0 0 333 333 444 444 0 500 0 0 0 0 0 0 0 The information considered was hand-collected and highly confidential. All economic models involve abstractions and idealisations. The problem with basing validation on model fit is that, like nonstructural estimation, model building is an inductive as well as deductive exercise. /Subtype /TrueType As long as the lag is symmetrical, i.e., is of similar length whether the cost of capital is generally rising or falling, both customers and investors can expect fair treatment over the (typically long) lives of regulated investments. Within-sample model fit: DCDP papers commonly assess model fit to the estimation sample, often, but not always, using formal statistical tests. Wanting robustness in insurance: A model of catastrophe risk pricing and its empirical test @article{Zhu2017WantingRI, title={Wanting robustness in insurance: A model of catastrophe risk pricing and its empirical test}, author={W. Zhu}, journal={Insurance Mathematics & Economics}, year={2017}, volume={77}, pages={14-23} } Note: Figure presents impulse response functions (IRFs), which show the responses of a variable of interest to a shock of one plus/minus standard deviation of the same variable or another variable within the panel-VAR. Given a solution β̭(τ), based on observations, {y, X}, as long as one doesn't alter the sign of the residuals, any of the y observations may be arbitrarily altered without altering the initial solution. While a more flexible view is adopted for prediction, a commitment to the estimated model is exploited in the design of a control law for reasons of tractability. In econometrics, both problems appear, usually together, and it is useful to refer to th e treatment of both problem s in economic applications as robust econometrics. We report the results of a regression where the dependent variable is the conditional volatility of the CAR. The cumulative abnormal return conditional volatility for different windows. Can one provide convincing evidence about the credibility of these exercises? More recently, Todd and Wolpin (2006) used data from a large-scale school subsidy experiment in Mexico, where villages were randomly assigned to control and treatment groups. The robustness of models of socio-spatial change, based on innovative knowledge, depends on the sophistication of the design and deployment of its agents. Looking at evidence from a number of models remains the best practice. Note: Table presents the variance decompositions (VDC), which show the components of the forecasts error variance of all variables within the panel-VAR. Robustness refers to the ability of a model to estimate the cost of capital reliably even when different economic conditions may influence its inputs and implementation, or when the model's assumptions are not fully satisfied. Neither ratio can distinguish between intermittent and consecutive losses. A central theme is that of (non-)robustness, i.e., the fact that the presence of heavy tails can either reinforce or reverse the implications of a number of models in these fields, depending on the degree of heavy-tailed ness. Variables within the panel-VAR are estimated alphas by country and by year (from Tables 5 and 6). /MissingWidth 250 The uncertainty about the baseline models estimated effect size increases of the robustness test model obtains different point estimates and/or gets larger standard errors. An example of such an approach may be to have a hearing at which only the cost of capital is reset, as opposed to an entire regulatory proceeding.10 Setting rates on a yearly basis is a good example of an approach that mitigates the concerns of volatility in the underlying true cost of capital. Robustness: the condition of being sound in body. Across the board, the three indicators happen to be significant with the right sign in the vast majority of cases. While quantile regression estimates are inherently robust to contamination of the response observations, they can be quite sensitive to contamination of the design observations, {xi}. /Widths [ 250 0 408 0 0 0 778 180 333 333 0 564 250 333 (1992), for example, estimated a model of the retirement behavior of workers in a single firm who were observed before and after the introduction of a temporary one-year pension window. Abstract. In contrast, in the absolutist view, a model would be considered useful for prediction only if it were not rejected on statistical grounds, even though non-rejection does not necessarily imply predicted effects will be close to actual effects. /CapHeight 662 endobj The formula of the Sharpe ratio is: with R¯ the annualized return of the trading rule, Rf, the annualized risk free returns of the asset under management, and σR annualized standard deviation of (daily) rule returns. A common exercise in empirical studies is a “robustness check”, where the researcher examines how certain “core” regression coefficient estimates behave when the regression specification is modified by adding or removing regressors. /MissingWidth 278 In principle, the cost of capital analyst could try to forecast how rapidly capital market conditions will return to “normal,” but in practice this would add controversy to the already controversial topic of how to estimate the cost of capital at any given time. The idea is as Andrew states – to make sure your conclusions hold under different assumptions. It has been argued that one problem with the conventional model of the hedge ratio, as represented by equation (6), is that it ignores short-run dynamics and the long-run relation between stock prices. As should be clear from this discussion, model validation, and model building more generally, are part art and part science. U(� �|�+u�Dq̋,�ՠ�A��� 4ܵ�9�n����8����8�f��;�,؉�7cG������~��' We identify three kinds of ‘robustness’: (1) robustness to changes in the model’s idealisations; (2) robustness to changes in the ‘background’ conditions; (3) robustness to changes in the implied causal mechanism. >> This strength is purchased at a cost. Nonlinearity in this case is captured by a polynomial in the error correction term. 0 444 0 722 667 667 722 611 556 722 722 333 389 722 611 889 /FontDescriptor 9 0 R /Flags 32 Whatever empirical approach to inference is adopted, structural or nonstructural, researchers should strive to provide as much validation evidence as the data and methods permit. A central theme is that of (non-)robustness, i.e., the fact that the presence of heavy tails can either reinforce or reverse the implications of a number of models in these fields, depending on the degree of heavy-tailed ness. It deserves a page of its own. Finally, note that our empirical analysis in this chapter is specific to the venture capital context in which investment is invariably made with a view toward exit in the form of an IPO or acquisition. Variables within the panel-VAR are estimated alphas by country and by year (from Table 8); z-score = (average return on assets + equity/assets)/(standard deviation of the return on assets); FR-regulation = Fraser Index on market regulation; Supervision = index measuring official disciplinary power. A central theme is that of (non-)robustness, i.e., the fact that the presence of heavy tails can either reinforce or reverse the implications of a number of models in these fields, depending on the degree of heavy-tailedness. Robustness Checks: Changing the Event Window. /FirstChar 32 Randomized social experiments have also provided opportunities for model validation and selection. Robustness to assumptions: One method is to check how robust the empirical findings are to alternative assumptions. First, the ways in which contracts between investors are negotiated in respect of preplanned exit behavior might be a fruitful avenue of further theoretical and empirical work. For instance, one might build into the analyses behavioral factors related to trust and/or over-optimism in the spirit of Landier and Thesmar (2009) and Manigart et al. Table 6. 8 0 obj The validation exercise exploited data that were unavailable at the time of estimation to validate their model. 667 722 611 722 611 500 556 722 611 0 0 0 0 0 0 0 Copyright © 2020 Elsevier B.V. or its licensors or contributors. For example, is the impact of the Brexit vote on the cost of capital long-lasting, such as the financial crisis, or short-lived? Thus, robust control and prediction combines Bayesian learning (about an unknown state vector) with robust control, while adaptive control combines flexible learning about parameters with standard control methods. Look it up now! /Widths [ 250 0 0 0 0 0 0 214 0 0 0 0 250 0 Impulse response functions (IRFs)—alpha, Fraser regulation, supervision index, z-score. 9 0 obj This finding is consistent with the evidence provided by Maharaj et al. Our “robust” decision-maker wants to know how well a given rule will work when he does not know a single transition law $ \ldots $. A model is deemed invalid if it is rejected according to some statistical criterion. As such, all individual models can be, and often are, subject to some instability over time. /MissingWidth 250 Re: Robustness of an economy: Quoted from this wikipedia article: "robustness is the ability of a financial trading system to remain effective under different markets and different market conditions" Effectiveness is the key concept in this definition. Looking at the first row of Fig. /Ascent 905 500 500 500 500 389 389 278 500 444 667 444 444 389]>> /LastChar 121 A central theme is that of (non-)robustness, i.e., the fact that the presence of heavy tails can either reinforce or reverse the Fig. We report the results of a regression in which the dependent variable is the conditional volatility of the CAR. The chapter introduces difficulties in seeking optimal solutions to the problems of distribution, especially where agents have formed interest groups, and outline some methods for achieving effective decisions in the face of bias and prejudice. If T is above 0.841, the returns are said to be significantly positive at the critical threshold of 20 per cent (that is, 5 per cent and 20 per cent probability, respectively, that this conclusion is incorrect). >> In this pragmatic view, there is no true decision-theoretic model, only models that perform better or worse in addressing particular questions. Sets of Models Imply Sets Of Values¶. Lars Peter Hansen, Thomas J. Sargent, in Handbook of Monetary Economics, 2010. endobj Fig. Mamatzakis, ... Mike G. Tsionas, in Panel Data Econometrics, 2019. This chapter outlines a range of key issues in agent behaviours, including the mental life, beliefs, drives and patterns of randomness that influence these behaviours. It is tempting to dismiss the approach for that reason, although we see no other empirical methodology with which to replace it. /Filter [/FlateDecode] endobj Only in 6 of 223 cases were differences observed (where the syndicated investor used common equity or warrants when the respondent investor used a security involving debt and/or preferred equity). The independent variables are the lagged volatility, the event type and an indicator of the market conditions, that is VIX in Panel A, market volatility in Panel B, and ICS in Panel C. For each regression we report three tests of the presence of a unit root in the residual of the regressions. ScienceDirect ® is a registered trademark of Elsevier B.V. ScienceDirect ® is a registered trademark of Elsevier B.V. URL: https://www.sciencedirect.com/science/article/pii/B0080430767004563, URL: https://www.sciencedirect.com/science/article/pii/B9780444534545000086, URL: https://www.sciencedirect.com/science/article/pii/B9781843347514500054, URL: https://www.sciencedirect.com/science/article/pii/S0169721811004102, URL: https://www.sciencedirect.com/science/article/pii/B9780128158593000251, URL: https://www.sciencedirect.com/science/article/pii/B9780124115491000296, URL: https://www.sciencedirect.com/science/article/pii/B9780128036150000066, URL: https://www.sciencedirect.com/science/article/pii/B9780128125878000034, URL: https://www.sciencedirect.com/science/article/pii/B9780750655163500121, URL: https://www.sciencedirect.com/science/article/pii/B9780124095373000128, Risk and Return for Regulated Industries, 2017, International Encyclopedia of the Social & Behavioral Sciences, The Structural Estimation of Behavioral Models: Discrete Choice Dynamic Programming Methods and Applications, Michael P. Keane, ... Kenneth I. Wolpin, in, Making Inference of Bank Managerial Preferences About Performance: A Panel Analysis, Emerging Market Stocks in Global Portfolios: A Hedging Approach, Corporate Social Responsibility and Macroeconomic Uncertainty, Handbook of Environmental and Sustainable Finance, Bente Villadsen, ... A. Lawrence Kolbe, in, Informative spillovers in the currency markets: a practical approach through exogenous trading rules, Venture Capital and Private Equity Contracting (Second Edition), Keuschnigg and Nielsen, 2001, 2003a,b, 2004a,b, Environmental Innovation and Societal Transitions, The Cochrane-Orcutt method with an AR(2) process in the residuals, Maximum likelihood with an MA(2) process in the residuals, Instrumental variables with an AR(3) process in the residuals, Autoregressive distributed lag model in first differences, OLS (the hedge ratio is the coefficient on the contemporaneous explanatory variable), OLS (the hedge ratio is the long-run coefficient calculated from the impact coefficients). The independent variables are the lagged volatility, the event type (Type), and an indicator of the market conditions, that is VIX in Panel A, Market volatility in Panel B, and ICS in Panel C. All the coefficients have been multiplied by 100 for readability. D. Wade Hands Derivational Robustness, Credible Substitute Systems, and Mathematical Economic Models: The Case of Stability Analysis in Walrasian General Equilibrium Theory, SSRN Electronic Journal (Jan 2014). This book presents recent research on robustness in econometrics. In economics, robustness is attributed to financial markets that continue to perform despite alterations in market conditions. For each regression we report three tests of the presence of a unit root in the residual of the regressions. They estimated several models on data before the window was introduced and compared the forecast of the impact of the pension window on retirement based on each estimated model to the actual impact as a means of model validation and selection. /AvgWidth 402 /Leading 150 Variables within the panel-VAR are estimated alphas by country and by year (from Table 8); z-score = (average return on assets + equity/assets)/(standard deviation of the return on assets); FR-regulation = Fraser Index on market regulation; Supervision = an index measuring official disciplinary power. /ItalicAngle 0 Variance Decomposition Estimations for Alpha, Herfindahl Index, Domestic Credit to the Private Sector and Sovereign Risk. Michael P. Keane, ... Kenneth I. Wolpin, in Handbook of Labor Economics, 2011. The adaptive control problem 5 is aimed at eliminating the commitment to a time-invariant benchmark model. In Panel A of Table 6.4 we present the results of the regression analysis when only the dependent variable is included in the regression. 5 0 obj We note that this is not only a modeling issue, but also a policy issue. The most stable and robust model will produce volatile estimates (over time) if the underlying cost of capital is itself volatile. (2007) and Drusch and Lioui (2010), CSR event type is likely to matter for the impact of CSR on firm value. Table 5. E.C. /StemV 77 3, the effect of a one standard deviation shock of the domestic credit to the private sector ratio on alpha is negative, as is the sovereign risk variable. The model was estimated using only control group data and was used to forecast the impact of the program on the treatment group. 250 0 0 0 0 0 0 0 0 0 0 0 333 333 0 0 The results are reported in Table 6.5. Our results indicate that about 15% of alpha’s forecast error variance after 20 years is explained by disturbances in the supervisory index, while 3.6% and 2.7% of the variation is explained by disturbances in the Fraser regulation index and the z-score variable, respectively. Economic theory itself does not tell which idealizations are truly fatal or harmful for the result and which are not. PIERRE LEQUEUX, in Advanced Trading Rules (Second Edition), 2002. Either way, robustness tests can increase the validity of inferences. The final specification results from a process in which the model structure is revised as estimation proceeds, by adding parameters and changing functional forms, as deficiencies in model fit are discovered. This book focuses on general frameworks for modeling heavy-tailed distributions in economics, finance, econometrics, statistics, risk management and insurance. The critical value for the t statistic at 1% confidence is −3.44. /FontName /TimesNewRomanPS-ItalicMT (2002a,b)Manigart et al. This column, taken from a recent Vox eBook, examines recent experiences and the risk-management literature. Lien (1996) provides a theoretical analysis of this proposition, concluding that an errant hedger who mistakenly omits the cointegrating relation always undertakes a smaller than optimal position on the hedging instrument. Surprisingly, philosophers of economics have only recently become interested in robustness. /FontDescriptor 5 0 R ADF1 assumes an autoregressive model for the residual, ADF2 assumes an autoregressive model with drift, and ADF3 assumes an autoregressive model with drift and trend stationary. 2���c��$��e���6��h��E� z)�M�8V/�^ȫ��^z��4J���R����e)�U�8P0���$B0EeLE�DE�Y}��,�N�jW�C ���(��VmZ�!l���ÞL.qyVW���V��u��R�z�)Lh�����ꩋ�^K�gaj4�'a^��Y�_�$��8t������#������'�� �K)d?s��QZ=W��aN2�lŪ�*/s.-��@Xƌ́8rW��܄sPsyd0h��c,U�.Q�ܭ���Q�������0P&� �4�Zz~l�y�k`ݛy��K�4���aa�- nw5�Q����f�O?c�, �ͩ�����;�؃��x�P�L�I����T#¸s��g�Y2�D��&=�i�[7^�d�yY��i����mU*Mn��{1O=���vt0%. The aim of the conference, “Robustness in Economics and Econometrics,” is to bring together researchers engaged in … I�?��� At the same time, sharp increases in the allowed rate of return create problems for customers. Decision-theoretic models are typically designed and estimated with the goal of predicting the impact on economic agents of changes in the economic environment. /StemH 77 << Some governments assert that global value chains create economic vulnerabilities in times of a pandemic. Presumably, disagreements can be reduced as confirmatory or contradictory evidence is accumulated. >> Further empirical research along these lines could also consider investor valuations practices and due diligence reviews, as well as the interplay between contractual governance, innovation, and performance (in the spirit of Kortum and Lerner, 2000; Baker and Gompers, 2003). Synonyms: fitness, health, healthiness… Antonyms: illness, sickness, unhealthiness… Find the right word. /XHeight 519 A central theme is that of (non-)robustness, i.e., the fact that the presence of heavy tails can either reinforce or reverse the implication… 0 0 0 500 500 444 500 444 278 500 500 278 0 444 278 722 The estimates and the associated inference apparatus have an inherent distribution-free character since quantile estimation is influenced only by the local behavior of the conditional distribution of the response near the specified quantile. /Widths [ 278 0 0 0 0 0 0 0 0 0 0 0 0 0 Kroner and Sultan (1993) used a bivariate GARCH error correction model to account for both nonstationarity and time-varying moments. /Descent -216 This is why much of what is seen as theoretical contribution in economics is constituted by deriving familiar results from different modelling assumptions. /StemV 78 We may also expect, however, that firms will not get financed in the latter case where the venture capitalist’s preplanned exit strategy is toward an acquisition and an entrepreneur does not want to give up control rights. 7 0 obj /Ascent 891 Interestingly, the smaller the event's window, the greater the conditional volatility. /Length 3184 10 0 obj Other theories about going public (Chemmanur and Fulghieri, 1999; Boot et al., 2006) more generally consider companies that are not necessarily financed by venture capitalists that invest with a view toward an IPO or acquisition. The “suburb” type happens to be the most important one with a negative impact on the uncertainty. Find another word for robustness. >> This is because the measure of risk (standard deviation) that they both use is independent on the order of the data. Fig. 2 presents the IRFs diagrams for the case that the panel-VAR includes; alpha, the Fraser Index on regulation, an index capturing supervisory disciplinary power, and the risk variable (z-score). Yet another procedure to estimate the hedge ratio is to use an autoregressive distributed lag (ARDL) model of the form: in which case the hedge ratio may be defined as the coefficient on Δpt∗(h=β0) or as the long-term coefficient, which is calculated as: In this exercise, we estimate the hedge ratio from nine combinations of model specifications and estimation methods, which are listed in Table 5. 0 0 0 722 722 722 0 667 0 0 0 278 0 0 0 833 Table 12. Robustness Checks: Accounting for CSR Event Type. We also consider standard models of aggregation and segregation among agent communities, as well as the tactical and strategic associations of agents with common interests. Although, in principle, such a method would provide evidence on the credibility of any particular set of findings, the number of assumptions in these models, their computational burden, and disagreements among researchers as to the a priori importance of particular assumptions, has led practitioners to limit the use of this approach.160 That is not to say that evidence accumulated from the estimation of models by different researchers, each with different modeling inclinations, is not valuable.161 Indeed, contradicting findings could be very revealing. In practice, researchers tend to stop well short of fitting the model to idiosyncratic features of the data just to improve model fit. We examine the fundamental trading of economic and social powers among agents, and draw on well-known methods of game theory for simulating and analysing outcomes to these interactions. /CapHeight 662 0 0 0 444 500 444 500 444 333 500 500 278 278 500 278 778 Lien (1996) argues that the estimation of the hedge ratio and hedging effectiveness may change significantly when the possibility of cointegration between prices is ignored. It is possible that other confidential data are relevant, but inclusion/exclusion of our control variables did not point to any pronounced concerns about robustness of the tests of the central hypotheses considered. Abstract. /Type /FontDescriptor Indeed, an approach that fails to reflect such underlying instability risks violating the goals for a reasonable return on capital discussed in Chapter 2. Table 6.5. Regardless, as discussed we were unable to empirically distinguish between these two themes due to an inability to obtain details from the investors as to when the preplanned exit strategy was revealed to the entrepreneur (the vast majority of the venture capitalists did not want to disclose this information). Sets of Models Imply Sets Of Values¶. This column, taken from a recent Vox eBook, examines recent experiences and the risk-management literature. If the coefficients are plausible and robust, this is commonly interpreted as evidence of structural validity. If estimates seem high or low by historical standards, the analyst should try to understand why. Some governments assert that global value chains create economic vulnerabilities in times of a pandemic. The first is the view that knowledge is absolute, that is, there exists a “true” decision-theoretic model from which observed data are generated. Jamie O’Brien, in Shaping Knowledge, 2014. %PDF-1.4 /Descent -212 All approaches fall short of an assumption-free ideal that does not and is likely never to exist. Variables within the panel-VAR are estimated alphas by country and by year (from Table 5); HHI = logarithm of Herfindahl Index; DCPC = logarithm of the domestic credit to the private sector as a percent of GDP; sovereign = sovereign lending rate. << Variance Decomposition Estimations for Alpha, Fraser Regulation, Supervision Index, z-Score. /CreationDate (D:20070925175427+03'00') /FontBBox [-628 -376 2000 1010] /Ascent 891 multiple robustness tests the uncertainty likely increases. If T is above 1.645, the returns are said to be significantly positive at the critical threshold of 5 per cent. It concludes that it is a mistake to equate self-sufficiency with robustness – putting all the eggs in one basket is still not a good idea. As such, it is important that analysts try to understand whether those conditions giving rise to unusual estimates are expected to persist over the regulatory period. Despite the leading place of fully parametric models in classical statistics, elementary President-elect Joe Biden on Tuesday urged Congress to pass a “robust package” to deal with the economic crisis wrought by the coronavirus pandemic. There are a number of possible approaches to model validation/selection. In economics, robustness is the ability of a financial trading system to remain effective under different markets and different market conditions, or the ability of an economic model to remain valid under different assumptions, parameters and initial conditions. Biden said his transition team is working on his own proposed legislation for the incoming Congress to address both the economic recovery and the coronavirus pandemic. Further theoretical work in the spirit of Casamatta and Haritchabalet (2007) and empirical work in the spirit of Lerner (1994a,b)Lerner (1994a)Lerner (1994b), Lockett and Wright (2001), and Gompers (1995) could consider staging and syndication vis-à-vis preplanned exits; those topics are beyond the scope of this chapter. ‎This book focuses on general frameworks for modeling heavy-tailed distributions in economics, finance, econometrics, statistics, risk management and insurance. In Lien and Luo (1994) it is shown that, although GARCH may characterize price behavior, the cointegrating relation is the only truly indispensable component when comparing ex post performance of various hedging strategies. Shows the economic consequences of observed heavy-tailed risk distributions in the fields of economics, finance and insurance. /FirstChar 32 Some researchers have deliberately held out data to use for validation purposes. McFadden’s model validation treats pre-BART observations as the estimation sample and post-BART observations as the validation sample. Biden spoke in Delaware to announce… Several proposals have been made to ameliorate this effect. All economic models involve abstractions and idealisations. Second, recall (Section 12.2) that our intuition linking preplanned exits to contracts involved two themes: one involved the venture capitalist disclosing to the entrepreneur the exit strategy, and the other did not. By continuing you agree to the use of cookies. Hendry and Ericcson (1991) suggest that a polynomial of degree three in the error correction term is sufficient to capture the adjustment process. /BaseFont /TimesNewRomanPSMT Estimation results with nine model specifications for the Hedge ratio. Robustness to distributional assumptions is an important consideration throughout statistics, so it is important to emphasize that quantile regression inherits robustness properties of the ordinary sample quantiles. Douglas J. Cumming, Sofia A. Johan, in Venture Capital and Private Equity Contracting (Second Edition), 2014. 0 0 0 0 722 0 611 0 0 0 0 0 0 0 0 0 This book focuses on general frameworks for modeling heavy-tailed distributions in economics, finance, econometrics, statistics, risk management and insurance. During the early 2000s, the DCF model, covered in Chapter 5, was subject to substantial criticism related to allegations of bias in analysts' earnings per share forecasts.9 Similarly, the risk premium model has produced very different results in times of high and low inflation, however, these swings in the model results do not necessarily reflect actual changes in the true cost of capital. The second robustness test is to use the hedging approach while calculating the hedge ratio by using various models. Further empirical work in this regard might also consider sources of funds in the spirit of Mayer et al. Robustness analysis was first explicitly identified as an important strategy for analytic model building by the biologist Richard Levins, but we argue that similar considerations give it significance in economics as well. Stability means that cost of capital estimates done in similar economic environments should be similar, not only period-to-period but also company-to-company within a comparable sample. Ghosh (1993) concluded that a smaller than optimal futures position is undertaken when the cointegrating relation is unduly ignored, attributing the under-hedge results to model misspecification. Model specifications and estimation methods. endobj There are two approaches to model validation, stemming from different epistemological perspectives. /Encoding /WinAnsiEncoding With all this said, it is our experience that rate regulation tends to adapt to changes in the cost of capital with a lag. Robustness. (2001) suggested that the hedge ratio should be estimated from a nonlinear model, which can be written in first differences as: Nonlinear error correction models have also been suggested (not necessarily for estimating the hedge ratio) by Escribano (1987), and the procedure is applied to a model of the demand for money in Hendry and Ericcson (1991). Rejected or invalid models are discarded. We examine the ways in which environments condition the degrees of freedom in agents’ behaviours, including their need for constraint in contrast to their need for liberty. However, this approach is time-consuming and potentially expensive to implement. /Type /FontDescriptor The results, therefore, are robust. For example, estimates of beta (the measure of risk in the CAPM) for North American utility stocks were very close to zero in the aftermath of the collapse of the tech bubble in 2000, suggesting a near risk-free rate of return for these securities and indicating (obviously wrongly) that investors were willing to invest in these companies' stocks at expected returns lower than those same companies' individual costs of debt! /FontBBox [-568 -307 2000 1007] Setting rates based on a transitory blip (up or down) in the cost of capital can lead to rates that will be expected to provide too much or too little return over most of the rate's life (before the next rate setting). Broll et al. /Subtype /TrueType (2002b). all that this may imply for policy analysis and economic insight. /StemH 78 Models are chosen that are “best” for some specific purpose; alternative models may be valid for different purposes. The latter were offered a rent subsidy. For this reason, researchers will attach different priors to a model’s credibility, different weights to the validation evidence, and may, therefore, come to different conclusions about the plausibility of the results. Robustness refers to the ability of a model to estimate the cost of capital reliably even when different economic conditions may influence its inputs and implementation, or when the model's assumptions are not fully satisfied. If the coefficients are plausible and robust, this is commonly interpreted as evidence of structural validity. Robustness analysis in economics is thus usually a special, degenerate form of general robustness analysis as Wimsatt defines it: checking the robustness of a result with respect to a limited set of modelling assumptions that are usually plainly unrealistic. 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Each of these is discussed and illustrated by means of examples from economic practice. (2005); our data only enabled a control variable for captive investors versus noncaptives. This leads naturally to a model validation strategy based on testing the validity of the model’s behavioral implications and/or testing the fit of the model to the data. ADF1 assumes an autoregressive model for the residual, ADF2 assumes an autoregressive model with drift, and ADF3 assumes an autoregressive model with drift and trend stationary. And, as we have noted, DCDP researchers have taken seriously the need to provide credible validation. /MaxWidth 1052 This validation sample can have a number of sources. /ItalicAngle 0 /Leading 150 >> As advocated by Bird et al. So, at best, robustness checks “some” assumptions for how they impact the conclusions, and at worst, robustness becomes just another form of the garden of forked paths. << In both settings, robust decision making requires the economic agent or the econometrician to explicitly allow for the risk of misspecification. Is it the case that the cost of capital has changed significantly, or is it a problem with the models and how they are implemented in the current environment? Robust data processing techniques – i.e., techniques that yield results minimally affected by outliers – and their applications to real-life economic and financial situations are the main focus of this book. A better alternative might be to set rates on the current estimates and provide an efficient mechanism by which rates can be adjusted as the cost of capital returns to a more normal state. 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 (2002a)Manigart et al. Halbert White Xun Lu Department of Economics University of California, San Diego June 18, 2010 Abstract A common exercise in empirical studies is a "robustness check," where the researcher examines how certain "core" regression coe¢ cient estimates behave when the regression speci–cation is modi–ed by adding or removing regressors. Numerous alternative specifications were considered. /MaxWidth 2000 6 0 obj /LastChar 233 Note: Table presents the variance decompositions (VDC), which show the components of the forecasts error variance of all variables within the panel-VAR. It is also noteworthy that the private investors did not indicate significant alterations to their contract structures across financing rounds (since they felt that the negotiation and transactions costs would outweigh any benefits). The Sharpe ratio will mechanically decrease over time. 11 0 obj /BaseFont /Arial-BoldMT If the unusual circumstances are instead believed to be temporary, the regulator may wish to take this into account in setting rates that will be reasonable over the entire regulatory period. It has been shown that since investors are, generally speaking, risk averse, a good measure of performance would be the ratio of reward per unit of risk taken (Murphy, 1986). /Type /FontDescriptor The standard theory of decision making under uncertainty advises the decision maker to form a statistical model linking outcomes to decisions and then to choose the optimal distribution of outcomes. Re: Robustness of an economy: Quoted from this wikipedia article: "robustness is the ability of a financial trading system to remain effective under different markets and different market conditions" Effectiveness is the key concept in this definition. I think this is related to the commonly used (at least in economics) idea of “these results hold, after accounting for … /Flags 32 We performed various robustness checks on the previous findings, in several directions. /Type /Font If the coefficients are plausible and robust, this is commonly interpreted as evidence of structural validity. As a robustness test and in order to deal with potential issues of endogeneity bias, we also employ a panel-VAR model to examine the relationship between bank management preferences and various banking sector characteristics.19 The main advantage of this methodology is that all variables enter as endogenous within a system of equations, which enables us to reveal the underlying causality among them.20 We specify a panel-VAR model where the key variable is alpha, the shape parameter of the managerial behavior function; we also include the main right side variables of the previous section. Out-of-sample validation: Out-of-sample validation relies on there being sample data not used in estimation, but that is assumed to come from the same underlying population. The first was to control for the window length. ADF, Augmented Dickey Fuller; Adj., adjusted. Robustness is recognized as a ubiquitous system property in many fields ranging from biological systems and economics to computer science and control systems. However, there may theoretically be cases in which the entrepreneur faces a trade-off when he knows the venture capitalists preplanned exit strategy is an acquisition: if he gives the venture capitalist more control, the firm is going to have a higher exit value but at the same time he loses his private benefits; if he gives the venture capitalist less control, the firm is going to have a lower exit value but the entrepreneur is able to retain his private benefits. /Leading 150 278 0 0 556 556 556 556 556 556 556 556 0 333 0 0 0 722 722 556 722 667 556 611 722 722 944 0 722 0 333 0 333 This book presents recent research on robustness in econometrics. endobj /FontBBox [-498 -307 1120 1023] Ideally, such data would enable controls for the expected performance and perceived quality of the venture. 3. 0 0 0 556 611 556 611 556 333 611 611 278 0 556 278 889 Interestingly, when the uncertainty surrounding the impact of CSR is concerned, the CSR event type seems to be of little importance, if any. << 0 500 0 611 611 667 0 611 611 722 722 333 444 667 556 833 Looking at the first row of Fig. Robustness in economics Economics is not so much concerned with experimentation or measurement as with building analytically solvable mathematical models. The answer is likely to vary by country. The forecast was compared to its actual impact. It is general practice to report performance in absolute terms as well as in a risk adjusted form (De Rosa, 1996; Murphy, 1990). robust statistics, which worries about the properties of . Hypothesis testing as a means of model validation or selection is eschewed because, given enough data, all models would be rejected as true models. Moreover, 2.7% of alpha’s forecast error variance after 20 years is explained by sovereign risk. Impulse response functions (IRFs)—alpha, Herfindahl Index, domestic credit to the private sector and sovereign risk. %���� Of these, 23 perform a robustness check along the lines just described, using a For VIX and Market, it seems that their significance depends on the window length, although the direction of the impact is the expected one (positive). Sultan ( 1993 ) used a bivariate GARCH error correction term robustness in economics the right.! 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