Search Results (13)

This work develops a scenario-based policy framework for the prospective implementation of AAOIFI Shariah Standard No. 62 in global sukuk markets. The analysis suggests that immediate, rigorous enforcement would advance Shariah authenticity yet risk near-term destabilisation: issuance could retrench, the pricing premia could widen, and the rating treatment could bifurcate or even become inapplicable for instruments with pronounced risk-sharing. By contrast, calibrated sequencing, targeted legal reforms to perfect title transfer, and harmonised supervisory guidance can mitigate fragmentation and sustain investor confidence while re-anchoring sukuk to their risk-sharing foundations. Taken together, aligning religious fidelity with market pragmatism is achievable: a measured adoption of Standard 62 can reinforce the ethical underpinnings of Islamic capital markets without compromising their capacity for resilient growth. Full article

The unbiased expectation theory stipulates that long-term interest rates are determined by the market’s expectations of future short-term interest rates. According to this hypothesis, if investors have unbiased expectations about future interest rate movements, the forward interest rates should be good predictors of future spot interest rates. This hypothesis of the term structure of interest rates has long been a subject of debate due to empirical and theoretical challenges. Despite extensive research, a satisfactory explanation for the observed systematic difference between future spot interest rates and forward interest rates has not yet been identified. In this study, we approach this issue from an arbitrage theory perspective, leveraging on the connection between the expectation hypothesis and changes in probability measures. We propose that the observed bias can be explained by two adjustments: a risk premia adjustment, previously considered in the literature, and a stochastic adjustment that has been overlooked until now resulting from two measure changes. We further demonstrate that for specific instances of the Vasicek and Cox, as well as the Ingersoll and Ross, stochastic interest rate models, quantifying these adjustments reveals that the stochastic adjustment plays a significant role in explaining the bias, and ignoring it may lead to an overestimation of the required risk premia/aversion adjustment. Our findings extend beyond the realm of financial economic theory to have tangible implications for interest rate modelling. The capacity to quantify and distinguish between risk and stochastic adjustments empowers modellers to make more informed decisions, leading to a more accurate understanding of interest rate dynamics over time. Full article

Fundamentally, the term premium in long-term nominal yields is compensation to investors for bearing interest rate risk. There is substantial evidence of sizable and time-varying term premia. As opposed to yields, term premia are not directly observable. In this paper, we estimate term premia in Norwegian interest rate swaps from a set of dynamic term structure models, covering the period from 2001/04 until 2022/06. In line with international studies, we find evidence of declining term premia over the sample period. Furthermore, our estimates indicate that term premia have been close to zero, as well as negative in periods, during the last decade of global extraordinary monetary policy measures. We find that the recent rise in Norwegian interest rate swaps is partly caused by increases in term premia. From a practitioner’s perspective, our term premia estimates can be utilized as part of applied management of both investment and debt portfolios. Full article

This paper explores the strategies and practices of capturing climate risk premia for venture capital (VC) fund managers and entrepreneurs in the private cleantech sector. It also examines the impact of the feed-in tariffs (FITs) policy on the management of cleantech investments. It is shown that a longer investment period, less investment capital in cleantech investment management strategies, and optimistic climate risk management practices will help investors to better capture climate risk premia. In fact, the FITs policy will give rise to VC fund managers and entrepreneurs having a positive view regarding the prospects of the cleantech sector, motivating them to make long-term investments. Furthermore, it is shown that the greater the impact of the FITs policy, the greater the climate risk premia to be captured. In addition, the captured climate risk premia are greater in weaker economic conditions and in times of increased uncertainty with regard to product demand. Full article

The present study documents a positive market reaction to mergers and acquisition (M&A) deals involving renewable energy companies. Acquirers record positive post-deal cumulative risk-adjusted returns upon taking over a renewable energy target, especially if the former also operates in the renewable energy sector. Such deals often involve purchases of majority equity stakes financed with acquirers’ stock rather than cash. Acquirers of renewable energy firms tend to be more profitable and cash-rich than their industry peers, yet they are less likely to be serial acquirers and channel cash reserves towards M&As. We evidence that the quality of corporate governance in the energy sector may play a substantial role in shaping the choice of targets; a director’s outside affiliations increase the likelihood of takeovers of non-energy firms, while the presence of outsiders on board appears to incentivize diversification into renewable energy. While acquisitions of renewable energy firms feature lower-than-average acquisition premia and generate positive short-term stock returns, they are found to exercise an overall negative short- and medium-term impact on the combined entities’ operating performance. Overall, capital markets appear to attach a sizeable premium to risky deals involving renewable energy firms, possibly in expectation of wealth accrual in the long term. Full article

Energy is traded using different products; long-term contracts or electricity forward contracts can assure the future transaction price. However, due to the difficulties in storing electrical energy for long periods and in large amounts, risks must be incorporated when defining contract prices through a Forward Risk Premia (FRP). This study analyzes the transfer of uncertainty from electricity market variables to the FRP in long-term contracts. We evaluate a type of econometric risk with the construction of Autoregressive Distributed Lag contagion models for the FRP using electricity demand, spot price, power generation via different technologies, and the Oceanic Niño Index. As a case study, we consider the Colombian electricity market. Our results show empirical models where the FRP has a short-term response with the following variables: hydropower generation, coal power generation, electricity demand, and Oceanic Niño Index, even though its transaction is reflected one or two years after the occurrence of the event. Full article

The reduction in construction and maintenance costs per MW of renewable energy facilities, together with low interest rates, have led to a significant growth in the purchase prices paid for these facilities in the Spanish market. This trend is shared by other European countries, especially for projects that hedge energy price risk incorporating power purchase agreements with third parties. In this framework, questions arise about the economic rationale of the purchase prices paid for these projects. Consequently, we develop a project evaluation model that forecasts expected cash flow and time-varying required rates of return for a standard photovoltaic plant, in order to study the extent to which foreseeable market conditions—interest rates and equity risk premia, among others—translate into economically viable buyouts. Our results suggest that purchase prices paid for these initiatives often lead to buyer returns below those that would be reasonable according to market conditions. Indeed, we find that only facilities that reach a production 23% higher than the number of hours considered in the base case provide returns that compensate long-term financing costs. However, specialised investors can exploit their relatively low cost of financing to pay prices up to 73% higher than those affordable by classic investors. Full article

The objective of this research was to demonstrate the (nonlinear) risks of sovereign insolvency and explore the applicability of stochastic modeling in public debt management, given a structural economic model of stochastic government debt dynamics. A stochastic optimal control model was developed to model public debt dynamics based on the debt accounting identity, where the interest-growth differential obeys a continuous random process. This stochasticity represents both the interest rate risk of public debt and the variability of the growth rate of the nominal Gross Domestic Product combined. The optimal fiscal policy was analyzed in terms of the model parameters. The model was simulated, and results were visualized. The insolvency risk was demonstrated by examining the variance of the optimal process. The model was amended with hidden credit risk premia and fiscal multipliers, which forces the debt dynamics to be nonlinear in the debt ratio. The results, on the other hand, confirm that the volatility of the interest-growth differential is crucial in terms of sovereign solvency and in addition, it demonstrates the large risks stemming from the multiplier effect, which underlines the need for prudent debt management and fiscal policy. Full article

This study examines the impact of changes in the yield curve factors on the Credit Default Swap (CDS) spreads of the U.S. industrial sectors. Stock returns and the crude oil-based volatility index are used in a quantile regression framework to test the validity of Merton’s model. The results suggest that the long-term factor of the yield curve is a negatively significant determinant of the CDS premia regardless of the sector and market state. The CDS spread of the financial sector exhibits sensitivity to the short-term factor of the yield rate in extreme market states. Basic materials, oil and gas and the utilities sector are responsive to variations in the medium-term factor of the yield rate in upmarket conditions. The empirical findings also suggest a significant inverse relationship between CDS spreads and stock returns. Full article

We study the optimal excess-of-loss reinsurance problem when both the intensity of the claims arrival process and the claim size distribution are influenced by an exogenous stochastic factor. We assume that the insurer’s surplus is governed by a marked point process with dual-predictable projection affected by an environmental factor and that the insurance company can borrow and invest money at a constant real-valued risk-free interest rate r. Our model allows for stochastic risk premia, which take into account risk fluctuations. Using stochastic control theory based on the Hamilton-Jacobi-Bellman equation, we analyze the optimal reinsurance strategy under the criterion of maximizing the expected exponential utility of the terminal wealth. A verification theorem for the value function in terms of classical solutions of a backward partial differential equation is provided. Finally, some numerical results are discussed. Full article

If we examine the characteristics of a sample of green bonds matched with their closest brown bond neighbors, we encounter a challenge. Green bonds have higher yields, lower variance, and are more liquid. The institutional/private issuer and the green third-party verification/non-verification breakdowns help explain this puzzle. Green bonds from institutional issuers have higher liquidity with respect to their brown bond correspondents and negative premia before correcting for their lower volatility. Green bonds from private issuers have much less favorable characteristics in terms of liquidity and volatility but have positive premia with respect to their brown correspondents, unless the private issuer commits to certify the “greenness” of the bond. An implication of our findings is that the issuer’s reputation or green third-party verifications are essential to reduce informational asymmetries, avoid suspicion of green (bond)-washing, and produce relatively more convenient financing conditions. Full article

Researchers who estimate affine term structure models often impose overidentifying restrictions (restrictions on parameters beyond those necessary for identification) for a variety of reasons. While some of those restrictions seem to have minor effects on the extracted factors and some measures of risk premia, such as the forward risk premium, they may have a large impact on other measures of risk premia that is often ignored. In this paper, we analyze how apparently innocuous overidentifying restrictions imposed on affine term structure models can lead to large differences in several measures of risk premiums. Full article

In vein with the new energy market rules drafted in the EU this paper presents and discusses two contract types for hedging the risks connected to long-term transmission rights, the financial transmission right (FTR) and the electricity price area differentials (EPAD) that are used in the Nordic electricity markets. The possibility to replicate the FTR contracts with a combination of EPAD contracts is presented and discussed. Based on historical evidence and empirical analysis of ten Nordic interconnectors and twenty bidding areas, we investigate the pricing accuracy of the replicated FTR contracts by quantifying ex-post forward risk premia. The results show that the majority of the studied FTR contain a negative risk premium, especially the monthly and the quarterly contracts. Reverse flow (unnatural) pricing was identified for two interconnectors. From a theoretical policy point of view the results imply that it may be possible to continue with the EPAD-based system by using EPAD Combos in the Nordic countries, even if FTR contracts would prevail elsewhere in the EU. In practice the pricing of bi-directional EPAD contracts is more complex and may not always be very efficient. The efficiency of the EPAD market structure should be discussed from various points of view before accepting their status quo as a replacement for FTRs in the Nordic electricity markets. Full article