Abstract:The fact that cap-weighted indices provide an ineffi cient risk-return trade-off is well known today. Various research approaches evolved suggesting alternative to cap-weighting in an effort to come up with a more effi cient market index benchmark. In this paper we aim to use such an approach and focus on the Croatian capital market. We apply statistical shrinkage method suggested by Ledoit and Wolf (2004) to estimate the covariance matrix and follow the work of Amenc et al. (2011) to obtain estimates of expected returns that rely on risk-return trade-off. Empirical fi ndings for the proposed portfolio optimization include out-of-sample and robustness testing. This way we compare the performance of the capital-weighted benchmark to the alternative and ensure that consistency is achieved in different volatility environments. Research fi ndings do not seem to support relevant research results for the developed markets but rather complement earlier research (Zoričić et al., 2014).
This paper focuses on designing a methodological workflow to fill a knowledge gap for determining the cost of capital for commercial forestry projects. Upon reviewing the literature, a method to determine the cost of capital for profit-oriented forestry seems to be lacking. Accordingly, we selected and analyzed 42 companies that do businesses worldwide, are present on the stock exchange, and possess or lease forest land. Based on their business activities (growing forest, sawmilling, final production, paper production), these companies are classified into four subgroups. An algorithm has been devised using the concept of risk diversification and the capital asset pricing model for three groups of investors and four forestry subgroups. In doing so, the real risk-free rate (0.43%) is set as the difference between an average return on 10-year US government bonds (2.59% nominal) and the 10-year average US inflation rate (2.16%). The measure of forestry systematic risk (beta coefficient) varies between 0.83 and 1.41, while the equity (stock exchange market) risk premium is set to 6%. Unsystematic risk is determined using a process of mapping which takes into account all risk elements marked as relevant for the forestry sector. This approach provides results that reveal the cost of capital varying between 5.41% and 16.55% based on the current level of an investor's portfolio diversification and the risk characteristics of the forestry subgroup. Finally, the forestry companies meeting the investor's expectations are noted as preferable investment opportunities.
High risk-adjusted returns, low correlation with financial asset classes and inflation hedging are investment characteristics that make forests a desirable investment opportunity. To examine returns on forestry investments (from 2011 to 2020), we focused solely on 48 forest companies (across the globe) that were listed on stock exchanges. Results indicate the economic justification of investing in publicly traded forestry companies. The positive five-year beta coefficients (β) range from 0.21 to 3.46, amounting to 1.15 on average. Taking the last 10-year comparison of the world’s most common capital market benchmarks, the highest return was achieved by the S&P500 (13.8% on average) followed by forestry companies (9.1%), U.S. Treasury bonds (4.4%), and gold (3.0%). Forestry companies, along with their associated business activities (sawmilling, final products production, and paper production), show the best historical performance from an investor’s point of view (total return of 13.2%).
The work of Arnott et al. (2005) presented an interesting fact that the fundamentally-weighted indices generally outperform the market capitalisation-weighted counterparts in the US stock market. The research results prompted the introduction of fundamentally-weighted indices in the US market. Since research dealing with Croatian capital market also points out the inefficiency of the risk return trade-off of the cap-weighted (CROBEX) index this paper examines more closely the risk return characteristics of the potential fundamentally-weighted alternative and analyses the source of higher returns in the case of fundamentally-weighted indices. We use the original and propose a modified Fama French three factor model in order to try to capture specific sources of risk in the small and illiquid market. We find evidence in support of the view that better risk return trade-off of the fundamentally-weighted indices is driven by additional exposure to risk factors in comparison to CROBEX index.
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