Risk Assessment Techniques for Split Capital Investment Trusts

Abstract

The split capital investment trust crisis brought into focus the need for more reliable risk assessment techniques for shares in the sector. We discuss the strengths and weaknesses of traditional pricing and risk description measures for split capital investment trusts (e.g. gross redemption yield, cover, hurdle rates) and ways of making these more useful. We then examine the application of traditional option pricing techniques and discuss the problems encountered in this approach. Finally, we propose the use of stochastic modelling to deal more effectively with the complexities involved in both pricing shares and understanding their risks.

A Stochastic Representation for Nonlocal Parabolic PDEs with Applications

“…Our representation result provides a rigorous PDE characterization of dual-purpose funds value in terms of a parabolic PDE with both nonlocal boundary condition and terminal condition. This link with PDE also provides an iterative numerical algorithm for estimating the fund value, which is more efficient than the Monte Carlo simulation as suggested in Adams and Clunie (2006). Our result is also related with Ingersoll (1976), which focused on the pricing of dual-purpose funds in U.S.…”

“…In contrast, our theoretical framework for the representation of nonlocal problems can be applied to price the type of dual-purpose funds considered in this section. On the other hand, our representation result also provides an iterative numerical algorithm for solving the one-dimensional PDE (39) -( 42) (see the discussion in Remark 3.1), which is perhaps less time-consuming than the Monte Carlo simulation suggested in Adams and Clunie (2006).…”