AJM - Editorial

Volume 22 Number 2 December 1997

Editor - Robert Marks

Risk and Information - Timely Topics

T he four papers in this issue address aspects of risk and information, two topics of great interest not only to today's manager, facing increased competition with globalisation and ever-cheaper communications, but also to government policy makers, in a world in which the role for national policy is increasingly circumscribed. The history of the management of risk is the focus of a recent book which will find great appeal - Peter Bernstein's (1996) Against the Gods: The Remarkable Story of Risk. Bernstein presents a lively narrative of the evolution of our tools for managing risk, from ancient dice games to modern financial derivatives, and shows how these have depended on development of the underlying mathematical theories. Highly recommended, and eminently readable.

The lead paper in this issue, by Greg Clinch and Robert Verrecchia, examines the incentives for two competing firms in a Cournot (quantity-setting) market, such as the automobile industry, to disclose or to withhold information of common interest, such as anticipated aggregate demand. In a well-argued model, the authors show that the firms will voluntarily withhold information of very high or very low future demand. (Were the demand range asymmetrical, of course, absence of disclosure would convey almost as much information as disclosure itself.) They show that, as competition between the firms intensifies, the region of the voluntary disclosure interval shrinks, and the ex-ante probability of voluntary disclosure falls. This implies that firms facing strong competition will be most affected by regulatory calls for fuller disclosure. The paper discusses the possibility of precommitment to disclosure via a trade association, but shows that, under such an arrangement, changes to firms' incentives to disclose will inhibit voluntary disclosure. This leads to the formation of such associations to enforce precommitment to withhold information above a certain intensity of competition. Although this paper does not address the question of whether society would benefit from more or less disclosure of information of common interest by competing companies, it sheds much light on the incentives underlying the observed behaviour of firms, and their managers' attitudes to attempts by governments to mandate further disclosure.

In the past twenty-five years, academic economists have devised new, artificial or synthetic, instruments to be exchanged in markets. Examples much in the news recently are tradeable emissions permits (for instance, for carbon dioxide) and financial derivatives (derived from traditional property rights, such as shares in limited-liability corporations). The rationale for the use of such instruments has been increased efficiency, in the light of market risk* (with derivatives) or uncertain abatement costs (with pollution permits).

* For those who believe that stock markets are nothing more than glorified lotteries with no relevance to the real economy, I recommend a good dose of Kenneth Arrow's 1953 paper (originally in French), 'The role of securities in the optimal allocation of risk-bearing', which outlines the important role for the stock market in allocating an economy's risk, by substituting for the non-existent set of Arrow-Debreu contingency markets.

With these new instruments have come new markets, and the discipline of market design. With new markets have emerged new market behaviours, which may sometimes have influenced traditional markets. This is the focus of the second paper, by Hans Stoll and Robert Whaley, which is an empirical examination of the possible effects on the Australian Stock Exchange of the cash settlement of the Sydney Futures Exchange's All Ordinaries Share Price Index (SPI) on the four expiration days a year, as well as a discussion of alternative procedures for futures settlement.

Unlike other futures contracts, all stock index futures contracts call for cash settlement, instead of delivery of the underlying shares of stock. Settlement usually brings a large volume of trading, and sometimes sharp price changes. The authors, however, find no evidence of a systematic price effect: settling the SPI at the close appears to have worked satisfactorily.

Risk is also the focus of Hazel Bateman's paper, which considers the role of financial options for the managers of pension funds. As the population ages, and with increased reliance on defined contribution superannuation funds for retirement support, such managers will be under increasing pressure to maintain high returns from their funds as well as reducing year-on-year volatility. Using extensive stochastic simulations, the author argues that portfolio insurance, in the form of combinations of equities and traded options, can offer a reasonable trade-off for such managers.

The final paper, by Sandra Hopkins and Jonathon Murphy, returns to the issue of information: in the movements of the Australian foreign exchange market, what is the relative importance of information, as conveyed by Reserve Bank of Australia announcements? This empirical study considers the relationship between the A$ and the US$ during a three-month period in 1993. After adjusting for the Reserve Bank's direct interventions in the market, the paper concludes that the Governor's statements probably had some steadying influence on the value of the Australian dollar during a period of political uncertainty.

Lex Donaldson's review of the book by Finkelstein and Humbrick provides some managerial counter to the predominance of finance, accounting, and economics of the four papers in this issue.

The Journal has not previously published a graduating address, but this issue's Counterpoint is devoted to the address given by Neville Roach of Fujitsu Australia in May 1997. We include it as a slight counter to the current political climate, which has dismayed many. Mr Roach's address speaks for itself, and reflects the underlying strength and decency of Australian society in general, and Australian management in particular, as we approach the centenary of Federation.

A final point. This is my first opportunity as General Editor to reflect on the contents of an issue in these pages. Although an old-timer (area editor for Economics since 1984, and reviewer and author since 1977), there has been one person at the AGSM who was midwife to the Journal's birth. I recently attended the farewell for Mrs Patricia Hillary, who retired from the University after more than twenty years of service. At her farewell, Pat recalled struggling with an IBM Selectric typewriter to produce Volume 1, Issue 1, of the Journal, which appeared in April 1976, under the foundation editorship of Ray Ball. Looking back at that issue, one can readily sympathise with Pat, who with no mathematical training had to struggle with linear algebra and matrices, with Greek and mathematical symbols, and with words that she had probably never heard aloud. After that effort, mastering the nroff system on the AGSM's PDP 11 for later issues must have been easy. Pat remained with the Journal for five years, and never forgot the early days. Thank you, Pat; may you enjoy a long and happy retirement.

References

Arrow, K. 1964 (1953), 'The role of securities in the optimal allocation of risk-bearing', Review of Economics Studies, vol. 31, April, pp. 91-6.

Bernstein, P. 1996, Against the Gods: The Remarkable Story of Risk, Wiley, New York.