Annals of Actuarial Science

Table of Contents - March 2006 - Volume 1, Issue 01  

Papers

The Froot-Stein Model Revisited

N. Høgha1, O. Lintona2 and J. P. Nielsena3

a1 Deloitte, Postboks 1600, 0900 kbh. C., Denmark., Email: nhoegh@deloitte.dk

a2 Department of Economics, London School of Economics, Houghton Street, London WC2A 2AE, U.K., Email: linton@lse.ac.uk

a3 Royal&SunAlliance Codan, 60 Gammel Kongevej, DK-1790 Copenhagen V, Denmark., Email: npj@codan.dk

ABSTRACT

We investigate the model of Froot & Stein (1998), a model which has very strong implications for risk management. We argue that their conclusions are too strong and need to be qualified. We also argue that their analysis is incorrect and incomplete. Specifically, there are some unusual consequences of their model, which may be linked to the chosen pricing formula.

KEYWORDS

  • Capital Budgeting;
  • CAPM;
  • Hedging;
  • Risk Management;
  • Sharpe Ratio