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Risk Assessment of Private Offered Fund in China

Fang-Wang College of Economic and Management,

Sichuan Agricultural University Ya’an, 625014, China

E-mail: hohowf@yahoo.com.cn

Hong-an Xiao College of Economic and Management,

Sichuan Agricultural University Ya’an, 625014, China

E-mail: honganxiao@163.com

Abstract—Private Offered Fund develops very rapidly in China, it has become a very important part of financial market. It has important insignificant that study the risk system to steady the financial market of China. In this research, we established system of risk assessment of private offered fund in China and assessed the risk level of each indexes by using AHP-Fuzzy Comprehensive Evaluation Methods. The result shows that credit risks, business risks and liquidity risks are the most important factors of private offered fund system. The holistic risk of private offered fund in China stands at a high level at present, in which credit risks and liquidity risks are the highest ones.

Keywords-Private Offered Fund Risk Assessment AHP- Fuzzy Comprehensive Evaluation Methods

I. INTRODUCTION Private Offered fund in China evolved from "Valet

financing" and "Valet Fried" during 1993 to 1994. In ten years, it has experienced the development from the high-speed to smooth. The stage of rapid development is between 1996 and 2001. According to estimation, the amount of Private Offered fund in China was about 95 to 110 billion Yuan in 1996 which rapidly grow up to 760 to 880 billion Yuan in 2001. The scale was shrunk between 600 to 700 billion Yuan after 2002. A part reason of the development of private offered fund is due to huge demanding market in China. In decades, China had a fast development in economy. Both the securities market and private businesses need capital injection for growth. Another part reason is perhaps due to the attraction of the high return of private offered fund. However, private offered fund has been in underground state before 2004. Owing to the lack of legalizing security and adverse effect of the securities market, it developed sluggishly. Nearly two years lately, private offered fund warmed up owing to the startup of fund law modification which would lead the legalization of it. In the meantime, it was pushed strongly by the development of equity investment after the comprehensively implement of shareholding reform. Private Offered fund is mainly divided into private equity securities funds and private equity funds in China. The former active in listed securities market and the latter mainly is invested in private company. Compared to public offered fund, the supervision of private offered fund is looser which makes capital a more flexible way to run that may bring bigger profit. A lot of investment of private offered fund returned to 150% above, some even reached 200% to 300%, which was published by a research institutes named Chao Yang Yong Xu who ranked 2009 annual private offered fund in China. High

return often represents high risk. First of all, the risk of Private Offered fund comes from its own characteristic. The leaky supervision, for instance the less disclosure of information, could cause credit risk and moral risk. The long period of investment also could cause liquidity risk. Secondly, since the time private offered fund start from in China was short that the legal and various mechanisms were not perfect which would product some specific risk and increase the level of risk above. The research of private offered fund in China belongs to the early stage. Domestic scholars mostly focus on the meaning of private offered fund discussed, legal supervision and standard operation issues. The research has not done thoroughly on risk system evaluation. Even scholars mainly used qualitative methods that quantitative analysis was barely done in this aspect. In this paper, we established system of risk assessment of private offered fund in China and assessed the risk level of each indexes by using AHP-Fuzzy Comprehensive Evaluation Method. We hope to provide a quantitative way of study the risk of private offered fund in China. It would not only be helpful to investor make right decision, but also to government implement policies which guarantee stability of the financial system.

II. SELECTION OF INDEX SYSTEM This research analyzed the main risks based on the features

and development of privately offered fund in China. The chosen indicators were showed below:

• Market risk. It means that detrimental changes of market price lead to the loss of investors’ declined assets. It involves interest rate risk, foreign exchange risk, commodity price risk, stock price risk. Market risk belongs to unavoidable risk in macro-environment.

• Credit risk. It means the loss caused by unpaid money including market credit risk, enterprise credit risk and individual credit risk.

• Liquidity risk. It indicates that the uncertainty loss risks of fund asset realizations that attributed to the uncertainty of investors’ quit time and quantity. In terms of anti-go public currency and transaction, risk of forbidden quit at will and risk of slathering financial leverage.

• Legal risk. The risk of illegal position at present in China, the risk of illegal capital source, the risk of

978-1-4244-8694-6/11/$26.00 ©2011 IEEE

manipulate stock price and the risk of illegal internal structure of the company are included.

• Business risk. Business risk is potential loss caused by failing business process and execution. It includes operation risk, transaction risk, technology risk, client compensation risk, capital loss risk and so on.

The system of risk assessment of private offered fund in China is showed in table 1.

TABLE 1.THE SYSTEM OF RISK ASSESSMENT OF PRIVATE OFFERED FUND IN CHINA

Objective layer Criteria layer Index layerRisk of private offered fund in

China

Business risk 1B Operational risk

11C

Transaction risk 12C

Technical risk 13C

Customer compensatory risk 14C

Assets loss risk 15C

Market risk 2B Interest rate risk

21C

Foreign exchange rate risk 22C

Stock price risk 23C

Commodity price risk 24C

Credit risk 3B Market credit risk

31C

Enterprise credit risk 32C

Individual credit risk 33C

Liquidity risk 4B Exit difficult

41C

High financial leverage risk 42C

Legal risk 5B

Existence form risk 51C

Capital source risk 52C

Stock price manipulation risk 53C

Internal structure risk54C

Moral risk 6B Information disclosure risk 61C

Capital abuse risk 62C

Excessive investment risk63C

Decreased service efficiency rate

64C

III. METHODOLOGY AND MATERIALS We compute the weight of each index using analytic

hierarchy process (AHP) method. Then the risk level of each index could be obtained by using fuzzy comprehensive evaluation method. The data is come from the questionnaire to the expert. Specific steps are listed below:

A. Analytic Hierarchy Process (AHP) method

1) Building judgment matrix The element

ija in the judgment matrix means the score ratios given by experts using 1 to 9 scale method. The score is explained by the relative importance of the index.

=

nnn2n1

2n2221

1n1211

......aaa.........................aaa......aaa

A

2) Computing maximum eigenvalue and weights The calculation formula is listed below:

1

n

i ijk

M a=

= ∏

ni iw M=

( )

1

1, 2, ......ii n

ii

ww i n

w=

= =

( )m a x

1

Ani

i i

w

n wλ

==

3) Consistency inspection

max. 1

nC I

nλ −=

−

..

.

C IC R

R I=

RI is a random index. The result is acceptable only when

. 0.1CR< .

B. Fuzzy comprehensive evaluation

• The evaluation factors set { }nuuuU ……= 21, , means the index of system. The evaluation set { }nvvvV ……= 21, means the risk level we ranked.

• The element ijr in the matrix equal to the ratio that the

number of experts who choose the level jv on

factoriu to the whole number of experts. The judgment

matrix is below:

…………………………

…………

=

mnm

n

n

rrr

rrr

rrr

R

21m

22221

11211

• The result of fuzzy comprehensive evaluation:

The first layer:iii R*WB =

The second layer: )B,B,(B*WB n21 ……=

Score is given to each level we ranked: )(5,4,3,2,1)v,v,v,v,(vV 54321 ==

IV. RESULTS AND DISCUSSION

A. Model analysis

1) The result of AHP method The weight obtained by AHP method is showed in table 2.

TABLE 2.THE EVALUATION OF SYSTEM AND WEIGHT OBTAINED BY AHP

Index Weight on the objective layer

Weight on the criteria layer

1B 0.2017 —

11C 0.0502 0.2489

12C 0.0457 0.2268

13C 0.0210 0.1042

14C 0.0266 0.1317

15C 0.0582 0.2884

2B 0.0786 —

21C 0.0170 0.2163

22C 0.0076 0.0961

23C 0.0229 0.2909

24C 0.0312 0.3968

3B 0.2282 —

31C 0.0863 0.3780

32C 0.1031 0.4520

33C 0.0388 0.1701

4B 0.2414 —

41C 0.1636 0.6779

42C 0.0778 0.3221

5B 0.1345

—

51C 0.0169 0.1259

52C 0.0509 0.3781

53C 0.0446 0.3314

54C 0.0221 0.1645

6B 0.1157

—

61C 0.0339 0.2930

62C 0.0408 0.3528

63C 0.0261 0.2260

64C 0.0148 0.1283

2) The result of fuzzy comprehensive evaluation a) The result of first layer

The result of first layer is showed in table 3. TABLE 3.RESULT OF FUZZY COMPREHENSIVE EVALUATION OF

FIRST LAYER Index High Relatively

high Moderate Relatively

low Low Score

1B 0.0277 0.2307 0.4028 0.3388 0.0000 2.9473

2B 0.0000 0.3831 0.2711 0.1015 0.2445 2.7932

3B 0.1193 0.4090 0.3607 0.1300 0.0000 3.5746

4B 0.0753 0.3296 0.4444 0.1506 0.0000 3.3293

5B 0.0183 0.3661 0.2816 0.3156 0.0183 3.0502

6B 0.0326 0.2291 0.4996 0.2389 0.0000 3.0560

b) The result of second layer

( )0.0217 0.2124 0.3878 0.3253 0.0572B =

B. The analysis of result The weights of business risk, credit risk and liquidity risk

are all higher than 0.2 which are the most important factors in B level. It is to say that business risk, credit risk and liquidity risk are crucial compositions of private offered fund in China. Meanwhile, the index of quit difficulty and enterprise credit risk both outweigh 0.1 in C level and the importance of which stand at the 1st and 2nd place respectively. They are the most significant indexes in C level.

The scores of credit risk and liquidity risk are the highest tow factors by the first grade evaluation which reach at 3.5746 and 3.3293 respectively. We can safely arrive at the conclusion that credit risk and liquidity risk stand at a high point in the private offered fund system in China. Through the second grade evaluation, the score of the integrated risk in the private offered fund system in China is 3.1973, which is a relatively high level.

V. DISCUSSION AND CONCLUSIONS In short, an obvious result can be found from the above

discussions.

• Liquidity risk is an important element in Chinese private offered fund system. The time and quantity of quit have great influence on the profits of funds. In case of adverse circumstance, quit successfully can minimize the losses of investment, in the contrast, quit difficultly may increase the losses. According to the result of vague overall merit, the liquidity risk of privately offered fund in China is on the high side. To begin with, the time horizon of privately offered fund is longer than public offered fund. Managers always sign contracts with investors which prevent them from withdrawing capital at will to ensure the stability of funds and long-term benefits of the investment

projects. Moreover, private offered funds generally are not circulated and also do not come into the market which could reduce their liquidity. At last, the mechanism of quitting is still incomplete in China.

• Credit risk is a consequence in private offered fund risk system in China. On one hand, private offered funds finance via nonpublic ways and lack guarantees of laws and regulations. As long as fund management corporations default to payoff, investors are faced with tremendous losses. On the other hand, credit factor is a main standard when investors choose an agency. A poor credit standing will lead to difficulties in raising money, results in un-going concern. According to the result of vague overall merit, credit risk is above normal in Chinese private offered fund system at present. First and foremost, credit mechanism is still not efficient in our country, investors sign a contract with fund management corporations based on their trusts. There are few legal approaches for them to protect and recover their benefits when agencies can not honour an agreement. In addition, incomplete

information of private offered fund corporations opened to the public makes investors difficultly fully aware of situations. They have to ask for company business and performance by means of private channel or explanation session. Last but not least, private offered fund corporations in our country are big in number but small in scale, and the good and bad of credit are intermingled.

• Private offered fund is a relatively flexible kind of investment and financing method which can utilize the dormant capital effectively and enhancing the use rate of dormant capital. At the same time, the doorsill of private offered fund is comparatively lower than public Offered fund, which may relieve the burden of finance for medium-sized and small enterprises. Overseas experience should be used for reference to instruct us to control the risks and standardize the development of private offered fund in China. It is a very important thing to financial industry as well as the healthy development of national economy.

REFERENCES [1] Masulis R.W. and A.N. Korwar, Seasoned Offerings: An Empirical

Investigation Owner. Journal of Financial and Economic, Vol.15, pp.91-118, 1986.

[2] Bin Xia, Private Offered Fund Report of China, Shanghai: Shanghai Far East Press, June 2002.

[3] Susheng Wang, Private-Offered Risk Management Study, People's Press, Feb 2007.

[4] Weisi Zheng, Present Situation and Development Prospect of Private Offered Fund in China, Journal of Fujian Provincial Committee of the Communist Party School, Vol.8, pp.71-74, Aug 2007.

[5] Simin Li, Innovation and Regulatory Problem of Private Offered Fund System of China, Journal of Financial and Economic, Vol.6, pp31-33, June 2007.

[6] Yuan Hong, Function and Risk Control of Private Offered Fund in Opening Condition, Journal of Finance Science, pp.29-36, Feb 2007.

[7] Qing Dai, Risk Analysis and Evaluation of Private Offered Fund, Journal of System of Engineering, Vol.21, Sep 2003.