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on Corporate Finance |
| By: | Eirik Gaard Kristiansen (Norwegian School of Economics and Business Administration and Norges Bank (Central Bank of Norway)) |
| Abstract: | Firms choose debt structure and competing banks choose monitoring intensity. Monitoring improves credit allocation, but creates informational lock-in effects in bank-borrower relationships. In a competitive credit market, banks dissipate anticipated profit from serving locked-in borrowers subsequently revealed to the bank as good to attract new borrowers with unknown credit quality. Consequently, banks’ lending strategies result in cross-subsidies from good to bad borrowers. We investigate how firms’ choice of debt structure interacts with the cross-subsidies inherent in banks’ lending strategies. The analysis sheds light on how dynamic bank competition determines monitoring intensity, seniority, and maturity structure in bank dependent industries. |
| Keywords: | Corporate debt structure, bank lending, lock-in effects |
| JEL: | D82 G32 G21 L14 |
| Date: | 2005–10–28 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2005_10&r=cfn |
| By: | Philip Arestis; Guglielmo Maria Caporale; Andrea Cipollini; Nicola Spagnolo |
| Abstract: | In this paper we examine whether during the 1997 East Asian crisis there was any contagion from the four largest economies in the region (Thailand, Indonesia, Korea and Malaysia) to a number of developed countries (Japan, UK, Germany and France).Following Forbes and Rigobon (2002), we test for contagion as a significant positive shift in the correlation between asset returns, taking into account heteroscedasticity and endogeneity bias. Furthermore, we improve on earlier empirical studies by carrying out a full sample test of the stability of the system that relies on more plausible (over)identifying restrictions. The estimation results provide some evidence of contagion, in particular from Japan (the major international lender in the region), which drastically cut its credit lines to the other Asian countries in 1997. |
| Date: | 2005–04 |
| URL: | http://d.repec.org/n?u=RePEc:bru:bruedp:05-08&r=cfn |
| By: | Guglielmo Maria Caporale; Luis A. Gil-Alana |
| Abstract: | This paper examines the long-run dynamics and the cyclical structure of the US stock market using fractional integration techniques. We implement a version of the tests of Robinson (1994a), which enables one to consider unit roots with possibly fractional orders of integration both at the zero (long-run) and the cyclical frequencies. We examine the following series: inflation, real risk-free rate, real stock returns, equity premium and price/dividend ratio,annually from 1871 to 1993. When focusing exclusively on the long-run or zero frequency, the estimated order of integration varies considerably, but nonstationarity is found only for the price/dividend ratio. When the cyclical component is also taken into account, the series appear to be stationary but to exhibit long memory with respect to both components in almost all cases. The exception is the price/dividend ratio, whose order of integration is higher than 0.5 but smaller than 1 for the long-run frequency, and is between 0 and 0.5 for the cyclical component. Also, mean reversion occurs in all cases. Finally, we use six different criteria to compare the forecasting performance of the fractional (at both zero and cyclical frequencies) models with others based on fractional and integer differentiation only at the zero frequency. The results show that the former outperform the others in a number of cases. |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:bru:bruedp:05-09&r=cfn |
| By: | Guglielmo Maria Caporale; Luis A. Gil-Alana |
| Abstract: | In this article we estimate the order of integration of the volatility process of several exchange rates and stock returns using fractionally integrated semiparametric techniques,namely a local Whittle semiparametric estimator. The results suggest that all series can be well described in terms of I(d) statistical models, with values of d higher than 0, indicating long-memory behaviour. |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:bru:bruedp:05-10&r=cfn |
| By: | Ray Barrell; E Philip Davis |
| Abstract: | We assess the impact of equity prices on the level of output in the Europe Union economies and the US using Vector Error Correction (VECM) time series techniques. The distinction between impacts in bank based and equity market based economies is shown to be important, with equity prices having a greater impact on output in market-based economies. Share prices are shown to be largely autonomous in variance decompositions, whilst equity price do have a strong impact on output in the UK and US in their variance decompositions. An analysis of impulse responses suggests that large market based economies have more effective fiscal and monetary policy instruments. |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:bru:bruedp:05-13&r=cfn |
| By: | E Philip Davis; CHRISTOS IOANNIDIS; NICOLA SPAGNOLO |
| Abstract: | We evaluate changes in international spillovers of equity price shocks with EMU by estimating BEKK-GARCH models over 1993-98 and 1999-2004. Results are consistent with EMU market integration via sectoral allocation, but not autonomy from the external influence of the US. |
| Date: | 2005–10 |
| URL: | http://d.repec.org/n?u=RePEc:bru:bruedp:05-19&r=cfn |
| By: | Eugen Kovac |
| Abstract: | The paper analyzes a finite time economy with a single risky asset which pays a one-shot payoff (dividend). The payoff is random and its distribution is not known a priori. Agents observe public signals (random draws from the same distribution) and update their beliefs about the payoff. They trade in order to reshuffle their portfolios according to new beliefs. Agents may use various updating rules and are considered to be of two types: sophisticated who are aware of their future beliefs and prices, and naive who are not. Drawing on the methodology by Sandroni (2000), it is shown that among sophisticated agents, those with less accurate beliefs are driven out, in the sense that their wealth becomes arbitrarily small when the number of signals is sufficiently large. On the other hand, it is shown that this statement may not hold in economies with naive agents only, where even agents with inaccurate beliefs may survive. |
| Keywords: | Market selection, wealth accumulation, speculation, learning, sophisticated agents, naive agents. |
| JEL: | D83 D84 G11 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:cer:papers:wp276&r=cfn |
| By: | Joseph Tham; Ignacio Velez-Pareja |
| Abstract: | Abstract: It is widely known that if the leverage is constant over time, then the after-tax Weighted Average Cost of Capital (WACC) is constant over time. In other words, it is inappropriate to use a constant after-tax WACC to discount the free cash flow (FCF) if the leverage changes over time. However, it is common to find analysts who inconsistently use a constant after-tax WACC even if the leverage is not constant. In this teaching note, we use a simple numerical example to illustrate how to model cash flows that are consistent with constant leverage. We verify the consistency of the example with two basic principles: conservation of cash flows and conservation of values. |
| Keywords: | WACC |
| JEL: | D61 |
| Date: | 2005–06–28 |
| URL: | http://d.repec.org/n?u=RePEc:col:000135:001420&r=cfn |
| By: | JOSEPH THAM; Ignacio Velez-Pareja |
| Abstract: | Abstract: In this note, we show that with respect to the Miles and Ezzell (M&E) Weighted Average Cost of Capital (WACC), the return to levered equity for finite cash flows is constant if the debt-equity ratio is constant. We assume that the reader is familiar with the M&E WACC. The expression that we derive is not new. We hope that our straightforward derivation with simple algebra makes the M&E WACC more widely known. |
| Keywords: | M&E WACC, |
| JEL: | D61 |
| Date: | 2005–03–07 |
| URL: | http://d.repec.org/n?u=RePEc:col:000135:001421&r=cfn |
| By: | Ignacio Velez-Pareja |
| Abstract: | In this paper we find restrictions for the value of a parameter used in defining the cost of capital for perpetuities and terminal values: the growth rate for the free cash flow. When defining the growth rate for the free cash flow the usual warning is to set it below the growth of the economy or the industry because in the long run the firm would be larger than the economy or the industry. This approach might be considered somewhat standard in the sense that usually they either take the growth of NOPLAT (mathematically) and/or check that it complies with the previous statement. However, in this paper we propose to find another objective limits deriving them from the formulation for the cost of capital in perpetuity and the traditional formula for the terminal value in a world where the discount rate for the tax savings is Kd, the cost of debt. These limits give additional criteria for determining the value of g. The limits are calculated in terms of real rate of growth. We use an example to show the effects of violating these limits. Calculating these limits is very important in valuation because usually the terminal value is a substantial portion of the levered value of the firm. |
| Keywords: | Cash flows, |
| JEL: | M21 |
| Date: | 2004–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:col:000135:001426&r=cfn |
| By: | Joseph Tham; Ignacio Velez-Pareja |
| Abstract: | In this teaching note, we present an integrated, consistent market-based framework for valuing finite cash flows. We derive the relevant cash flows from integrated financial statements, and based on Modigliani and Miller's (M & M) theories, we estimate the appropriate cost of capital and value the cash flows in seven different ways. The first five methods are variations of the Discounted Cash Flow (DCF) method. The last two methods, the RIM and EVA, are interesting because they differ from the DCF methods. In particular, they apply a charge for equity (based on the book value of equity) to the net income or a charge for invested capital (based on the book value of invested capital) to the Net Operating Profit after tax (NOPLAT), roughly speaking. Happily, the results from the DCF methods are fully consistent with the RIM and EVA. Since the results from the seven methods must always match, calculating the (present) values with the seven methods is a powerful check on the consistency of the valuation exercise. With the availability of computing resources, it is easy to implement the seven methods on a routine basis. In Principles of Cash Flow Valuation, 2004, Academic Press we present and explain the valuation methods in detail. |
| Keywords: | Multiperiod WACC, |
| JEL: | D61 |
| Date: | 2005–01–08 |
| URL: | http://d.repec.org/n?u=RePEc:col:000135:001428&r=cfn |
| By: | Joseph Tham; Ignacio Velez-Pareja Velez-Pareja |
| Abstract: | In the standard Weighted Average Cost of Capital (WACC) applied to the free cash flow (FCF), we assume that the cost of debt is the market, unsubsidized rate. With debt at the market rate and perfect capital markets, debt only creates value in the presence of taxes through the tax shield. In some cases, the firm may be able to obtain a loan at a rate that is below the market rate. With subsidized debt and no taxes, there would be a benefit to debt financing, and the unlevered and levered values of the cash flows would be unequal. How would we adjust the WACC to take account of the subsidized debt? And how would we adjust the expression for the required return to levered equity? In this paper, using a single period example we present the adjustments to the WACC with subsidized debt. We demonstrate the analysis for both the WACC applied to the FCF and the WACC applied to the capital cash flow (CCF). For simplicity, we assume that there are no taxes. The analysis can be extended easily to multiple periods in the presence of taxes. |
| Keywords: | WACC, |
| JEL: | D61 |
| Date: | 2005–03–07 |
| URL: | http://d.repec.org/n?u=RePEc:col:000135:001431&r=cfn |
| By: | Matthew Pritsker |
| Abstract: | The growing share of financial assets that are held and managed by large institutional investors whose desired trades move asset prices is at odds with the traditional competitive assumption that investors are small and take prices as given. This paper relaxes the traditional price-taking assumption and instead presents a dynamic multiple asset model of imperfect competition in asset markets among large investors who differ in their risk aversion. The model is used to study asset price dynamics during an LTCM-like scenario in which market rumors of distressed asset sales are followed at a later date by the sales themselves. Using the model, it is shown that large investors front-run distressed sales; asset prices overshoot their long-run fundamentals; and asset pricing models experience temporary breakdown. During the period of model breakdown assets equilibrium returns are explained by the market portfolio and by transient liquidity factors. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-36&r=cfn |
| By: | Daniel Covitz; Steven A. Sharpe |
| Abstract: | We compile and analyze detailed information on the debt structure and interest rate derivative positions of nonfinancial firms in 2000 and 2002. We find that differences in debt structure across firms and time tend to be counterbalanced by difference in derivative positions. In particular, among derivative users, smaller firms tend to have relatively more interest rate exposure from liabilities than larger firms and tend to use derivatives that offset these exposures. Larger firms also tend to limit their interest rate exposures, but they do so through their choice of debt structure rather than with derivatives. On the other hand, we find that a large fraction of the change in derivative positions over time cannot be explained by changes in debt structure. Finally, we find no evidence that nonfinancial firms hedge interest rate exposures from their operating assets, but do not see this as supporting the hypothesis that firms use derivatives to speculate. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-39&r=cfn |
| By: | Gur Huberman; Zhenyu Wang |
| Abstract: | Focusing on capital asset returns governed by a factor structure, the Arbitrage Pricing Theory (APT) is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation. |
| Keywords: | Arbitrage - Econometric models ; Stock - Prices ; Portfolio management |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:216&r=cfn |
| By: | Donald P. Morgan; Kevin J. Stiroh |
| Abstract: | The naming of eleven banks as "too big to fail (TBTF)" in 1984 led bond raters to raise their ratings on new bond issues of TBTF banks about a notch relative to those of other, unnamed banks. The relationship between bond spreads and ratings for the TBTF banks tended to flatten after that event, suggesting that investors were even more optimistic than raters about the probability of support for those banks. The spread-rating relationship in the 1990s remained flatter for TBTF banks (or their descendants) even after the passage of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), suggesting that investors still see those banks as TBTF. Until investors are disabused of such beliefs, investor discipline of big banks will be less than complete. |
| Keywords: | Bank management ; Bank failures ; Corporate bond |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:220&r=cfn |
| By: | Barry Eichengreen; Kenneth Kletzer; Ashoka Mody |
| Abstract: | The IMF attempts to stabilize private capital flows to emerging markets by providing public monitoring and emergency finance. In analyzing its role we contrast cases where banks and bondholders do the lending. Banks have a natural advantage in monitoring and creditor coordination, while bonds have superior risk sharing characteristics. Consistent with this assumption, banks reduce spreads as they obtain more information through repeat transactions with borrowers. By comparison, repeat borrowing has little influence in bond markets, where publicly-available information dominates. But spreads on bonds are lower when they are issued in conjunction with IMF-supported programs, as if the existence of a program conveyed positive information to bondholders. The influence of IMF monitoring in bond markets is especially pronounced for countries vulnerable to liquidity crises. |
| Keywords: | Capital market ; Developing countries ; International Monetary Fund |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2005-12&r=cfn |
| By: | Filippo Ippolito |
| Abstract: | We present a model of cash constrained entrepreneurs who need an investor to finance their project. Investors can either be uninformed, such as individual bondholders, or informed, such as venture capitalists and banks. There is an entrepreneurial moral hazard problem, which can be partially overcome through monitoring only by informed investors. However, monitoring is only effective if investors can commit ex ante to liquidate the project after observing a poor signal. We show that a capital structure that minimizes commitment and information costs requires informed investors to hold senior convertible debt, uninformed investors to hold junior debt and entrepreneurs to hold common stock. |
| JEL: | G21 G24 G32 G33 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:sbs:wpsefe:2005fe12&r=cfn |
| By: | Filippo Ippolito |
| Abstract: | We examine the shareholder wealth effects of takeover defenses by developing a model in which takeovers facilitate the implementation of technological innovations. In the rational expectations equilibrium of the model with explicit contracts, we show that takeover defenses are deployed to insure employees' firm-specific skills and that defenses dominate severance payments as an insurance mechanism because the latter distort the incentives of employees to exert effort. However, takeover defenses also result in managerial entrenchment. Managers of firms with weak boards choose takeover defenses which maximize their benefits of control, rather than shareholder wealth: golden parachutes serve to align managerial and shareholder preferences. |
| JEL: | G34 J24 J41 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:sbs:wpsefe:2005fe13&r=cfn |
| By: | Ekrem Kilic (Marmara University) |
| Abstract: | Volatility of financial markets is an important topic for academics, policy makers and market participants. In this study first I summarized several specifications for the conditional variance and also define some methods for combination of these specifications. Then assuming that the squared returns are the benchmark estimate for actual volatility of the day, I compare all of the models with respect to how much efficient they are to mimic the realized volatility. At the same time I used a VaR approach to compare these forecasts. With the help of these analyses I examine if combination of the forecast could outperform the single models. |
| Keywords: | volatility, arch, garch, combination, VaR |
| JEL: | C1 C2 C3 C4 C5 C8 |
| Date: | 2005–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpem:0510007&r=cfn |