nep-cfn New Economics Papers
on Corporate Finance
Issue of 2006‒02‒12
six papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. Valuing companies with a fixed book-value leverage ratio By Fernandez, Pablo
  2. Modeling Conditional Skewness in Stock Returns By Markku Lanne; Pentti Saikkonen
  3. The role of longevity bonds in optimal portfolios By Francesco Menoncin
  4. Credit Spread Specification and the Pricing of Spread Options By Nicolas Mougeot
  5. Mutual fund flows’ performance reaction: does convexity apply to small markets? By Carlos F. Alves; Victor Mendes

  1. By: Fernandez, Pablo (IESE Business School)
    Abstract: We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and claim that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. The value of tax shields depends only on the present value of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. We also show that the appropriate discount rates for the equity cash flows and for the expected value of the equity are different.
    Keywords: Company valuation; value of tax shields; present value of the net increases of debt; required return to equity;
    JEL: G12 G31 G32
    Date: 2005–11–03
  2. By: Markku Lanne; Pentti Saikkonen
    Abstract: In this paper we propose a new GARCH-in-Mean (GARCH-M) model allowing for conditional skewness. The model is based on the so-called z distribution capable of modeling moderate skewness and kurtosis typically encountered in stock return series. The need to allow for skewness can also be readily tested. Our empirical results indicate the presence of conditional skewness in the postwar U.S. stock returns. Small positive news is also found to have a smaller impact on conditional variance than no news at all. Moreover, the symmetric GARCH-M model not allowing for conditional skewness is found to systematically overpredict conditional variance and average excess returns.
    Keywords: Conditional skewness, GARCH-in-Mean, Risk-return tradeoff
    JEL: C16 C22 G12
    Date: 2005
  3. By: Francesco Menoncin
    Abstract: A longevity bond pays coupons which are proportional to the survival rate of a given population. In such a way the longevity risk becomes hedgeable on the financial market. In our model there are: (i) a longevity bond as a derivative on the population survival rate, (ii) a bond as a derivative on the stochastic instantaneously riskless interest rate, and (iii) a stock. The investor maximizes the expected (CRRA) utility of his intertemporal consumption. In such a framework we demonstrate that the amount of wealth invested in the longevity bond reduces the portfolio weight of the bond without affecting neither the weight of the stock nor the weight of the riskless asset.
  4. By: Nicolas Mougeot (FAME and Institute of Banking and Financial Management, Ecole des HEC)
    Abstract: This paper presents a simple approach to the pricing of options on spread and some arguments in favor of modelling the spread using its two components instead of the spread itself. We show that, even in a simple Gaussian setting, the spread should not be modelled directly, and that convergence speeds of the two components are crucial parameters. There exist conditions, discussed in this paper, under which the analysis can be reduced to a two-factor model based on the dynamics of the spread itself. Hence, we propose a three-factor model based on the dynamics of the riskless rate and of the two components of the spread. This is done by following the Longstaff (1990) methodology and with the assumption that both the riskless rate and the spread or its two components follow correlated Ornstein-Uhlenbeck processes. Greeks analysis shows that spread options have some very specific features compared to the Black-Scholes-Merton (1973) option model. Moreover, the results show that the mispricing is important and not systematic when one chooses a spread option model based on the dynamics of the spread instead of using the dynamics of its two components. We finally show how the spread option model allows us to price other yield derivatives, like options to exchange a yield for another or the options on the maximum or the minimum of two yields.
    Keywords: Credit spread, Option valuation, Change of probability measure
    JEL: G13
  5. By: Carlos F. Alves (CEMPRE, Faculdade de Economia, Universidade do Porto); Victor Mendes (CMVM - Portuguese Securities Commission)
    Abstract: In this paper we study the performance reaction of investors in a small market context. Instead of the asymmetrical investors’ reaction to winners and losers, as usually documented for the US, an absence of risk-adjusted performance reaction was observed. The absence of reaction can be attributed to either lower investor sophistication, conflicts of interests in the context of the Portuguese universal banking industry, or the existence of relevant back-end load cost which prevent investors from reacting. A high persistence of net investment flows was also noted. Our results are consistent with the idea that the financial groups with larger market shares have the capacity “to drive” their customers to funds with larger fees. This practice emerges as a non-transparent means of increasing prices.
    Keywords: Mutual Funds, Performance Reaction, Investor Behaviour, Small Markets and Regulation
    JEL: G20 G23 G28
    Date: 2006–02
  6. By: Arturo Galindo; Alejandro Micco
    Abstract: We develop a model that shows that inefficient legal protections, disproportionately increase financial restrictions for debtors that have less wealth. Due to fixed monitoring costs in equilibrium banks will not monitor small firms and therefore these firms will adopt risky technologies that imply a higher probability of bankruptcy. This implies that inefficiencies in the bankruptcy procedure will have a greater effect on small firms vis a vis large ones. Using a survey of firms in 62 countries around the world (WBES) and econometric techniques that allow us to deal with observed and unobserved country specific components as well as with partial endogeneity, we explore the role of creditor protection on small and medium-size enterprises' access to bank credit. We find that better protection of creditors reduces the financing gap between small and large firms
    Date: 2005–09–10

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