nep-cfn New Economics Papers
on Corporate Finance
Issue of 2006‒03‒18
nine papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. Transaction services and asset-price bubbles (Revised) By Keiichiro Kobayashi
  2. Supply matters for asset prices: evidence from IPOs in emerging markets By Matías Braun; Borja Larrain
  3. Equity market volatility and expected risk premium By Long Chen; Hui Guo; Lu Zhang
  5. Asset Prices When Agents are Marked-to-Market By Gary Gorton; Ping He; Lixin Huang
  6. Estimating quadratic variation when quoted prices jump by a constant increment By Jeremy Large
  7. Small Caps in International Equity Portfolios: The Effects of Variance Risk By Massimo Guidolin; Giovanna Nicodano
  9. Does firm value move too much to be justified by subsequent changes in cash flow? By Borja Larrain; Motohiro Yogo

  1. By: Keiichiro Kobayashi
    Abstract: This paper examines asset-price bubbles in an economy where a nondepletable asset (e.g., land) can provide transaction services, using a variant of the cash-in-advance model. When a landowner can borrow money immediately using land as collateral, one can say that land essentially provides a transaction service. The transaction services that such an asset can provide increase as its price rises, since the asset owner can borrow more money against the asset's increased value. Thus an asset-price bubble can emerge due to the externality of self-reference, wherein the asset price reflects the transaction services that it can provide, while the amount of the transaction services reflects the asset price. If the collateral ratio of the asset (Į) and money supply (m) are not very large, a steady state equilibrium exists where the asset price has a bubble component and resource allocation is inefficient; if Į)and/or m become large, the bubble component of the asset price vanishes and the equilibrium allocation becomes efficient. The paper shows that in the case where the equilibrium concept is relaxed to allow for sticky prices and a temporary supply-demand gap, an equilibrium exists where a bubble develops temporarily and eventually bursts.
    Date: 2006–03
  2. By: Matías Braun; Borja Larrain
    Abstract: We show that the introduction of a new asset affects the prices of previously existing assets in a market. Using data from 254 IPOs in emerging markets, we find that stocks in industries that covary highly with the industry of the IPO experience a larger decline in prices relative to other stocks during the month of the IPO. The effects are stronger when the IPO is issued in a market that is less integrated internationally, and when the IPO is big. The evidence supports the idea that the composition of asset supply affects the cross-section of stock prices.
    Keywords: Assets (Accounting) - Prices ; Going public (Securities)
    Date: 2005
  3. By: Long Chen; Hui Guo; Lu Zhang
    Abstract: This paper revisits the time-series relation between the conditional risk premium and variance of the equity market portfolio. The main innovation is that we construct a measure of the ex ante equity market risk premium using corporate bond yield spread data. This measure is forward-looking and does not rely critically on either realized equity returns or instrumental variables. We find strong support for a positive risk-return tradeoff, and this result is not sensitive to a number of robustness checks, including alternative proxies of the conditional stock variance and controls for hedging demands.
    Keywords: Stock exchanges ; Securities
    Date: 2006
  4. By: Margus Kõomägi; Priit Sander
    Abstract: The aim of the article is to describe how Estonian venture capitalists make financing and investment decisions, and compare these results with theoretical recommendations found in corporate finance and venture capital literature. The focus is on the methodological procedures in venture capital investment and financing. A case study approach is used to collect information about the current practice of venture capital investments and financing in Estonia. Five of the largest Estonian venture capital funds were analyzed in this article, and different problems have been presented in the article. Some of them require an academic and some a practical solution. The problems are divided into four parts: venture capital deal structuring, corporate governance and investor protection, the cost of venture capital and valuation. Venture capital deal structuring is discussed first, and we look at of the following topics: syndication, staged investment, use of financial instruments, ownership share and dilution problems. Syndication of investments, staged investments and convertible financial instruments are used quite rarely by Estonian venture capitalists. Most Estonian venture capitalists take a minority holding in their portfolio companies and the ownership share changes mainly due to the use of convertible instruments and financial options. Estonian venture capitalists do not consider this kind of dilution a big problem. Most Estonian venture capitalists do not have a measure of the required rate of return as considered in financial theory. The determination of the rate of return among Estonian venture capitalists is more intuitive: they use an internal rate of return instead. The required rates of return used by Estonian venture capitalists have about the same interval as in the rest of the world. Corporate control and investor protection are important issues in the venture capital process. These are closely linked to deal structuring. The Estonian Commercial code has average investor protection, but it restricts the use of preferred shares, which are often used in venture capital deal structuring abroad. Some corporate control problems have arisen at the board level in Estonia. Although venture capitalists do not use complicated models to find the cost of capital, they pay much more attention to complicated valuation models. Multiples, book value, and DCF methods are used. Numerical analysis is not as important as the authors expected. Much attention is paid to the linkages between these themes.
    Date: 2006
  5. By: Gary Gorton; Ping He; Lixin Huang
    Abstract: "Risk management" in securities markets refers to the oversight of portfolio managers and professional traders when they trade on behalf of investors in security markets. Monitoring of their trading performance, profit and loss, and risk-taking behavior, is measured by principals using security market prices. We study the optimality of the practice of marking-to-market and provide conditions under which investing principals should optimally monitor their agent traders using market prices to measure traders' performance. Asset prices, however, can be affected by mark-to-market contracts. We show that such contracts introduce an externality when there are many traders. Traders may rationally herd, trading on irrelevant information. Ironically, this causes asset prices to be less informative than they would be without the mark-to-market feature.
    Date: 2006–03
  6. By: Jeremy Large (Nuffield College, Oxford)
    Abstract: Financial assets' quoted prices normally change through frequent revisions, or jumps. For markets where quotes are almost always revised by the minimum price tick, this paper proposes a new estimator of Quadratic Variation which is robust to microstructure effects. It compares the number of alternations, where quotes are revised back to their previous price, to the number of other jumps. Many markets exhibit a lack of autocorrelation in their quotes' alternation pattern. Under quite general 'no leverage' assumptions, whenever this is so the proposed statistic is consistent as the intensity of jumps increases without bound. After an empirical implementation, some useful corollaries of this are given.
    JEL: C10 C22 C80
    Date: 2006–03–09
  7. By: Massimo Guidolin (Federal Reserve Bank of St. Louis); Giovanna Nicodano (Department of Economics, University of Turin and Center for Research on Pensions and Welfare Policies, Turin)
    Abstract: Small capitalization stocks are known to have asymmetric risk across bull and bear markets. This paper investigates how variance risk affects international equity diversification by examining the portfolio choice of a power utility investor confronted with an asset menu that includes (but is not limited to) European and North American small equity portfolios. Stock returns are generated by a multivariate regime switching process that is able to account for both non-normality and predictability of stock returns. Non-normality matters for portfolio choice because the investor has a power utility function, implying a preference for positively skewed returns and aversion to kurtosis. We find that small cap portfolios command large optimal weights only when regime switching (and hence variance risk) is ignored. Otherwise a rational investor ought to hold a well-diversified portfolio. However, the availability of small caps substantially increases expected utility, in the order of riskless annualized gains of 3 percent and higher. These findings are robust to a number of modifications concerning the coefficient of relative risk aversion, the investment horizon, short-sale possibilities, and the exact structure of the asset menu.
    Keywords: strategic asset allocation, markov-switching, size effects, liquidity (variance) risk
    Date: 2005–02
  8. By: O.T. Henry; S. Suardi
    Abstract: Empirical evidence documents a level effect in the volatility of short term rates of interest. That is, volatility is positively correlated with the level of the short term interest rate. Using Monte-Carlo simulations this paper examines the performance of the commonly used Engle-Ng (1993) tests which differentiate the effect of good and bad news on the predictability of future short rate volatility. Our results show that the tests exhibit serious size distortions and loss of power in the face of a neglected level effect.
    Keywords: Level Effects; Asymmetry; Engle-Ng Tests
    JEL: C12 G12 E44
    Date: 2005
  9. By: Borja Larrain; Motohiro Yogo
    Abstract: Movements in the value of corporate assets are justified by changes in expected future cash flow. The appropriate measure of cash flow for valuing assets is net payout, which is the sum of dividends, interest, and net repurchases of equity and debt. When discount rates are low and equity issuance is high, expected cash-flow growth is low because firms repurchase debt to offset equity issuance. A variance decomposition of the ratio of net payout reveals little transitory variation in discount rates that is not offset by common variation with expected cashflow growth.
    Keywords: Assets (Accounting) - Prices ; Cash flow
    Date: 2005

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