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on Corporate Finance |
| By: | An Chen; Michael Suchanecki |
| Abstract: | The topic of insolvency risk in connection with life insurance companies has recently attracted a great deal of attention. In this paper, the question is investigated of how the value of the equity and of the liability of a life insurance company are affected by the default risk and the choice of the relevant bankruptcy procedure. As an example, the U.S. Bankruptcy Code with Chapter 7 and Chapter 11 bankruptcy procedures is used. Grosen and Jørgensen's (2002) contingent claim model, implying only a Chapter 7 bankruptcy procedure, is extended to allow for more general bankruptcy procedures such as Chapter 11. Thus, more realistically, default and liquidation are modelled as distinguishable events. This is realized by using so-called standard and cumulative Parisian barrier option frameworks. It is shown that these options have appealing interpretations in terms of the bankruptcy mechanism. Furthermore, a number of representative numerical analyses and comparative statics are performed in order to investigate the effects of different parameter changes on the values of the insurance company's equity and liability, and hence on the value of the life insurance contract. To complete the analysis, the shortfall probabilities of the insurance company implied by the proposed models are computed and compared. |
| Keywords: | Equity--Linked Life Insurance, Default Risk, Liquidation Risk, Contingent Claims Pricing, Parisian Options, Bankruptcy Procedures |
| JEL: | G13 G22 G33 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse8_2006&r=cfn |
| By: | Jose L. B. Fernandes; Augusto Hasman; Juan Ignacio Peña |
| Abstract: | The aim of this paper is twofold: First to test the adequacy of Pareto distributions to describe the tail of financial returns in emerging and developed markets, and second to study the possible correlation between stock market indices observed returns and return’s extreme distributional characteristics measured by Value at Risk and Expected Shortfall. We test the empirical model using daily data from 41 countries, in the period from 1995 to 2005. The findings support the adequacy of Pareto distributions and the use of a log linear regression estimation of their parameters, as an alternative for the usually employed Hill’s estimator. We also report a significant relationship between extreme distributional characteristics and observed returns, especially for developed countries. |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wbrepe:wb062808&r=cfn |
| By: | Luciano Campi (CEREMADE, Université Paris Dauphine); Simon Polbennikov (Econometrics and Operations Research, Tilburg University, The Netherlands,); Sbuelz (Department of Economics (University of Verona)) |
| Abstract: | Unlike in structural and reduced-form models, we use equity as a liquid and observable primitive to analytically value corporate bonds and credit default swaps. Restrictive assumptions on the firm’s capital structure are avoided. Default is parsimoniously represented by equity value hitting the zero barrier. Default can be either predictable, according to a CEV process that yields a positive probability of diffusive default and enables the leverage effect, or unpredictable, according to a Poisson-process jump that implies non-zero credit spreads for short maturities. Easy cross-asset hedging is enabled. By means of a carefully specified pricing kernel, we also enable analytical credit-risk management under possibly systematic jump-to-default risk. |
| Keywords: | Equity, Corporate Bonds, Credit Default Swaps, Constant-Elasticity-of-Variance (CEV) Diffusion, Jump to Default |
| JEL: | G12 G33 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:ver:wpaper:24&r=cfn |
| By: | Dam, Lammertjan (Groningen University) |
| Abstract: | Inter-generational externalities associated with the conservation of the environment are usually tackled through fiscal policy. The recent increase in socially responsible investment funds creates a potential role for the stock market to deal with these environmental externalities. We study this alternative approach in an overlapping generations model in which agents choose between investing in clean or polluting technologies. Since agents are short-lived, they do not account for the long-term effects of pollution. We show that when firm property rights are traded separately on a forward looking stock market, proper firm valuation can resolve the conflict between current and future generations. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:rugccs:2006/01&r=cfn |
| By: | Kuper, Gerard H.; Lestano (Groningen University) |
| Abstract: | This paper examines the dynamic linkages among financial markets in Thailand and Indonesia. In particular, we focus on the cross-border relationship in individual markets and on the relationship between finan- cial markets within each country. We find that while tight monetary policy pursued by Thailand authorities helped to defend the exchange rate at the outbreak of the financial crisis, it had little consequences for Indonesia at the end of 1998. The correlations between countries within each of the financial market reveals a certain degree of interde- pendence among countries, which is lower during crises. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:rugccs:2006/02&r=cfn |
| By: | Francis A. Longstaff; Arvind Rajan |
| Abstract: | We study the pricing of collateralized debt obligations (CDOs) using an extensive new data set for the actively-traded CDX credit index and its tranches. We find that a three-factor portfolio credit model allowing for firm-specific, industry, and economywide default events explains virtually all of the time-series and crosssectional variation in CDX index tranche prices. These tranches are priced as if losses of 0.4, 6, and 35 percent of the portfolio occur with expected frequencies of 1.2, 41.5, and 763 years, respectively. On average, 65 percent of the CDX spread is due to firm-specific default risk, 27 percent to clustered industry or sector default risk, and 8 percent to catastrophic or systemic default risk. Recently, however, firm-specific default risk has begun to play a larger role. |
| JEL: | G1 |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12210&r=cfn |
| By: | D. Johannes Juttner (Department of Economics, Macquarie University); David Chung (Department of Economics, Macquarie University); Wayne Leung (Department of Economics, Macquarie University) |
| Abstract: | The last twenty five years provided international investors in sovereign bonds of emerging market countries with a colourful experience consisting of several defaults that resulted in protracted, frustrating and – most importantly – costly salvage operations. It therefore appears natural to ask how investors have priced sovereign bonds under these challenging conditions. The novel feature of this study consists in applying a conventional multifactor global market model to emerging market sovereign bond index rates of return that are denominated in US dollars and subsequently relating the unexplained residual from the market model’s estimates of each country’s total bond index return to country specific factors. They include political and financial risks as well as other presumed determinants of bond index rates of return. The estimation approach allows us to separate out the common influences of global bond market movements from the country-specific influences that drive rates of return on the outstanding bonds of 19 emerging market countries from Latin America, Transition Economies, Asian and African countries. The results of our study confirm that sovereign countries’ bond index rates of return that include interest payments and capital gains/losses may be explained in terms of conventional bond pricing models by combining global market factors with local risk and other country-specific influences. Unsurprisingly, emerging market bonds appear to be dancing to different tunes than those in developed economies. |
| Keywords: | Emerging bond markets, International investments, Sovereign bonds |
| JEL: | F21 F30 G15 |
| Date: | 2004–08 |
| URL: | http://d.repec.org/n?u=RePEc:mac:wpaper:0406&r=cfn |