nep-cfn New Economics Papers
on Corporate Finance
Issue of 2006‒08‒19
four papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. Estimation of the Default Risk of Publicly Traded Canadian Companies By Georges Dionne; Sadok Laajimi; Sofiane Mejri; Madalina Petrescu
  2. Implications for liquidity from innovation and transparency in the European corporate bond market By Marco Laganá; Martin Perina; Isabel von Köppen-Mertes; Avinash Persaud
  3. A firm-level analysis of small and medium size enterprise financing in Poland By Klapper, Leora; Sarria-Allende, Virginia; Zaidi, Rida
  4. Utility-based Pricing of the Weather Derivatives By Helene Hamisultane

  1. By: Georges Dionne; Sadok Laajimi; Sofiane Mejri; Madalina Petrescu
    Abstract: Two models of default risk are prominent in the financial literature: Merton's structural model and Altman's non-structural model. Merton's structural model has the benefit of being responsive, since the probabilities of default can continually be updated with the evolution of firms' asset values. Its main flaw lies in the fact that it may over- or underestimate the probabilities of default, since asset values are unobservable and must be extrapolated from the share prices. Altman's nonstructural model, on the other hand, is more precise, since it uses firms' accounting data-but it is less flexible. In this paper, the authors investigate the hybrid contingent claims approach with publicly traded Canadian companies listed on the Toronto Stock Exchange. The authors' goal is to assess how their ability to predict companies' probability of default is improved by combining the companies' continuous market valuation (structural model) with the value given in their financial statements (non-structural model). The authors' results indicate that the predicted structural probabilities of default (PDs from the structural model) contribute significantly to explaining default probabilities when PDs are included alongside the retained accounting variables in the hybrid model. The authors also show that quarterly updates to the PDs add a large amount of dynamic information to explain the probabilities of default over the course of a year. This flexibility would not be possible with a non-structural model. The authors conduct a preliminary analysis of correlations between structural probabilities of default for the firms in their database. Their results indicate that there are substantial correlations in the studied data.
    Keywords: Debt management; Credit and credit aggregates; Financial markets; Recent economic and financial developments; Econometric and statistical methods
    JEL: G21 G24 G28 G33
    Date: 2006
  2. By: Marco Laganá (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Martin Perina (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Isabel von Köppen-Mertes (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Avinash Persaud (Intelligence Capital Limited, 145-147 St. John Street, London EC1V 4PY, United Kingdom)
    Abstract: This paper offers a new framework for the assessment of financial market liquidity and identifies two types: search liquidity and systemic liquidity. Search liquidity, i.e. liquidity in “normal” times, is driven by search costs required for a trader to find a willing buyer for an asset he/she is trying to sell or vice versa. Search liquidity is asset specific. Systemic liquidity, i.e. liquidity in “stressed” times, is driven by the homogeneity of investors - the degree to which one’s decision to sell is related to the decision to sell made by other market players at the same time. Systemic liquidity is specific to market participants’ behaviour. This framework proves fairly powerful in identifying the role of credit derivatives and transparency for liquidity of corporate bond markets. We have applied it to the illiquid segments of the European credit market and found that credit derivatives are likely to improve search liquidity as well as systemic liquidity. However, it is possible that in their popular use today, credit derivatives reinforce a concentration of positions that can worsen systemic liquidity. We also found that post-trade transparency has surprisingly little bearing on liquidity in that where it improves liquidity it is merely acting as a proxy for pre-trade transparency or transparency of holdings. We conclude that if liquidity is the objective, pre-trade transparency, as well as some delayed transparency on net exposures and concentrations, is likely to be more supportive of both search and systemic liquidity than post-trade transparency. JEL Classification: G14, G15, G18.
    Keywords: Financial market functioning, liquidity, transparency, credit markets and financial innovation.
    Date: 2006–08
  3. By: Klapper, Leora; Sarria-Allende, Virginia; Zaidi, Rida
    Abstract: The authors test competing theories of capital structure choices using firm-level data on firm borrowings. The majority of firms in the dataset are privately owned, young, micro or small and medium enterprise (SME) firms concentrated in the service sector. In general, the financing pattern of firms is low leverage ratios and, in particular, low levels of intermediated financing and long-term financing. Average firm growth rates decreased during the five years of the sample period. Average profitability growth ratios are also negative across age and sectors and large firms have the highest negative profit growth rates. Statistical tests find a positive firm size effect on financial intermediation. Larger firms have higher leverage ratios (both short term and long term), including higher use of trade credit. There is also a negative influence of profitability on leverage ratios (more profitable firms use less external financing), which supports the " pecking order " theory that in environments with greater asymmetric information (such as weaker credit information) firms prefer to use internal or inter-firm financing. Finally, firms operating in a competitive environment have higher leverage ratios. For instance, young, small firms are the most active employment generators in the Polish economy. In particular, the authors find that although SMEs seem to be very active in creating jobs in recent years. This suggests that a new type of firm is emerging that is more market and profit-oriented. But at the same time, these firms appear to have financial constraints that impede their growth. Improvements in the business environment, such as better credit and registry information, could help promote growth in this sector.
    Keywords: Small Scale Enterprise,Microfinance,Economic Theory & Research,Investment and Investment Climate,Financial Intermediation
    Date: 2006–08–01
  4. By: Helene Hamisultane (EconomiX, University of Nanterre)
    Abstract: Since the underlying of the weather derivatives is not a traded asset, these contracts cannot be evaluated by the traditional financial theory. Cao and Wei (2004) price them by using the consumption-based asset pricing model of Lucas (1978) and by assuming different values for the constant relative risk aversion coefficient. Instead of taking this coefficient as given, we suggest in this paper to estimate it by using the consumption data and the quotations of one of the most transacted weather contracts which is the New York weather futures on the Chicago Mercantile Exchange (CME). We will apply the well-known generalized method of moments (GMM) introduced by Hansen (1982) to estimate it as well as the simulated method of moments (SMM) attributed to Lee and Ingram (1991) and Duffie and Singleton (1993). This last method is studied since we think that it can give satisfactory results in the case of the weather derivatives for which the prices are simulated. We find that the estimated coefficient from the SMM approach must have improbably high values in order to have the calculated weather futures prices matching the observations. This finding is in accordance with the results of the prior works which have shown the empirical failures of the consumption-based asset pricing model.
    Keywords: weather derivatives, consumption-based asset pricing model, constant relative risk aversion utility function, generalized method of moments, simulated method of moments, HAC matrix, Monte-Carlo simulations, periodic variance, GARCH
    JEL: C51 C53 G13
    Date: 2006–07

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