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on Corporate Finance |
| By: | Stuart M. Turnbull; Jun Yang |
| Abstract: | The paper examines three equity-based structural models to study the nonlinear relationship between equity and credit default swap (CDS) prices. These models differ in the specification of the default barrier. With cross-firm CDS premia and equity information, we are able to estimate and compare the three models. We find that the stochastic barrier model performs better than the constant and uncertain barrier models in terms of both in-sample fit and out-of-sample forecasting of CDS premia. In addition, we demonstrate a linkage between the default barrier, jump intensity, and barrier volatility estimated from our models and firm-specific variables related to default risk, such as credit ratings, equity volatility, and leverage ratios. |
| Keywords: | Econometric and statistical methods; Financial markets |
| JEL: | G12 G13 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:08-1&r=cfn |
| By: | Henrekson, Magnus (Research Institute of Industrial Economics (IFN)); Sanandaji, Tino (University of Chicago) |
| Abstract: | Taxation theory rarely takes entrepreneurship into consideration. We discuss how this omission affects conclusions derived from standard models of capital taxation when applied to entrepreneurial income. Some of the defining features of entrepreneurship often omitted by standard capital taxation theory are incorporated into the analysis. This includes the lack of a well-functioning external market for entrepreneurial effort, limited access to external capital and the complementarities between entrepreneurial effort, entrepre-neurial innovation and capital investment. Because of these constraints, the entrepreneurial project is tied to the individual owner-manager. Unlike the typical passive portfolio investor assumed in cost of capital models the entrepreneur is unable to decouple savings decisions from investment decisions, and due to the comple-mentarities in production makes a joint decision on the supply of effort and capital. The returns from success-ful entrepreneurial ventures thus cannot be readily divided into labor and capital income, in stark contrast to what is assumed in standard taxation theory. When unique attributes of entrepreneurship are taken into account, some major conclusions of capital taxation models no longer hold, including the neutrality of capital taxation in owner-managed firms. These results are particularly important for the Nordic system of dual taxation, the theoretical foundation of which relies on the ability to neatly separate capital income from the labor income of the self-employed. |
| Keywords: | Capital Income Taxation; Dual Income Taxation; Entrepreneurship; Innovation; Institutions; Labor Supply; New Firm Creation; Optimal Factor Taxes; Taxation; Tax Policy |
| JEL: | E25 G32 H21 H25 L26 L50 M13 O31 |
| Date: | 2008–01–31 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:iuiwop:0732&r=cfn |
| By: | Giovanni Cespa (Queen Mary University of London, Università di Salerno, CSEF and CEPR); Xavier Vives (IESE Business School and UPF) |
| Abstract: | We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We look at the bias of prices as estimators of fundamental value in relation to traders' average expectations and note that prices are more (less) biased than average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. We find that prices are biased in relation to average expectations whenever traders speculate on short-run price move- ments. In a market with long term traders, over-reliance on public information obtains if noise trade increments are correlated enough and/or there is low enough residual uncertainty in the payoff. This defines a “Keynesian” region; the complementary region is “Hayekian” in that prices are less biased than average expectations in the estimation of fundamental value. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions. With short-term traders there typically are two equilibria, with the stable (unstable) one displaying over- (under-) reliance on public information. |
| Keywords: | Price bias, long and short-term trading, multiple equilibria, average expectations, higher order beliefs, over-reliance on public information. |
| JEL: | G10 G12 G14 |
| Date: | 2008–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:191&r=cfn |
| By: | Piero Gottardi (Dipartimento di Scienze Economiche, Università di Venezia); Ronel Elul (Federal Reserve Bank of Philadelphia) |
| Abstract: | In many countries, lenders are not permitted to use information about past defaults after a specified period of time has elapsed. We model this provision and determine conditions under which it is optimal. We develop a model in which entrepreneurs must repeatedly seek external funds to finance a sequence of risky projects under conditions of both adverse selection and moral hazard. We show that forgetting a default makes incentives worse, ex-ante, because it reduces the punishment for failure. However, following a default it is generally good to forget, because by improving an entrepreneur’s reputation, forgetting increases the incentive to exert effort to preserve this reputation. Our key result is that if agents are sufficiently patient, and low effort is not too inefficient, then the optimal law would prescribe some amount of forgetting — that is, it would not permit lenders to fully utilize past information. We also argue that forgetting must be the outcome of a regulatory intervention by the government — no lender would willingly agree to ignore information available to him. |
| Keywords: | Bankruptcy, Information, Incentives, Fresh Start |
| JEL: | D86 G33 K35 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2007_23&r=cfn |
| By: | Piero Gottardi (Dipartimento di Scienze Economiche, Università di Venezia); Alberto Bisin (Department of Economics, New York University); Adriano Rampini (Fuqua School of Business, Duke University) |
| Abstract: | Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his compensation using financial markets and shareholders can monitor the manager’s portfolio in order to keep him from hedging, but monitoring is costly. We find that the optimal incentive compensation and governance provisions have the following properties: (i) the manager’s portfolio is monitored only when the firm performs poorly, (ii) the manager’s compensation is more sensitive to firm performance when the cost of monitoring is higher or when hedging markets are more developed, and (iii) conditional on the firm’s performance, the manager’s compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring. Moreover, the model suggests that the optimal level of portfolio monitoring is higher for managers of firms whose performance can be hedged more easily, such as larger firms and firms in more developed financial markets. |
| Keywords: | Executive Compensation, Incentives, Monitoring, Corporate Governance |
| JEL: | G30 D82 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2007_24&r=cfn |
| By: | Pausch, Thilo |
| Abstract: | Instruments for credit risk transfer arise endogenously from and interact with optimizing behavior of their users. This is particularly true with credit derivatives which are usually OTC contracts between banks as buyers and sellers of credit risk. Recent literature, however, does not account for this fact when analyzing the effects of these instruments on banking. The present paper closes this gap by explicitly modelling the market for credit derivatives and its interaction with banks’ loan granting and deposit taking activities. |
| Keywords: | credit risk, credit derivatives, bargaining |
| JEL: | D53 D82 G11 G14 G21 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp2:6928&r=cfn |