New Economics Papers
on Financial Markets
Issue of 2007‒01‒13
sixteen papers chosen by

  1. Selection or Influence? Institutional Investors and Acquisition Targets By Lily Qiu; Hong Wan
  2. Hedging Housing Risk By Peter Englund; Min Hwang; John Quigley
  3. The Dividend Pricing Model: New Evidence from the Korean Housing Market. By Min Hwang; John Quigley; Jae Son
  4. Risk Neutral Investors Do Not Acquire Information¤ By Marc-Andreas Muendler
  5. A Pure Test for the Elasticity of Yield Spreads By Gady Jacoby; Chuan Liao; Jonathan A. Batten
  6. Revisiting the Home Bias Puzzle. Downside Equity Risk By Rachel A. Campbell; Roman Kräussl
  7. Liquidity and Capital Structure By Andrew Carverhill; Ron Anderson
  8. The yield curve as a predictor and emerging economies By Mehl, Arnaud
  9. The Q-Theory of Mergers: International and Cross-Border Evidence By Peter L. Rousseau
  10. Financial Integration and International Risk Sharing By Yan Bai; Jing Zhang
  11. Comparing Financial Systems: A structural Analysis By Sylvain Champonnois
  12. Stock market optimism and participation cost: a mean-variance estimation By Andrea Tiseno; Monica Paiella
  13. Financial Frictions, Investment and Tobin's q By Guido Lorenzoni; Karl Walentin
  14. Asymmetric effects and long memory in the volatility of Dow Jones stocks By Marcel Scharth; Marcelo Cunha Medeiros
  15. A reexamination of the equity-premium puzzle: A robust non-parametric approach By Maasoumi, Esfandiar; Lim, G.C.; Martin, Vance
  16. Current challenges in financial regulation By Claessens, Stijn

  1. By: Lily Qiu; Hong Wan
    Date: 2006
  2. By: Peter Englund (Stockholm School of Ecomonics); Min Hwang (University of California at Berkeley); John Quigley (University of California at Berkeley)
    Abstract: An unusually rich source of data on housing prices in Stockholm is used to analyze the investment implications of housing choices. This empirical analysis derives market-wide price and return series for housing investment during a 13-year period, and it also provides estimates of the individual-specific, idiosyncratic, variation in housing returns. Because the idiosyncratic component follows an autocorrelated process, the analysis of portfolio choice is dependent upon the holding period. We analyze the composition of household investment portfolios containing housing, common stocks, stocks in real estate holding companies, bonds, and t-bills. For short holding periods, the efficient portfolio contains essentially no housing. For longer periods, low risk portfolios contain 15 to 50 percent housing. These results suggest that there are large potential gains from policies or institutions that would permit households to hedge their lumpy investments in housing. We estimate the potential value of hedges in reducing risk to households, yet yielding the same investment returns. The value is surprisingly large, especially to poorer homeowners.
    Date: 2006–06–27
  3. By: Min Hwang (National University of Singapore); John Quigley (University of California, Berkeley); Jae Son (Kok-Kuk University)
    Abstract: It is generally conceded that dividend pricing models are poor predictors of asset prices. This finding is sometimes attributed to excess volatility or to a dividend process manipulated by firm managers. In this paper, we present rather powerful panel tests of the dividend pricing relation using a unique data set in which dividends are set by market forces independent of managers' preferences. We rely on observations on the market for condominium dwellings in Korea - perhaps the only market in which information on dividends and prices is publicly and continuously available to consumers and investors. We extend the "dividend-price ratio model" to panels of housing returns and rents differentiated by type and location. We find broad support for the dividend pricing model during periods both before and after the Asian Financial Crisis of 1997-1998, suggesting that the market for housing assets in Korea has been remarkably efficient.
    Keywords: Housing prices,
    Date: 2006–07–13
  4. By: Marc-Andreas Muendler (University of California, San Diego)
    Abstract: Give a risk neutral investor the choice to acquire a costly signal prior to Walrasian asset market equilibrium. She refuses to pay for the signal. The reason is that a risk neutral investor is indifferent between a risky stock or a safe bond in equilibrium and expects the same return to her portfolio ex ante, whether or not she acquires information. Risk neutral asset pricing thus implies the absence of costly information from asset price,unless non-Walrasian market conditions prevail. Non-Walrasian market conditions, however, get reflected in price beyond the asset's fundamental payoff value.
    Keywords: information acquisition; risk neutrality; portfolio choice; rational expectations equilibrium,
    Date: 2005–09–01
  5. By: Gady Jacoby; Chuan Liao; Jonathan A. Batten
    Abstract: The correlation between interest rates and corporate bond yield spreads is a well-known feature of structural bond pricing models. Duffee (1998) argues that this correlation is weak once the effects of call options are removed from the data; a conclusion that contradicts the negative correlation expected by Longstaff and Schwartz (1995). However, Elton et al. (2001) point out that Duffee's analysis ignores the effects of the tax differential between U.S. Treasury and corporate bonds. Canadian bonds have no such tax differential, yet, after controlling for callability, we find that the correlation between interest rates and corporate bond spreads remains negligible. We also find a significant negative relationship for callable bonds with this relationship increasing with the moneyness of the call provision. These results are robust under alternate empirical specifications.
    Keywords: Bond Yield Spread, Default Risk, Callable Bonds, Corporate Bonds
    Date: 2007–01–05
  6. By: Rachel A. Campbell (Maastricht University); Roman Kräussl (Free University of Amsterdam and CFS)
    Abstract: Deviations from normality in financial return series have led to the development of alternative portfolio selection models. One such model is the downside risk model, whereby the investor maximizes his return given a downside risk constraint. In this paper we empirically observe the international equity allocation for the downside risk investor using 9 international markets’ returns over the last 34 years. The results are stable for various robustness checks. Investors may think globally, but instead act locally, due to greater downside risk. The results provide an alternative view of the home bias phenomenon, documented in international financial markets.
    Keywords: Asset Pricing, Home Bias, Downside Risk, Prospect Theory
    JEL: G11 G12 G15
    Date: 2006–12–20
  7. By: Andrew Carverhill; Ron Anderson
    Abstract: This paper solves for a firm's optimal cash holding policy within a continuous time, contingent claims framework that has been extended to incorporate most of the significant contracting frictions that have been identified in the corporate finance literature. Under the optimal policy the firm targets a level of cash holding that is a non-monotonic function of business conditions and an increasing function of the amount of long-term debt outstanding. By allowing firms to either issue equity or to borrow short-term, we show how share issue and dividends on the one hand and cash accumulation and bank borrowing on the other are all mutually interlinked. We calibrate the model and show that it matches closely a wide range of empirical benchmarks including cash holdings, leverage, equity volatility, yield spreads, default probabilities and recovery rates. Furthermore, we show the predicted dynamics of cash and leverage are in line with the empirical literature. Despite the presence of significant contracting frictions we show that the model exhibits a near irrelevance of long-term capital structure property. Furthermore, the optimal policy exhibits a state-dependent hierarchy among financing alternatives that is consistent with recent explorations of pecking order theory. We calculate the agency costs generated by the confliict of interest between shareholders and creditors regarding the firm's liquidity policy and show that bond covenants that establish an earnings restriction on dividend payments may be value increasing.
    Date: 2006–12
  8. By: Mehl, Arnaud (BOFIT)
    Abstract: This paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and euro area yield curves help to predict. It finds that the domes-tic yield curve in emerging economies contains in-sample information even after control-ling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and euro area yield curves also contain in- and out-of-sample information for future inflation and growth in emerging economies. In particular, for emerging economies with exchange rates pegged to the US dollar, the US yield curve is often found to be a better predictor than the domes-tic curves and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements at the low end of the yield curve.
    Keywords: emerging economies; yield curve; forecasting; international linkages
    JEL: C50 E44 F30
    Date: 2006–12–20
  9. By: Peter L. Rousseau (Vanderbilt University)
    Abstract: The main implications of the Q-theory of mergers are tested for United States and seven continental European countries in both the domestic and cross-border cases. I find that European firms, much like those in the United States, tend to use mergers and acquisitions to make large increases in their capital stocks, that this choice is more sensitive to the acquirer's Tobin's Q than its direct investment, and that mergers raise the efficiency of target assets. Data from cross-border mergers between U.S. acquirers and European targets support the theory most emphatically
    Keywords: reallocation, Tobin's Q, European Union
    JEL: O3 L2
    Date: 2006–12–03
  10. By: Yan Bai; Jing Zhang (University of Michigan public)
    Abstract: In the last two decades, financial integration has increased dramatically across the world. At the same time, the fraction of countries in default has more than doubled. Contrary to theory, however, there appears to have been no substantial improvement in the degree of international risk sharing. To account for this puzzle, we construct a general equilibrium model that features a continuum of countries and default choices on state-uncontingent bonds. We model increased financial integration as a decrease in the cost of borrowing. Our main finding is that as the cost of borrowing is lowered, financial integration and sovereign default increases substantially, but the degree of risk sharing as measured by cross section and panel regressions increases hardly at all. The explanation, we propose, is that international risk sharing is not sensitive to the increase in financial integration given the current magnitude of capital flows because countries can insure themselves through accumulation of domestic assets. To get better risk sharing, capital flows among countries need to be extremely large. In addition, although the ability to default on loans provides state contingency, it restricts international risk sharing in two ways: higher borrowing rates and future exclusion from international credit markets
    Keywords: Finanical Integration, Risk Sharing, Globalization, Sovereign Debt
    JEL: F34 F36 F41
    Date: 2006–12–03
  11. By: Sylvain Champonnois (Economics Princeton University)
    Abstract: This paper investigates whether the financial markets are relatively more efficient than banks in the UK than in continental Europe. The UK channels a larger fraction of the financial flow to the firms through financial markets than continental Europe but this is explained by larger firms in the UK, not relatively more efficient markets. This conclusion is drawn from an industry-level structural estimation using data on the UK, France, Germany and Italy. The structural model is based on a novel theory of capital allocation and investment in which the decisions of heterogenous firms across financing instruments are aggregated in closed-form
    Keywords: Financial structure, bank finance, market finance, heterogenous firms, structural estimation,
    JEL: C51 E44 G31
    Date: 2006–12–03
  12. By: Andrea Tiseno (Banca D'Italia public); Monica Paiella
    Abstract: Using Italian household data we jointly estimate the yearly cost of participating to the stock market and the cross sectional distribution of optimism about excess returns of stocks over bonds. Using mean-variance analysis we derive individual efficient portfolio allocation rules, as functions of amount invested and optimism, which provide a structural latent variable model. The observed heterogeneity in amounts invested and in risky portfolio allocations delivers identification: we estimate a yearly cost of participation of about 100 euro and a standard deviation of 30% in optimism
    Keywords: heterogeneous household portfolios, mean-variance frontier, participation cost, expectation error
    JEL: D12 D14 G11
    Date: 2006–12–03
  13. By: Guido Lorenzoni; Karl Walentin (Research Division Sveriges Riksbank (Bank of Sweden))
    Abstract: We develop a model of investment with financial constraints and use it to investigate the relation between investment and Tobin’s q. A firm is financed partly by insiders, who control its assets, and partly by outside investors. When insiders’ wealth is scarce, they earn a rate of return higher than the market rate of return, i.e. insiders earn a quasi-rent on invested capital. This rent is priced into the value of the firm, so Tobin’s q is driven by two forces: changes in the value of invested capital, and changes in the value of the insiders’ future rents. The second effect weakens the correlation between q and investment. We calibrate the model and show that, thanks to this effect, the model can generate realistic correlations between investment, q and cash flow
    Keywords: Financial constraints, Tobin's q, limited enforcement, investment, optimal capital structure
    JEL: E22 E30 E44 E51
    Date: 2006–12–03
  14. By: Marcel Scharth (Department of Economics - PUC-Rio); Marcelo Cunha Medeiros (Department of Economics PUC-Rio)
    Abstract: Does volatility reflect a continuous reaction to past shocks or changes in the markets induce shifts in the volatility dynamics? In this paper, we provide empirical evidence that cumulated price variations convey meaningful information about multiple regimes in the realized volatility of stocks, where large falls (rises) in prices are linked to persistent regimes of high (low) variance in stock returns. Incorporating past cumulated daily returns as a explanatory variable in a flexible and systematic nonlinear framework, we estimate that falls of different magnitudes over less than two months are associated with volatility levels 20% and 60% higher than the average of periods with stable or rising prices. We show that this effect accounts for large empirical values of long memory parameter estimates. Finally, we analyze that the proposed model significantly improves out of sample performance in relation to standard methods. This result is more pronounced in periods of high volatility.
    Keywords: Realized volatility, long memory, nonlinear models, asymmetric effects, regime switching, regression trees, smooth transition, value-at-risk, forecasting, empirical finance.
    Date: 2006–11
  15. By: Maasoumi, Esfandiar (SMU); Lim, G.C. (University of Melbourne); Martin, Vance (University of Melbourne)
    Keywords: Equity-premium puzzle; Stochastic dominance; Non-parametric; Subsampling; Recentered bootstraps; Higher 23 order moments
    JEL: F18 Q4
    Date: 2006–01
  16. By: Claessens, Stijn
    Abstract: Financial intermediation and financial services industries have undergone many changes in the past two decades due to deregulation, globalization, and technological advances. The framework for regulating finance has seen many changes as well, with approaches adapting to new issues arising in specific groups of countries or globally. The objectives of this paper are twofold: to review current international thinking on what regulatory framework is needed to develop a financial sector that is stable, yet efficient, and provides proper access to households and firms; and to review the key experiences regarding international financial architecture initiatives, with a special focus on issues arising for developing countries. The paper outlines a number of areas of current debate: the special role of banks, competition policy, consumer protection, harmonization of rules-across products, within markets, and globally-and the adaptation and legitimacy of international standards to the circumstances facing developing countries. It concludes with some areas where more research would be useful.
    Keywords: Banks & Banking Reform,Financial Intermediation,Non Bank Financial Institutions,Economic Theory & Research,ICT Policy and Strategies
    Date: 2006–12–01

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