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on Risk Management |
| By: | Kwamie Dunbar (University of Connecticut, Stamford, and Sacread Heart University); Albert J. Edwards (Northeast Utilities Service Company) |
| Abstract: | In this paper, we extend the debate concerning Credit Default Swap valuation to include time varying correlation and co-variances. Traditional multi-variate techniques treat the correlations between covariates as constant over time; however, this view is not supported by the data. Secondly, since financial data does not follow a normal distribution because of its heavy tails, modeling the data using a Generalized Linear model (GLM) incorporating copulas emerge as a more robust technique over traditional approaches. This paper also includes an empirical analysis of the regime switching dynamics of credit risk in the presence of liquidity by following the general practice of assuming that credit and market risk follow a Markov process. The study was based on Credit Default Swap data obtained from Bloomberg that spanned the period January 1st 2004 to August 08th 2006. The empirical examination of the regime switching tendencies provided quantitative support to the anecdotal view that liquidity decreases as credit quality deteriorates. The analysis also examined the joint probability distribution of the credit risk determinants across credit quality through the use of a copula function which disaggregates the behavior embedded in the marginal gamma distributions, so as to isolate the level of dependence which is captured in the copula function. The results suggest that the time varying joint correlation matrix performed far superior as compared to the constant correlation matrix; the centerpiece of linear regression models. |
| Keywords: | Credit Default Swaps, Market Liquidity, Copulas, Joint conditional distributions, Markov process, Regime Switching, Illiquidity, and Correlation. |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:uct:uconnp:2007-10&r=rmg |
| By: | Cohen, Ruben D |
| Abstract: | Implemented widely in the area of corporate finance, Hamada’s Equation enables one to separate the financial risk of a levered firm from its business risk. The relationship, which results from combining the Modigliani-Miller capital structuring theorems with the Capital Asset Pricing Model, is used extensively in practice, as well as in academia, to help determine the levered beta and, through it, the optimal capital structure of corporate firms. Despite its regular use in the industry, it is acknowledged that the equation does not incorporate the impact of default risk and, thus, credit spread - an inherent component within every levered institution. Several attempts have been made so far to correct this, but, for one reason or another, they all seem to have their faults. This, of course, presents a major setback, as there is a strong need, especially by practitioners, to have in place a solid methodology to enable them to assess a firm’s capital structure in a consistent manner. This work addresses the issue and provides a robust modification to Hamada’s Equation, which achieves this consistency. |
| Keywords: | corporate finance; capital structure; optimal leverage; debt; equity; Modigliani-Miller; Hamada's Equation; beta |
| JEL: | G30 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:3190&r=rmg |
| By: | Groh, Alexander P. (IESE Business School); Baule, Rainer (University of Goettingen); Gottschalg, Oliver (HEC School of Management) |
| Abstract: | We use a CCA model to calculate implied idiosyncratic risks of LBO transactions. A decisive model feature is the consideration of amortization. From the model, the asset value volatility and the equity value volatility can be derived via a numerical procedure. For a sample of 40 LBO transactions we determine the necessary model parameters and calculate the transactions' implied idiosyncratic risks. We discuss the expected model sensitivities and verify them by variation of the input parameters. With the knowledge of the returns to the equity investors of the LBOs we are able to calculate Sharpe Ratios on individual transaction levels for the first time, thereby fully incorporating the superimposed leverage risks. |
| Keywords: | Idiosyncratic Risk; Private Equity; Benchmarking; |
| JEL: | G13 G24 G32 |
| Date: | 2007–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0682&r=rmg |
| By: | Eckhard Platen (School of Finance and Economics, University of Technology, Sydney); Renata Sidorowicz (School of Finance and Economics, University of Technology, Sydney) |
| Abstract: | The aim of this paper is to document some empirical facts related to log-returns of diversified world stock indices when these are denominated in different currencies. Motivated by earlier results, we have obtained the estimated distribution of log-returns for a range of world stock indices over long observation periods. We expand previous studies by applying the maximum likelihood ratio test to the large class of generalized hyperbolic distributions, and investigate the log-returns of a variety of diversified world stock indices in different currency denominations. This identifies the Student-t distribution with about four degrees of freedom as the typical estimated log-return distribution of such indices. Owing to the observed high levels of significance, this result can be interpreted as a stylized empirical fact. |
| Keywords: | diversified world stock index; growth optimal portfolio; log-return distribution; Student-t distribution; generalized hyperbolic distribution; likelihood ratio test |
| JEL: | G10 G13 |
| Date: | 2007–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:rpaper:194&r=rmg |
| By: | Evans, Kevin (Cardiff Business School); Speight, Alan |
| Abstract: | Investigation of the dynamic, short-run response of exchange rate returns to the information surprise of macroeconomic announcements reveals that US macroeconomic news generates far more dramatic responses in exchange rate returns and returns volatility than news on the macroeconomic performance of other countries. Eurozone, German, French and Japanese news have very little impact. However, some UK announcements are important for the EUR-GBP rate. The reaction of exchange rate returns to news is very quick and occurs within the first five minutes of the release with very little reaction in the following fifteen minutes, thus enabling us to characterise such reactions as conditional mean return jumps. These jumps show that exchange rates are strongly linked to fundamentals in the five-minute intervals immediately following the data release. Interestingly, despite causing large responses in returns volatility, the large jumps in returns following interest rate decisions do not appear to be correlated with the informational innovation surrounding their announcement. |
| Keywords: | Intraday volatility; macroeconomic announcements; exchange rates |
| JEL: | G12 E44 E32 |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:accfin:2006/4&r=rmg |