Abaffy, J., M. Bertocchi, et al. (2007). "Pricing nondiversifiable credit risk in the corporate Eurobond market." Journal of Banking & Finance 31(8): 2233-2263.
The price of defaultable or credit-risky bonds differs from the equivalent maturity price of a risk-free bond for a well identified number of factors: the positive probability of default prior to the bond maturity, the estimated loss given default, that depends on the adopted assumption on the recovery rate for that class, see Duffie and Singleton [Duffie, D., Singleton, K.J., 1999. Modeling term structures of defaultable bonds. Rev. Financ. Stud. 12, 687-720] for several models of recovery rates, the probability that the bond issuer will migrate from the current rating class to a lower class. In this study we apply two well-known modelling approaches, due to Jarrow et al. [Jarrow, R.A., Lando, D., Turnbull, S.M., 1997. A Markov model for the term structure of credit risk spreads. Rev. Financ. Stud. 10, 481-523] and Schönbucher [Schönbucher, P.J., 2002. A tree implementation of a credit spread model for credit. J. Comput. Finance 6 (2), 175-196] to price specifically two risk sources affecting the evolution of bond prices over time: the risk to move from a current risk class to a different one over the bond residual life, and the risk associated with comovements of the credit spread curves and the risk-free term structure. The former is referred to as transition risk, the latter as correlation risk. The analysis is conducted extending appropriately to a multinomial setting the classical discrete binomial model of the term structure formulated by Black et al. [Black, F., Derman, E., Toy, W., 1990. A one-factor model of interest rates and its application to treasury bond options. Financ. Analysts J. (January/February), 33-39], applied previously by Abaffy et al. [Abaffy, J., Bertocchi, M., Dupacová, J., Moriggia, V., 2000. On generating scenarios for bond portfolios. Bull. Czech Econom. Soc. 11, 3-27, and references ibidem] and many other authors in literature. The generalised model, with transition [by Jarrow et al.] and correlation risk [by Schönbucher], is applied to a large dataset of corporate spreads to evaluate the sensitivity of the isolated risk sources on the fair price of risky bonds traded in the Eurobond market.
Abhyankar, A., D. Basu, et al. (2007). "Portfolio efficiency and discount factor bounds with conditioning information: An empirical study." Journal of Banking & Finance 31(2): 419-437.
Stochastic discount factor bounds provide a useful diagnostic tool for testing asset pricing models by specifying a lower bound on the variance of any admissible discount factor. In this paper, we provide a unified derivation of such bounds in the presence of conditioning information, which allows us to compare their theoretical and empirical properties. We find that, while the location of the [`]unconditionally efficient (UE)' bounds of [Ferson, W., Siegel, A., 2001. The efficient use of conditioning information in portfolios. Journal of Finance 56 (3), 967-982] is statistically indistinguishable from the (theoretically) optimal bounds of [Gallant, R., Hansen, L., Tauchen, G., 1990. Using conditional moments of asset payoffs to infer the volatility of intertemporal marginal rates of substitution. Journal of Econometrics 45 (1), 141-179] (GHT), the former exhibit better sampling properties. We demonstrate that the difference in sampling variability of the UE and GHT bounds is due to the different behavior of the efficient return weights underlying their construction.
Abhyankar, A. and A. Gonzalez (2009). "News and the cross-section of expected corporate bond returns." Journal of Banking & Finance 33(6): 996-1004.
We study the cross-section of expected corporate bond returns using an inter-temporal CAPM (ICAPM) with three-factors: innovations in future excess bond returns, future real interest rates and future expected inflation. Our test assets are a broad range of corporate bond market index portfolios. We find that two factors - innovations about future inflation and innovations about future real interest rates - explain the cross-section of expected corporate bond returns in our sample. Our model provides an alternative to the ad hoc risk factor models used, for example, in evaluating the performance of bond mutual funds.
Ackert, L. F. and G. Athanassakos (2005). "The relationship between short interest and stock returns in the Canadian market." Journal of Banking & Finance 29(7): 1729-1749.
This paper provides new insight into the relationship between short sales and stock market returns using a sample of stocks sold short in Canada. Short interest is defined in relation to trading volume. The results strongly support the assertion that short sales and excess returns are contemporaneously negatively correlated in Canada. The paper further finds that excess returns are more negative for small firms because the supply of shortable shares is constrained for these firms. Excess returns are less negative for stocks with associated options and convertible bonds. Importantly, the evidence is consistent with the proposition that informed traders short sell Canadian interlisted stocks in Canada, rather than the US, to exploit lower execution costs. Together the results suggest that less restrictive regulation of short sales will improve the efficiency of markets.
Adam, A., M. Houkari, et al. (2008). "Spectral risk measures and portfolio selection." Journal of Banking & Finance 32(9): 1870-1882.
This paper deals with risk measurement and portfolio optimization under risk constraints. Firstly we give an overview of risk assessment from the viewpoint of risk theory, focusing on moment-based, distortion and spectral risk measures. We subsequently apply these ideas to an asset management framework using a database of hedge funds returns chosen for their non-Gaussian features. We deal with the problem of portfolio optimization under risk constraints and lead a comparative analysis of efficient portfolios. We show some robustness of optimal portfolios with respect to the choice of risk measure. Unsurprisingly, risk measures that emphasize large losses lead to slightly more diversified portfolios. However, risk measures that account primarily for worst case scenarios overweight funds with smaller tails which mitigates the relevance of diversification.
Adams, J. C. and S. A. Mansi (2009). "CEO turnover and bondholder wealth." Journal of Banking & Finance 33(3): 522-533.
We examine the impact of CEO turnover announcements on bondholder wealth, stockholder wealth, and overall firm value. Using publicly traded data for the period from 1973 to 2000, we find evidence consistent with both the wealth transfer and signaling hypotheses. Specifically, we find that CEO turnover events are associated with lower bondholder values, higher stockholder values, and that net changes in firm value are a function of turnover type (forced vs voluntary and outside vs inside firm replacements) and the riskiness of the firm's debt (investment vs non-investment grade). Overall, the results contribute to the understanding of the effects of corporate governance mechanisms, of which CEO turnover is an extreme form, on bondholders.
Adams, M., P. Hardwick, et al. (2008). "Reinsurance and corporate taxation in the United Kingdom life insurance industry." Journal of Banking & Finance 32(1): 101-115.
There are two main tax-related arguments regarding the use of reinsurance - the income volatility reduction and the income level enhancement arguments. The income volatility reduction argument contends that firms facing convex tax schedules have incentives to hedge in order to reduce the volatility of their annual taxable income and thereby lower expected tax liabilities [Smith, C.W., Stulz, R.M., 1985. Optimal hedging policies. Journal of Financial and Quantitative Analysis 19, 127-140]. The income level enhancement argument, advanced by Adiel [Adiel, R., 1996. Reinsurance and the management of regulatory ratios and taxes in the property-casualty insurance industry. Journal of Accounting and Economics 22, 207-240], is more specific to hedging via reinsurance. This perspective holds that reinsurance enhances current reported earnings via the receipt of reinsurance commissions and so increases tax liabilities. Consequently, insurance firms with high marginal tax rates should use less reinsurance than those with low marginal tax rates if tax matters. Prior studies using data on financial derivatives have produced mixed results on the validity of the first argument, while Adiel (1996) finds the second argument insignificant in his study of the use of reinsurance by a sample of United States (US) property-liability insurance firms. This study tests the two tax-related arguments using 1992-2001 data for a sample of United Kingdom (UK) life insurance firms. We find that UK life insurers with low before-planning marginal tax rates tend to use more reinsurance; in contrast, tax convexity is found to have no significant impact on the purchase of reinsurance and so the volatility-reduction argument is not supported.
Adesi, G. B. (2005). "Introduction." Journal of Banking & Finance 29(4): 801-802.
Agarwal, V. and R. Taffler (2008). "Comparing the performance of market-based and accounting-based bankruptcy prediction models." Journal of Banking & Finance 32(8): 1541-1551.
Recently developed corporate bankruptcy prediction models adopt a contingent claims valuation approach. However, despite their theoretical appeal, tests of their performance compared with traditional simple accounting-ratio-based approaches are limited in the literature. We find the two approaches capture different aspects of bankruptcy risk, and while there is little difference in their predictive ability in the UK, the z-score approach leads to significantly greater bank profitability in conditions of differential decision error costs and competitive pricing regime.
Agca, S. and A. Mozumdar (2008). "The impact of capital market imperfections on investment-cash flow sensitivity." Journal of Banking & Finance 32(2): 207-216.
We examine the investment-cash flow sensitivity of US manufacturing firms in relation to five factors associated with capital market imperfections - fund flows, institutional ownership, analyst following, bond ratings, and an index of antitakeover amendments. We find a steady decline in the estimated sensitivity over time. Furthermore, we find that investment-cash flow sensitivity decreases with increasing fund flows, institutional ownership, analyst following, antitakeover amendments and with the existence of a bond rating. The overall evidence suggests that investment-cash flow sensitivity decreases with factors that reduce capital market imperfections.
Aggarwal, R., S. Dahiya, et al. (2007). "ADR holdings of US-based emerging market funds." Journal of Banking & Finance 31(6): 1649-1667.
What motivates investors to hold American Depositary Receipts (ADRs) rather than the underlying stock of US listed foreign firms? We analyze the investment allocation decision of actively-managed emerging market mutual fund managers. Although legal provisions are typically assumed to affect ADR and its underlying domestic shares equally, investors holding ADRs may have a higher level of legal protection as these securities are issued and traded in the US. We find that ADRs are the preferred mode of holdings if the local market of the issuer has weak investor protection, low liquidity and high transaction costs.
Aggarwal, R. and J. W. Goodell "Markets and institutions in financial intermediation: National characteristics as determinants." Journal of Banking & Finance In Press, Corrected Proof.
Given the importance of financial intermediation and the rise of globalization, there is little prior research on how national preferences for financial intermediation (markets versus institutions) are determined by cultural, legal, and other national characteristics. Using panel analysis for data on a recent 8-year period for 30 countries, this paper documents that national preferences for market financing increase with political stability, societal openness, economic inequality, and equity market concentration, and decreases with regulatory quality and ambiguity aversion. We confirm with robustness tests that our result for regulatory quality is independent of differences in national wealth and that our result for political stability is independent of both wealth and political legitimacy. These results should be of much interest to managers, scholars, regulators, and policy makers.
Aggarwal, R., L. Klapper, et al. (2005). "Portfolio preferences of foreign institutional investors." Journal of Banking & Finance 29(12): 2919-2946.
This paper examines the investment allocation choices of actively-managed US mutual funds in emerging market equities after the market crises of the 1990s. We analyze both country- and firm-level disclosure and institutional policies that influence mutual funds' allocation choices relative to major stock market indices. At the country level, we find that US funds invest more in open emerging markets with stronger accounting standards, shareholder rights, and legal frameworks. At the firm level, US funds are found to invest more in firms that adopt discretionary policies such as greater accounting transparency and the issuance of an ADR. Our results suggest that steps can be taken both at the country and the firm level to create an environment conducive to foreign institutional investment.
Agusman, A., G. S. Monroe, et al. (2008). "Accounting and capital market measures of risk: Evidence from Asian banks during 1998-2003." Journal of Banking & Finance 32(4): 480-488.
This study examines the relation between accounting and capital market risk measures for a sample of 46 listed Asian banks during the period 1998-2003. By applying a panel data analysis that includes a control for country-specific factors, the results show that the standard deviation of the return-on-assets and loan-loss-reserves-to-gross-loans are significantly related to total risk. Also gross-loans-to-total-assets and loan-loss-reserves-to-gross-loans are significantly related to non-systematic risk. These results indicate that in these Asian countries, firm-specific risk is more important than systematic risk and the results are robust even though significant differences exist across Asian countries in banking activities, capital adequacy requirements, and deposit insurance protection.
Ahn, H.-J., J. Cai, et al. (2005). "Adverse selection, brokerage coverage, and trading activity on the Tokyo Stock Exchange." Journal of Banking & Finance 29(6): 1483-1508.
Limit-order trading mechanisms, corporate ownership structure, and incentive structures in the Japanese brokerage industry differ from those in the US in several important ways. This paper exploits these differences to examine the joint and cross-sectional determinants of adverse selection costs, brokerage coverage, and trading activity for a large sample of Japanese firms traded on the Tokyo Stock Exchange. We find that adverse selection costs are associated with firm characteristics but not with ownership characteristics, which implies that adverse selection costs are affected by inside trading rather than inside holdings. We also find that while brokerage coverage reduces adverse selection costs, higher adverse selection costs lead more brokerage firms to enter the market because of the greater profit potential. Finally, we find that causality also runs both ways between brokerage coverage and trading volume: brokerage coverage increases trading volume and trading volume increases brokerage coverage.
Ahn, S. and W. Choi (2009). "The role of bank monitoring in corporate governance: Evidence from borrowers' earnings management behavior." Journal of Banking & Finance 33(2): 425-434.
In this paper, we examine the corporate governance role of banks by investigating the effect of bank monitoring on the borrowers' earnings management behavior. Our analyses suggest that a borrowing firm's earnings management behavior generally decreases as the strength of bank monitoring increases. The strength of bank monitoring is measured as (1) the magnitude of a bank loan, (2) the reputation (rank) of a lead bank, (3) the length of a bank loan, and (4) the number of lenders. These results imply that bank monitoring plays an important role in the corporate governance of bank-dependent firms. We further examine other bank loan characteristics (collateral, refinancing, loan types, and loan purposes) and their effects on borrowers' earnings management behavior. Our analyses show that collateral and loan types are significantly associated with borrowers' earnings management behavior while refinancing and loan purposes have no association.
AitSahlia, F. (2007). "Editorial." Journal of Banking & Finance 31(11): v-vi.
Aivazian, V. A., Y. Ge, et al. (2005). "Corporate governance and manager turnover: An unusual social experiment." Journal of Banking & Finance 29(6): 1459-1481.
This paper examines empirically the quality of the governance mechanisms of Chinese state-owned enterprises from 1994-1999, a period marked by substantial changes in policies affecting the governance structure of these firms. It shows that the restructuring of these enterprises according to corporate law improved the effectiveness of their governance system. Specifically, restructuring strengthened the links between manager turnover and firm performance. The results indicate that firm performance was significantly and negatively related to manager demotion for incorporated state-owned enterprises, while this relationship was insignificant for unincorporated enterprises. They also indicate that manager turnover was a viable incentive mechanism for improving future enterprise performance.
Akhigbe, A. and A. D. Martin (2006). "Valuation impact of Sarbanes-Oxley: Evidence from disclosure and governance within the financial services industry." Journal of Banking & Finance 30(3): 989-1006.
The Sarbanes-Oxley (Sarbox) legislation aimed to reduce the opacity of financial statements and improve the integrity of financial reporting by enhancing corporate disclosure and governance practices. We estimate the valuation effects of Sarbox for firms in the financial services industry and find that, except for securities firms, these firms significantly benefited from its adoption. As hypothesized, these positive effects may be attributed to expected improvement in the transparency of the relatively opaque financial services firms. We find that the cross-sectional variation in the valuation effects can be explained by disclosure and governance characteristics. Several of the significant factors are supportive of a compliance cost hypothesis. In particular, we find that the effects were less favorable for firms with less independent audit committees, without a financial expert on the audit committee, with less financial statement footnote disclosures, with less involved CEOs, and if they were smaller. In addition, reflecting the value of stronger governance, more favorable effects occurred for firms with a greater degree of independence of the board and the board committees, when there is greater motivation and ability of board members to monitor the firm, and with a greater degree of institutional ownership. Lastly, we find the wealth effects of firms viewed as non-compliant are significantly lower than firms viewed as compliant, and the variation across the group of non-compliant firms is explained by disclosure and governance measures.
Akhigbe, A. and A. D. Martin (2008). "Influence of disclosure and governance on risk of US financial services firms following Sarbanes-Oxley." Journal of Banking & Finance 32(10): 2124-2135.
This study finds significant changes in capital market measures of risk following the passage of Sarbanes-Oxley for US financial services firms. Shorter-term measures of risk shifts are positive, on average, and consistent with the mandatory nature of the disclosure and governance provisions. Longer-term total and unsystematic risk shifts are negative, on average, and consistent with reductions in investor uncertainty as transparency improved. We find that the changes in shorter-term and longer-term risk measures vary inversely with the strength of disclosure and governance characteristics. The financial market rewarded (punished) firms with stronger (weaker) disclosure and stronger (weaker) governance.
Akhigbe, A., A. D. Martin, et al. (2007). "Partial acquisitions, the acquisition probability hypothesis, and the abnormal returns to partial targets." Journal of Banking & Finance 31(10): 3080-3101.
The acquisition of a partial stake in a target firm has been positively linked to the likelihood that the target will be involved in a follow on full acquisition involving either the original bidder or a third party bidder. Existing studies provide only suggestive evidence of this linkage by comparing the abnormal returns to partial targets that are ultimately acquired to those that are not. Using a sample of partial acquisitions, we identify characteristics that impact the probability of a full acquisition and provide a tangible link between partial target gains and the ex ante probability of acquisition. Partial targets experience positive announcement effects, and the gains are greater for subsequently acquired targets. Partial bids initiated by corporate bidders are more likely to result in a full acquisition, and the size of the acquired stake and the level of institutional ownership are positively linked to the probability of acquisition. Further, the partial target gains are positively linked to the ex ante probability of acquisition even after controlling for any increased monitoring and discipline that the partial bidder is expected to impose. The findings are robust across various time horizons and model specifications.
Akram, Q. F. and Ø. Eitrheim (2008). "Flexible inflation targeting and financial stability: Is it enough to stabilize inflation and output?" Journal of Banking & Finance32(7): 1242-1254.
We investigate empirically whether a central bank can promote financial stability by stabilizing inflation and output, and whether additional stabilization of asset prices and credit growth would enhance financial stability in particular. We employ an econometric model of the Norwegian economy to investigate the performance of simple interest rate rules that allow a response to asset prices and credit growth, in addition to inflation and output. We find that output stabilization tends to improve financial stability. Additional stabilization of house prices, equity prices and/or credit growth enhances stability in both inflation and output, but has mixed effects on financial stability. In general, financial stability as measured by e.g., asset price volatility improves, while financial stability measured by indicators that depend directly on interest rates deteriorates, mainly because of higher interest rate volatility owing to a more active monetary policy.
Akram, Q. F., D. Rime, et al. "Does the law of one price hold in international financial markets? Evidence from tick data." Journal of Banking & Finance In Press, Corrected Proof.
This paper investigates the validity of the law of one price (LOP) in international financial markets by examining the frequency, size and duration of inter-market price differentials for borrowing and lending services ([`]one-way arbitrage'). Using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, we find that the LOP holds on average, but numerous economically significant violations of the LOP arise. The duration of these violations is high enough to make it worthwhile searching for one-way arbitrage opportunities in order to minimize borrowing costs and/or maximize earnings on given funds. We also document that such opportunities decline with the pace of the market and increase with market volatility.
Aktas, N., E. de Bodt, et al. (2008). "Legal insider trading and market efficiency." Journal of Banking & Finance 32(7): 1379-1392.
Does legal insider trading contribute to market efficiency? Using refinements proposed in the recent microstructure literature, we analyzed the information content of legal insider trading. We used data on 2110 companies subject to 59,244 aggregated daily insider trades between January 1995 and the end of September 1999. Our main finding is that, even though financial markets do not respond strongly in terms of abnormal returns to insider trading activities, the significant change in price sensitivity to relative order imbalance due to abnormal insider trades reveals that price discovery is hastened on insider trading days.
Alavi, A., P. K. Pham, et al. (2008). "Pre-IPO ownership structure and its impact on the IPO process." Journal of Banking & Finance 32(11): 2361-2375.
We investigate the impact of pre-issue ownership structure on the key decisions surrounding an IPO. We find that managerial ownership is significantly related to (1) the proportion of shares offered, (2) share allocation, and (3) direct issue-related expenses. This suggests that pre-IPO ownership by managers influences their incentive to maintain control and to lower the cost of going public. In comparison, large pre-IPO non-managerial shareholders are more concerned about exiting, and their presence tends to increase issue size and costs. Our findings indicate that differences in pre-IPO owners' incentives and bargaining power as implied by their pre-IPO shareholdings can significantly influence the IPO process.
Albanese, C. and O. X. Chen (2006). "Implied migration rates from credit barrier models." Journal of Banking & Finance 30(2): 607-626.
The risk-neutral credit migration process captures quantitative information which is relevant to the pricing theory and risk management of credit derivatives. In this article, we derive implied migration rates by means of a recently introduced credit barrier model which is calibrated on the basis of aggregate information such as credit migration rates and credit spread curves. The model is characterized by an underlying stochastic process that represents credit quality, and default events are associated to barrier crossings. The stochastic process has state dependent volatility and jumps which are estimated by using empirical migration and default rates. A risk-neutralizing drift and forward liquidity spreads are estimated to consistently match the average spread curves corresponding to all the various ratings. The implied migration rates obtained with our credit barrier model are then compared with those obtained via the Kijima-Komoribayashi model.
Alderson, M. J., B. L. Betker, et al. (2006). "Investment and financing activity following calls of convertible bonds." Journal of Banking & Finance 30(3): 895-914.
The staged financing hypothesis of Mayers [Mayers, D., 1998. Why firms issue convertible bonds: The matching of financial and real investment options. Journal of Financial Economics 47, 83-102] predicts that investment and financing activity will increase following in the money convertible bond calls. The prediction for out of the money convertible calls is different: no increase is expected. We study the rate of both corporate investment and external financing around forced conversions using benchmarks that are analogous to those recommended by Barber and Lyon [Barber, B., Lyon, J., 1996. Detecting abnormal operating performance: The empirical power and specification of test statistics. Journal of Financial Economics 41, 359-400]. We also examine the cross-section of changes in investment and financing activity. Conversion-forcing firms exhibit an increase in both capital expenditures and debt financing around the year of the convertible bond call; however, the same result holds for the sample firms that conducted out-of-the-money convertible calls. Further, there is no relation between changes in investment activity and changes in debt issuance at the firm level. The evidence is inconsistent with the notion that forced conversions serve as a catalyst for staged financing and investment.
Alessandrini, P., G. Calcagnini, et al. (2008). "Asset restructuring strategies in bank acquisitions: Does distance between dealing partners matter?" Journal of Banking & Finance 32(5): 699-713.
One of the most lively-debated effects of banking acquisitions is the change in lending and asset allocation of the target bank in favour of transaction-based products, at the expense of small and informationally opaque borrowers. These changes may be the result of two distinct restructuring strategies pursued by the acquirer with respect to the asset portfolio of the acquired bank: a cleaning strategy (CS), in which the acquirer makes a clean sweep of all the negative net present value activities in the portfolio of the acquired bank, and a portfolio strategy (PS), in which the acquiring bank permanently changes the portfolio allocation of the acquired bank. In this paper we focus on Italian bank acquisitions and test which asset restructuring strategy was predominantly pursued over the period 1997-2003. Moreover, we distinguish acquisitions according to their geographic diversifying character and to the physical and cultural distances that separate acquiring from acquired banks. When we look at the mean value, we do not find clear evidence of a primacy either of CSs or PSs. When we separate in-market from out-of-market bank acquisitions, however, results show that the CSs prevail only in the former type of deals, while in the latter the portfolio of acquired banks is subject to PSs. Finally, we find that differences in asset restructuring strategies can be explained by differences in corporate culture and the workplace environment of the dealing partners.
Alexander, C. and A. Barbosa (2008). "Hedging index exchange traded funds." Journal of Banking & Finance 32(2): 326-337.
This paper presents an empirical comparison of the out of sample hedging performance from naïve and minimum variance hedge ratios for the four largest US index exchange traded funds (ETFs). Efficient hedging is important to offset long and short positions on market maker's accounts, particularly imbalances in net creation or redemption demands around the time of dividend payments. Our evaluation of out of sample hedging performance includes aversion to negative skewness and excess kurtosis. The results should be of interest to hedge funds employing tax arbitrage or leveraged long-short equity strategies as well as to ETF market makers.
Alexander, C. and A. Kaeck (2008). "Regime dependent determinants of credit default swap spreads." Journal of Banking & Finance 32(6): 1008-1021.
Credit default swap (CDS) spreads display pronounced regime specific behaviour. A Markov switching model of the determinants of changes in the iTraxx Europe indices demonstrates that they are extremely sensitive to stock volatility during periods of CDS market turbulence. But in ordinary market circumstances CDS spreads are more sensitive to stock returns than they are to stock volatility. Equity hedge ratios are three or four times larger during the turbulent period, which explains why previous research on single-regime models finds stock positions to be ineffective hedges for default swaps. Interest rate movements do not affect the financial sector iTraxx indices and they only have a significant effect on the other indices when the spreads are not excessively volatile. Raising interest rates may decrease the probability of credit spreads entering a volatile period.
Alexander, C. and L. M. Nogueira (2007). "Model-free hedge ratios and scale-invariant models." Journal of Banking & Finance 31(6): 1839-1861.
A price process is scale-invariant if and only if the returns distribution is independent of the price measurement scale. We show that most stochastic processes used for pricing options on financial assets have this property and that many models not previously recognised as scale-invariant are indeed so. We also prove that price hedge ratios for a wide class of contingent claims under a wide class of pricing models are model-free. In particular, previous results on model-free price hedge ratios of vanilla options based on scale-invariant models are extended to any contingent claim with homogeneous pay-off, including complex, path-dependent options. However, model-free hedge ratios only have the minimum variance property in scale-invariant stochastic volatility models when price-volatility correlation is zero. In other stochastic volatility models and in scale-invariant local volatility models, model-free hedge ratios are not minimum variance ratios and our empirical results demonstrate that they are less efficient than minimum variance hedge ratios.
Alexander, C. and E. Sheedy (2008). "Developing a stress testing framework based on market risk models." Journal of Banking & Finance 32(10): 2220-2236.
The Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing portfolios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatility clustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and unconditional return distributions over different rolling estimation periods. When applied to major currency pairs using daily data spanning more than 20 years we find that stress test results should have little impact on current levels of foreign exchange regulatory capital.
Alexander, G. J. and A. M. Baptista (2006). "Portfolio selection with a drawdown constraint." Journal of Banking & Finance 30(11): 3171-3189.
When identifying optimal portfolios, practitioners often impose a drawdown constraint. This constraint is even explicit in some money management contracts such as the one recently involving Merrill Lynch' management of Unilever's pension fund. In this setting, we provide a characterization of optimal portfolios using mean-variance analysis. In the absence of a benchmark, we find that while the constraint typically decreases the optimal portfolio's standard deviation, the constrained optimal portfolio can be notably mean-variance inefficient. In the presence of a benchmark such as in the Merrill Lynch-Unilever contract, we find that the constraint increases the optimal portfolio's standard deviation and tracking error volatility. Thus, the constraint negatively affects a portfolio manager's ability to track a benchmark.
Alexander, G. J., A. M. Baptista, et al. (2007). "Mean-variance portfolio selection with [`]at-risk' constraints and discrete distributions." Journal of Banking & Finance 31(12): 3761-3781.
We examine the impact of adding either a VaR or a CVaR constraint to the mean-variance model when security returns are assumed to have a discrete distribution with finitely many jump points. Three main results are obtained. First, portfolios on the VaR-constrained boundary exhibit (K + 2)-fund separation, where K is the number of states for which the portfolios suffer losses equal to the VaR bound. Second, portfolios on the CVaR-constrained boundary exhibit (K + 3)-fund separation, where K is the number of states for which the portfolios suffer losses equal to their VaRs. Third, an example illustrates that while the VaR of the CVaR-constrained optimal portfolio is close to that of the VaR-constrained optimal portfolio, the CVaR of the former is notably smaller than that of the latter. This result suggests that a CVaR constraint is more effective than a VaR constraint to curtail large losses in the mean-variance model.
Alexander, S., T. F. Coleman, et al. (2006). "Minimizing CVaR and VaR for a portfolio of derivatives." Journal of Banking & Finance 30(2): 583-605.
Value at risk (VaR) and conditional value at risk (CVaR) are frequently used as risk measures in risk management. Compared to VaR, CVaR is attractive since it is a coherent risk measure. We analyze the problem of computing the optimal VaR and CVaR portfolios. We illustrate that VaR and CVaR minimization problems for derivatives portfolios are typically ill-posed. We propose to include cost as an additional preference criterion for the CVaR optimization problem. We demonstrate that, with the addition of a proportional cost, it is possible to compute an optimal CVaR derivative investment portfolio with significantly fewer instruments and comparable CVaR and VaR. A computational method based on a smoothing technique is proposed to solve a simulation based CVaR optimization problem efficiently. Comparison is made with the linear programming approach for solving the simulation based CVaR optimization problem.
Alizadeh, A. H., N. K. Nomikos, et al. (2008). "A Markov regime switching approach for hedging energy commodities." Journal of Banking & Finance 32(9): 1970-1983.
This paper estimates constant and dynamic hedge ratios in the New York Mercantile Exchange oil futures markets and examines their hedging performance. We also introduce a Markov regime switching vector error correction model with GARCH error structure. This specification links the concept of disequilibrium with that of uncertainty (as measured by the conditional second moments) across high and low volatility regimes. Overall, in and out-of-sample tests indicate that state dependent hedge ratios are able to provide significant reduction in portfolio risk.
Allen, L. and T. G. Bali (2007). "Cyclicality in catastrophic and operational risk measurements." Journal of Banking & Finance 31(4): 1191-1235.
Using equity returns for financial institutions we estimate both catastrophic and operational risk measures over the period 1973-2003. We find evidence of cyclical components in both the catastrophic and operational risk measures obtained from the generalized Pareto distribution and the skewed generalized error distribution. Our new, comprehensive approach to measuring operational risk shows that approximately 18% of financial institutions' returns represent compensation for operational risk. However, depository institutions are exposed to operational risk levels that average 39% of the overall equity risk premium. Moreover, operational risk events are more likely to be the cause of large unexpected catastrophic losses, although when they occur, the losses are smaller than those resulting from a combination of market risk, credit risk or other risk events.
Allen, L. and S. Peristiani (2007). "Loan underpricing and the provision of merger advisory services." Journal of Banking & Finance 31(12): 3539-3562.
This paper investigates the primary and secondary syndicated bank loan market to analyze the effect on pricing when the financial institution commingles syndicated lending with merger advisory services. In particular, we investigate the connection between the acquirer's choice of financial advisor in a merger and future financing commitments. We find evidence of underpricing of syndicated bank loans in both the primary and secondary market. In the primary market, we show that non-acquisition loans granted by merger advisors to acquiring firms after the merger announcement date are charged a lower all-in-spread relative to acquisition loans if there has been a prior lending relationship. Consistent with this finding, we find that syndicated bank loans for non-acquisition purposes arranged by the acquirer's advisor after the merger announcement date trade in the secondary market at a significant discount. Since the terms on these non-acquisition loans are not set upon merger announcement, they are most subject to risk shifting and underpricing agency problems. These findings offer evidence consistent with the existence of loss leader and potentially conflicted loans (priced at below-market terms) that are offered by the acquirer's relationship bank advisor in order to win merger advisory business.
Allen, L. and A. Rai (2007). "Bricks versus Clicks: The changing nature of banking in the 21st century." Journal of Banking & Finance 31(4): 999-1001.
Almeida, C. and J. Vicente (2008). "The role of no-arbitrage on forecasting: Lessons from a parametric term structure model." Journal of Banking & Finance 32(12): 2695-2705.
Parametric term structure models have been successfully applied to numerous problems in fixed income markets, including pricing, hedging, managing risk, as well as to the study of monetary policy implications. In turn, dynamic term structure models, equipped with stronger economic structure, have been mainly adopted to price derivatives and explain empirical stylized facts. In this paper, we combine flavors of those two classes of models to test whether no-arbitrage affects forecasting. We construct cross-sectional (allowing arbitrages) and arbitrage-free versions of a parametric polynomial model to analyze how well they predict out-of-sample interest rates. Based on US Treasury yield data, we find that no-arbitrage restrictions significantly improve forecasts. Arbitrage-free versions achieve overall smaller biases and root mean square errors for most maturities and forecasting horizons. Furthermore, a decomposition of forecasts into forward-rates and holding return premia indicates that the superior performance of no-arbitrage versions is due to a better identification of bond risk premium.
Almeida, C. and J. Vicente (2009). "Are interest rate options important for the assessment of interest rate risk?" Journal of Banking & Finance 33(8): 1376-1387.
Fixed income options contain substantial information on the price of interest rate volatility risk. In this paper, we ask if those options will also provide information related to other moments of the objective distribution of interest rates. Based on dynamic term structure models within the class of affine models, we find that interest rate options are useful for the identification of interest rate quantiles. Two three-factor models are adopted and their adequacy to estimate Value at Risk of zero-coupon bonds is tested. We find significant difference on the quantitative assessment of risk when options are (or not) included in the estimation process of each of these dynamic models. Statistical backtests indicate that bond estimated risk is clearly more adequate when options are adopted, although not yet completely satisfactory.
Almeida, C. and J. Vicente (2009). "Identifying volatility risk premia from fixed income Asian options." Journal of Banking & Finance 33(4): 652-661.
Fixed income options are frequently adopted by companies to hedge interest rate risk. Their payoff dependence on the cumulative short-term rate makes them particularly informative about interest rate volatility risk. Based on a joint dataset of bonds and Asian interest rate options, we study the interrelations between bond and volatility risk premia in a major emerging fixed income market. We propose a dynamic term structure model that generates an incomplete market compatible with a preliminary empirical analysis of the dataset. Approximation formulas for at-the-money Asian option prices avoid the use of computationally intensive Fourier transform methods, allowing for an efficient implementation of the model. The model generates a bond risk premium strongly correlated with a widely accepted emerging market benchmark index (EMBI-Global), and a negative volatility risk premium, consistent with the use of Asian options as insurance in this market.
Al-Muharrami, S., K. Matthews, et al. (2006). "Market structure and competitive conditions in the Arab GCC banking system." Journal of Banking & Finance30(12): 3487-3501.
This paper investigates the market structure of Arab GCC banking industry during the years of 1993-2002 using the most frequently applied measures of concentration k-bank concentration ratio (CRk) and Herfindahl-Hirschman Index (HHI) and evaluates the monopoly power of banks over the ten years period using the [`]H-statistic' by Panzar and Rosse. The results show that Kuwait, Saudi Arabia and UAE have moderately concentrated markets and are moving to less concentrated positions. The measures of concentration also show that Qatar, Bahrain and Oman are highly concentrated markets. The Panzar-Rosse H-statistics suggest that banks in Kuwait, Saudi Arabia and the UAE operate under perfect competition; banks in Bahrain and Qatar operate under conditions of monopolistic competition; and we are unable to reject monopolistic competition for the banking market in Oman.
Andersson, M. and M. Lomakka (2005). "Evaluating implied RNDs by some new confidence interval estimation techniques." Journal of Banking & Finance 29(6): 1535-1557.
This paper evaluates the precision of the parametric double lognormal and the non-parametric smoothing spline method for estimating risk-neutral distributions (RNDs) from observed option prices. By using a bootstrap technique, confidence bands are estimated for the risk-neutral distributions and the width of the confidence bands is used as a criterion when evaluating the precision of the two methods. Previous literature on estimating confidence bands has to a large extent been estimated using Monte Carlo methods. This paper argues that the bootstrap technique is to be preferred due to the non-normality feature of the error structure. Furthermore, it is shown that the inclusion of a heteroscedastic error structure improves the precision of the estimated RNDs. Our findings favour the smoothing spline method as it produces tighter confidence bands. In addition, an example of how to apply the estimated confidence bands in practice is also provided.
Andres, P. d. and E. Vallelado (2008). "Corporate governance in banking: The role of the board of directors." Journal of Banking & Finance 32(12): 2570-2580.
We use a sample of large international commercial banks to test hypotheses on the dual role of boards of directors. We use a suitable econometric model (two step system estimator) to solve the well-known endogeneity problem in corporate governance literature, and demonstrate the empirical and theoretical superiority of system estimator over OLS and within estimators. We find an inverted U-shaped relation between bank performance and board size, and between the proportion of non-executive directors and performance. Our results show that bank board composition and size are related to directors' ability to monitor and advise management, and that larger and not excessively independent boards might prove more efficient in monitoring and advising functions, and create more value. All of these relations hold after we control for the measure of performance, the weight of the banking industry in each country, bank ownership, and regulatory and institutional differences.
Andrikopoulos, A. (2009). "Irreversible investment, managerial discretion and optimal capital structure." Journal of Banking & Finance 33(4): 709-718.
We explore the significance of employee compensation and alternative (reservation) income on investment timing, endogenous default, yield spreads and capital structure. In a real-options setting, a manager's incentive to under(over)invest in a project is associated to labor income he has to forego in order to work on the project, the manager's salary, his stake on the project's equity capital and his subsequent income, should he decide to terminate operations. We find that the optimal level of coupon payments decreases with managerial salary and ownership stake while it is increasing in the manager's reservation income. Yield spreads (optimal leverage ratios) are increasing (decreasing) in the manager's salary and ownership stake, while they are decreasing (increasing) in the manager's reservation income. Exploring agency costs of debt as deviations from a value-maximizing investment policy, we document a U-shaped relationship between agency costs of debt and the managerial compensation parameters: the manager's reservation income, salary and ownership share.
Angelelli, E., R. Mansini, et al. (2008). "A comparison of MAD and CVaR models with real features." Journal of Banking & Finance 32(7): 1188-1197.
In this paper we consider two different mixed integer linear programming models for solving the single period portfolio selection problem when integer stock units, transaction costs and a cardinality constraint are taken into account. The first model has been formulated by using the maximization of the worst conditional expectation as objective function. The second model is based on the maximization of the safety measure corresponding to the mean absolute deviation. Extensive computational results are provided to compare the financial characteristics of the optimal portfolios selected by the two models on real data from European stock exchange markets. Some simple heuristics are also introduced that provide efficient and effective solutions when an optimal integer solution cannot be found in a reasonable amount of time.
Annaert, J., M. J. K. De Ceuster, et al. (2005). "The value of asset allocation advice: Evidence from The Economist's quarterly portfolio poll." Journal of Banking & Finance 29(3): 661-680.
This study analyzes the economic importance of portfolio advice for an investor with an international and multiple-asset investment strategy. We construct portfolios based upon the asset allocation and security market advice of major international investment bankers and analyze the performance using weight-based techniques. Our results indicate that portfolio advisers are not able to outperform passive benchmarks. They do not realize superior performance either through appropriate timing or selection skills. Apparent market timing skills as measured by the Portfolio Change Measure are to a large extent an artifact caused by serial correlation in the return indices used. Likewise, the apparent short-run performance persistence is more due to the serial correlation in returns than to active portfolio selection strategies.
Annaert, J., S. V. Osselaer, et al. (2009). "Performance evaluation of portfolio insurance strategies using stochastic dominance criteria." Journal of Banking & Finance 33(2): 272-280.
This paper evaluates the performance of the stop-loss, synthetic put and constant proportion portfolio insurance techniques based on a block-bootstrap simulation. We consider not only traditional performance measures, but also some recently developed measures that capture the non-normality of the return distribution (value-at-risk, expected shortfall, and the Omega measure). We compare them to the more comprehensive stochastic dominance criteria. The impact of changing the rebalancing frequency and level of capital protection is examined. We find that, even though a buy-and-hold strategy generates higher average excess returns, it does not stochastically dominate the portfolio insurance strategies, nor vice versa. Our results indicate that a 100% floor value should be preferred to lower floor values and that daily-rebalanced synthetic put and CPPI strategies dominate their counterparts with less frequent rebalancing.
Antell, J. and M. Vaihekoski (2007). "International asset pricing models and currency risk: Evidence from Finland 1970-2004." Journal of Banking & Finance 31(9): 2571-2590.
In this paper we investigate whether global, local and currency risks are priced in the Finnish stock market using conditional international asset pricing models. We take the view of a US investor. The estimation is conducted using a modified version of the multivariate GARCH framework of [De Santis, G., Gérard, B., 1998. How big is the premium for currency risk? Journal of Financial Economics 49, 375-412]. For a sample period from 1970 to 2004, we find the world risk to be time-varying. While local risk is not priced for the USA, the local component is significant and time-varying for Finland. Currency risk is priced in the Finnish market, but is not time-varying using the De Santis and Gérard specification. This suggests that the linear specification for the currency risk may not be adequate for non-free floating currencies.
Antoniou, A., H. Y. T. Lam, et al. (2007). "Profitability of momentum strategies in international markets: The role of business cycle variables and behavioural biases."Journal of Banking & Finance 31(3): 955-972.
The paper investigates whether business cycle variables and behavioural biases can explain the profitability of momentum trading in three major European markets. Unlike previous studies, the paper nests both risk-based and behavioural-based variables in a two-stage model specification in an attempt to explain momentum profits. The findings show that, although momentum profitability in European markets is unexplained by conditional asset pricing models, it is attributable to asset mispricing that systematically varies with global business conditions. In addition, behavioural variables do not appear to matter much. Thus risk factors, which are undetected thus far and are largely attributable to the business cycle, could explain the momentum payoffs in European stock markets.
Arena, M. (2008). "Bank failures and bank fundamentals: A comparative analysis of Latin America and East Asia during the nineties using bank-level data." Journal of Banking & Finance 32(2): 299-310.
This paper uses bank-level data from recent banking crises in East Asia and Latin America to address the following two questions: (1) To what extent did individual bank conditions explain the failures (2) In terms of their fundamentals, was it mainly the weak banks ex ante that failed in the crisis countries The results show that for the two regions, bank-level fundamentals significantly affect the likelihood of collapse for these banks. Systemic shocks (both macroeconomic and liquidity) that triggered the crises mainly destabilized the weak banks ex ante, particularly in East Asia, which raises questions about the role that regional differences play for the degree of banking sector resilience to systemic shocks in the financial and macroeconomic environment.
Arquette, G. C., W. O. Brown Jr, et al. (2008). "US ADR and Hong Kong H-share discounts of Shanghai-listed firms." Journal of Banking & Finance 32(9): 1916-1927.
This paper examines the differential between the share prices of Chinese securities traded on their home market of Shanghai versus prices observed offshore in New York and Hong Kong. The discounts attached to Chinese securities, whether trading as ADRs on the NYSE or as H-shares on the Hong Kong market, appear to have been significantly influenced by changes in both exchange rate expectations and investor sentiment during 1998-2006. Expected exchange rate changes alone account for approximately 40% of the total variation in each case. This is combined with large cross-sectional variation, however, reflecting additional significant market-wide and company-specific sentiment effects.
Asaftei, G. (2008). "The contribution of product mix versus efficiency and technical change in US banking." Journal of Banking & Finance 32(11): 2336-2345.
Similar to a Du Pont analysis, this paper divides the changes in returns on assets of US commercial banks for the period from 2000 to 2005 into conventional measures of bank performance. The contribution of product mix is significant and offsets losses from technical change and operating efficiency. Banks respond to changes in the business environment by switching towards more lucrative traditional and nontraditional products. Large banks are found to benefit more than community banks from the switch to an optimal output portfolio mix including new products spawned by recent financial innovations and deregulation.
Ascioglu, A., S. P. Hegde, et al. (2008). "Information asymmetry and investment-cash flow sensitivity." Journal of Banking & Finance 32(6): 1036-1048.
Models of capital market imperfections predict that information asymmetry decreases firm investment and increases the sensitivity of investment expenditures to fluctuations in internal funds. Previous empirical tests of the link between investment and financing decisions have relied on indirect measures of financial constraint due to market frictions. In contrast, we use more direct measures derived from the market microstructure literature. Consistent with the theoretical predictions, our analysis shows that scaled investment expenditures are on average lower and the investment-cash flow sensitivity is greater when the probability of informed trading is high. Our results are robust to alternative measures of informed trading and liquidity, but they are not pervasive in our sample.
Asdrubali, P. and S. Kim (2008). "On the empirics of international smoothing." Journal of Banking & Finance 32(3): 374-381.
By fully exploiting the statistical properties of panel data, this paper improves upon existing methodologies to estimate consumption smoothing at least in three respects. First, we model explicitly incomplete risksharing as well as incomplete intertemporal smoothing, and couch the two mechanisms in a unified framework. Second, we fully exploit simple panel data analysis in order to measure degrees of both risksharing and intertemporal smoothing taking place in a given set of economic regions. In particular, we are able to measure not only the smoothing of idiosyncratic shocks, but also the dependence on aggregate (non-diversifiable) shocks. Third, we distinguish neatly between the effects of temporary vs. permanent shocks. This can be done by taking advantage of the complementarity between the "within" estimator and the "between" estimator in a panel regression. We apply the above methodology to a panel of 23 OECD countries in the period from 1955 to 2005. The main finding is consistent with the puzzle of negligible international risksharing, as domestic consumption growth - once properly analyzed - does not depend on aggregate income growth. Our analysis shows that industrial countries have tended to absorb output shocks mostly through intertemporal smoothing. About 25% of all temporary shocks are smoothed this way, while a comparable fraction of permanent shocks determine consumption growth.
Asem, E. (2009). "Dividends and price momentum." Journal of Banking & Finance 33(3): 486-494.
Stock market evidence shows that momentum profits are lower among dividend-paying firms than their non-paying counterparts due to differences in losers' returns. Additionally, dividend maintenance is associated with higher returns for losers but not for winners. Finally, buying winners that increased their dividends and shorting losers that decreased their dividends enhances momentum profits. Consistent with the evidence, the behavioral models suggest that investors underreact to the losers' positive dividend-maintaining news, reducing their return momentum and shrinking the payers' momentum profit. Also, underreaction to positive news from winners' dividend-increasing announcements as well as to negative news from losers' dividend-decreasing announcements explains the higher momentum profits for strategies based on these stocks. The results do not appear consistent with risk-based explanations.
Ashton, J. K. and R. S. Hudson (2008). "Interest rate clustering in UK financial services markets." Journal of Banking & Finance 32(7): 1393-1403.
This study forwards an explanation and empirical investigation of price clustering in retail banking markets. It is proposed that price or interest rate clustering forms in retail markets as firms wish to maximise returns from customers, some of whom have difficulties in recalling and processing price information. This theory is developed and tested using a dataset of retail interest rates from the UK which enables interest rate clustering to be viewed in both lending and investment markets, and at different levels of financial involvement. It is found that interest rate clustering occurs in a manner consistent with firms maximising returns from customers. These findings are viewed to be a key policy concern for financial regulators and firms concerned with consumer protection.
Attig, N., W.-M. Fong, et al. (2006). "Effects of large shareholding on information asymmetry and stock liquidity." Journal of Banking & Finance 30(10): 2875-2892.
Prior studies, such as Claessens et al.'s [Claessens, S., Djankov, S., Fan, J., Lang, L., 2002. Disentangling the incentive and entrenchment effects of large shareholding. Journal of Finance 57, 2741-2771], suggest that deviation between ultimate control and ownership decreases firm value (due to the entrenchment effects of large shareholding). Using a sample of Canadian firms, we study the relation of ultimate control and ownership with an important dimension of stock liquidity - bid-ask spread. We find that stocks with greater deviations between ultimate control and ownership have a larger information asymmetry component of their bid-ask spread and wider bid-ask spread. Our results are consistent with the notion that the ultimate owners of these stocks may have selfish agendas. To increase the probability of the agendas being implemented, the firms may have poor information disclosure, resulting in poor stock liquidity.
Audrino, F. and G. Barone-Adesi (2005). "Functional gradient descent for financial time series with an application to the measurement of market risk." Journal of Banking & Finance 29(4): 959-977.
The estimation and forecast of the volatility matrix are two of the main tasks of financial econometrics since they are essential ingredients in many practical applications. Unfortunately the use of classical multivariate methods in large dimensions is difficult because of the curse of dimensionality. We present a general semiparametric technique, based on functional gradient descent (FGD) and able to overcome most problems associated with a multivariate GARCH-type estimation. By testing the accuracy of the volatility estimates for the measurement of market risk on real data we provide empirical evidence of the strong predictive potential of the FGD approach, also in comparison to other standard methods.
Autore, D. M., R. S. Billingsley, et al. (2009). "Information uncertainty and auditor reputation." Journal of Banking & Finance 33(2): 183-192.
This paper explores the relationship between information uncertainty and auditor reputation revealed by the failure of Arthur Andersen (AA). AA's reputation deteriorated considerably when it announced on January 10, 2002, that it had shredded documents related to its audit of Enron. AA's demise was sealed on March 14, 2002, with its indictment for obstruction of justice. We find that on these dates the clients of AA and other Big Five auditors that are characterized by higher information uncertainty experience relatively larger share price declines compared to clients with lower information uncertainty. The findings suggest that the market relies more heavily on auditor reputation for higher information uncertainty firms, which implies that the value of an audit is greater when a firm is harder to value. Our results highlight the importance of information uncertainty in financial markets: where there is a shock to auditor reputation, firms with greater information uncertainty suffer the largest losses.
Autore, D. M., T. Kovacs, et al. (2009). "Do analyst recommendations reflect shareholder rights?" Journal of Banking & Finance 33(2): 193-202.
We examine whether sell-side analyst recommendations reflect shareholder rights. Our rationale is that analysts should be influenced by external governance only if market participants do not efficiently price its value. We find that stronger shareholder rights are associated with more favorable recommendations. Further analysis reveals that analysts favor firms with strong shareholder rights only when strong rights appear to be warranted, but do not penalize firms for having strong rights when not needed. These findings occupy middle ground in the debate on the pricing efficiency of shareholder rights. Moreover, we find that firm value is positively associated with the strength of shareholder rights regardless of the expected external governance structure. The latter result is consistent with a "one-size-fits-all" interpretation, and implies that firms across the board could increase share value by reducing their number of anti-takeover provisions.
Ayadi, M. A. and L. Kryzanowski (2005). "Portfolio performance measurement using APM-free kernel models." Journal of Banking & Finance 29(3): 623-659.
A general asset-pricing framework is used to derive a conditional asset-pricing kernel that accounts efficiently for time variation in expected returns and risk, and is suitable to perform (un)conditional evaluations of passive and dynamic investment strategies. The positive abnormal unconditional performance of Canadian equity mutual funds over the period 1989-1999 becomes negative with conditioning, and is robust to the removal of ex post index mimickers. The reversal in the size-based performance results with limited information conditioning is alleviated somewhat with an expansion of the conditioning set. The performance statistics are weakly sensitive to changes in the level of relative risk aversion of the uninformed investor. Unconditional positive performances based on averages of individual fund performances lose their significance when cross-correlations are accounted for using the block-bootstrap method. Estimates of survivorship bias due to the elimination of funds with shorter lives, which range from 36 to 58 basis points per year, are stable across performance models but differ across groupings by fund objective.
Baba, N. and F. Packer "Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper investigates the spillover effects of money market turbulence in 2007-08 on the short-term covered interest parity (CIP) condition between the US dollar and the euro through the foreign exchange (FX) swap market. Sharp and persistent deviations from the CIP condition observed during the turmoil are found to be significantly associated with differences in the counterparty risk between European and US financial institutions. Furthermore, evidence is found that US dollar term funding auctions by the ECB, supported by US dollar swap lines with the Federal Reserve, alleviated the level of dislocations, as well as the instability, of the FX swap market.
Bacidore, J. M., R. Battalio, et al. (2005). "Sources of liquidity for NYSE-listed non-US stocks." Journal of Banking & Finance 29(12): 3075-3098.
We examine the components of displayed (quoted) liquidity and the amount of non-displayed liquidity on the NYSE for a sample of non-US stocks. Consistently with prior work, non-US stocks have less displayed liquidity than similar US stocks. Extending prior research, we find that this is true both in the limit order book and on the floor. As Domowitz et al. [Domowitz, I., Glen, J., Madhavan, A., 1998. International cross-listing and order flow migration: Evidence from and emerging market. Journal of Finance 53, 2001-2027] posit, non-US stocks from transparent/linked home markets have more displayed NYSE liquidity when the home market is open but non-US stocks from opaque/non-linked home markets have more NYSE displayed liquidity when the home market is closed. Non-US and US stocks have similar supplies of non-displayed liquidity, consistent with the idea that the conditional nature of non-displayed liquidity allows NYSE traders to mitigate adverse selection problems inherent in trading non-US stocks. Our results imply that non-US stocks have less total (displayed plus non-displayed) liquidity than US stocks.
Backé, P. and C. Wójcik (2008). "Credit booms, monetary integration and the new neoclassical synthesis." Journal of Banking & Finance 32(3): 458-470.
Credit to the private sector has risen rapidly in many new Central and Eastern European EU Member States (nMS) in recent years. The lending boom has recently been particularly strong in the segment of loans to households, primarily mortgage-based housing loans, and in those countries that operate currency boards or other forms of hard pegs. The main aim of this paper is to propose a conceptual framework to analyze the observed developments with a view to exploring some policy implications at a stage in which these countries are preparing for their prospective integration with the euro area. To achieve this, we first use a stylized new neoclassical synthesis (NNS) framework, which has recently been advanced by Goodfriend [Goodfriend, M., 2002. Monetary policy in the new neoclassical synthesis: A primer, Federal Reserve Bank of Richmond, July.] and Goodfriend and King [Goodfriend, M., King, R., 2001. The case for price stability. NBER Working Paper 8423]. We then discuss the implications of the NNS model for credit dynamics and ensuing monetary policy challenges. Specifically, we emphasize consumption smoothing as an important channel of the observed credit expansion and we show how it is related to and how it affects the monetary policy making in MS. In doing so, we place our discussion in the context of the monetary integration process in general and the nominal convergence process in particular.
Baele, L., O. De Jonghe, et al. (2007). "Does the stock market value bank diversification?" Journal of Banking & Finance 31(7): 1999-2023.
This paper investigates whether or not functionally diversified banks have a comparative advantage in terms of long-term performance/risk profile compared to their specialized competitors. To that end, this study uses market-based measures of return potential and bank risk. We calculate the franchise value over time of European banks as a measure of their long-run performance potential. In addition, we measure risk as both the systematic and the idiosyncratic risk components derived from a bank stock return model. Finally, we analyze the return/risk trade-off implied in different functional diversification strategies using a panel data analysis over the period 1989-2004. A higher share of non-interest income in total income affects banks' franchise values positively. Diversification of revenue streams from distinct financial activities increases the systematic risk of banks while the effect on the idiosyncratic risk component is non-linear and predominantly downward-sloping. These findings have conflicting implications for different stakeholders, such as investors, bank shareholders, bank managers and bank supervisors.
Bagella, M., L. Becchetti, et al. (2006). "Real effective exchange rate volatility and growth: A framework to measure advantages of flexibility vs. costs of volatility."Journal of Banking & Finance 30(4): 1149-1169.
By devising a real effective exchange rate (REER) index where bilateral exchange rates are weighted for relative trade shares, we find that the REER volatility (differently from the bilateral exchange rate volatility with the dollar) has significant impact on growth of per capita income after controlling for other variables traditionally considered in conditional convergence estimates. We also find that this (cost of volatility) effect can be reconciled with the concurring negative and significant effect on growth of the adoption of a fixed exchange rate regime (advantage of flexibility effect), where the latter may be also interpreted as the cost of choosing pegged regimes without harmonization of rules and macroeconomic policies with main trading partners. The adoption of an REER volatility measure, instead of a bilateral exchange rate with the dollar, has the advantage of making it possible a joint test for these two effects. This is because, while fixed exchange rate regimes are strongly negatively correlated, and almost collinear, with bilateral exchange rate volatility with the dollar, the correlation is much weaker when considering our REER volatility measure.
Bailey, W., J. Cai, et al. (2009). "Stock returns, order imbalances, and commonality: Evidence on individual, institutional, and proprietary investors in China." Journal of Banking & Finance 33(1): 9-19.
Using a unique dataset from the Shanghai Stock Exchange, we study the relation between daily open-to-close stock returns and order imbalances, and the commonality in order imbalances across individual, institutional, and proprietary investors. We find that institutional (proprietary) order imbalances have a larger price impact, but account for a significantly smaller proportion of daily price fluctuations. Commonality is much stronger for individual, rather than institutional (proprietary), order imbalances. Institutional (proprietary) investors favor large capitalization stocks, and co-movement in institutional (proprietary) order imbalances is stronger for these stocks.
Bali, T. G., K. O. Demirtas, et al. (2008). "Nonlinear mean reversion in stock prices." Journal of Banking & Finance 32(5): 767-782.
This paper provides new evidence on the time-series predictability of stock market returns by introducing a test of nonlinear mean reversion. The performance of extreme daily returns is evaluated in terms of their power to predict short- and long-horizon returns on various stock market indices and size portfolios. The paper shows that the speed of mean reversion is significantly higher during the large falls of the market. The parameter estimates indicate a negative and significant relation between the monthly portfolio returns and the extreme daily returns observed over the past one to eight months. Specifically, in a quarter in which the minimum daily return is -2% the expected excess return is 37 basis points higher than in a month in which the minimum return is only -1%. This result holds for the value-weighted and equal-weighted stock market indices and for each of the size decile portfolios. The findings are also robust to different sample periods, different indices, and investment horizons.
Bali, T. G., S. Gokcan, et al. (2007). "Value at risk and the cross-section of hedge fund returns." Journal of Banking & Finance 31(4): 1135-1166.
Using two large hedge fund databases, this paper empirically tests the presence and significance of a cross-sectional relation between hedge fund returns and value at risk (VaR). The univariate and bivariate portfolio-level analyses as well as the fund-level regression results indicate a significantly positive relation between VaR and the cross-section of expected returns on live funds. During the period of January 1995 to December 2003, the live funds with high VaR outperform those with low VaR by an annual return difference of 9%. This risk-return tradeoff holds even after controlling for age, size, and liquidity factors. Furthermore, the risk profile of defunct funds is found to be different from that of live funds. The relation between downside risk and expected return is found to be negative for defunct funds because taking high risk by these funds can wipe out fund capital, and hence they become defunct. Meanwhile, voluntary closure makes some well performed funds with large assets and low risk fall into the defunct category. Hence, the risk-return relation for defunct funds is more complicated than what implies by survival. We demonstrate how to distinguish live funds from defunct funds on an ex ante basis. A trading rule based on buying the expected to live funds and selling the expected to disappear funds provides an annual profit of 8-10% depending on the investment horizons.
Bali, T. G., H. Mo, et al. (2008). "The role of autoregressive conditional skewness and kurtosis in the estimation of conditional VaR." Journal of Banking & Finance32(2): 269-282.
This paper investigates the role of high-order moments in the estimation of conditional value at risk (VaR). We use the skewed generalized t distribution (SGT) with time-varying parameters to provide an accurate characterization of the tails of the standardized return distribution. We allow the high-order moments of the SGT density to depend on the past information set, and hence relax the conventional assumption in conditional VaR calculation that the distribution of standardized returns is iid. The maximum likelihood estimates show that the time-varying conditional volatility, skewness, tail-thickness, and peakedness parameters of the SGT density are statistically significant. The in-sample and out-of-sample performance results indicate that the conditional SGT-GARCH approach with autoregressive conditional skewness and kurtosis provides very accurate and robust estimates of the actual VaR thresholds.
Bali, T. G. and L. Wu (2006). "A comprehensive analysis of the short-term interest-rate dynamics." Journal of Banking & Finance 30(4): 1269-1290.
This paper provides a comprehensive analysis of the short-term interest-rate dynamics based on three different data sets and two flexible parametric specifications. The significance of nonlinearity in the short-rate drift declines with increasing maturity for the interest-rate series used in the study. Using a flexible diffusion specification and incorporating GARCH volatility and non-normal innovation reduce the need for a nonlinear drift specification. Finally, the nonlinear drift specification performs better than the linear drift specification only when the short-term interest-rate levels reach historical highs.
Ballestra, L. V., G. Pacelli, et al. (2007). "A numerical method to price exotic path-dependent options on an underlying described by the Heston stochastic volatility model." Journal of Banking & Finance 31(11): 3420-3437.
We consider the problem of pricing European exotic path-dependent derivatives on an underlying described by the Heston stochastic volatility model. Lipton has found a closed form integral representation of the joint transition probability density function of underlying price and variance in the Heston model. We give a convenient numerical approximation of this formula and we use the obtained approximated transition probability density function to price discrete path-dependent options as discounted expectations. The expected value of the payoff is calculated evaluating an integral with the Monte Carlo method using a variance reduction technique based on a suitable approximation of the transition probability density function of the Heston model. As a test case, we evaluate the price of a discrete arithmetic average Asian option, when the average over n = 12 prices is considered, that is when the integral to evaluate is a 2n = 24 dimensional integral. We show that the method proposed is computationally efficient and gives accurate results.
Balvers, R. J. and D. Huang (2009). "Evaluation of linear asset pricing models by implied portfolio performance." Journal of Banking & Finance 33(9): 1586-1596.
We present a theoretical perspective that motivates the use of the Generalized Least Squares R-Square, prominently advocated by Lewellen et al. [Lewellen, J., Nagel, S., Shanken, J., forthcoming. A skeptical appraisal of asset-pricing tests. Journal of Financial Economics], as an evaluation measure for multivariate linear asset pricing models. Adapting results from Shanken [Shanken, J., 1985. Multivariate tests of the zero-beta CAPM. Journal of Financial Economics 14, 327-348] and Kandel and Stambaugh [Kandel, S., Stambaugh, R.F., 1995. Portfolio inefficiency and the cross-section of expected returns. Journal of Finance 50, 157-184], we provide various interpretations and a graphical account in mean-variance space of this measure, facilitating a better understanding of its properties. We furthermore relate it to another leading evaluation metric, the HJ-distance of Hansen and Jagannathan [Hansen, L.P., Jagannathan, R., 1997. Assessing specification errors in stochastic discount factor models. Journal of Finance 52, 557-590]. Additionally, we present a comparison between these evaluation measures using mean-variance mathematics in risk-return space, and we provide a simple formula for calculating both model evaluation measures that involves only the parameters of the mean-variance asset and factor frontiers.
Banerjee, P. S., J. S. Doran, et al. (2007). "Implied volatility and future portfolio returns." Journal of Banking & Finance 31(10): 3183-3199.
Prior studies find that the CBOE volatility index (VIX) predicts returns on stock market indices, suggesting implied volatilities measured by VIX are a risk factor affecting security returns or an indicator of market inefficiency. We extend prior work in three important ways. First, we investigate the relationship between future returns and current implied volatility levels and innovations. Second, we examine portfolios sorted on book-to-market equity, size, and beta. Third, we control for the four Fama and French [Fama, E., French, K., 1993. Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3-56.] and Carhart [Carhart, M., 1997. On persistence in mutual fund performance. Journal of Finance, 52, 57-82.] factors. We find that VIX-related variables have strong predictive ability.
Banerji, S. and V. R. Errunza (2005). "Privatization under incomplete information and bankruptcy risk." Journal of Banking & Finance 29(3): 735-757.
We study privatization under moral hazard and adverse selection. We show that if the fraction of efficient investors is either insignificant or productivity differences between efficient and inefficient investors are negligible, the government would offer a pooling contract and sell the same fraction of equity to both types of investors. The lower the productivity difference, the greater the equity stake offered to investors. On the other hand, if the fraction of efficient investors is significant or productivity differentials are large, the optimal policy consists of a dual method of privatization in which it offers two methods of privatization to outside investors. The first method consists of a sale of 100% equity together with a subsidy and charges higher price. Under the second option, the investor pays a smaller price but buys less than 100% equity without any subsidy. Efficient investors opt for the first method while inefficient investors prefer the second. The dual privatization method screens investors and provides them with maximum incentives to invest while minimizing the risk of post-privatization bankruptcy.
Baptista, A. M. (2008). "Optimal delegated portfolio management with background risk." Journal of Banking & Finance 32(6): 977-985.
Most investors delegate the management of a fraction of their wealth to portfolio managers who are given the task of beating a benchmark. However, in an influential paper [Roll, R., 1992. A mean/variance analysis of tracking error. Journal of Portfolio Management 18, 13-22] shows that the objective functions commonly used by these managers lead to the selection of portfolios that are suboptimal from the perspective of investors. In this paper, we provide an explanation for the use of these objective functions based on the effect of background risk on investors' optimal portfolios. Our main contribution is to provide conditions under which investors can optimally delegate the management of their wealth to portfolio managers.
Barnes, M. L. and J. A. Lopez (2006). "Alternative measures of the Federal Reserve Banks' cost of equity capital." Journal of Banking & Finance 30(6): 1687-1711.
The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the 12 Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French [Fama, E.F., French, K.R., 1997. Industry costs of equity. Journal of Financial Economics 43, 153-193] conclude that COE estimates are "woefully" and "unavoidably" imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the CAPM model and compare them using econometric and materiality criteria. Our results suggest that the benchmark CAPM model applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM model provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks' payments business.
Barone-Adesi, G. (2005). "The saga of the American put." Journal of Banking & Finance 29(11): 2909-2918.
The American put is one of the oldest problems in mathematical finance. We review the development of the relevant literature over the last 40 years. Today the mainstream computational problems have been solved satisfactorily and the target of research is shifting towards the development of further insights into the value of timing investment decisions.
Barone-Adesi, G. (2005). "Thirty years of continuous-time finance." Journal of Banking & Finance 29(11): 2699-2699.
Barros, C. P., C. Ferreira, et al. (2007). "Analysing the determinants of performance of best and worst European banks: A mixed logit approach." Journal of Banking & Finance 31(7): 2189-2203.
Using a dataset of 7635 observations on 1384 commercial banks operating in the EU between 1993 and 2001, we utilise a mixed logit model to identify factors that explain the probability of a bank being a best [worst] performer. The empirical evidence confirms the importance of country-level characteristics (location and legal tradition), and firm-level features (bank ownership, balance sheet structure and size). Specifically, smaller sized banks with higher loan-intensity, and foreign banks from countries upholding common law traditions have a higher probability of best performance.
Barry, C. B., S. C. Mann, et al. (2009). "Interest rate changes and the timing of debt issues." Journal of Banking & Finance 33(4): 600-608.
There is much recent interest in the role of market timing in firm financial decisions. Using a large detailed sample of corporate public debt issues, private placements, Rule 144A issues and bank loans over the period 1970-2006, we investigate the relationship between interest rate changes and issues of floating and fixed-rate debt. Our results indicate that both past and future rates are associated with issuance decisions. We examine whether firms are able to lower their cost of capital by anticipating future rate changes, controlling for firm characteristics and market conditions. Our findings suggest that evidence of timing success is dependent on the time interval and type of debt examined. Over the longest time intervals available in our data, we do not find evidence of timing ability for fixed-rate or floating-rate debt issues.
Bartram, S. M. (2008). "What lies beneath: Foreign exchange rate exposure, hedging and cash flows." Journal of Banking & Finance 32(8): 1508-1521.
This paper presents results from an in-depth analysis of the foreign exchange rate exposure of a large nonfinancial firm based on proprietary internal data including cash flows, derivatives and foreign currency debt, as well as external capital market data. While the operations of the multinational firm have significant exposure to foreign exchange rate risk due to foreign currency-based activities and international competition, corporate hedging mitigates this gross exposure. The analysis illustrates that the insignificance of foreign exchange rate exposures of comprehensive performance measures such as total cash flow can be explained by hedging at the firm level. Thus, the residual net exposure is economically and statistically small, even if the operating cash flows of the firm are significantly exposed to exchange rate risk. The results of the paper suggest that managers of nonfinancial firms with operations exposed to foreign exchange rate risk take savvy actions to reduce exposure to a level too low to allow its detection empirically.
Bartram, S. M. and F. Fehle (2007). "Competition without fungibility: Evidence from alternative market structures for derivatives." Journal of Banking & Finance31(3): 659-677.
In this paper, we compare option contracts from a traditional derivatives exchange to bank-issued options, also referred to as covered warrants. While bank-issued option markets and traditional derivatives exchanges exhibit significant structural differences such as the absence of a central counterparty for bank-issued options, they frequently exist side-by-side, and the empirical evidence shows that there is significant overlap in their product offerings although options are not fungible between the two markets. The empirical analysis indicates that bid-ask spreads in either market are lowered by 1-2% due to competition from the other market, providing evidence that the benefits of competing market structures are available in the absence of fungibility.
Bartram, S. M., S. J. Taylor, et al. (2007). "The Euro and European financial market dependence." Journal of Banking & Finance 31(5): 1461-1481.
A time-varying copula model is used to investigate the impact of the introduction of the Euro on the dependence between 17 European stock markets during the period 1994-2003. The model is implemented with a GJR-GARCH-MA-t model for the marginal distributions and the Gaussian copula for the joint distribution, which allows capturing time-varying, non-linear relationships. The results show that, within the Euro area, market dependence increased after the introduction of the common currency only for large equity markets, such as in France, Germany, Italy, the Netherlands and Spain. Structural break tests indicate that the increase in financial market dependence started around the beginning of 1998 when Euro membership was determined and the relevant information was announced. The UK and Sweden, but not other European countries outside the Euro area, are found to exhibit an increase in equity market co-movement, which is consistent with the interpretation that these countries may be expected to join the Euro in the future.
Barucci, E. and F. Mattesini (2008). "Bank shareholding and lending: Complementarity or substitution? Some evidence from a panel of large Italian firms." Journal of Banking & Finance 32(10): 2237-2247.
The paper studies the motivations behind banks' shareholding of non-financial firms using a panel of large Italian companies in the period 1994-2000. Empirical evidence shows that banks are shareholders of companies that are less profitable, have experienced slower growth, are more indebted, are endowed with collateral and have hard time to repay their debt out of current income. Banks are more likely to hold shares in companies they lend to. Overall the evidence suggests that there is complementarity between bank equity holding and lending. A plausible explanation is the shareholder-debtholder conflict, the evidence is weakly compatible with governance and information hypotheses.
Basak, S. (2005). "Asset pricing with heterogeneous beliefs." Journal of Banking & Finance 29(11): 2849-2881.
This paper studies the dynamic behavior of security prices in the presence of investors' heterogeneous beliefs. We provide a tractable continuous-time pure-exchange model and highlight the mechanism through which investors' differences of opinion enter into security prices. In the determination of equilibrium, we employ a representative investor with stochastic weights and solve for all economic quantities in closed form, including the perceived market prices of risk and interest rate. The basic analysis is generalized to incorporate multiple sources of risk, disagreement about nonfundamentals, and multiple investors. Other applications involving multiple goods and nominal asset pricing within monetary economies are discussed.
Basak, S., A. Pavlova, et al. (2008). "Offsetting the implicit incentives: Benefits of benchmarking in money management." Journal of Banking & Finance 32(9): 1883-1893.
Money managers are rewarded for increasing the value of assets under management. This gives a manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. The misaligned incentives create potentially significant deviations of the manager's policy from that desired by fund investors. In the context of a familiar continuous-time portfolio choice model, we demonstrate how a simple risk management practice that accounts for benchmarking can ameliorate the adverse effects of managerial incentives. Our results contrast with the conventional view that benchmarking a fund manager is not in the best interest of investors.
Basistha, A. and A. Kurov (2008). "Macroeconomic cycles and the stock market's reaction to monetary policy." Journal of Banking & Finance 32(12): 2606-2616.
This paper examines cyclical variation in the effect of Fed policy on the stock market. We find a much stronger response of stock returns to unexpected changes in the federal funds target rate in recession and in tight credit market conditions. Using firm-level data, we also show that firms that face financial constraints are more affected by monetary shocks in tight credit conditions than the relatively unconstrained firms. Overall, the results are consistent with the credit channel of monetary policy transmission.
Basu, N., L. Dimitrova, et al. (2009). "Family control and dilution in mergers." Journal of Banking & Finance 33(5): 829-841.
We analyze the influence of the level as well as the change in family ownership on value creation in mergers involving newly public firms. Our findings suggest that acquirers with low levels of family ownership earn lower abnormal returns than do those with high levels of ownership. In addition, families with low ownership in their firm are more likely to use cash as the medium of exchange, thus avoiding dilution and maintaining their control. Further, acquisitions of targets with low levels of family ownership are associated with greater value creation. Our results are consistent with the entrenchment of families at low levels of ownership and a better alignment of their interests with those of minority shareholders at high levels of ownership. Finally, we find that dilution of the family's ownership, due to the use of stock as the medium of exchange, alters the family's incentives and thus influences firm value.
Bauer, K. (2008). "Detecting abnormal credit union performance." Journal of Banking & Finance 32(4): 573-586.
Credit unions are an important financial intermediary, but little credit union research is done. A primary reason for the lack of research is the cooperative nature of the industry, making traditional methods of detecting abnormal performance inappropriate. This paper proposes two methods of detecting abnormal performance, one parametric, the other non-parametric. Instead of testing the efficiency of the institution, this paper proposes testing the return vector, as indicated in the theoretical objective function of the member. Simulations demonstrate that both methods are correctly specified and powerful.
Bauer, K. and S. E. Hein (2006). "The effect of heterogeneous risk on the early adoption of Internet banking technologies." Journal of Banking & Finance 30(6): 1713-1725.
Financial service providers have increasingly offered customers new remote access to such services, with Internet banking being the latest example. While Internet banking has been available for years, the early adoption by customers of this technology was disappointing to most. This paper examines the demand for remote access to banking accounts by consumers and finds that when the technology is new, the traditional risk return models including variables allowing for heterogeneous risk add power in modeling the adoption decision. Perceived risks in Internet banking are seen to be responsible for some of the hesitation to adopt. Ironically, older consumers are found to be less likely to adopt Internet banking regardless of their risk tolerances. However, younger consumers are found to be early adopters only when they have relatively high levels of risk tolerance.
Bauer, R., M. Cosemans, et al. (2009). "Option trading and individual investor performance." Journal of Banking & Finance 33(4): 731-746.
This paper examines the impact of option trading on individual investor performance. The results show that most investors incur substantial losses on their option investments, which are much larger than the losses from equity trading. We attribute the detrimental impact of option trading on investor performance to poor market timing that results from overreaction to past stock market returns. High trading costs further contribute to the poor returns on option investments. Gambling and entertainment appear to be the most important motivations for trading options while hedging motives only play a minor role. We also provide strong evidence of performance persistence among option traders.
Bauer, R., K. Koedijk, et al. (2005). "International evidence on ethical mutual fund performance and investment style." Journal of Banking & Finance 29(7): 1751-1767.
Using an international database containing 103 German, UK and US ethical mutual funds we review and extend previous research on ethical mutual fund performance. By applying a Carhart multi-factor model [Carhart, Journal of Finance 57 (1997) 57] we overcome the benchmark problem most prior ethical studies suffered from. After controlling for investment style, we find no evidence of significant differences in risk-adjusted returns between ethical and conventional funds for the 1990-2001 period. Our results also suggest that ethical mutual funds underwent a catching up phase, before delivering financial returns similar to those of conventional mutual funds. Finally, our performance estimates are robust to the inclusion of ethical indexes, which, surprisingly, are not incrementally capable of explaining ethical mutual fund return variation.
Beccalli, E. (2007). "Does IT investment improve bank performance? Evidence from Europe." Journal of Banking & Finance 31(7): 2205-2230.
This paper investigates whether investment in information technology (IT) - hardware, software and other IT services - influences the performance of banks. Using a sample of 737 European banks over the period 1995-2000 we analyse whether IT investment is reflected in improved performance (measured using both standard accounting ratios and cost and alternative profit efficiency measures). Despite banks being major investors in IT we find little relationship between total IT investment and improved bank profitability or efficiency indicating the existence of a profitability paradox. However, the impact of different types of IT investment (hardware, software and services) on banks' performance is heterogeneous. Investment in IT services from external providers (consulting services, implementation services, training and education, support services) appears to have a positive influence on accounting profits and profit efficiency, while the acquisition of hardware and software seems to reduce banks' performance.
Beck, T., J. M. Crivelli, et al. (2005). "State bank transformation in Brazil - choices and consequences." Journal of Banking & Finance 29(8-9): 2223-2257.
This paper analyzes the different options - liquidation, federalization, privatization and restructuring - that the Brazilian state governments had for the transformation of their state banks under the PROES in the late 1990s. Specifically, this paper explores (i) the factors behind the states' choices and (ii) the effects of the transformation process on bank performance and efficiency. We find that states that were more dependent on federal transfers, whose banks were already under federal intervention and that established development agencies, were more likely to relinquish control over their banks and its transformation process. We find that privatized banks increased their performance, while restructured banks did not.
Beck, T., R. Cull, et al. (2005). "Bank privatization and performance: Empirical evidence from Nigeria." Journal of Banking & Finance 29(8-9): 2355-2379.
We assess the effect of privatization on performance in a panel of Nigerian banks for the period 1990-2001. We find evidence of performance improvement in nine banks that were privatized, which is remarkable given the inhospitable environment for true financial intermediation. Our results also suggest negative effects of the continuing minority government ownership on the performance of many Nigerian banks. Finally, our results complement aggregate indications of decreasing financial intermediation over the 1990s; banks that focused on investment in government bonds and non-lending activities enjoyed a relatively better performance.
Beck, T. and A. Demirguc-Kunt (2006). "Small and medium-size enterprises: Access to finance as a growth constraint." Journal of Banking & Finance 30(11): 2931-2943.
This paper presents recent research on access to finance by small and medium-size enterprises (SMEs). SMEs form a large part of private sector in many developed and developing countries. While cross-country research sheds doubt on a causal link between SMEs and economic development, there is substantial evidence that small firms face larger growth constraints and have less access to formal sources of external finance, potentially explaining the lack of SMEs' contribution to growth. Financial and institutional development helps alleviate SMEs' growth constraints and increase their access to external finance and thus levels the playing field between firms of different sizes. Specific financing tools such as leasing and factoring can be useful in facilitating greater access to finance even in the absence of well-developed institutions, as can systems of credit information sharing and a more competitive banking structure.
Beck, T., A. Demirgüç-Kunt, et al. (2006). "Bank concentration, competition, and crises: First results." Journal of Banking & Finance 30(5): 1581-1603.
Motivated by public policy debates about bank consolidation and conflicting theoretical predictions about the relationship between bank concentration, bank competition and banking system fragility, this paper studies the impact of national bank concentration, bank regulations, and national institutions on the likelihood of a country suffering a systemic banking crisis. Using data on 69 countries from 1980 to 1997, we find that crises are less likely in economies with more concentrated banking systems even after controlling for differences in commercial bank regulatory policies, national institutions affecting competition, macroeconomic conditions, and shocks to the economy. Furthermore, the data indicate that regulatory policies and institutions that thwart competition are associated with greater banking system fragility.
Beck, T., A. Demirgüç-Kunt, et al. (2006). "The influence of financial and legal institutions on firm size." Journal of Banking & Finance 30(11): 2995-3015.
Theory does not predict an unambiguous relationship between a country's financial and legal institutions and firm size. Using data on the largest industrial firms for 44 countries, we find that firm size is positively related to financial intermediary development, the efficiency of the legal system and property rights protection. We do not find any evidence that firms are larger in order to internalize the functions of the banking system or to compensate for the general inefficiency of the legal system.
Becker, R., A. E. Clements, et al. (2009). "The jump component of S&P 500 volatility and the VIX index." Journal of Banking & Finance 33(6): 1033-1038.
Much research has investigated the differences between option implied volatilities and econometric model-based forecasts. Implied volatility is a market determined forecast, in contrast to model-based forecasts that employ some degree of smoothing of past volatility to generate forecasts. Implied volatility has the potential to reflect information that a model-based forecast could not. This paper considers two issues relating to the informational content of the S&P 500 VIX implied volatility index. First, whether it subsumes information on how historical jump activity contributed to the price volatility, followed by whether the VIX reflects any incremental information pertaining to future jump activity relative to model-based forecasts. It is found that the VIX index both subsumes information relating to past jump contributions to total volatility and reflects incremental information pertaining to future jump activity. This issue has not been examined previously and expands our understanding of how option markets form their volatility forecasts.
Becker, R., A. E. Clements, et al. (2007). "Does implied volatility provide any information beyond that captured in model-based volatility forecasts?" Journal of Banking & Finance 31(8): 2535-2549.
This paper contributes to our understanding of the informational content of implied volatility. Here we examine whether the S&P 500 implied volatility index (VIX) contains any information relevant to future volatility beyond that available from model based volatility forecasts. It is argued that this approach differs from the traditional forecast encompassing approach used in earlier studies. The findings indicate that the VIX index does not contain any such additional information relevant for forecasting volatility.
Bedendo, M. and S. D. Hodges (2009). "The dynamics of the volatility skew: A Kalman filter approach." Journal of Banking & Finance 33(6): 1156-1165.
Much attention has been devoted to understanding and modeling the dynamics of implied volatility curves and surfaces. This is crucial for both trading, pricing and risk management of option positions. We suggest a simple, yet flexible, model, based on a discrete and linear Kalman filter updating of the volatility skew. From a risk management perspective, we assess whether this model is capable of producing good density forecasts of daily returns on a number of option portfolios. We also compare our model to the sticky-delta and the vega-gamma alternatives. We find that it clearly outperforms both alternatives, given its ability to easily account for movements of different nature in the volatility curve.
Beechey, M., E. Hjalmarsson, et al. (2009). "Testing the expectations hypothesis when interest rates are near integrated." Journal of Banking & Finance 33(5): 934-943.
Nominal interest rates are unlikely to be generated by unit-root processes. Using data on short and long interest rates from eight developed and six emerging economies, we test the expectations hypothesis using cointegration methods under the assumption that interest rates are near integrated. If the null hypothesis of no cointegration is rejected, we then test whether the estimated cointegrating vector is consistent with that suggested by the expectations hypothesis. The results show support for cointegration in 10 of the 14 countries we consider, and the cointegrating vector is similar across countries. However, the parameters differ from those suggested by theory. We relate our findings to existing literature on the failure of the expectations hypothesis and to the role of term premia.
Behr, P. and A. Güttler (2008). "The informational content of unsolicited ratings." Journal of Banking & Finance 32(4): 587-599.
This paper investigates whether the stock market reacts to unsolicited ratings for a sample of firms rated by S&P between January 1996 and December 2005. We first analyze the stock market reaction to the assignment of an initial unsolicited rating. We find evidence that this reaction is negative and particularly accentuated for small Japanese firms. We then analyze the stock market reaction to changes in unsolicited ratings for a Japanese sub-sample and find that here too the stock market reacts negatively. Our results imply that unsolicited ratings convey new information to the stock market and that investors react to this information. Although unsolicited ratings are based on publicly available information only, the stock market seems to be inefficient in processing this information for Japanese companies.
Beijnen, C. and W. Bolt (2009). "Size matters: Economies of scale in European payments processing." Journal of Banking & Finance 33(2): 203-210.
This paper investigates the existence and extent of economies of scale in the European payment processing industry. It is expected that the creation of a single European payments area (SEPA) will spur consolidations and mergers among European payment processors to more fully realize payment economies of scale. We find evidence for the existence of significant economies of scale using data of eight European payment processors during the years 1990-2005. The analysis also reveals that ownership structure is an important factor to explain cost differences across European processing centers.
Beine, M., O. Bernal, et al. (2009). "Intervention policy of the BoJ: A unified approach." Journal of Banking & Finance 33(5): 904-913.
Intervening in the FX market implies a complex decision process for central banks. Monetary authorities have to decide whether to intervene or not, and if so, when and how. Since the successive steps of this procedure are likely to be highly interdependent, we adopt a nested logit approach to capture their relationships and to characterize the prominent features of the various steps of the intervention decision process. Our estimations based on Japanese data from 1991 to 2004 indicate that the Bank of Japan: (i) mainly reacted to deviations of the exchange rate with respect to fundamentals and (ii) tended to favour secrecy when its credibility was low. We also provide new insights on the so-called secrecy puzzle by modeling explicitly the risk for a secret intervention to be detected. Our results have important implications in terms of exchange rate policy, such as the emergence of a trade-off between intervention size, communication policy and secrecy. Our results tend to provide some explanation for the observed persistence of ineffective intervention policy during some sub-periods.
Beine, M., P. D. Grauwe, et al. (2009). "The impact of FX central bank intervention in a noise trading framework." Journal of Banking & Finance 33(7): 1187-1195.
In this paper, we analyse the effectiveness of the direct central bank interventions using a new effectiveness criterion. To this aim, we investigate the effects of central bank interventions (CBI) in a noise trading model with chartists and fundamentalists. We first estimate a model in which chartists extrapolate past returns and fundamentalists forecast a mean reverting dynamics of the exchange rate towards a fundamental value. Then, we investigate the role of central bank interventions for explaining the switching properties between the two types of agents. We find evidence that in the medium run, interventions increase the proportion of fundamentalists and therefore exert some stabilizing influence on the exchange rate.
Belaire-Franch, J. and K. K. Opong (2005). "Some evidence of random walk behavior of Euro exchange rates using ranks and signs." Journal of Banking & Finance29(7): 1631-1643.
This study utilises recently developed tests based on ranks and signs, in addition to the traditional variance ratio test, to examine the behavior of Euro exchange rates. We show that adjustments for multiple tests must be employed in order to avoid size distortions. Overall, such adjustments provide evidence consistent with random walk behavior of Euro exchange rates.
Bell, A. R., C. Brooks, et al. (2007). "Interest rates and efficiency in medieval wool forward contracts." Journal of Banking & Finance 31(2): 361-380.
While it is commonly believed that derivative instruments are a recent invention, we document the existence of forward contracts for the sale of wool in medieval England around 700 years ago. The contracts were generally entered into by English monasteries, who frequently sold their wool for up to 20 years in advance to mostly foreign and particularly Italian merchants. Employing a unique source of data collected by hand from the historical records, we determine the interest rates implied in these transactions and we also examine the efficiency of the forward and spot markets. The calculated interest rates average around 20%, in accordance with available information concerning the interest rates used in other types of transactions at that time. Perhaps surprisingly, we also find little evidence of informational inefficiencies in these markets.
Bellini, F. and E. Rosazza Gianin (2008). "On Haezendonck risk measures." Journal of Banking & Finance 32(6): 986-994.
We study the Haezendonck risk measure (introduced by [Haezendonck, J., Goovaerts, M., 1982. A new premium calculation principle based on Orlicz norms. Insurance: Mathematics and Economics 1, 41-53] and by [Goovaerts, M.J., Kaas, R., Dhaene, J., Tang, Q., 2003. A unified approach to generate risk measures. ASTIN Bulletin 33 (2), 173-191; Goovaerts, M.J., Kaas, R., Dhaene, J., Tang, Q., 2004. Some new classes of consistent risk measures. Insurance: Mathematics and Economics 34 (3), 505-516]) and prove its subadditivity. Since the Haezendonck risk measure is defined as an infimum of Orlicz premia, we investigate when the infimum is actually attained. We determine the corresponding generalized scenarios and show how its construction can be seen as a special case of the operation of inf-convolution of convex functionals.
Beltratti, A. (2005). "Capital market equilibrium with externalities, production and heterogeneous agents." Journal of Banking & Finance 29(12): 3061-3073.
The paper studies general equilibrium in an economy with externalities, production and heterogeneous agents. The model developed builds on Brock [Brock, W.A., 1982. Asset prices in a production economy. In: McCall, J.J. (Ed.), The Economics of Information and Uncertainty. University of Chicago Press, Chicago, pp. 1-43] and Merton [Merton, R.C., 1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance 42, 483-510]; it involves both a stock market and a market for loans, together with negative externalities produced by a subset of firms. Importantly, the technological production structure of the firms is reflected in the properties of the shares traded in the stock market. Agents are heterogeneous in their financial choices, potentially discriminating against the firms producing a negative externality. The model sheds light on the utility costs of the discriminating behavior and on the impact on the price of the stock issued by the firm which is responsible for the externality. The model is used to study the factors which may magnify or reduce the impact of discrimination. A set of discriminated firms may be seriously affected only if the discriminating investors command a large portion of overall wealth and/or they do not represent important diversification instruments. The model can be applied to understanding the effects of socially responsible investment, whereby investors discriminate against companies belonging to some sectors which are perceived as socially dangerous or unethical.
Ben Omrane, W. and E. de Bodt (2007). "Using self-organizing maps to adjust for intra-day seasonality." Journal of Banking & Finance 31(6): 1817-1838.
The existence of an intra-day seasonality component in financial market variables (volatility, volume, activity, etc.) has been highlighted in many previous studies. To remove this cyclical component from raw data, many researchers use the intra-day average observations model (IAOM) and/or some smoothing techniques (e.g. the kernel method). When the seasonality is related to the first moment (the conditional expectation) and involves only a deterministic component, the IAOM method succeeds in estimating the periodicity almost perfectly. However, when seasonality affects the first or the second moment (the conditional variance) of the data and contains both deterministic and stochastic components, both IAOM and the kernel method fail to capture it. We introduce self-organizing maps (SOM) as a solution. SOM are based on neural network learning and nonlinear projections. Their flexibility allows seasonality to be captured even in the presence of stochastic cycles.
Ben-Abdallah, R., H. Ben-Ameur, et al. (2009). "An analysis of the true notional bond system applied to the CBOT T-bond futures." Journal of Banking & Finance33(3): 534-545.
The conversion factor system (CFS) is used in the determination of the invoice price of the Chicago Board of Trade Treasury-bond futures. As an alternative to the CFS, Oviedo [Oviedo, R.A., 2006. Improving the design of Treasury-Bond futures contracts. The Journal of Business 79, 1293-1315] proposed the True Notional Bond System (TNBS), and showed that it outperforms the CFS when interest rates are deterministic. The main purpose of this paper is to compare the effectiveness of the two systems in a stochastic environment. In order to do so, we price the CBOT T-bond futures as well as all its embedded delivery options under both the CFS and the TNBS. Our pricing procedure is an adaptation of the Dynamic Programming algorithm described in Ben-Abdallah et al. [Ben-Abdallah, R., Ben-Ameur, H., Breton, M., 2007. Pricing CBOT Treasury Bond futures. Les Cahiers du GERAD G-2006-77]. Numerical illustrations show that, in a stochastic framework, TNBS does not always outperform the CFS. However, as the long-term mean moves away from the level of the notional rate, the TNBS performs increasingly better than the CFS.
Benet, B. A., A. Giannetti, et al. (2006). "Gains from structured product markets: The case of reverse-exchangeable securities (RES)." Journal of Banking & Finance30(1): 111-132.
"Structured products" (SP) have recently been introduced onto organized markets in the United States. Payoffs for such financially-engineered securities typically combine stock, bond and contingent claims features. In this paper attention is focused upon reverse-exchangeable securities (RES), an important and rapidly growing segment of the American SP market. First we undertake a replication of RES payout with a linear portfolio of publicly traded securities in a simple no-arbitrage framework. It is thereby possible to estimate theoretically "fair" terms of issuance, and contrast these with actual terms. We conclude that there is a significant pricing bias in favor of the issuing financial institution. Credit enhancement resulting from observed positive correlation between the RES terminal payoff and issuer financial performance is proposed as explanation for the apparent pricing discrepancy. Market completeness and possible tax advantages may also play a role in SP demand and the rapid expansion of this new derivatives market.
Bennedsen, M., H. C. Kongsted, et al. (2008). "The causal effect of board size in the performance of small and medium-sized firms." Journal of Banking & Finance32(6): 1098-1109.
Empirical studies of large publicly traded firms have shown a robust negative relationship between board size and firm performance. The evidence on small and medium-sized firms is less clear; we show that existing work has been incomplete in analyzing the causal relationship due to weak identification strategies. Using a rich data set of almost 7000 closely held corporations we provide a causal analysis of board size effects on firm performance: We use a novel instrument given by the number of children of the chief executive officer (CEO) of the firms. First, we find a strong positive correlation between family size and board size and show this correlation to be driven by firms where the CEO's relatives serve on the board. Second, we find empirical evidence of a small adverse board size effect driven by the minority of small and medium-sized firms that are characterized by having comparatively large boards of six or more members.
Benson, K. L. and J. E. Humphrey (2008). "Socially responsible investment funds: Investor reaction to current and past returns." Journal of Banking & Finance32(9): 1850-1859.
This paper investigates and compares the determinants of fund flows for socially responsible investment (SRI) funds and conventional funds. We consider the impact of current and past measures of monthly and annual return on fund flow. The results suggest SRI fund flows are less sensitive to returns than conventional funds. Our model also shows that flow is persistent and SRI investors are more likely to invest in a fund they already own relative to conventional investors. These results reflect the difficulty SRI investors face in finding alternative investments that meet their non-financial goals.
Benth, F. E., Á. Cartea, et al. (2008). "Pricing forward contracts in power markets by the certainty equivalence principle: Explaining the sign of the market risk premium." Journal of Banking & Finance 32(10): 2006-2021.
In this paper we provide a framework that explains how the market risk premium, defined as the difference between forward prices and spot forecasts, depends on the risk preferences of market players and the interaction between buyers and sellers. In commodities markets this premium is an important indicator of the behavior of buyers and sellers and their views on the market spanning between short-term and long-term horizons. We show that under certain assumptions it is possible to derive explicit solutions that link levels of risk aversion and market power with market prices of risk and the market risk premium. We apply our model to the German electricity market and show that the market risk premium exhibits a term structure which can be explained by the combination of two factors. Firstly, the levels of risk aversion of buyers and sellers, and secondly, how the market power of producers, relative to that of buyers, affects forward prices with different delivery periods.
Berger, A. N. (2007). "Obstacles to a global banking system: "Old Europe" versus "New Europe"." Journal of Banking & Finance 31(7): 1955-1973.
"Old Europe" - the developed nations of continental Europe - averages only about 15% foreign bank ownership, whereas "New Europe" - the transition nations of Eastern Europe - averages about 70%. Similar findings hold elsewhere in the world - developed nations tend to have much lower foreign bank ownership shares than developing nations. We examine the causes of the differences within Europe with an eye toward more general conclusions. Our findings suggest that the low foreign bank shares in "Old Europe" - and perhaps developed nations more generally - may primarily result from net comparative disadvantages for foreign banks and relatively high implicit government entry barriers. The high foreign penetration in "New Europe" - and perhaps developing nations more generally - may be due to net comparative advantages for foreign banks and low government entry barriers, particularly in nations that reduced their state bank ownership.
Berger, A. N. and E. Bonaccorsi di Patti (2006). "Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry." Journal of Banking & Finance 30(4): 1065-1102.
Corporate governance theory predicts that leverage affects agency costs and thereby influences firm performance. We propose a new approach to test this theory using profit efficiency, or how close a firm's profits are to the benchmark of a best-practice firm facing the same exogenous conditions. We are also the first to employ a simultaneous-equations model that accounts for reverse causality from performance to capital structure. We find that data on the US banking industry are consistent with the theory, and the results are statistically significant, economically significant, and robust.
Berger, A. N., G. R. G. Clarke, et al. (2005). "Corporate governance and bank performance: A joint analysis of the static, selection, and dynamic effects of domestic, foreign, and state ownership." Journal of Banking & Finance 29(8-9): 2179-2221.
We jointly analyze the static, selection, and dynamic effects of domestic, foreign, and state ownership on bank performance. We argue that it is important to include indicators of all the relevant governance effects in the same model. "Nonrobustness" checks (which purposely exclude some indicators) support this argument. Using data from Argentina in the 1990s, our strongest and most robust results concern state ownership. State-owned banks have poor long-term performance (static effect), those undergoing privatization had particularly poor performance beforehand (selection effect), and these banks dramatically improved following privatization (dynamic effect), although much of the measured improvement is likely due to placing nonperforming loans into residual entities, leaving "good" privatized banks.
Berger, A. N., I. Hasan, et al. (2009). "Bank ownership and efficiency in China: What will happen in the world's largest nation?" Journal of Banking & Finance 33(1): 113-130.
China is reforming its banking system, partially privatizing and taking on minority foreign ownership of three of its dominant "Big Four" state-owned banks. This paper helps predict the effects by analyzing the efficiency of Chinese banks over 1994-2003. Findings suggest that Big Four banks are by far the least efficient; foreign banks are most efficient; and minority foreign ownership is associated with significantly improved efficiency. We present corroborating robustness checks and offer several credible mechanisms through which minority foreign owners may increase Chinese bank efficiency. These findings suggest that minority foreign ownership of the Big Four will likely improve performance significantly.
Berger, A. N., R. J. Rosen, et al. (2007). "Does market size structure affect competition? The case of small business lending." Journal of Banking & Finance 31(1): 11-33.
Market size structure refers to the distribution of shares of different size classes of local market participants, where the sizes are inclusive of assets both within and outside the local market. We apply this new measure of market structure in two empirical analyses of the US banking industry to address concerns regarding the effects of the consolidation in banking. Our quantity analysis of the likelihood that small businesses borrow from large versus small banks and our small business loan price analysis that includes market size structure as well as conventional measures yield very different findings from most of the literature on bank size and small business lending. Our results do not suggest a significant net advantage or disadvantage for large banks in small business lending overall, or in lending to informationally opaque small businesses in particular. We argue that the prior research that excluded market size structure may be misleading and offer some likely explanations of why our results differ.
Berger, A. N. and G. F. Udell (2006). "A more complete conceptual framework for SME finance." Journal of Banking & Finance 30(11): 2945-2966.
We propose a more complete conceptual framework for analysis of SME credit availability issues. In this framework, lending technologies are the key conduit through which government policies and national financial structures affect credit availability. We emphasize a causal chain from policy to financial structures, which affect the feasibility and profitability of different lending technologies. These technologies, in turn, have important effects on SME credit availability. Financial structures include the presence of different financial institution types and the conditions under which they operate. Lending technologies include several transactions technologies plus relationship lending. We argue that the framework implicit in most of the literature is oversimplified, neglects key elements of the chain, and often yields misleading conclusions. A common oversimplification is the treatment of transactions technologies as a homogeneous group, unsuitable for serving informationally opaque SMEs, and a frequent misleading conclusion is that large institutions are disadvantaged in lending to opaque SMEs.
Berkelaar, A. and R. Kouwenberg (2009). "From boom [`]til bust: How loss aversion affects asset prices." Journal of Banking & Finance 33(6): 1005-1013.
This article studies the impact of heterogeneous loss averse investors on asset prices. In very good states loss averse investors become gradually less risk averse as wealth rises above their reference point, pushing up equity prices. When wealth drops below the reference point the investors become risk seeking and demand for stocks increases drastically, eventually leading to a forced sell-off and stock market bust in bad states. Heterogeneity in reference points and initial wealth of the loss averse investors does not change the salient features of the equilibrium price process, such as a relatively high equity premium, high volatility and counter-cyclical changes in the equity premium.
Berkman, H., T. Brailsford, et al. (2005). "A note on execution costs for stock index futures: Information versus liquidity effects." Journal of Banking & Finance29(3): 565-577.
This paper examines execution costs and the impact of trade size for stock index futures using price-volume transaction data from the London International Financial Futures and Options Exchange. Consistent with Subrahmanyam [Rev. Financ. Stud. 4 (1991) 17] we find that effective half spreads in the stock index futures market are small compared to stock markets, and that trades in stock index futures have only a small permanent price impact. This result is important as it helps to better understand the success of equity index products such as index futures and Exchange Traded Funds. We also find that there is no asymmetry in the post-trade price reaction between purchases and sales for stock index futures across various trade sizes. This result is consistent with the conjecture in Chan and Lakonishok [J. Financ. Econ. 33 (1993) 173] that the asymmetry surrounding block trades in stock markets is due to the high cost of short selling and the general reluctance of traders to short sell on stock markets.
Berkman, H., R. A. Cole, et al. (2009). "Expropriation through loan guarantees to related parties: Evidence from China." Journal of Banking & Finance 33(1): 141-156.
We identify and analyze a sample of publicly traded Chinese firms that issued loan guarantees to their related parties (usually the controlling block holders), thereby expropriating wealth from minority shareholders. Our results show that the issuance of related guarantees is less likely at smaller firms, at more profitable firms and at firms with higher growth prospects. We also find that the identity and ownership of block holders affect the likelihood of expropriation. In addition, we use this sample to provide new evidence on the relation between tunneling and proxies for firm value and financial performance. We find that Tobin's Q, ROA and dividend yield are significantly lower, and that leverage is significantly higher, at firms that issued related guarantees.
Berkowitz, M. K. and J. Qiu (2006). "A further look at household portfolio choice and health status." Journal of Banking & Finance 30(4): 1201-1217.
This paper investigates the effect of changes in health status on household financial wealth and financial portfolio choice. It is shown that the impact of health events on household financial and non-financial wealth is asymmetric. A diagnosis of a new disease leads to a larger decrease in financial wealth than in non-financial wealth. Moreover, we find that the puzzle pertaining to the relationship between health status and portfolio choice discussed in the extant literature generally disappears after controlling for differences in the amount of financial assets held by healthy and sick people. The results suggest that the effect of changes in health status on household financial portfolios is indirect. A health shock significantly reduces household total financial wealth, in turn leading households to restructure the composition of their financial assets.
Bertocco, G. (2008). "Finance and development: Is Schumpeter's analysis still relevant?" Journal of Banking & Finance 32(6): 1161-1175.
In recent years, numerous studies have been published highlighting the role of financial structures in the development process of contemporary economies. In these recent studies, there is always a reference to the pioneering work of Schumpeter; in particular in the writings of Rajan and Zingales [Rajan, R., Zingales, L. 2003a. Banks and markets: The changing character of european finance, NBER Working Paper Series, No. 9595, March; Rajan, R., Zingales, L. 2003b. The great reversal: The politics of financial development in the twentieth century, Journal of Financial Economics 69, 5-50; Rajan, R., Zingales, L. 2003c. Saving Capitalism from Capitalist, Crown Business Division of Random House, New York], important elements of Schumpeter's theoretical framework are used. These works afford us an interesting opportunity to re-evaluate the importance of Schumpeter's contribution. The thesis put forward in this paper is that while they do indeed highlight important elements of Schumpeter's theory, Rajan and Zingales do not take the implications thereof into account and, furthermore, they neglect certain fundamental aspects of the Schumpeterian analysis that are closely connected with the parts that they consider. This renders their work incomplete, and prevents their analysis from achieving the coherence of Schumpeter's theory.
Bertus, M., J. S. Jahera Jr, et al. (2008). "A note on foreign bank ownership and monitoring: An international comparison." Journal of Banking & Finance 32(2): 338-345.
This paper empirically analyzes the relation between foreign bank ownership and the three pillars of the New Basel Capital Accord (i.e., capital regulatory oversight, supervisory oversight, and market discipline). Using a new database covering 153 countries, we find that countries with greater market discipline have a lower presence of foreign banks operating in their economy. Furthermore, our evidence indicates that capital regulatory oversight and supervisory oversight are not significantly related to foreign bank ownership.
Bhanot, K. (2005). "What causes mean reversion in corporate bond index spreads? The impact of survival." Journal of Banking & Finance 29(6): 1385-1403.
Previous studies document that the spread between the yield on commonly used corporate bond indexes (e.g., Moody's Baa index) and a comparable maturity treasury bond exhibits mean reversion. An analytical model shows that a part of the observed negative relationship between changes in the spread and the level of spreads is a natural consequence of ratings based classification of bonds included in the index and the related effects of survival. Using data on individual corporate bonds over the period January 1985 to December 1996, I corroborate the analysis and illustrate the effects of survival. The result has several implications for parametric specifications of spread dynamics in the pricing of contingent claims, for the application of spreads in tests of asset pricing models (such as the conditional version of the CAPM) and for the use of spreads in business cycle forecasts.
Bialkowski, J., S. Darolles, et al. (2008). "Improving VWAP strategies: A dynamic volume approach." Journal of Banking & Finance 32(9): 1709-1722.
In this paper, we present a new methodology for modelling intraday volume, which allows for a reduction of the execution risk in VWAP (Volume Weighted Average Price) orders. The results are obtained for all the stocks included in the CAC40 index at the beginning of September 2004. The idea of considered models is based on the decomposition of traded volume into two parts: one reflects volume changes due to market evolution; the second describes the stock specific volume pattern. The dynamic of the specific volume part is depicted by ARMA and SETAR models. The implementation of VWAP strategies allows some dynamic adjustments during the day in order to improve tracking of the end-of-day VWAP.
Bialkowski, J., K. Gottschalk, et al. (2008). "Stock market volatility around national elections." Journal of Banking & Finance 32(9): 1941-1953.
This paper investigates a sample of 27 OECD countries to test whether national elections induce higher stock market volatility. It is found that the country-specific component of index return variance can easily double during the week around an election, which shows that investors are surprised by the election outcome. Several factors, such as a narrow margin of victory, lack of compulsory voting laws, change in the political orientation of the government, or the failure to form a government with parliamentary majority significantly contribute to the magnitude of the election shock. Furthermore, some evidence is found that markets with short trading history exhibit stronger reaction. Our findings have important implications for the optimal strategies of institutional and individual investors who have direct or indirect exposure to volatility risk.
Bierbrauer, M., C. Menn, et al. (2007). "Spot and derivative pricing in the EEX power market." Journal of Banking & Finance 31(11): 3462-3485.
Using spot and futures price data from the German EEX Power market, we test the adequacy of various one-factor and two-factor models for electricity spot prices. The models are compared along two different dimensions: (1) We assess their ability to explain the major data characteristics and (2) the forecasting accuracy for expected future spot prices is analyzed. We find that the regime-switching models clearly outperform its competitors in almost all respects. The best results are obtained using a two-regime model with a Gaussian distribution in the spike regime. Furthermore, for short and medium-term periods our results underpin the frequently stated hypothesis that electricity futures quotes are consistently greater than the expected future spot, a situation which is denoted as contango.
Biggs, T. and M. K. Shah (2006). "African SMES, networks, and manufacturing performance." Journal of Banking & Finance 30(11): 3043-3066.
This paper examines the role of private support institutions in determining small and medium enterprise (SMES) growth and performance in Sub-Saharan Africa (SSA). It finds that SMES in SSA get around market failures and lack of formal institutions by creating private governance systems in the form of long-term business relationships and tight, ethnically based, business networks. There are important links between these informal governance institutions and SME performance. Networks raise the performance of "insiders" and, in the sparse business environments of the SSA region, have attendant negative consequences for market participation of "outsiders," such as indigenous-African SMES. This is indicated through the determinants of access to supplier credit. Policy interventions will be needed to improve the platform for relation-based governance mechanisms and to address the exclusionary effects of tight networks.
Birge, J. R. and S. Yang (2007). "A model for tax advantages of portfolios with many assets." Journal of Banking & Finance 31(11): 3269-3290.
Taxable portfolios present challenges for optimization models with even a limited number of assets. Holding many assets, however, has a distinct tax advantage over holding few assets. In this paper, we develop a model that takes an extreme view of a portfolio as a continuum of assets to gain the broadest possible advantage from holding many assets. We find the optimal strategy for trading in this portfolio in the absence of transaction costs and develop bounding approximations on the optimal value. We compare the results in a simulation study to a portfolio consisting only of a market index and show that the multi-asset portfolio's tax advantage can lead either to significant consumption or bequest increases.
Blanchet-Scalliet, C., A. Diop, et al. (2007). "Technical analysis compared to mathematical models based methods under parameters mis-specification." Journal of Banking & Finance 31(5): 1351-1373.
In this study, we compare the performance of trading strategies based on possibly mis-specified mathematical models with a trading strategy based on a technical trading rule. In both cases, the trader attempts to predict a change in the drift of the stock return occurring at an unknown time. We explicitly compute the trader's expected logarithmic utility of wealth for the various trading strategies. We next rely on Monte Carlo numerical experiments to compare their performance. The simulations show that under parameter mis-specification, the technical analysis technique out-performs the optimal allocation strategy but not the Model and Detect strategies. The latter strategies dominance is confirmed under parameter mis-specification as long as the two stock returns' drifts are high in absolute terms.
Blejer, M. I. (2006). "Economic growth and the stability and efficiency of the financial sector." Journal of Banking & Finance 30(12): 3429-3432.
It has been claimed that the ability of emerging markets to adopt optimal stabilization policies is hampered by a number of factors. Among them, it has been recently emphasized the role of financial instability, inefficiencies, and financial market imperfections. It is claimed here that the current financial regulatory paradigm, embodied in Basel II, may improve financial stability but reinforces cyclicality. Therefore, countries should emphasize financial efficiency since it would lead to enhanced financial stability, without increasing cyclicality.
Blöchlinger, A. and M. Leippold (2006). "Economic benefit of powerful credit scoring." Journal of Banking & Finance 30(3): 851-873.
We study the economic benefits from using credit scoring models. We contribute to the literature by relating the discriminatory power of a credit scoring model to the optimal credit decision. Given the receiver operating characteristic (ROC) curve, we derive (a) the profit-maximizing cutoff and (b) the pricing curve. Using these two concepts and a mixture thereof, we study a stylized loan market model with banks differing in the quality of their credit scoring model. Even for small quality differences, the variation in profitability among lenders is large and economically significant. We end our analysis by quantifying the impact on profits when information leaks from a competitor's scoring model into the market.
Blum, J. M. (2008). "Why [`]Basel II' may need a leverage ratio restriction." Journal of Banking & Finance 32(8): 1699-1707.
We analyze regulatory capital requirements where the amount of required capital depends on the level of risk reported by the banks. It is shown that if the supervisors have a limited ability to identify or to sanction dishonest banks, an additional, risk-independent leverage ratio restriction may be necessary to induce truthful risk reporting. The leverage ratio helps to offset the banks' potential capital savings of understating their risks by (i) reducing banks' put option value of limited liability ex ante, and by (ii) increasing the banks' net worth, which in turn enhances the supervisors' ability to sanction banks ex post.
Boehmer, E., R. C. Nash, et al. (2005). "Bank privatization in developing and developed countries: Cross-sectional evidence on the impact of economic and political factors." Journal of Banking & Finance 29(8-9): 1981-2013.
We examine how political, institutional, and economic factors are related to a country's decision to privatize state-owned banks. Using a panel of 101 countries from 1982 to 2000, we find that political factors significantly affect the likelihood of bank privatization only in developing countries. Specifically, in non-OECD countries, bank privatization is more likely the more accountable the government is to its people. In contrast, none of our political variables affects the bank privatization decision in developed countries. Economic factors (such as the quality of the nation's banking sector) are significant determinants of bank privatization in both OECD and non-OECD nations.
Boeri, T. and P. Garibaldi (2006). "Are labour markets in the new member states sufficiently flexible for EMU?" Journal of Banking & Finance 30(5): 1393-1407.
New Member States (NMS) coming from central planning are often advised against early Euro adoption because of their rigid labour markets. But are labour markets so rigid in these countries? We argue in this paper that this is not the case. Labour market institutions are no more "rigid" than among current EMU Members whilst wage bargaining institutions are actually better equipped for microeconomic wage flexibility than in the EU-15. NMS also achieved substantial reallocation of jobs and workers in the transition to markets, display relatively large job turnover rates and are reducing their regional mismatch. The view that NMS have rigid labour markets is fuelled by the low job content of growth in the region. But there is evidence that the latter is related to productivity enhancing job destruction in the aftermath of prolonged labour hoarding. Reduced-form employment equations estimated in this paper also suggest that tight fiscal policies, rather than being harmful to job creation, may actually improve the employment performance of the region. Our interpretation of this result is that loose fiscal policies weaken the confidence of investors and crowd-out private employment growth through generous pay rises to civil servants.
Bohl, M. T., P. L. Siklos, et al. (2007). "Do central banks react to the stock market? The case of the Bundesbank." Journal of Banking & Finance 31(3): 719-733.
In this paper, we ask whether the Bundesbank, prior to the European Central Bank taking responsibility for monetary policy in 1999, reacted systematically to stock price movements. In contrast to the results for the US, our empirical findings show a generally weak relationship between German stock returns and short-term interest rates at the daily and the monthly frequency. The results are extremely robust to alternative model specifications. The evidence is inconsistent with the hypothesis of a systematic reaction of the Bundesbank to German stock prices. However, we do find that, as in the US, the Bundesbank may have reacted to the stock market crash of 1987 by loosening monetary policy.
Bollen, N. P. B. and W. G. Christie (2009). "Market microstructure of the Pink Sheets." Journal of Banking & Finance 33(7): 1326-1339.
We study the microstructure of the Pink Sheets and assess the ability of existing theory to capture salient features of this relatively unstructured and unregulated market. Clustering patterns in quotes, quoted spreads, and trade prices indicate that market participants have selected price-dependent tick sizes for different stocks. Clustering intensity varies across stocks as a function of proxies for information availability. Similarly, the bid-ask spread varies as a function of volatility and liquidity. These results suggest (1) microstructure research has established robust predictions of market attributes and (2) unstructured markets are able to develop at least some effective behavioral norms endogenously.
Bonaccorsi di Patti, E. and D. C. Hardy (2005). "Financial sector liberalization, bank privatization, and efficiency: Evidence from Pakistan." Journal of Banking & Finance 29(8-9): 2381-2406.
The Pakistani banking system has been transformed over the past 15 years through liberalization, the entry of private banks, the privatization of public-sector banks, and the tightening of prudential regulations. The effects of these changes on bank productivity and relative efficiency are investigated using various techniques. Bank productivity in terms of profits has increased, and new entrants have been efficient, but the dispersion of efficiency remains wide. The privatized banks improved their profit efficiency in the period immediately following their privatization, but in the subsequent years only one significantly improved its efficiency, whereas the other did not differentiate itself in terms of efficiency from the remaining state-owned banks. The new private domestic banks generally proved to be among the most efficient, and sometimes out-performed the foreign banks.
Bonfim, D. (2009). "Credit risk drivers: Evaluating the contribution of firm level information and of macroeconomic dynamics." Journal of Banking & Finance 33(2): 281-299.
Understanding if credit risk is driven mostly by idiosyncratic firm characteristics or by systematic factors is an important issue for the assessment of financial stability. By exploring the links between credit risk and macroeconomic developments, we observe that in periods of economic growth there may be some tendency towards excessive risk-taking. Using an extensive dataset with detailed information for more than 30 000 firms, we show that default probabilities are influenced by several firm-specific characteristics. When time-effect controls or macroeconomic variables are also taken into account, the results improve substantially. Hence, though the firms' financial situation has a central role in explaining default probabilities, macroeconomic conditions are also very important when assessing default probabilities over time.
Bongaerts, D. and E. Charlier (2009). "Private equity and regulatory capital." Journal of Banking & Finance 33(7): 1211-1220.
Regulatory capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the capital requirements directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under different approaches. For the internal model approach we present a structural model that we calibrate to a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of private equity investments. We also implement the early default feature with a fast simulation algorithm. Our results support capital requirements lower than in Basel II, but not as low as in CRD, thereby giving adverse incentives to banks for using advanced risk models. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios.
Bonin, J. P., I. Hasan, et al. (2005). "Bank performance, efficiency and ownership in transition countries." Journal of Banking & Finance 29(1): 31-53.
Using data from 1996 to 2000, we investigate the effects of ownership, especially by a strategic foreign owner, on bank efficiency for eleven transition countries in an unbalanced panel consisting of 225 banks and 856 observations. Applying stochastic frontier estimation procedures, we compute profit and cost efficiency taking account of both time and country effects directly. In second-stage regressions, we use the efficiency measures along with return on assets to investigate the influence of ownership type. With respect to the impact of ownership, we conclude that privatization by itself is not sufficient to increase bank efficiency as government-owned banks are not appreciably less efficient than domestic private banks. We find that foreign-owned banks are more cost-efficient than other banks and that they also provide better service, in particular if they have a strategic foreign owner. The remaining government-owned banks are less efficient in providing services, which is consistent with the hypothesis that the better banks were privatized first in transition countries.
Bonin, J. P., I. Hasan, et al. (2005). "Privatization matters: Bank efficiency in transition countries." Journal of Banking & Finance 29(8-9): 2155-2178.
To investigate the impact of bank privatization in transition countries, we take the largest banks in six relatively advanced countries, namely, Bulgaria, the Czech Republic, Croatia, Hungary, Poland and Romania. Income and balance sheet characteristics and efficiency measures computed from stochastic frontiers are compared across four bank ownership types. Our empirical results support the hypotheses that foreign-owned banks are most efficient and government-owned banks are least efficient. In addition, the importance of attracting a strategic foreign owner in the privatization process is confirmed. However, counter to the conjecture that foreign banks cherry pick the most profitable opportunities, we find that domestic banks have a local advantage in pursuing fee-for-service business. Finally, we show that both the method and the timing of privatization matter to performance; specifically, voucher privatization does not lead to increased efficiency and early-privatized banks are more efficient than later-privatized banks, even though we find no evidence of a selection effect.
Bonin, J. P. and M. Imai (2007). "Soft related lending: A tale of two Korean banks." Journal of Banking & Finance 31(6): 1713-1729.
In this paper, we present indirect evidence that the IMFs insistence on foreign control of two large nationwide Korean banks in exchange for short-term support during the 1997 financial crisis helped restrain soft related lending practices. News signaling the likely sale of a bank to a foreign financial institution yields an average daily decrease of about 2% in the stock price of related borrowers. News indicating difficulty in finding an interested foreign investor generates an increase in the stock price of related borrowers of about the same magnitude. These signals have larger impacts on less-profitable, less-liquid, and more bank-dependent firms.
Bordo, M. D. and C. M. Meissner (2006). "The role of foreign currency debt in financial crises: 1880-1913 versus 1972-1997." Journal of Banking & Finance30(12): 3299-3329.
We show that exposure to foreign currency debt does not necessarily increase the risk of having a financial crisis. Some countries do not suffer from financial fragility despite original sin. Before 1913 British offshoots and Scandinavia afflicted with it avoided financial meltdowns. Today many advanced countries have original sin, but few have had crises. In both periods, aggregate balance sheet mismatches are associated with a greater likelihood of a crisis. The evidence suggests that foreign currency debt is dangerous when mis-managed. This is part of the difference between developed countries and emerging markets both of which borrow in foreign currency.
Borio, C. (2006). "Monetary and financial stability: Here to stay?" Journal of Banking & Finance 30(12): 3407-3414.
We argue that changes in the monetary and financial regimes over the last twenty years or so have been subtly altering the dynamics of the economy and hence the challenges that monetary and prudential authorities face. In particular, the current environment may be more vulnerable to the occasional build up of financial imbalances, i.e. over-extensions in (private sector) balance sheets, which herald economic weakness and unwelcome disinflation down the road, as they unwind. As a result, achieving simultaneous monetary and financial stability in a lasting way may call for refinements to current monetary and prudential policy frameworks. These refinements would entail a firmer long-term focus, greater symmetry in policy responses between upswings and downswings, with greater attention to actions during upswings, and closer coordination between monetary and prudential authorities.
Bortolotti, B., F. de Jong, et al. (2007). "Privatization and stock market liquidity." Journal of Banking & Finance 31(2): 297-316.
This paper shows that share issue privatization (SIP) is a major source of domestic stock market liquidity in 19 developed economies. Particularly, privatization IPOs have a negative effect on the price impact - measured by the ratio of the absolute return on the market index to turnover. This result is robust to the inclusion of controls for other observable and unobservable factors, having also considered the endogenous nature of the decision to privatize. We also provide evidence of a positive spillover of SIP on the liquidity of private companies. This cross-asset externality is one implication of liquidity theories emphasizing the improved risk diversification opportunities and risk sharing brought about by privatization. This externality stems from both domestic privatization IPOs and cross-listings.
Bos, J. W. B., K. H. W. Knot, et al. (2006). "Banking and finance in an integrating Europe." Journal of Banking & Finance 30(7): 1835-1837.
Bos, J. W. B. and C. J. M. Kool (2006). "Bank efficiency: The role of bank strategy and local market conditions." Journal of Banking & Finance 30(7): 1953-1974.
In this paper we focus on the assumption of a common efficient frontier when performing an efficiency study for the banking sector. The fact that environmental factors that are not appropriately controlled may easily bias efficiency estimates. First, we estimate a common cost and profit frontier. In this first stage, as an innovation to the literature, we use exogenously computed input prices rather than the normally used endogenous input prices. Second, we regress the estimated inefficiencies on a set of a bank's strategic choices, local banking market variables, and local (regional) macro variables. For the analysis, we use a unique dataset of 401 largely independent cooperative local banks in the Netherlands for the years 1998 and 1999. Our results show that the use of exogenous input prices rather than endogenous input prices is particularly important for the cost frontier as the spread in cost inefficiencies becomes larger and more plausible. Our second stage results suggest that most of the estimated inefficiency indeed is managerial (X-) inefficiency. Environmental factors do play a role, but only to a limited extent.
Bos, J. W. B. and H. Schmiedel (2007). "Is there a single frontier in a single European banking market?" Journal of Banking & Finance 31(7): 2081-2102.
This paper attempts to estimate comparable efficiency scores for European banks operating in the Single Market in the EU. Using a data set of more than 5000 large commercial banks from all major European banking markets over the period 1993-2004, the application of meta-frontiers enables us to assess the existence of a single and integrated European banking market. We find evidence in favor of a single European banking market characterized by cost and profit meta-frontiers. However, compared to the meta-frontier estimations, pooled frontier estimations tend to underestimate efficiency levels and correlate poorly with country-specific frontier efficiency ranks.
Boscaljon, B. and C.-C. Ho (2005). "Information content of bank loan announcements to Asian corporations during periods of economic uncertainty." Journal of Banking & Finance 29(2): 369-389.
In this study, changes in the borrower-lender relationship prior to and after the Asian crisis are examined. We find the lender quality is the most important determinant of the information content of bank loan announcements, as evidenced by differences in the banking systems of Hong Kong, Korea, Thailand and Taiwan. In addition, the results suggest that the commercial banking relationship is increasingly important in times of economic uncertainty.
Boubaker, S. and F. Labégorre (2008). "Ownership structure, corporate governance and analyst following: A study of French listed firms." Journal of Banking & Finance 32(6): 961-976.
This study investigates the effects of some characteristics of the French corporate governance model - deemed to foster entrenchment and facilitate private benefits extraction - on the extent of analyst following. The results show that analysts are more likely to follow firms both with high discrepancy level between ownership and control and those controlled through pyramiding. These findings provide empirical support to the argument that minority shareholders value private information on firms with high expropriation likelihood, asking thence for more analyst services. Additional findings show that analysts are reticent to follow firms managed by controlling family members. This is, in part, explained by these firms' reliance on private communication channels rather than public disclosure, producing a poor informational environment.
Boubakri, N., J.-C. Cosset, et al. (2005). "Privatization and bank performance in developing countries." Journal of Banking & Finance 29(8-9): 2015-2041.
We examine the postprivatization performance of 81 banks from 22 developing countries. Our results suggest that: (i) On average, banks chosen for privatization have a lower economic efficiency, and a lower solvency than banks kept under government ownership. (ii) In the postprivatization period, profitability increases but, depending on the type of owner, efficiency, risk exposure and capitalization may worsen or improve. However, (iii) Over time, privatization yields significant improvements in economic efficiency and credit risk exposure. (iv) We also find that newly privatized banks that are controlled by local industrial groups become more exposed to credit risk and interest rate risk after privatization.
Boubakri, N., J.-C. Cosset, et al. (2009). "From state to private ownership: Issues from strategic industries." Journal of Banking & Finance 33(2): 367-379.
This paper investigates the effects of privatization for a panel of 189 firms from strategic industries headquartered in 39 countries, and privatized between 1984 and 2002. Strategic firms can hardly be compared to manufacturing or competitive industries as they are generally under state monopoly, and involve specific issues such as regulation, political and institutional constraints. We examine the change in ownership and postprivatization means of control by the government, and assess whether positive changes in performance obtain in these particular industries that include firms from the financial, mining, steel, telecommunications, transportation, utilities, and oil sectors. We document that governments continue to exert influence on former state-owned firms after three years by retaining golden shares and/or appointing politicians to key positions in the firm. Our multivariate results reveal a negative effect of state ownership on profitability and operating efficiency, which the presence of a sound institutional and political environment moderates.
Boubakri, N., G. Dionne, et al. (2008). "Consolidation and value creation in the insurance industry: The role of governance." Journal of Banking & Finance 32(1): 56-68.
We examine the long run performance of M&A transactions in the property-liability insurance industry. We specifically investigate whether such transactions create value for the bidders' shareholders, and assess how corporate governance mechanisms, internal and external, affect such performance. Our results show that M&A create value in the long run as buy and hold abnormal returns are positive and significant after 3 years. While tender offers appear to be more profitable than mergers, our multivariate evidence does not support the conjecture that domestic transactions create more value than cross-border transactions. Furthermore, positive returns are significantly higher for frequent acquirers and in countries where investor protection is weaker. Internal corporate governance mechanisms, such as board independence, and CEO share ownership, are also significant determinants of the long run positive performance of bidders.
Bougheas, S., S. Mateut, et al. (2009). "Corporate trade credit and inventories: New evidence of a trade-off from accounts payable and receivable." Journal of Banking & Finance 33(2): 300-307.
Trade credit is an important source of finance for firms and has been well researched, but the focus has been on financial trade-offs. In this paper, we consider the trade-offs with inventories and develop a simple model that recognizes the incentives a firm faces to offer and receive trade credit. Our model identifies the response of accounts payable and accounts receivable to changes in the cost of inventories, profitability, risk and liquidity, and importantly, this influence operates through a production channel. Our results support the model and complement many existing studies focused on explaining the financial terms of trade credit.
Bougheas, S., P. Mizen, et al. (2006). "Access to external finance: Theory and evidence on the impact of monetary policy and firm-specific characteristics." Journal of Banking & Finance 30(1): 199-227.
This paper examines firms' access to bank and market finance when allowance is made for differences in firm-specific characteristics. A theoretical model determines the characteristics such as size, risk and debt that would determine firms' access to bank or market finance; these characteristics can result in greater (or lesser) tightening of credit when interest rates increase. An empirical evaluation of the predictions of the model is conducted on a large panel of UK manufacturing firms. We confirm that small, young and risky firms are more significantly affected by tight monetary conditions than large, old and secure firms.
Boulatov, A., B. C. Hatch, et al. (2009). "Dealer attention, the speed of quote adjustment to information, and net dealer revenue." Journal of Banking & Finance33(8): 1531-1542.
Using trade and quote data from the NYSE, we examine the relation between dealer attention, dealer revenue, and the probability of informed trade. We find that dealer revenue net of losses to better-informed traders in NYSE stocks is positively related to the speed at which quotes adjust to full information levels. The speed of quote adjustment is faster for stocks with greater dealer attention, as measured by a stock's relative prominence at its post and panel location on the NYSE floor. The level of dealer attention in turn is positively related to a stock's probability of information-based trading. The results are consistent with a theoretical model we derive in which dealers trade multiple securities and must optimally allocate their limited attention to monitoring order flow to minimize losses to better-informed traders.
Bourgeon, J.-M., P. Picard, et al. (2008). "Providers' affiliation, insurance and collusion." Journal of Banking & Finance 32(1): 170-186.
This paper provides a theoretical analysis of the benefits for an insurance company to develop its own network of service providers when insurance fraud is characterized by collusion between policyholders and providers. In a static framework without collusion, exclusive affiliation of providers allows insurance companies to recover some market power and to lessen competition on the insurance market. This entails a decrease in the insured's welfare. However, exclusive affiliation of providers may entail a positive effect on customers' surplus when insurers and providers are engaged in a repeated relationship. In particular, while insurers must cooperate to retaliate against a fraudulent provider under non-exclusive affiliation, no cooperation is needed under exclusive affiliation. In that case, an insurer is indeed able to reduce the profit of a malevolent provider by moving to collusion-proof contracts when collusion is detected, and this threat may act as a deterrent for fraudulent activities. This possibility may supplement an inefficient judicial system: it is thus a second-best optimal anti-fraud policy.
Boyle, G. W. and G. A. Guthrie (2006). "Hedging the value of waiting." Journal of Banking & Finance 30(4): 1245-1267.
We analyze the optimal hedging policy of a firm that has flexibility in the timing of investment. Conventional wisdom suggests that hedging adds value by alleviating the under-investment problem associated with capital market frictions. However, our model shows that hedging also adds value by allowing investment to be delayed in circumstances where the same frictions would cause it to commence prematurely. Thus, hedging can have the paradoxical effect of reducing investment. We also show that greater timing flexibility increases the optimal quantity of hedging, but has a non-monotonic effect on the additional value created by hedging. These results may help explain the empirical findings that investment rates do not differ between hedgers and non-hedgers, and that hedging propensities do not depend on standard measures of growth opportunities.
Brada, J. C., A. M. Kutan, et al. (2005). "Real and monetary convergence between the European Union's core and recent member countries: A rolling cointegration approach." Journal of Banking & Finance 29(1): 249-270.
We use rolling cointegration to measure the convergence of base money, M2, the CPI and industrial output between Germany and France and recent EU members and some transition countries that are now joining the EU. Countries that joined the EU previously exhibit time-varying cointegration with the core countries over the 1980-2000 sample period. Cointegration for the transition economies was comparable for M2 and prices, but not for monetary policy and industrial output. Thus a peg to the Euro soon after accession is feasible for the East European countries, but the benefits of joining the Euro zone are as yet limited.
Bradley, D., K. Chan, et al. (2008). "Are there long-run implications of analyst coverage for IPOs?" Journal of Banking & Finance 32(6): 1120-1132.
Analyst coverage has been cited increasingly as an important attribute in the selection of an underwriter for a firm about to go public. However, it has also been alleged that affiliated analysts provide biased research. In this study, we examine these interrelated issues by examining the long-run performance of IPOs with coverage from their managing underwriters in a 1993-2003 sample. We find that (1) analysts' research coverage from their managing syndicate is not related to long-run performance; (2) long-run performance is not different for firms that receive all-star analyst coverage; and (3) investors are not systematically worse off for following lead underwriter recommendations.
Branger, N., C. Schlag, et al. (2008). "Optimal portfolios when volatility can jump." Journal of Banking & Finance 32(6): 1087-1097.
We consider an asset allocation problem in a continuous-time model with stochastic volatility and jumps in both the asset price and its volatility. First, we derive the optimal portfolio for an investor with constant relative risk aversion. The demand for jump risk includes a hedging component, which is not present in models without volatility jumps. We further show that the introduction of derivative contracts can have substantial economic value. We also analyze the distribution of terminal wealth for an investor who uses the wrong model, either by ignoring volatility jumps or by falsely including such jumps, or who is subject to estimation risk. Whenever a model different from the true one is used, the terminal wealth distribution exhibits fatter tails and (in some cases) significant default risk.
Brau, J. C., M. Li, et al. (2007). "Do secondary shares in the IPO process have a negative effect on aftermarket performance?" Journal of Banking & Finance 31(9): 2612-2631.
We revisit and extend the topic of secondary share sales and revisions in IPOs. First we test to determine if secondary share sales constitute a negative signal that is captured in aftermarket performance. We find secondary share sales in general are not correlated with poorer initial or long-run performance, but selling by officers and directors is associated with poorer long-run returns. Second, we examine if secondary share revisions (1) reflect selling shareholders' attempts to conceal private information or (2) are contingent upon whether a firm can reach its goal of raising sufficient capital. We find empirical support for a capital goal, but not for concealment.
Brenner, M., E. Y. Ou, et al. (2006). "Hedging volatility risk." Journal of Banking & Finance 30(3): 811-821.
Volatility risk plays an important role in the management of portfolios of derivative assets as well as portfolios of basic assets. This risk is currently managed by volatility "swaps" or futures. However, this risk could be managed more efficiently using options on volatility that were proposed in the past but were never introduced mainly due to the lack of a cost efficient tradable underlying asset. The objective of this paper is to introduce a new volatility instrument, an option on a straddle, which can be used to hedge volatility risk. The design and valuation of such an instrument are the basic ingredients of a successful financial product. In order to value these options, we combine the approaches of compound options and stochastic volatility. Our numerical results show that the straddle option is a powerful instrument to hedge volatility risk. An additional benefit of such an innovation is that it will provide a direct estimate of the market price for volatility risk.
Breuer, T., M. Jandacka, et al. "Does adding up of economic capital for market- and credit risk amount to conservative risk assessment?" Journal of Banking & Finance In Press, Corrected Proof.
There is a tradition in the banking industry of dividing risk into market risk and credit risk. Both categories are treated independently in the calculation of risk capital. But many financial positions depend simultaneously on both market risk and credit risk factors. In this case, an approximation of the portfolio value function separating value changes into a pure market risk plus pure credit risk component can result not only in an overestimation, but also in an underestimation of risk. We discuss this compounding effect in the context of foreign currency loans and argue that a separate calculation of economic capital for market risk and for credit risk may significantly underestimate true risk.
Breuer, W. and A. Perst (2007). "Retail banking and behavioral financial engineering: The case of structured products." Journal of Banking & Finance 31(3): 827-844.
We apply cumulative prospect theory and hedonic framing to evaluate discount reverse convertibles (DRCs) and reverse convertible bonds (RCBs) as important examples of structured products from a boundedly rational investor's point of view. While common expected utility theory would also conclude that DRCs and RCBs are of interest to investors with moderate return expectations and underestimated stock return volatility, that theory would overestimate the market success of DRCs and underestimate that of RCBs in comparison to a situation with bounded rationality. Hedonic framing and relatively low subjectively felt competence levels of investors are decisive for the demand for RCBs.
Brewer Iii, E. and W. E. Jackson Iii (2006). "A note on the "risk-adjusted" price-concentration relationship in banking." Journal of Banking & Finance 30(3): 1041-1054.
Price-concentration studies in banking typically find a significant and negative relationship between consumer deposit rates (i.e., prices) and market concentration. This implies highly concentrated banking markets are "bad" for depositors. It also provides support for the Structure-Conduct-Performance hypothesis and rejects the Efficient-Structure hypothesis. However, these studies have focused almost exclusively on supply-side control variables and neglected demand-side variables when estimating the reduced form price-concentration relationship. For example, previous studies have not included in their analysis bank-specific risk variables as measures of cross-sectional derived deposit demand. We find that when bank-specific risk variables are included in the analysis the magnitude of the relationship between deposit rates and market concentration decreases by over 50%. We offer an explanation for these results based on the correlation between a bank's risk profile and the structure of the market in which it operates. These results suggest that it may be necessary to reconsider the well-established assumption that higher market concentration necessarily leads to anticompetitive deposit pricing behavior by commercial banks. This has direct implications for the antitrust evaluations of bank merger and acquisition proposals by regulatory agencies. And, in a more general sense, these results suggest that any Structure-Conduct-Performance based study that does not explicitly consider the possibility of very different risk profiles of the firms analyzed may indeed miss a very important set of explanatory variables. And, thus, the results from those studies may be spurious.
Brissimis, S. N., M. D. Delis, et al. (2008). "Exploring the nexus between banking sector reform and performance: Evidence from newly acceded EU countries."Journal of Banking & Finance 32(12): 2674-2683.
The aim of this study is to examine the relationship between banking sector reform and bank performance - measured in terms of efficiency, total factor productivity growth and net interest margin - accounting for the effects through competition and bank risk-taking. To this end, we develop an empirical model of bank performance, which is consistently estimated using recent econometric techniques. The model is applied to bank panel data from ten newly acceded EU countries. The results indicate that both banking sector reform and competition exert a positive impact on bank efficiency, while the effect of reform on total factor productivity growth is significant only toward the end of the reform process. Finally, the effect of capital and credit risk on bank performance is in most cases negative, while it seems that higher liquid assets reduce the efficiency and productivity of banks.
Brockman, P. and X. Yan (2009). "Block ownership and firm-specific information." Journal of Banking & Finance 33(2): 308-316.
This study examines the impact of block ownership on the firm's information environment. Previous research shows that stock price efficiency depends on the cost of acquiring private information, as well as on the precision of this information. Blockholders have a clear advantage over diffuse, atomistic shareholders in terms of the precision and acquisition cost of their private information. We hypothesize that this informational advantage will manifest itself primarily in the firm-specific component of stock returns. Our empirical findings confirm that blockholders increase the probability of informed trading and idiosyncratic volatility, and decrease the firm's stock return synchronicity. These results hold for both inside and outside blockholders, but are insignificant for blocks controlled by employee stock ownership plans (ESOPs). Overall, our findings support the contention that ownership structure plays a significant role in shaping the firm's information environment.
Brounen, D., A. de Jong, et al. (2006). "Capital structure policies in Europe: Survey evidence." Journal of Banking & Finance 30(5): 1409-1442.
In this paper we present the results of an international survey among 313 CFOs on capital structure choice. We document several interesting insights on how theoretical concepts are being applied by professionals in the UK, the Netherlands, Germany, and France and we directly compare our results with previous findings from the US our results emphasize the presence of pecking-order behavior. At the same time this behavior is not driven by asymmetric information considerations. The static trade-off theory is confirmed by the importance of a target debt ratio in general, but also specifically by tax effects and bankruptcy costs. Overall, we find remarkably low disparities across countries, despite the presence of significant institutional differences. We find that private firms differ in many respects from publicly listed firms, e.g. listed firms use their stock price for the timing of new issues. Finally, we do not find substantial evidence that agency problems are important in capital structure choice.
Brown, C. and K. Davis (2009). "Capital management in mutual financial institutions." Journal of Banking & Finance 33(3): 443-455.
Capital management by mutual financial institutions (such as credit unions) provides a valuable testing ground for assessing the impact of capital regulation and theories of managerial behaviour in financial institutions. Limited access to external equity capital means that capital accumulation must be met primarily by reliance on retained earnings. To deal with shocks to the capital position and avoid breaching regulatory requirements, managers will aim to have a buffer of capital in excess of the regulatory minimum. Moreover, mutual governance arrangements and an absence of capital market discipline mean that managers have discretion to set target capital ratios which differ significantly from industry averages. This paper develops a formal model of capital management and risk management in mutual financial institutions such as credit unions which reflects these industry characteristics. The model is tested using data from larger credit unions in Australia, which have been subject to the Basel Accord Risk Weighted Capital Requirements since 1993. The data supports the hypothesis that credit unions manage their capital position by setting a short term target profit rate (return on assets) which is positively related to asset growth and which is aimed at gradually removing discrepancies between the actual and desired capital ratio. Desired capital ratios vary significantly across credit unions. There is little evidence of short run adjustments to the risk of the asset portfolio to achieve a desired capital position.
Brown, C. R., K. B. Cyree, et al. (2008). "Further analysis of the expectations hypothesis using very short-term rates." Journal of Banking & Finance 32(4): 600-613.
Longstaff [Longstaff, F., 2000. The term structure of very short-term rates: new evidence for the expectations hypothesis. Journal of Financial Economics 58, 397-415] finds support for the expectations hypothesis at the very short end of the repurchase agreement (repo) term structure while other studies find calendar-time-based regularities cause rejection of the expectations hypothesis. Using Longstaff's methods on a sample of repo rates that pre-dates Longstaff's sample, we reject the expectations hypothesis for every maturity. The pre-Longstaff-sample repo data comes from a time period where the behavior of short-term interest rates is similar to the long-run average behavior of short-term interest rates. Our results imply that expectations hold when rates are less volatile and/or that we may be entering a period of lower volatility.
Brown, J. R. and B. C. Petersen (2009). "Why has the investment-cash flow sensitivity declined so sharply? Rising R&D and equity market developments." Journal of Banking & Finance 33(5): 971-984.
The study of the investment-cash flow (ICF) sensitivity constitutes one of the largest literatures in corporate finance, yet little is known about changes in the ICF relationship over time, and the literature has largely ignored how rising R&D investment and developments in equity markets have impacted ICF sensitivity estimates. We show that for the time period 1970-2006, the ICF sensitivity: (i) largely disappears for physical investment, (ii) remains comparatively strong for R&D, and (iii) declines, but does not disappear, for total investment. We argue that these findings can largely be explained by the changing composition of investment and the rising importance of public equity as a source of funds, particularly for firms with persistent negative cash flows.
Brown, M., M. R. Maurer, et al. (2009). "The impact of banking sector reform in a transition economy: Evidence from Kyrgyzstan." Journal of Banking & Finance33(9): 1677-1687.
We examine the impact of financial sector reform on interest rate levels and spreads using Kyrgyz bank-level data from 1998 to 2005. We find that, in addition to macroeconomic stabilization, structural reforms to the banking sector significantly contributed to lower interest rates. In particular, our results suggest that foreign bank entry and regulatory efforts to increase average bank size were important in reducing deposit rates. In contrast, we find little evidence that banking sector reform or macroeconomic stabilization has impacted interest rate spreads.
Bruche, M. and C. González-Aguado "Recovery rates, default probabilities, and the credit cycle." Journal of Banking & Finance In Press, Corrected Proof.
In recessions, the number of defaulting firms rises. On top of this, the average amount recovered on the bonds of defaulting firms tends to decrease. This paper proposes an econometric model in which this joint time-variation in default rates and recovery rate distributions is driven by an unobserved Markov chain, which we interpret as the "credit cycle". This model is shown to fit better than models in which this joint time-variation is driven by observed macroeconomic variables. We use the model to quantitatively assess the importance of allowing for systematic time-variation in recovery rates, which is often ignored in risk management and pricing models.
Buch, C. M. and A. Lipponer (2007). "FDI versus exports: Evidence from German banks." Journal of Banking & Finance 31(3): 805-826.
We use a new bank-level dataset to study the FDI-versus-exports decision for German banks. We extend the literature on multinational firms in two directions. First, we simultaneously study FDI and the export of cross-border financial services. Second, we test recent theories on multinational firms which show the importance of firm heterogeneity [Helpman, E., Melitz, M.J., Yeaple, S.R., 2004. Export versus FDI. American Economic Review 94 (1), 300-316]. Our results show that FDI and cross-border services are complements rather than substitutes. Heterogeneity of banks has a significant impact on the internationalization decision. More profitable and larger banks are more likely to expand internationally than smaller banks. They have more extensive foreign activities, and they are more likely to engage in FDI in addition to cross-border financial services.
Buraschi, A. and F. Corielli (2005). "Risk management implications of time-inconsistency: Model updating and recalibration of no-arbitrage models." Journal of Banking & Finance 29(11): 2883-2907.
A widespread approach in the implementation of asset pricing models is based on the periodic recalibration of its parameters and initial conditions to eliminate any conflict between model-implied and market prices. Modern no-arbitrage market models facilitate this procedure since their solution can usually be written in terms of the entire initial yield curve. As a result, the model fits (by construction) the interest rate term structure. This procedure is, however, generally time inconsistent since the model at time t = 0 completely specifies the set of possible term structures for any t > 0. In this paper, we analyze the pros and cons of this widespread approach in pricing and hedging, both theoretically and empirically. The theoretical section of the paper shows (a) under which conditions recalibration improves the hedging errors by limiting the propagation of an initial error, (b) that recalibration introduces time-inconsistent errors that violate the self-financing argument of the standard replication strategy. The empirical section of the paper quantifies the trade-off between (a) and (b) under several scenarios. First, we compare this trade-off for two economies with and without model specification error. Then, we discuss the trade-off when the underlying economy is not Markovian.
Burns, N., B. B. Francis, et al. (2007). "Cross-listing and legal bonding: Evidence from mergers and acquisitions." Journal of Banking & Finance 31(4): 1003-1031.
Using a sample of foreign acquisitions of US targets, this study examines the extent to which cross-listing in the US leads to legal and regulatory bonding, and/or whether reputational bonding proxied by financial intermediaries monitoring, an often ignored component of the bonding mechanism, is an important factor in US investors decision to hold shares in cross-listed firms. We find that compared to US firms, cross-listed firms are less likely to use equity in takeovers of US targets. Further, cross-listed firms from countries with poorer legal protections are less likely to finance with equity and pay higher premiums than cross-listed firms from countries with better legal protections. Using analysts' coverage and institutional following as proxies for financial intermediary monitoring, we find some support for the importance of reputational bonding. The evidence suggests that while cross-listing reduces barriers to investment, there are limits to its ability to completely subsume both the legal environment and the importance of the monitoring of financial intermediaries. This further suggests that the extent of actual legal and regulatory bonding by cross-listed firms may be more limited than often assumed.
Burns, N. and S. Kedia (2008). "Executive option exercises and financial misreporting." Journal of Banking & Finance 32(5): 845-857.
Several recent papers document that the magnitude of potential gains from stock-based compensation is positively related to the likelihood of misreporting. In a sample of firms that announce restatements of their financial statements from 1997 to 2002, we examine whether managers realize these potential gains occurring from their accounting choices. After controlling for diversification needs and stock price impact, we find no significant evidence of higher option exercises by executives in the misreported years. However, for firms that are more likely to have made deliberate aggressive accounting choices, we find significant evidence of higher option exercises. For these firms, option exercises are higher by 20-60% in comparison to industry and size matched nonrestating firms. Options exercises by executives are also increasing in the magnitude of the restatement as captured by the effect of the restatement on net income. These higher option exercises tend to be more pervasive and are not just confined to the CEO and CFO of the firm.
Cai, Y., R. Y. Chou, et al. "Explaining international stock correlations with CPI fluctuations and market volatility." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper investigates the dynamic correlations among six international stock market indices and their relationship to inflation fluctuation and market volatility. The current research uses a newly developed time series model, the Double Smooth Transition Conditional Correlation with Conditional Auto Regressive Range (DSTCC-CARR) model. Findings reveal that international stock correlations are significantly time-varying and the evolution among them is related to cyclical fluctuations of inflation rates and stock volatility. The higher/lower correlations emerge between countries when both countries experience a contractionary/expansionary phase or higher/ lower volatilities.
Calcagno, R. and L. Renneboog (2007). "The incentive to give incentives: On the relative seniority of debt claims and managerial compensation." Journal of Banking & Finance 31(6): 1795-1815.
We show that the relative seniority of debt and managerial compensation has important implications for the design of remuneration contracts. Whereas the traditional literature assumes that debt is senior to remuneration, there are in reality many cases in which remuneration contracts are de facto senior to debt claims in financially distressed firms and in workouts. We theoretically show that risky debt changes the incentive to provide the manager with performance-related incentives (a "contract substitution" effect). In other words, the relative degree of seniority of managers' claims and creditors' claims in case a bankruptcy procedure starts is crucial to determine the optimal incentive contract ex-ante. If managerial compensation is more senior than debt, higher leverage leads to lower power incentive schemes (lower bonuses and option grants) and a higher base salary. In contrast, when compensation is junior, we expect more emphasis on pay-for-performance incentives in highly-levered firms.
Calem, P. S., M. B. Gordy, et al. (2006). "Switching costs and adverse selection in the market for credit cards: New evidence." Journal of Banking & Finance 30(6): 1653-1685.
To explain persistence of credit card interest rates at relatively high levels, Calem and Mester (AER, 1995) argued that informational barriers create switching costs for high-balance customers. As evidence, using data from the 1989 Survey of Consumer Finances, they showed that these households were more likely to be rejected when applying for new credit. In this paper, we revisit the question using the 1998 and 2001 SCF. Further, we use new information on card interest rates to test for pricing effects consistent with information-based switching costs. We find that informational barriers to competition persist, although their role may have declined.
Câmara, A. (2009). "Two counters of jumps." Journal of Banking & Finance 33(3): 456-463.
This paper introduces a class of two counters of jumps option pricing models. The stock price follows a jump-diffusion process with price jumps up and price jumps down, where each type of jumps can have different means and standard deviations. Price jumps can be negatively autocorrelated as it has been observed in practice. We investigate the volatility surfaces generated by this class of two counters of jumps option pricing models. Our formulae, like the jump-diffusion models with a single counter of jumps, are able to generate smiles, and skews with similar shapes to those observed in the options markets. More importantly, unlike the jump-diffusion models with a single counter of jumps, our formulae are able to generate term structures of implied volatilities of at-the-money options with [intersection]-shaped patterns similar to those observed in the marketplace.
Campa, J. M. and I. Hernando (2006). "M&As performance in the European financial industry." Journal of Banking & Finance 30(12): 3367-3392.
This paper looks at the performance record of M&As that took place in the European Union financial industry in the period 1998-2002. First, the paper reports evidence on shareholder returns from the merger. Merger announcements implied positive excess returns to the shareholders of the target company around the date of the announcement, with a slight positive excess-return on the 3-months period prior to announcement. Returns to shareholders of the acquiring firms were essentially zero around announcement. One year after the announcement, excess returns were not significantly different from zero for both targets and acquirers. The paper also provides evidence on changes in the operating performance for the subsample of merges involving banks. M&As usually involved targets with lower operating performance than the average in their sector. The transaction resulted in significant improvements in the target banks performance beginning on average 2 years after the transaction was completed. Return on equity of the target companies increased by an average of 7%, and these firms also experience efficiency improvements.
Candelon, B., J. Piplack, et al. (2008). "On measuring synchronization of bulls and bears: The case of East Asia." Journal of Banking & Finance 32(6): 1022-1035.
This paper implements estimation and testing procedures for comovements of stock market "cycles" or "phases" in Asia. We extend the Harding and Pagan [Harding, D., Pagan, A.P., 2006. Synchronization of cycles. Journal of Econometrics 132 (1), 59-79] test for strong multivariate nonsynchronization (SMNS) between business cycles to a test that allows for an imperfect degree of multivariate synchronization between stock market cycles. Moreover, we propose a test for endogenously determining structural change in the bivariate and multivariate synchronization indices. Upon applying the technique to five Asian stock markets we find a significant increase in the cross country comovements of Asian bullish and bearish periods in 1997. A power study of the stability test suggests that the detected increase in comovement is more of a sudden nature (i.e. contagion or "Asian Flu") instead of gradual (i.e. financial integration). It is furthermore argued that stock market cycles and their propensity toward (increased) synchronization contain useful information for both investors, policy makers and financial regulators.
Cao, C., E. C. Chang, et al. (2008). "An empirical analysis of the dynamic relationship between mutual fund flow and market return volatility." Journal of Banking & Finance 32(10): 2111-2123.
We study the dynamic relation between aggregate mutual fund flow and market-wide volatility. Using daily flow data and a VAR approach, we find that market volatility is negatively related to concurrent and lagged flow. A structural VAR impulse response analysis suggests that shock in flow has a negative impact on market volatility: An inflow (outflow) shock predicts a decline (an increase) in volatility. From the perspective of volatility-flow relation, we find evidence of volatility timing for recent period of 1998-2003. Finally, we document a differential impact of daily inflow versus outflow on intraday volatility. The relation between intraday volatility and inflow (outflow) becomes weaker (stronger) from morning to afternoon.
Cao, M. and J. Wei (2005). "Stock market returns: A note on temperature anomaly." Journal of Banking & Finance 29(6): 1559-1573.
This study investigates whether stock market returns are related to temperature. Research in psychology has shown that temperature significantly affects mood, and mood changes in turn cause behavioral changes. Evidence suggests that lower temperature can lead to aggression, while higher temperature can lead to both apathy and aggression. Aggression could result in more risk-taking while apathy could impede risk-taking. We therefore expect lower temperature to be related to higher stock returns and higher temperature to be related to higher or lower stock returns, depending on the trade-off between the two competing effects. We examine many stock markets world-wide and find a statistically significant, negative correlation between temperature and returns across the whole range of temperature. Apathy dominates aggression when temperature is high. The observed negative correlation is robust to alternative tests and retains its statistical significance after controlling for various known anomalies.
Caprio, L. and E. Croci (2008). "The determinants of the voting premium in Italy: The evidence from 1974 to 2003." Journal of Banking & Finance 32(11): 2433-2443.
We examine the voting premium in Italy in the period 1974 to 2003, when it ranged from 1% to 100%. At firm level, the measure of the price differential between voting and non-voting stocks cannot be fully explained without taking into account the effect of the largest shareholder's identity. Family-controlled firms have higher voting premiums, especially when the family owns a large stake in the company's voting equity and the founder is the firm's CEO and/or Chairman. We explain this result by showing that families attach greater importance to control and are more prone than other types of controlling shareholders to expropriate the non-voting class of shareholders.
Carbó Valverde, S., D. B. Humphrey, et al. (2007). "Do cross-country differences in bank efficiency support a policy of "national champions"?" Journal of Banking & Finance 31(7): 2173-2188.
As banking consolidation proceeds and Europe moves toward a single market, cross-country differences in banking efficiency can affect the future competitive position of a country's financial market, helping to determine which European money centers may expand or contract. Looking at large banks across 10 countries, we find they are roughly equally efficient after controlling for differences in business environment, banking costs, and bank productivity. As no country seems to have a strong efficiency advantage, it seems likely that state efforts to promote "national champions" through favorable mergers which expand scale and market share may determine the outcome.
Carbó Valverde, S. and F. Rodríguez Fernández (2007). "The determinants of bank margins in European banking." Journal of Banking & Finance 31(7): 2043-2063.
Most of the theoretical and empirical literature on bank margins has dealt solely with interest margins. Applying the seminal Ho-Saunders model (JFQA, 1981) to a multi-output framework, we show that the relationship between bank margins and market power varies significantly across bank specializations. In this context, European banks are a better laboratory than US banks, since they have generally enjoyed a more flexible regulatory environment in which to provide a wider range of services. Using accounting margins and New Empirical Industrial Organization margins, we find that market power increases as output becomes more diversified towards non-traditional activities in European banking.
Cardak, B. A. and R. Wilkins (2009). "The determinants of household risky asset holdings: Australian evidence on background risk and other factors." Journal of Banking & Finance 33(5): 850-860.
We study the portfolio allocation decisions of Australian households using the relatively new Household, Income and Labour Dynamics in Australia (HILDA) Survey. We focus on household allocations to risky financial assets. Our empirical analysis considers a range of hypothesised determinants of these allocations. We find background risk factors posed by labor income uncertainty and health risk are important. Credit constraints and observed risk preferences play the expected role. A positive age gradient is identified for risky asset holdings and home-ownership is associated with greater risky asset holdings. A unifying theme for many of our empirical findings is the important role played by financial awareness and knowledge in determining risky asset holdings. Many non-stockholding households appear to lack the experience and financial literacy that might enable them to benefit from direct investment in stocks.
Carline, N. F., S. C. Linn, et al. "Operating performance changes associated with corporate mergers and the role of corporate governance." Journal of Banking & Finance In Press, Corrected Proof.
We find that corporate governance characteristics of acquiring firms (board ownership, board size, and block-holder control) have an economically and statistically significant impact on operating performance changes following mergers. We also show that dispersion of intra-board ownership stakes is an important but heretofore overlooked factor when judging the influence of ownership on the outcomes of corporate choices. Finally, we present evidence that suggests the market sometimes under- or overreacts to merger news when initially revaluing merger partners but corrects any miscalculation following the consummation of the merger.
Carling, K., T. Jacobson, et al. (2007). "Corporate credit risk modeling and the macroeconomy." Journal of Banking & Finance 31(3): 845-868.
Despite a surge in the research efforts put into modeling credit and default risk during the past decade, few studies have incorporated the impact that macroeconomic conditions have on business defaults. In this paper, we estimate a duration model to explain the survival time to default for borrowers in the business loan portfolio of a major Swedish bank over the period 1994-2000. The model takes both firm-specific characteristics, such as accounting ratios and payment behaviour, loan-related information, and the prevailing macroeconomic conditions into account. The output gap, the yield curve and consumers' expectations of future economic development have significant explanatory power for the default risk of firms. We also compare our model with a frequently used model of firm default risk that conditions only on firm-specific information. The comparison shows that while the latter model can make a reasonably accurate ranking of firms' according to default risk, our model, by taking macro conditions into account, is also able to account for the absolute level of risk.
Carow, K. A., S. R. Cox, et al. (2009). "Demutualization: Determinants and consequences of the mutual holding company choice." Journal of Banking & Finance33(8): 1454-1463.
We investigate the determinants and consequences of the mutual holding company (MHC) structure that allows mutual thrifts to issue stock to outside shareholders while maintaining the mutual form. Capital constrained firms with greater profit opportunities are more likely to choose a full demutualization; demonstrating that the MHC choice can be used to control for over- and under-investment costs. During periods of greater regulatory constraints, MHC firms have lower offer-day returns than full demutualizations. MHC firms are also less likely to be acquired, as the MHC structure provides protection from the market for corporate control. Demonstrating a clear preference by minority shareholders for the elimination of the MHC structure, the announcement of a second-stage conversion generates a 12% return.
Carpenter, R. E. and A. Guariglia (2008). "Cash flow, investment, and investment opportunities: New tests using UK panel data." Journal of Banking & Finance32(9): 1894-1906.
The interpretation of the correlation between cash flow and investment is controversial. Some argue that it is caused by financial constraints, others by the correlation between cash flow and investment opportunities that are not properly measured by Tobin's Q. This paper uses UK firms' contracted capital expenditure to capture information about opportunities available only to insiders and thus not included in Q. When this variable is added to investment regressions, the explanatory power of cash flow falls for large firms, but remains unchanged for small firms. This suggests that the significance of cash flow stems from its role in capturing the effects of credit frictions.
Carr, P. and L. Wu (2007). "Theory and evidence on the dynamic interactions between sovereign credit default swaps and currency options." Journal of Banking & Finance 31(8): 2383-2403.
Using sovereign CDS spreads and currency option data for Mexico and Brazil, we document that CDS spreads covary with both the currency option implied volatility and the slope of the implied volatility curve in moneyness. We propose a joint valuation framework, in which currency return variance and sovereign default intensity follow a bivariate diffusion with contemporaneous correlation. Estimation shows that default intensity is much more persistent than currency return variance. The market price estimates on the two risk factors also explain the well-documented evidence that historical average default probabilities are lower than those implied from credit spreads.
Cartea, Á. and P. Villaplana (2008). "Spot price modeling and the valuation of electricity forward contracts: The role of demand and capacity." Journal of Banking & Finance 32(12): 2502-2519.
We propose a model where wholesale electricity prices are explained by two state variables: demand and capacity. We derive analytical expressions to price forward contracts and to calculate the forward premium. We apply our model to the PJM, England and Wales, and Nord Pool markets. Our empirical findings indicate that volatility of demand is seasonal and that the market price of demand risk is also seasonal and positive, both of which exert an upward (seasonal) pressure on the price of forward contracts. We assume that both volatility of capacity and the market price of capacity risk are constant and find that, depending on the market and period under study, it could either exert an upward or downward pressure on forward prices. In all markets we find that the forward premium exhibits a seasonal pattern. During the months of high volatility of demand, forward contracts trade at a premium. During months of low volatility of demand, forwards can either trade at a relatively small premium or, even in some cases, at a discount, i.e. they exhibit a negative forward premium.
Carter, D. A. and J. E. McNulty (2005). "Deregulation, technological change, and the business-lending performance of large and small banks." Journal of Banking & Finance 29(5): 1113-1130.
According to DeYoung et al. [Journal of Financial Services Research, 2004] deregulation and technological change has divided the US banking industry into two primary size-based groups: very large banks, specializing in the use of "hard" information to make standardized loans and smaller banks, specializing in the use of "soft" information and relationship development to make non-standardized loans. We evaluate business-lending performance for small and large banks over the 1993-2001 period. Small business lending by small banks is characterized by relationship development and non-standardized loans. Consistent with DeYoung et al.'s model, we find that, after controlling for market concentration, cost of funds, and a variety of other factors that might influence yields, smaller banks perform better than larger banks in the small business lending market. However, larger banks appear to have the advantage in credit card lending, a market characterized by impersonal relationships and standardized loans. Interestingly, we find evidence that larger banks have been making inroads in the market for the smallest business loans, a result consistent with the use of credit scoring by large banks to make very small business loans [Berger et al., Journal of Money, Credit, and Banking, 2004].
Casassus, J., P. Collin-Dufresne, et al. (2005). "Unspanned stochastic volatility and fixed income derivatives pricing." Journal of Banking & Finance 29(11): 2723-2749.
We propose a parsimonious [`]unspanned stochastic volatility' model of the term structure and study its implications for fixed-income option prices. The drift and quadratic variation of the short rate are affine in three state variables (the short rate, its long-term mean and variance) which follow a joint Markov (vector) process. Yet, bond prices are exponential affine functions of only two state variables, independent of the current interest rate volatility level. Because this result holds for an arbitrary volatility process, such a process can be calibrated to match fixed income derivative prices. Furthermore, this model can be [`]extended' (by relaxing the time-homogeneity) to fit any arbitrary term structure. In its [`]HJM' form, this model nests the analogous stochastic equity volatility model of Heston (1993) [Heston, S.L., 1993. A closed form solution for options with stochastic volatility. Review of Financial Studies 6, 327-343]. In particular, if the volatility process is specified to be affine, closed-form solutions for interest rate options obtain. We propose an efficient algorithm to compute these prices. An application using data on caps and floors shows that the model can capture very well the implied Black spot volatility surface, while simultaneously fitting the observed term structure.
Castiglionesi, F. (2007). "Financial contagion and the role of the central bank." Journal of Banking & Finance 31(1): 81-101.
We investigate the role of a central bank (CB) in preventing and avoiding financial contagion. The CB, by imposing reserve requirements on the banking system, trades off the cost of reducing the resources available for long-term investment with the benefit of raising liquidity to face an adverse shock that could cause contagious crises. We argue that contagion is not due to the structure of the interbank deposit market, but to the impossibility to sign contracts contingent on unforeseen contingencies. As long as incomplete contracts are present, the CB may have a useful role in curbing contagion. Moreover, the CB allows the banking system to reach first-best allocation in all the states of the world when the notion of incentive-efficiency is considered. If the analysis is restricted to constrained-efficiency, the CB still avoids contagion without, however, reaching first-best consumption allocation. The model provides a rationale for reserve requirements without the presence of fiat money or asymmetric information.
Cerutti, E., G. Dell'Ariccia, et al. (2007). "How banks go abroad: Branches or subsidiaries?" Journal of Banking & Finance 31(6): 1669-1692.
We examine the factors influencing international banks' organizational form, using an original database on the operations in Latin America and Eastern Europe of the world's top 100 banks. We find that banks are more likely to operate as branches in countries that have higher taxes and lower regulatory restrictions on bank entry and on foreign branches. Subsidiary operations are preferred by banks seeking to penetrate host markets by establishing large retail operations. Finally, economic and political risks have opposite effects, suggesting that legal differences in parent banks' responsibilities associated with branches and subsidiaries are important determinants of banks' organizational form.
Chae, J., S. Kim, et al. "How corporate governance affects payout policy under agency problems and external financing constraints." Journal of Banking & FinanceIn Press, Accepted Manuscript.
This paper analyzes the effect of corporate governance on the payout policy when a firm has both agency problems and external financing constraints. We empirically test whether strong corporate governance would lead to higher payout to minimize agency problems (outcome hypothesis), or to lower payout to avoid costly external financing (substitute hypothesis). We find that firms with higher (lower) external financing constraints tend to decrease (increase) payout ratio with an improvement in their corporate governance. The results are consistent with our hypothesis that the relation between payout and corporate governance is reversed depending on the relative sizes of agency and external financing costs.
Chakrabarti, R., W. Huang, et al. (2005). "Price and volume effects of changes in MSCI indices - nature and causes." Journal of Banking & Finance 29(5): 1237-1264.
Using changes in the MSCI Standard Country Indices for 29 countries between 1998 and 2001, we document that stock returns and volumes exhibit "index effects" in international markets similar to those detected by the studies of US stocks. The stocks added to the indices experience a sharp rise in prices after the announcement and a further rise during the period preceding the actual change, though part of the gain is lost after the actual change date. The stocks that are deleted from the indices, on the other hand, witness a steady and marked decline in their prices. Trading volumes increase significantly and remain at high levels after the change date for the added stocks. There are also considerable cross-country variations in these effects. Tests using data on various measures reflecting the different hypotheses fail to turn up any evidence in support of information effects. Our evidence appears to be more supportive of the downward sloping demand curve hypothesis. There is some evidence of price-pressure and mild evidence of liquidity effect, particularly in Japan and UK.
Chakrabarty, B., B. Li, et al. (2007). "Trade classification algorithms for electronic communications network trades." Journal of Banking & Finance 31(12): 3806-3821.
Ellis et al. [Ellis, K., Michaely, R., O'Hara, M., 2000. The accuracy of trade classification rules: Evidence from Nasdaq. Journal of Financial and Quantitative Analysis 35 (4), 529-551] find that trade classification rules have limited success in classifying trades which execute inside the quotes. We reconfirm this result and propose an alternative algorithm to improve the classification accuracy for trades inside the quotes. This alternative algorithm improves the overall success rate for classifying trades, especially for trades that occur inside the quotes. Additionally, we show that the Lee and Ready [Lee, C., Ready, M., 1991. Inferring trade direction from intraday data. Journal of Finance 46, 733-747] and Ellis et al. (2000) trade classification algorithms provide biased estimates of the actual effective spreads and price impacts, while our algorithm provides statistically unbiased estimates of actual effective spreads and price impacts.
Chamon, M. and P. Mauro (2006). "Pricing growth-indexed bonds." Journal of Banking & Finance 30(12): 3349-3366.
Growth-indexed bonds have been suggested as a way of reducing the procyclicality of emerging-market countries' fiscal policies and the likelihood of costly debt crises. Investor attitude surveys suggest that pricing difficulties are seen as a considerable obstacle. In an effort to reduce such concerns, this article presents a simple way of pricing growth-indexed bonds. As a pleasant by-product, the analysis tracks the quantitative implications of an increase in the share of growth-indexed bonds in total debt, measuring the ensuing decline in the probability of default and the reduction in the spreads at which standard bonds can be issued.
Champagne, C. and L. Kryzanowski (2007). "Are current syndicated loan alliances related to past alliances?" Journal of Banking & Finance 31(10): 3145-3161.
The odds of a current syndicate relationship between two lenders depend upon their previous alliances. The odds are significantly higher [lower] and strongest for a current lead-participant relationship with a continuation [reversal] of their previous roles. To illustrate, the odds are nearly four times higher when two lenders have allied in the previous 5 years. The strength of lead-participant syndicate relationships between two lenders with same-ordered roles is most sensitive to the lead bank's reputation and informationally opaque participants tend to have stronger relationships with lead banks. Lenders exhibit home bias in their syndicate alliances since ongoing relationships are stronger with domestic counterparts.
Chan, C. C. and W. M. Fong (2006). "Realized volatility and transactions." Journal of Banking & Finance 30(7): 2063-2085.
This paper re-examines the impact of number of trades, trade size and order imbalance on daily stock returns volatility. In contrast to prior studies, we estimate daily volatility using realized volatility obtained by summing up intraday squared returns. Consistent with the theory of quadratic variation, realized volatility estimates are shown to be less noisy than standard volatility measures such as absolute returns used in previous studies. In general, our results confirm [Jones, C.M., Kaul, G., Lipson, M.L., 1994. Transactions, volume, and volatility. Review of Financial Studies 7, 631-651] that number of trades is the dominant factor behind the volume-volatility relation. Neither trade size nor order imbalance adds significantly more explanatory power to realized volatility beyond number of trades. This finding is robust to different time periods, firm sizes and regression specifications. The implications of our results for microstructure theory are discussed.
Chan, J. S. P., D. Hong, et al. (2008). "A tale of two prices: Liquidity and asset prices in multiple markets." Journal of Banking & Finance 32(6): 947-960.
This paper investigates the liquidity effect in asset pricing by studying the liquidity-premium relationship of an American depositary receipt (ADR) and its underlying share. Using the [Amihud, Yakov, 2002. Illiquidity and stock returns: cross-section and time series effects. Journal of Financial Markets 5, 31-56] measure, the turnover ratio and trading infrequency as proxies for liquidity, we show that a higher ADR premium is associated with higher ADR liquidity and lower home share liquidity, in terms of changes in these variables. We find that the liquidity effects remain strong after we control for firm size and a number of country characteristics, such as the expected change in the foreign exchange rate, the stock market performance, as well as several variables measuring the openness and transparency of the home market.
Chan, K., D. L. Ikenberry, et al. (2007). "Do managers time the market? Evidence from open-market share repurchases." Journal of Banking & Finance 31(9): 2673-2694.
A contentious debate exists over whether executives possess market timing skills when announcing certain corporate transactions. Pseudo-market timing, however, has recently emerged as an important alternative hypothesis as to why the appearance of timing might be evident when, in fact, none exists. We reconsider this debate in the context of share repurchases. Consistent with prior studies, we also report evidence of abnormal stock performance following buyback announcements. Pseudo-market timing, however, does not appear to be a viable explanation. Our results are more consistent with the notion that managers possess timing ability, at least in the context of share repurchases.
Chandar, N., D. K. Patro, et al. (2009). "Crises, contagion and cross-listings." Journal of Banking & Finance 33(9): 1709-1729.
We investigate whether cross-listing shares in the form of depositary receipts in overseas markets benefits investors in emerging market countries during periods of local financial crisis from 1994 to 2002. We regress cumulative abnormal returns for three windows surrounding the crisis events on the cross-listing status while controlling for cross-sectional differences in firm age, trading volume, foreign exposure, disclosure quality and corporate governance. Further, we examine cross-listing effects in countries popularly thought to experience contagious effects of these crises. We find that cross-listed firms react significantly less negatively than non-cross-listed firms, particularly in the aftermath of the crisis. The results on contagious cross-listing effects are however mixed. Our findings are consistent with predictions based on theories of market segmentation as well as differential disclosure/governance between developed and emerging markets. We do not find evidence that foreign investors "panic" during a currency crisis.
Chang, C.-C., P.-F. Hsieh, et al. (2009). "Do informed option investors predict stock returns? Evidence from the Taiwan stock exchange." Journal of Banking & Finance 33(4): 757-764.
In this paper, we set out to investigate the information content of options trading using a unique dataset to examine the predictive power of the put and call positions of different types of traders in the TAIEX option market. We find that options volume, as a whole, carries no information on TAIEX spot index changes. On the other hand, however, although foreign institutional investors do not engage in much trading, there is strong evidence to show that the trading in which they do engage has significant predictive power on the underlying asset returns. We also find that foreign institutional investors have greater predictive power with regard to in near-the-money and middle-horizon options.
Chang, E. C., J. Ren, et al. (2009). "Effects of the volatility smile on exchange settlement practices: The Hong Kong case." Journal of Banking & Finance 33(1): 98-112.
The well-documented volatility smile phenomenon in the US options market has affected the option settlement practices of other markets. To settle Hang Seng Index (HSI) options, the Hong Kong Stock Exchange artificially builds in a piecewise linear "smile" or "sneer" volatility function, which is determined daily by market makers rather than directly by market forces. In this study, we investigate the time-varying settlement function and find the following economic determinants of the volatility function: lag parameters, current-day HSI returns, the distribution of HSI returns, transaction costs as proxied by the bid-ask spread, and the "Monday effect". For evaluation purposes, we use as a benchmark the estimated piecewise linear volatility function as directly driven by market forces. The comparison analyses show that base volatilities set by market makers run somewhat high, while downside slopes are not steep enough. This results in the overpricing of the lion's share of traded options. An economic determinants analysis of market-force-driven parameters reveals that market makers can better align artificial volatility parameters both by reducing reliance on the function parameters of prior days and by more precisely accounting for current-day HSI returns, option time-to-maturity, bid-ask spreads and buying pressure.
Chang, R. P., S. G. Rhee, et al. (2008). "How does the call market method affect price efficiency? Evidence from the Singapore Stock Market." Journal of Banking & Finance 32(10): 2205-2219.
On August 21, 2000, the Singapore Exchange (SGX) adopted the call market method to open and close the market while the remainder of the day's trading continued to rely on the continuous auction method. The call method significantly improved the price discovery process and market quality. A positive spillover effect is observed from the opening and closing calls. Day-end price manipulation also declined after the introduction of the call market method. However, the beneficial impact from the call market method is asymmetric, benefiting liquid stocks more than illiquid stocks.
Chang, S.-C., S.-S. Chen, et al. (2008). "Weather and intraday patterns in stock returns and trading activity." Journal of Banking & Finance 32(9): 1754-1766.
We examine the relation between weather in New York City and intraday returns and trading patterns of NYSE stocks. While stock returns are found to be generally lower on cloudier days, cloud cover has a significant influence on stock returns only at the market open. There are significantly more seller-initiated trades when there is more cloud cover at the market open, which is consistent with the return results. Cloudy skies are associated with higher volatility and less market depth over the entire trading day. Finally, cloud cover is not significantly correlated with spread measures and turnover ratios. The findings overall suggest that weather has a significant influence on investors' intraday trading behavior.
Chapelle, A., Y. Crama, et al. (2008). "Practical methods for measuring and managing operational risk in the financial sector: A clinical study." Journal of Banking & Finance 32(6): 1049-1061.
This paper analyzes the implications of the advanced measurement approach (AMA) for the assessment of operational risk. Through a clinical case study on a matrix of two selected business lines and two event types of a large financial institution, we develop a procedure that addresses the major issues faced by banks in the implementation of the AMA. For each cell, we calibrate two truncated distributions functions, one for "normal" losses and the other for the "extreme" losses. In addition, we propose a method to include external data in the framework. We then estimate the impact of operational risk management on bank profitability, through an adapted measure of RAROC. The results suggest that substantial savings can be achieved through active management techniques.
Chaplinsky, S. and G. R. Erwin (2009). "Great expectations: Banks as equity underwriters." Journal of Banking & Finance 33(2): 380-389.
We examine the in-roads commercial banks have made into equity underwriting over 1990-2002. While banks end the period handling upwards of 25% of equity underwriting, this increase results almost exclusively from acquisitions of investment banks with an already established market share of equity underwriting. We find a significant decline in the market share of equity underwriting that banks acquired in the post-merger period, a decline that is larger than that experienced by independent investment banks of comparable reputation. Banks lose market share because they originate fewer IPOs and their IPOs have a lower incidence of follow-on SEOs compared to independent investment banks. Following the merger, banks experience a large fall off in their ability to retain follow-on SEOs and are less successful in winning SEO mandates when an issuer switches from its IPO underwriter. Overall, the findings suggest it has been difficult for banks to achieve scope economies in equity underwriting.
Chatrath, A., R. A. Christie-David, et al. (2009). "Competitive inventory management in Treasury markets." Journal of Banking & Finance 33(5): 800-809.
We decompose US Treasury bid-ask spreads into inventory, adverse selection and order processing costs by using the fact that inventory trades have different effects on spreads than do proprietary trades. We exploit this asymmetry and develop a technique to identify the three components of the spread in order to test three hypotheses: dealers make larger changes to inventory (1) following macroeconomic announcements (2) at the start and toward the end of the New York trading hours, and (3) when transaction sizes are relatively large. We test these predictions using GovPX data for on-the-run 2-year and 10-year Treasury Notes. All three predictions are supported. We also assess how primary dealers react to the Federal Reserve's open market operations (OMOs). Our findings reveal interesting intraday patterns in the inventory component for both securities.
Chavez-Demoulin, V., P. Embrechts, et al. (2006). "Quantitative models for operational risk: Extremes, dependence and aggregation." Journal of Banking & Finance30(10): 2635-2658.
Due to the new regulatory guidelines known as Basel II for banking and Solvency 2 for insurance, the financial industry is looking for qualitative approaches to and quantitative models for operational risk. Whereas a full quantitative approach may never be achieved, in this paper we present some techniques from probability and statistics which no doubt will prove useful in any quantitative modelling environment. The techniques discussed are advanced peaks over threshold modelling, the construction of dependent loss processes and the establishment of bounds for risk measures under partial information, and can be applied to other areas of quantitative risk management.1
Chelley-Steeley, P. L. (2008). "Market quality changes in the London Stock Market." Journal of Banking & Finance 32(10): 2248-2253.
This paper examines the impact that the introduction of a closing call auction had on market quality at the London Stock Exchange. Using estimates from the partial adjustment with noise model of Amihud and Mendelson [Amihud, Y., Mendelson, H., 1987. Trading mechanisms and stock returns: An empirical investigation. Journal of Finance 42, 533-553] we show that opening and closing market quality improved for participating stocks. When we stratify our sample securities into five groups based on trading activity we find that the least active securities experience the greatest improvements to market quality. A control sample of stocks are not characterized by discernable changes to market quality.
Chen, A.-S. and B.-S. Hong (2006). "Institutional ownership changes and returns around analysts' earnings forecast release events: Evidence from Taiwan." Journal of Banking & Finance 30(9): 2471-2488.
Traditional data sources do not have institutional holding data on a daily basis. Because of this, most prior empirical studies of institutional herding have focused on quarterly or annual data. The problem, however, with using quarterly or annual data on institutional holdings is that these data may not reveal institutional herding if it occurs over a shorter time interval. For this study, we make use of data from the Taiwan Stock Exchange (TSE). Unlike traditional data sources, the TSE provides daily institutional holdings information. The use of this detailed data allows us to make more interesting analysis and inferences. In this study, we examine the relationship between institutional ownership changes and returns localized around analysts' earnings forecast release events. Analysis of institutional ownership and return data around the earnings release event allows us to investigate institutional herding and feedback behavior in a different level. Our major results are as follows: (1) there exists a relation between company specific attributes and institutional herding, (2) observed changes in institutional ownership and contemporaneous return are mainly the results of inter-day price impact of herding, (3) institutional investors show evidence of being informed traders in buying but not selling.
Chen, A.-S. and M. T. Leung (2005). "Modeling time series information into option prices: An empirical evaluation of statistical projection and GARCH option pricing model." Journal of Banking & Finance 29(12): 2947-2969.
This paper compares the empirical performances of statistical projection models with those of the Black-Scholes (adapted to account for skew) and the GARCH option pricing models. Empirical analysis on S&P500 index options shows that the out-of-sample pricing and projected trading performances of the semi-parametric and nonparametric projection models are substantially better than more traditional models. Results further indicate that econometric models based on nonlinear projections of observable inputs perform better than models based on OLS projections, consistent with the notion that the true unobservable option pricing model is inherently a nonlinear function of its inputs. The econometric option models presented in this paper should prove useful and complement mainstream mathematical modeling methods in both research and practice.
Chen, C., R. Chen, et al. (2007). "Fundamental indexation via smoothed cap weights." Journal of Banking & Finance 31(11): 3486-3502.
If prices of individual stocks are unbiased but noisy approximations to fundamental values, there will be a gap in returns between the standard cap-weighted market portfolio and the one based on fundamentals. The discrepancy occurs because, relative to fundamentals, cap-weights are too large (small) for stocks with positive (negative) deviations from fundamental values. It follows that the usual cap-weighted portfolio will underperform relative to the fundamental-based portfolio as long as prices revert to fundamental values. This has led Arnott et al. to propose new market indices based on a firm's fundamental size as measured by its revenues, number of employees, and so on. In this paper we follow the same principle but propose to estimate fundamental weights using a smoothed average of standard cap-weights. Since the putative excess returns of a fundamentals-weighted portfolio requires reversion to fundamental values, and because fundamental values are likely to change slowly, we can estimate current fundamentals by smoothing the time series of a stock's noisy prices. The determination of fundamental size in terms of accounting data is thereby replaced by a simple estimate based on price history. We derive expressions for expected returns of the market capitalization-based and fundamentals-based portfolios under various assumptions about (i) the random deviations from fundamental values and (ii) the change in fundamentals over time. We present empirical comparisons between portfolios and find the returns of the fundamentals-based portfolios exceed the standard indices by an amount comparable to the prior estimates that used accounting data to determine size.
Chen, C. R., T. L. Steiner, et al. (2006). "Does stock option-based executive compensation induce risk-taking? An analysis of the banking industry." Journal of Banking & Finance 30(3): 915-945.
We investigate the relation between option-based executive compensation and market measures of risk for a sample of commercial banks during the period of 1992-2000. We show that following deregulation, banks have increasingly employed stock option-based compensation. As a result, the structure of executive compensation induces risk-taking, and the stock of option-based wealth also induces risk-taking. The results are robust across alternative risk measures, statistical methodologies, and model specifications. Overall, our results support a management risk-taking hypothesis over a managerial risk aversion hypothesis. Our results have important implications for regulators in monitoring the risk levels of banks.
Chen, G., M. Firth, et al. (2009). "Does the type of ownership control matter? Evidence from China's listed companies." Journal of Banking & Finance 33(1): 171-181.
By tracing the identity of large shareholders, we group China's listed companies into those controlled by state asset management bureaus (SAMBs), state owned enterprises (SOEs) affiliated to the central government (SOECGs), SOEs affiliated to the local government (SOELGs), and Private investors. We argue that these distinct types of owners have different objectives and motivations and this will affect how they exercise their control rights over the firms they invest in. In particular, we contend that private ownership of listed firms in China is not necessarily superior to certain types of state ownership. To test our arguments we investigate the relative efficiency of state versus private ownership of listed firms and the efficiency of various forms of state ownership. The empirical results indicate that the operating efficiency of Chinese listed companies varies across the type of controlling shareholder. SOECG controlled firms perform best and SAMB and Private controlled firms perform worst. SOELG controlled firms are in the middle. The results are consistent with our predictions.
Chen, H.-C., L. Fauver, et al. (2009). "What do investment banks charge to underwrite American Depositary Receipts?" Journal of Banking & Finance 33(4): 609-618.
We investigate how investment banks determine the gross spreads paid by American Depositary Receipts (ADRs) from 1980 to 2004. We begin by comparing the gross spreads of ADR IPOs and ADR SEOs to those of matching US IPOs and US SEOs. We document clustering at the 7% level for our ADR IPO sample (44% for the ADR IPO firms without a previous equity listing), whereas our ADR SEO sample exhibits no discernable clustering at any level. We then find that ADR IPO gross spreads can be explained by firm and offer characteristics (similar to our matched sample of US IPOs), and by whether the ADR IPO firm has a previous equity listing. ADR SEO gross spreads can be explained more by offer characteristics (more similar to our matched sample of US SEOs).
Chen, L.-W. and F. Chen (2009). "Does concurrent management of mutual and hedge funds create conflicts of interest?" Journal of Banking & Finance 33(8): 1423-1433.
This paper shows that conflicts of interest may exist in cases where a hedge fund manager starts a mutual fund but not in the opposite case. We compare performance, asset flows, and risk incentives to establish several key differences between these two scenarios: First, prior to concurrent management, hedge fund managers experience worse performance while mutual fund managers achieve better performance relative to their full-time peers. Second, hedge fund managers who choose concurrent management are disproportionately the ones with less experience. Their hedge funds tend to suffer a decline in performance after the event. By contrast, mutual fund managers who choose concurrent management tend to outperform their full-time peers. Based on our findings, we make important recommendations for policy makers and companies. The relevance of our recommendations extends beyond the small share of companies presently engaged in concurrent management.
Chen, L.-W., S. A. Johnson, et al. (2009). "Information, sophistication, and foreign versus domestic investors' performance." Journal of Banking & Finance 33(9): 1636-1651.
Using an intraday transaction dataset with trader identity, we study foreign and domestic investors' trading activities and investment performance ahead of open-ending events of Taiwanese closed-end funds. Simply buying the funds at a discount and holding until open-ending generates large abnormal returns. All information required to execute this strategy is made public, so the events set up natural experiments to examine how investors trade, holding constant access to information. Foreign investors are net buyers ahead of the open-endings, more than doubling their positions and earning large abnormal returns. Domestic investors are net sellers while the discounts are still large, and forego large abnormal returns. The results suggest that investor sophistication in interpreting the same information is potentially an important determinant of investment performance differences across foreign and domestic investors.
Chen, S.-S. (2009). "Predicting the bear stock market: Macroeconomic variables as leading indicators." Journal of Banking & Finance 33(2): 211-223.
This paper investigates whether macroeconomic variables can predict recessions in the stock market, i.e., bear markets. Series such as interest rate spreads, inflation rates, money stocks, aggregate output, unemployment rates, federal funds rates, federal government debt, and nominal exchange rates are evaluated. After using parametric and nonparametric approaches to identify recession periods in the stock market, we consider both in-sample and out-of-sample tests of the variables' predictive ability. Empirical evidence from monthly data on the Standard & Poor's S&P 500 price index suggests that among the macroeconomic variables we have evaluated, yield curve spreads and inflation rates are the most useful predictors of recessions in the US stock market, according to both in-sample and out-of-sample forecasting performance. Moreover, comparing the bear market prediction to the stock return predictability has shown that it is easier to predict bear markets using macroeconomic variables.
Chen, Z., D. Li, et al. (2005). "China's financial services industry: The intra-industry effects of privatization of the Bank of China Hong Kong." Journal of Banking & Finance 29(8-9): 2291-2324.
The purpose of this paper is to discuss and apply some of the key issues and lessons from similar privatization in other parts of the world to the partial privatization of the Bank of China Hong Kong (BOCHK). The empirical results of this paper indicate that some of the banks and non-bank financial institutions reacted negatively to the partial privatization announcements of the BOCHK. The empirical results also show that HSBC, the largest bank in Hong Kong had no significant reaction to the restructuring announcement or the listing announcement of the BOCHK. However, the Hang Seng Bank, the third largest bank in Hong Kong, suffered a loss after the announcement of the BOCHK listing. Compared with the banks and non-bank financial institutions in China, the BOCHK over-performed the rival firms in Mainland China 1 year after its partial privatization.
Chen, Z. and Y. Wang (2008). "Two-sided coherent risk measures and their application in realistic portfolio optimization." Journal of Banking & Finance 32(12): 2667-2673.
By using a different derivation scheme, a new class of two-sided coherent risk measures is constructed in this paper. Different from existing coherent risk measures, both positive and negative deviations from the expected return are considered in the new measure simultaneously but differently. This innovation makes it easy to reasonably describe and control the asymmetry and fat-tail characteristics of the loss distribution and to properly reflect the investor's risk attitude. With its easy computation of the new risk measure, a realistic portfolio selection model is established by taking into account typical market frictions such as taxes, transaction costs, and value constraints. Empirical results demonstrate that our new portfolio selection model can not only suitably reflect the impact of different trading constraints, but find more robust optimal portfolios, which are better than the optimal portfolio obtained under the conditional value-at-risk measure in terms of diversification and typical performance ratios.
Chern, K.-Y., K. Tandon, et al. (2008). "The information content of stock split announcements: Do options matter?" Journal of Banking & Finance 32(6): 930-946.
We provide a new test of the informational efficiency of trading in stock options in the context of stock split announcements. These announcements tend to be associated with positive abnormal returns. Our traditional event study results show abnormal returns that are significantly lower for optioned than non-optioned stocks, whether traded on the NYSE, Amex, or Nasdaq. After controlling for market returns, capitalization, book-to-market ratio, and trading volume, we find that the abnormal returns are significantly lower for NYSE/Amex optioned than non-optioned stocks. Although the results for Nasdaq stocks are not as clear, the overall effects tend to be lower after optioning. These findings are consistent with the hypothesis that the prices of optioned stocks embody more information, diminishing the impact of the stock split announcement. They provide new evidence of the beneficial effects of options on their underlying stocks.
Chernobai, A. and Y. Yildirim (2008). "The dynamics of operational loss clustering." Journal of Banking & Finance 32(12): 2655-2666.
This paper investigates the characteristics of the operational loss data formation mechanism that takes place between the date of discovery of a new operational risk event and the final settlement date on which all losses are materialized. The first loss that characterizes the initial impact of a new operational risk event frequently triggers a sequence of related losses. Then, losses generated by the same event are not independent and follow a predictable scheme and the frequency of secondary losses is not homogeneous: both are functions of the initial loss amount and time. We model the arrival intensity and loss severities with a shot-noise stochastic process and derive its key properties. We then discuss implications of our model for the estimation of the regulatory capital charge for operational risk. In an empirical analysis, we find strong evidence of a shot-noise behavior in operational losses using the data of a major US commercial bank.
Cheung, Y.-L., Y. Qi, et al. (2009). "Buy high, sell low: How listed firms price asset transfers in related party transactions." Journal of Banking & Finance 33(5): 914-924.
We examine a sample of 254 related party and arms' length acquisitions and sales of assets in Hong Kong during 1998-2000. Our analysis shows that publicly listed firms enter deals with related parties at unfavourable prices compared to similar arms' length deals. Firms acquire assets from related parties by paying a higher price compared to similar arms' length deals. In contrast, when they sell assets to related parties, they receive a lower price than in similar arms' length deals. With the exception of audit committees, corporate governance characteristics have limited impact on transaction prices. Firms with audit committees on their boards pay lower prices to related parties for acquisitions and receive higher prices from related parties from divestments.
Chi, J. and M. Gupta (2009). "Overvaluation and earnings management." Journal of Banking & Finance 33(9): 1652-1663.
Consistent with Jensen's [Jensen, M., 2005. Agency costs of overvalued equity. Financial Management 34, 5-19] agency-costs-of-overvalued-equity prediction, we find that overvaluation is statistically and economically related to subsequent income-increasing earnings management. This relation is robust to a series of tests that address potential endogeneity concerns, including omitted variable bias and reverse causality. The agency costs of overvalued equity are substantial. Overvaluation-induced income-increasing earnings management is negatively related to future abnormal stock returns and operating performance, and this negative relation becomes more pronounced as prior overvaluation intensifies. Among the most overvalued firms, those with high discretionary accruals underperform those with low discretionary accruals during the following year by 11.88% as measured by the three-factor alphas, and by 12.87% points as measured by industry-adjusted unmanaged EBITDA-to-assets ratio.
Chiou, I. and L. J. White (2005). "Measuring the value of strategic alliances in the wake of a financial implosion: Evidence from Japan's financial services sector."Journal of Banking & Finance 29(10): 2455-2473.
This paper examines the wealth effects of financial-institution strategic alliances on the shareholders of the newly allied firms. Our paper is different from most previous studies, in that we focus on financial institutions, we employ Japanese data for the late 1990s, and we study whether different types of alliances result in differing magnitudes of stock market responses. We find that a strategic alliance, on average, increases the value of the partner firms. Second, the gains from the alliance are spread more widely among the partners than would be suggested by a random alternative. Third, smaller partners tend to experience larger percentage gains. Fourth, the market values inter-group alliance announcements more than intra-group alliance announcements. Fifth, we do not find a significant difference in the abnormal returns shown by domestic-foreign alliances and domestic-domestic alliances.
Chiyachantana, C. N., P. K. Jain, et al. (2006). "Volatility effects of institutional trading in foreign stocks." Journal of Banking & Finance 30(8): 2199-2214.
This paper examines the impact of institutional trades on volatility in international stocks across 43 countries. There is a temporary volatility spike during the trade execution period, merely reflecting the price impact costs faced by the institutions. Cross sectional regressions suggest that trade imbalances, enforcement of insider trading laws, stock prices, and an emerging market classification are positively associated with temporary volatility increases whereas the presence of market makers and better shareholders' rights dampen such increases. In the long term, institutional trades do not destabilize markets as the levels of volatility after their trades are almost identical to their pre-decision levels.
Chng, M. T. (2009). "Economic linkages across commodity futures: Hedging and trading implications." Journal of Banking & Finance 33(5): 958-970.
We investigate cross-market trading dynamics in futures contracts written on seemingly unrelated commodities that are consumed by a common industry. On the Tokyo Commodity Exchange, we find such evidence in natural rubber (NR), palladium (PA) and gasoline (GA) futures markets. The automobile industry is responsible for more than 50% of global demand for each of these commodities. VAR estimation reveals short-run cross-market interaction between NR and GA, and from NR to PA. Cross-market influence exerted by PA is felt in longer dynamics, with PA volatility (volume) affecting NR (GA) volume (volatility). Our findings are robust to lag-specification, volatility measure, and consistent with full BEKK-GARCH estimation results. Further analysis, which benchmarks against silver futures market, TOCOM index and TOPIX transportation index, confirms that our results are driven by a common industry exposure, and not a commodity market factor. A simple trading rule that incorporates short-run GA and long-run PA dynamics to predict NR return yields positive economic profit. Our study offers new insights into how commodity and equity markets relate at an industry level, and implications for multi-commodity hedging.
Choi, H. S., J. Clarke, et al. (2009). "The effects of regulation on industry structure and trade generation in the US securities industry." Journal of Banking & Finance33(8): 1434-1445.
This study investigates the effects of Regulation FD and the Global Research Analyst Settlement on market share within the US securities industry as well as the determinants of market share during 1996-2004. We find that these regulations did not cause top brokers to lose market share in spite of their reduction of information asymmetries existing within the brokerage industry. They did, however, significantly reduce the quarterly variability in market share changes. We find that Regulation FD and the Global Research Analyst Settlement reduce the importance of an all-star analyst, issuer affiliation, and analyst optimism for gaining brokerage market share. We further discover that the Global Research Analyst Settlement increases the importance of coverage as a market share determinant while reducing the value of analyst experience for non-top brokers. We find that our results remain robust even when we limit our analysis to a set of pure brokerage firms.
Choi, J. J. and C. Jiang "Does multinationality matter? Implications of operational hedging for the exchange risk exposure." Journal of Banking & Finance In Press, Corrected Proof.
An important issue in global corporate risk management is whether the multinationality of a firm matters in terms of its effect on exchange risk exposure. In this paper, we examine the exchange risk exposure of US firms during 1983-2006, comparing multinational and non-multinational firms and focusing on the role of operational hedging. Since MNCs and non-multinationals differ in size and other characteristics, we construct matched samples of MNCs and non-multinationals based on the propensity score method. We find that the multinationality in fact matters for a firm's exchange exposure but not in the way usually presumed - the exchange risk exposures are actually smaller and less significant for MNCs than non-multinationals. The results are robust with respect to different samples and model specifications. There is evidence that operational hedging decreases a firm's exchange risk exposure and increases its stock returns. The effective deployment of operational risk management strategies provides one reason why MNCs may have insignificant exchange risk exposure estimates.
Chong, B. S., M.-H. Liu, et al. (2006). "Monetary transmission via the administered interest rates channel." Journal of Banking & Finance 30(5): 1467-1484.
This paper examines the dynamics of administered interest rate changes in response to changes in the benchmark money market rate in Singapore. Our results show that the administered rates' adjustment speed differs across both financial institutions and financial products. The financial institutions' administered (lending and deposit) rates, moreover, are more rigid when they are below their equilibrium level than when they are above. Our finding, hence, implies that the speed of monetary transmission is not uniform across all sectors of the economy and that a tightening monetary policy takes a longer time to impact the economy than an expansionary monetary policy.
Chong, B.-S., M.-H. Liu, et al. (2006). "The wealth effect of forced bank mergers and cronyism." Journal of Banking & Finance 30(11): 3215-3233.
This study examines the impact of forced bank mergers on the shareholders' wealth of Malaysian banks. Forced bank mergers, which are the result of direct government intervention in the consolidation of the banking industry, are generally rare. Unlike the findings on voluntary mergers and acquisitions, our study shows that the forced merger scheme destroys economic value in aggregate and the acquiring banks tend to gain at the expense of the target banks. Further analysis shows that the contrasting forced merger finding is linked to cronyism.
Chortareas, G. and G. Kapetanios (2009). "Getting PPP right: Identifying mean-reverting real exchange rates in panels." Journal of Banking & Finance 33(2): 390-404.
Recent advances in testing for the validity of Purchasing Power Parity (PPP) focus on the time series properties of real exchange rates in panel frameworks. One weakness of such tests, however, is that they fail to inform the researcher as to which cross-section units are stationary. As a consequence, a reservation for PPP analyses based on such tests is that a small number of real exchange rates in a given panel may drive the results. In this paper we examine the PPP hypothesis focusing on the stationarity of the real exchange rates in up to 25 OECD countries. We introduce a methodology that when applied to a set of established panel unit-root tests, allows the identification of the real exchange rates that are stationary. Our results reveal evidence of mean-reversion that is significantly stronger as compared to that obtained by the existing literature, strengthening the case for PPP.
Christiansen, C. (2005). "Multivariate term structure models with level and heteroskedasticity effects." Journal of Banking & Finance 29(5): 1037-1057.
The paper introduces and estimates a multivariate level-GARCH model for the long rate and the term-structure spread where the conditional volatility is proportional to the [gamma]th power of the variable itself (level effects) and the conditional covariance matrix evolves according to a multivariate GARCH process (heteroskedasticity effects). The long-rate variance exhibits heteroskedasticity effects and level effects in accordance with the square-root model. The spread variance exhibits heteroskedasticity effects but no level effects. The level-GARCH model is preferred above the GARCH model and the level model. GARCH effects are more important than level effects. The results are robust to the maturity of the interest rates.
Christiansen, C. and A. Ranaldo (2009). "Extreme coexceedances in new EU member states' stock markets." Journal of Banking & Finance 33(6): 1048-1057.
We analyze the financial integration of the new European Union (EU) member states' stock markets using the negative (positive) coexceedance variable that counts the number of large negative (large positive) returns on a given day across the countries. A similar analysis is performed for the old EU countries. We use a multinomial logit model to investigate how persistence, asset classes, and volatility are related to the coexceedance variables. We find that the effects differ (a) between negative and positive coexceedance variables (b) between old and new EU member states, and (c) before and after the EU enlargement in 2004, suggesting a closer connection of new EU stock markets to those in Western Europe.
Chua, C. T., C. S. Eun, et al. (2007). "Corporate valuation around the world: The effects of governance, growth, and openness." Journal of Banking & Finance31(1): 35-56.
The purpose of this paper is to provide a comprehensive analysis of corporate valuation around the world. Specifically, we (i) document and compare corporate valuation around the world, and (ii) identify the key factors that drive cross-country differences in valuation. In doing so, we utilize the country-level Tobin's q (CTQ), computed as the ratio of the aggregate market value to book value of all assets held by all public firms domiciled in a country, which amounts to the Tobin's q for the [`]market portfolio' of the country. The key findings of the paper are: First, CTQ varies greatly across countries, ranging from 0.73 for Venezuela to 2.11 for Finland, with the international mean of 1.30 during our sample period 1999-2004. Despite the steady integration of the world economy in recent years, corporate valuation remains starkly different across countries. Second, apart from the effect of corporate governance, cross-country differences in corporate valuation are significantly driven by the growth options of countries represented by the R&D intensities, capital expenditures, and GDP growth. In addition, the degree of capital market openness has a significant, independent effect on valuation. Third, our regression analyses show that CTQ varies directly with shareholder rights, enforcement of insider trading laws, GDP growth, R&D intensity, and the degree of capital market openness. The key findings remain robust to the inclusion of inflation and industry effects.
Chua, C. T., S. Lai, et al. (2008). "Effective fair pricing of international mutual funds." Journal of Banking & Finance 32(11): 2307-2324.
We propose a new methodology to provide fair prices of international mutual funds by adjusting prices at the individual security level using a comprehensive and economically relevant information set. Stepwise regressions are used to endogenously determine the stock-specific optimal set of factors. Using 16 synthetic funds whose characteristics are extracted from 16 corresponding actual US-based Japanese mutual funds, we demonstrate that our method estimates fund prices significantly more accurately than existing methods. Although existing fair-pricing methods provide an improvement over the current practice of simply using Japanese market closing prices, they are still highly vulnerable to exploitation by market-timers. By contrast, our method is the most successful in preventing such strategic exploitation since no competing method can profit from our stated prices.
Chuang, C.-C., C.-M. Kuan, et al. (2009). "Causality in quantiles and dynamic stock return-volume relations." Journal of Banking & Finance 33(7): 1351-1360.
This paper investigates the causal relations between stock return and volume based on quantile regressions. We first define Granger non-causality in all quantiles and propose testing non-causality by a sup-Wald test. Such a test is consistent against any deviation from non-causality in distribution, as opposed to the existing tests that check only non-causality in certain moment. This test is readily extended to test non-causality in different quantile ranges. In the empirical studies of three major stock market indices, we find that the causal effects of volume on return are usually heterogeneous across quantiles and those of return on volume are more stable. In particular, the quantile causal effects of volume on return exhibit a spectrum of (symmetric) V-shape relations so that the dispersion of return distribution increases with lagged volume. This is an alternative evidence that volume has a positive effect on return volatility. Moreover, the inclusion of the squares of lagged returns in the model may weaken the quantile causal effects of volume on return but does not affect the causality per se.
Chuang, W.-I. and B.-S. Lee (2006). "An empirical evaluation of the overconfidence hypothesis." Journal of Banking & Finance 30(9): 2489-2515.
Recently, several behavioral finance models based on the overconfidence hypothesis have been proposed to explain anomalous findings, including a short-term continuation (momentum) and a long-term reversal in stock returns. We characterize the overconfidence hypothesis by the following four testable implications: First, if investors are overconfident, they overreact to private information and underreact to public information. Second, market gains make overconfident investors trade more aggressively in subsequent periods. Third, excessive trading of overconfident investors in securities markets contributes to the observed excessive volatility. Fourth, overconfident investors underestimate risk and trade more in riskier securities. To document the presence of overconfidence in financial markets, we empirically evaluate these four hypotheses using aggregate data. Overall, we find empirical evidence in support of the four hypotheses.
Chue, T. K. and D. Cook (2008). "Emerging market exchange rate exposure." Journal of Banking & Finance 32(7): 1349-1362.
We estimate the exposure of emerging market companies to fluctuations in their domestic exchange rates. We use an instrumental-variable approach that identifies the total exposure of a company to exchange rate movements, yet abstracts from the influence of confounding macroeconomic shocks. In the sub-period of 1999-2002, we find that depreciations tend to have a negative impact on emerging market stock returns. In the sub-period of 2002-2006, this tendency has largely disappeared. Since we estimate the exchange rate exposure of firms from different countries with a common set of instruments, we can make coherent, cross-country comparisons of their determinants. We find that the impact of various measures of debt on exchange rate exposure, which is negative and significant in the early sub-period, becomes insignificant and even reverses sign in the recent sub-period.
Chung, H. (2006). "Investor protection and the liquidity of cross-listed securities: Evidence from the ADR market." Journal of Banking & Finance 30(5): 1485-1505.
Using [`]American depository receipt' (ADR) data on various countries, this paper sets out to investigate the relationship between investor protection and firm liquidity. Since weak investor protection leads to greater expropriation by managers, and thus greater asymmetric information costs, liquidity providers will incur relatively higher costs and will therefore offer higher bid-ask spreads. The empirical results demonstrate that the liquidity costs of poor investor protection were more significant during the period of the Asian financial crisis when the expected agency costs were particularly severe. This issue is further analyzed by investigating whether there is any evidence of increases in the vulnerability of ADRs of firms operating in countries with relatively poor investor protection mechanisms during periods of financial crisis.
Chung, K. H. and C. Chuwonganant (2007). "Quote-based competition, market share, and execution quality in NASDAQ-listed securities." Journal of Banking & Finance 31(9): 2770-2795.
We show that competitive quotes help increase dealer market share on NASDAQ, despite the fact that a large proportion of order flow is preferenced. We find that decimal pricing and the introduction of new trading platforms such as SuperSOES and SuperMontage have significantly changed the effect of quote aggressiveness on dealer market share. In particular, decimal pricing reduces (increases) the price (size) elasticity, SuperSOES increases the size elasticity, and SuperMontage increases both the size and price elasticity of dealer market share. We also show that market centers provide greater price improvements and faster executions when they post competitive quotes.
Chung, K. H., C. Chuwonganant, et al. (2008). "The dynamics of quote adjustments." Journal of Banking & Finance 32(11): 2390-2400.
Liquidity providers on the NYSE make faster quote adjustments towards equilibrium spreads and depths than they do on NASDAQ. Liquidity providers in both markets make faster spread and depth adjustments for stocks with more frequent trading, greater return volatility, higher prices, smaller market capitalizations, and smaller trade sizes. We find that stocks with greater information-based trading and in more competitive trading environments exhibit faster quote adjustments. The speed of quote adjustment is faster after decimalization in both markets. These results are robust and not driven by differences in stock attributes between the two markets or time periods. Overall, our results indicate that stock attributes, market structure, and tick size exert a significant impact on the speed of quote adjustment.
Chung, K. H. and Y. Kim (2005). "The dynamics of dealer markets and trading costs." Journal of Banking & Finance 29(12): 3041-3059.
In this study we examine the temporal dynamics of dealer market share and their ramification for competition and trading costs using a large sample of NASDAQ securities. Our results show that although the total market share of the top five dealers is relatively stable over time, there is significant monthly variation in the composition of the top five dealers. We show that market share turbulence among top dealers is another form of competition that narrows bid-ask spreads, especially for stocks with less competitive market structure.
Chung, K. H., M. Li, et al. (2005). "Information-based trading, price impact of trades, and trade autocorrelation." Journal of Banking & Finance 29(7): 1645-1669.
In this study we show that both the price impact of trades and serial correlation in trade direction are positively and significantly related to the probability of information-based trading (PIN). The positive relation remains significant even after controlling for the effects of stock attributes. Higher trading activity (i.e., shorter intervals between trades) induces both larger price impact and stronger positive serial correlation in trade direction. The effect of time interval between trades on quote revision is stronger for stocks with higher PIN values. These results provide direct empirical support for the information models of trade and quote revision.
Chung, K. H., W. T. Smith, et al. (2009). "Time diversification: Definitions and some closed-form solutions." Journal of Banking & Finance 33(6): 1101-1111.
We establish general conditions under which younger investors should invest a larger proportion of their wealth in risky assets than older ones. In the finite horizon dynamic setting, we show that such phenomenon, known as [`][`]time diversification," can occur in the presence of human wealth, guaranteed consumption, or mean-reverting stock returns. We formalize two alternative notions of time diversification commonly confounded in the literature. Analytic solutions are provided for both time-series and cross-sectional forms of time diversification. To our best knowledge, this paper is the first to solve in closed-form the hedging demand for a CARA investor with inter-temporal consumption and a finite horizon, facing mean-reverting expected returns. Our results indicate that horizon can have a significant effect on the portfolio demand of a CARA investor due to inter-temporal hedging.
Chung, S.-L. and P.-T. Shih "Static hedging and pricing American options." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper utilizes the static hedge portfolio (SHP) approach of Derman, Ergener, and Kani (1995) and Carr, Ellis, and Gupta (1998) to price and hedge American options under the Black-Scholes (1973) model and the constant elasticity of variance (CEV) model of Cox (1975). The static hedge portfolio of an American option is formulated by applying the value-matching and smooth-pasting conditions on the early exercise boundary. The results indicate that the numerical efficiency of our static hedge portfolio approach is comparable to some recent advanced numerical methods such as Broadie and Detemple's (1996) binomial Black-Scholes method with Richardson extrapolation (BBSR). The accuracy of the SHP method for the calculation of deltas and gammas is especially notable. Moreover, when the stock price changes, the recalculation of the prices and hedge ratios of the American options under the SHP method is quick because there is no need to solve the static hedge portfolio again. Finally, our static hedging approach also provides an intuitive derivation of the early exercise boundary near expiration.
Chung, S.-L. and Y.-H. Wang (2008). "Bounds and prices of currency cross-rate options." Journal of Banking & Finance 32(5): 631-642.
This paper derives the pricing bounds of a currency cross-rate option using the option prices of two related dollar rates via a copula theory and presents the analytical properties of the bounds under the Gaussian framework. Our option pricing bounds are useful, because (1) they are general in the sense that they do not rely on the distribution assumptions of the state variables or on the selection of the copula function; (2) they are portfolios of the dollar-rate options and hence are potential hedging instruments for cross-rate options; and (3) they can be applied to generate bounds on deltas. The empirical tests suggest that there are persistent and stable relationships between the market prices and the estimated bounds of the cross-rate options and that our option pricing bounds (obtained from the market prices of options on two dollar rates) and the historical correlation of two dollar rates are highly informative for explaining the prices of the cross-rate options. Moreover, the empirical results are consistent with the predictions of the analytical properties under the Gaussian framework and are robust in various aspects.
Clarke, G. R. G., J. M. Crivelli, et al. (2005). "The direct and indirect impact of bank privatization and foreign entry on access to credit in Argentina's provinces."Journal of Banking & Finance 29(1): 5-29.
Privatization and increased foreign ownership transformed the Argentine banking sector during the 1990s. While both improved sector efficiency, there was concern that they might reduce access to credit outside of Buenos Aires. The results in this paper suggest that these fears were exaggerated. Provinces that privatized their banks suffered only temporary reductions in credit associated with cleaning the portfolio of the privatized banks. Typically, growth in lending by the privatized entity and by other banks restored credit to pre-privatization levels within a few years. In addition, increased foreign ownership coincided with more, not less, lending outside of Buenos Aires.
Clarke, G. R. G., R. Cull, et al. (2005). "Introduction to the special issue on bank privatization." Journal of Banking & Finance 29(8-9): 1903-1904.
Clarke, G. R. G., R. Cull, et al. (2005). "Bank privatization in developing countries: A summary of lessons and findings." Journal of Banking & Finance 29(8-9): 1905-1930.
Although a large and growing literature shows that privatization can improve the performance of non-financial enterprises, there is less evidence on how it affects the performance of the banking sector. This paper summarizes the results from the papers in the special issue of the Journal of Banking and Finance on bank privatization. It concludes that although bank privatization usually improves bank efficiency, gains are greater when the government fully relinquishes control, when banks are privatized to strategic investors, when foreign banks are allowed to participate in the privatization process and when the government does not restrict competition.
Clayton, M. J. (2009). "Debt, investment, and product market competition: A note on the limited liability effect." Journal of Banking & Finance 33(4): 694-700.
This paper extends a model by Brander and Lewis [Brander, J., Lewis, T., 1986. Oligopoly and financial structure: The limited liability effect. American Economic Review 76, 956-970] on the relationship between capital structure, investment and product market competition based on the limited liability effect of debt. Empirical papers (see for example Campello [Campello, M., 2003. Capital structure and product markets interactions: Evidence from business cycles. Journal of Financial Economics 68, 353-378], and Chevalier [Chevalier, J., 1995a. Capital structure and product market competition: Empirical evidence from the supermarket industry. American Economic Review 85, 415-435; Chevalier, J., 1995b. Do LBO supermarkets charge more? An empirical analysis of the effect of LBOs on supermarket pricing. Journal of Finance 50, 1095-1112]) generally reject the limited liability theories in favor of the predatory theories because leverage leads to less investment and weaker product market competition. This paper shows that when firms also have an investment choice, leverage can lead to weaker product market competition in a limited liability model. In addition, non-zero leverage is still optimal within this model based solely on the limited liability effect. In predatory models debt is motivated by issues outside of product market concerns, for example to solve an agency problem. Finally, this model is also consistent with the investment decisions documented empirically.
Cleary, S. (2006). "International corporate investment and the relationships between financial constraint measures." Journal of Banking & Finance 30(5): 1559-1580.
This paper uses international panel data to examine the interrelationships among some commonly used measures of financial constraint. The analysis reveals the following insights: (1) firms with stronger financial positions are more investment-cash flow sensitive than firms with weaker financial positions even after controlling for size and dividend payout and (2) higher payout firms are more investment-cash flow sensitive than lower payout firms even after controlling for size and financial strength. Evidence regarding the impact of firm size that is documented originally becomes much weaker once financial health and dividend payout behavior are controlled for. Finally, additional analysis reveals that many of these results may be driven by the fact that firms possessing high cash flow volatility display lower investment-cash flow sensitivities.
Coakley, J. and A.-M. Fuertes (2006). "Valuation ratios and price deviations from fundamentals." Journal of Banking & Finance 30(8): 2325-2346.
This paper sheds light on US stock price deviations from fundamentals by analyzing the time-series dynamics of post-1870 S&P valuation ratios. It employs a non-linear, two-regime framework that allows for different behavior over phases of the stock market cycle. Persistence in the ratios implies prolonged price deviations from fundamentals stemming from short run continuation fueled by investor sentiment during bull markets. However, the pull from fundamentals ensures that valuation ratios and prices move toward their equilibrium levels in bear markets. Impulse response functions highlight sluggish adjustment and indicate that the effects of positive shocks are more pronounced and long-lasting in bull markets. The main conclusion is that, while market sentiment plays an important transitory role, valuation ratios do mean revert and so prices reflect fundamentals in the long run.
Coccorese, P. (2005). "Competition in markets with dominant firms: A note on the evidence from the Italian banking industry." Journal of Banking & Finance 29(5): 1083-1093.
In this paper we consider the Italian banking industry, where the eight largest firms operate at a national level, manage about a half of total loans, and have a notably larger dimension than the other competitors. We estimate a structural model containing a behavioural parameter, in order to assess the market conduct of the largest banks for the period 1988-2000. Our finding is that, in spite of their noteworthy size and significant market share, these banks have been characterised by a more competitive conduct than the Bertrand-Nash outcome: this is in line with the results of the latest literature of the field, for which in the banking industry there is often no conflict between competition and concentration.
Coccorese, P. (2009). "Market power in local banking monopolies." Journal of Banking & Finance 33(7): 1196-1210.
By means of two NEIO techniques, this paper analyzes the conduct of a group of Italian single-branch banks operating as monopolists in small local areas (municipalities) in the years 1988-2005, in order to assess pricing behavior in highly concentrated banking markets. Both tests strongly reject the hypothesis of pure monopoly pricing: regardless the advantageous condition, these banks are able to exploit only partially their market power, principally by reason of the nearby competition, the latest banking consolidation trend and the local presence of big banks. Employing another sample, we also show that in duopolistic markets the conduct of single-branch banks is virtually competitive.
Cole, R. A., F. Moshirian, et al. (2008). "Bank stock returns and economic growth." Journal of Banking & Finance 32(6): 995-1007.
Previous research has established (i) that a country's financial sector influence future economic growth and (ii) that stock market index returns affect future economic growth. We extend and tie together these two strands of the growth literature by analyzing the relationship between banking industry stock returns and future economic growth. Using dynamic panel techniques to analyze panel data from 18 developed and 18 emerging markets, we find a positive and significant relationship between bank stock returns and future GDP growth that is independent of the previously documented relationship between market index returns and economic growth. We also find that much of the informational content of bank stock returns is captured by country-specific and institutional characteristics, such as bank-accounting-disclosure standards, banking crises, enforcement of insider trading law and government ownership of banks.
Coleman, T. F., D. Levchenkov, et al. (2007). "Discrete hedging of American-type options using local risk minimization." Journal of Banking & Finance 31(11): 3398-3419.
Local risk minimization and total risk minimization discrete hedging have been extensively studied for European options [e.g., Schweizer, M., 1995. Variance-optimal hedging in discrete time. Mathematics of Operation Research 20, 1-32; Schweizer, M., 2001. A guided tour through quadratic hedging approaches. In: Jouini, E., Cvitanic, J., Musiela, M., Option pricing, interest rates and risk management, Cambridge University Press, pp. 538-574]. In practice, hedging of options with American features is more relevant. For example, equity linked variable annuities provide surrender benefits which are essentially embedded American options. In this paper we generalize both quadratic and piecewise linear local risk minimization hedging frameworks to American options. We illustrate that local risk minimization methods outperform delta hedging when the market is highly incomplete. In addition, compared to European options, distributions of the hedging costs are typically more skewed and heavy-tailed. Moreover, in contrast to quadratic local risk minimization, piecewise linear risk minimization hedging strategies can be significantly different, resulting in larger probabilities of small costs but also larger extreme cost.
Consiglio, A., D. Saunders, et al. (2006). "Asset and liability management for insurance products with minimum guarantees: The UK case." Journal of Banking & Finance 30(2): 645-667.
Modern insurance products are becoming increasingly complex, offering various guarantees, surrender options and bonus provisions. A case in point are the with-profits insurance policies offered by UK insurers. While these policies have been offered in some form for centuries, in recent years their structure and management have become substantially more involved. The products are particularly complicated due to the wide discretion they afford insurers in determining the bonuses policyholders receive. In this paper, we study the problem of an insurance firm attempting to structure the portfolio underlying its with-profits fund. The resulting optimization problem, a non-linear program with stochastic variables, is presented in detail. Numerical results show how the model can be used to analyze the alternatives available to the insurer, such as different bonus policies and reserving methods.
Coricelli, F., B. Jazbec, et al. (2006). "Exchange rate pass-through in EMU acceding countries: Empirical analysis and policy implications." Journal of Banking & Finance 30(5): 1375-1391.
Countries that joined the European Union in 2004 have to decide when to adopt the Euro. This decision depends on the evaluation of the relative costs and benefits associated with giving up the exchange rate instrument. Recent empirical work on several new EU members has questioned the role of the exchange rate as a shock absorber, thus downplaying the potential costs in terms of macroeconomic stabilization. In this paper, we address the issue from a different perspective, emphasizing the role of pass-through from exchange rate to domestic inflation in new EU members. The focus is on four countries (Czech Republic, Hungary, Poland and Slovenia - NM-4) that have adopted some form of floating or managed exchange rate regimes. The paper reports empirical results indicating high pass-through coefficients and links them to the degree of policy accommodation. High exchange rate pass-through in NM-4 indicates that stabilization of nominal exchange rates would lower inflationary pressures and help fulfill criteria to enter the EMU.
Corielli, F. and M. Marcellino (2006). "Factor based index tracking." Journal of Banking & Finance 30(8): 2215-2233.
Stock index tracking requires to build a portfolio of stocks (a replica) whose behavior is as close as possible to that of a given stock index. Typically, much fewer stocks should appear in the replica than in the index, and there should be no low frequency or integrated (persistent) components in the tracking error. The latter property is not satisfied by many commonly used methods for index tracking. These are based on the in-sample minimization of a loss function, but do not take into account the dynamic properties of the index components. Moreover, most existing methods do not take into account the known structure of the index weight system. In this paper we represent the index components with a dynamic factor model. In this model the price of each stock in the index is driven by a set of common and idiosyncratic factors. Factors can be either integrated or stationary. We develop a procedure that, in a first step, builds a replica that is driven by the same persistent factors as the index. This procedure is grounded in recent results which suggest the application of principal component analysis for factor estimation even for integrated processes. In a second step, it is also possible to refine the replica so that it minimizes a specific loss function, as in the traditional approach. In both steps the replica weights depend on the existing information on the index weights system. An extended set of Monte Carlo simulations and an application to the most widely used index in the European stock market, the EuroStoxx50 index, provide substantial support for our approach.
Cornett, M. M., A. J. Marcus, et al. (2007). "The impact of institutional ownership on corporate operating performance." Journal of Banking & Finance 31(6): 1771-1794.
This paper examines the relation between institutional investor involvement in and the operating performance of large firms. We find a significant relation between a firm's operating cash flow returns and both the percent of institutional stock ownership and the number of institutional stockholders. However, this relation is found only for a subset of institutional investors: those less likely to have a business relationship with the firm. These results suggest that institutional investors with potential business relations with the firms in which they invest are compromised as monitors of the firm.
Cornett, M. M., H. Tehranian, et al. (2007). "Regulation fair disclosure and the market's reaction to analyst investment recommendation changes." Journal of Banking & Finance 31(3): 567-588.
Previous research has shown that affiliated analysts (those who are working for investment banks that underwrite securities for companies) have an incentive to provide optimistically biased recommendations from selective information they are given by the firm. In an effort to halt such activities, as of October 2000, Regulation Fair Disclosure (RegFD) prohibits selective disclosure of material non-public information by public companies to privileged individuals (such as favored research analysts) and requires broad, non-exclusionary disclosure of such information. We examine firms' stock price reactions to investment recommendation changes from affiliated analysts versus unaffiliated analysts from October 1998 to November 2002, around the passage of RegFD. Similar to previous research, we find that investors reacted more significantly to recommendation downgrades by affiliated analysts than to those by unaffiliated analysts prior to the passage of RegFD. However, we find that the difference in the reactions to recommendation changes is not present after the passage of RegFD. We also find that stock price reactions to analysts' (both affiliated and unaffiliated) recommendation changes decreased significantly after the passage of RegFD. Thus, RegFD appears to have curbed the selective disclosure of information (particularly negative information) by firms to affiliated analysts. Further, the smaller reactions to recommendation changes by all analysts after RegFD may reflect a change in analysts' behavior (irrespective of information that is available) or a response by corporate managers to withhold information rather than risking a violation of fair disclosure rules.
Cottarelli, C., G. Dell'Ariccia, et al. (2005). "Early birds, late risers, and sleeping beauties: Bank credit growth to the private sector in Central and Eastern Europe and in the Balkans." Journal of Banking & Finance 29(1): 83-104.
Following a period of privatization and restructuring, commercial banks in Central and Eastern Europe and, more recently, in the Balkans have expanded rapidly their lending to the private sector. This paper studies whether these developments are consistent with a process of convergence and structural financial deepening by estimating an "equilibrium" level of the bank-credit-to-GDP ratio. It concluded that while there is no clear evidence that the recent increases in bank credit ratios is inconsistent with financial deepening, policy-makers will have to evaluate carefully its implications for macroeconomic developments and financial stability.
Cotter, J. and K. Dowd (2006). "Extreme spectral risk measures: An application to futures clearinghouse margin requirements." Journal of Banking & Finance30(12): 3469-3485.
This paper applies the extreme-value (EV) generalised pareto distribution to the extreme tails of the return distributions for the S&P500, FT100, DAX, Hang Seng, and Nikkei225 futures contracts. It then uses tail estimators from these contracts to estimate spectral risk measures, which are coherent risk measures that reflect a user's risk-aversion function. It compares these to VaR and expected shortfall (ES) risk measures, and compares the precision of their estimators. It also discusses the usefulness of these risk measures in the context of clearinghouses setting initial margin requirements, and compares these to the SPAN measures typically used.
Cousot, L. (2007). "Conditions on option prices for absence of arbitrage and exact calibration." Journal of Banking & Finance 31(11): 3377-3397.
Under the assumption of absence of arbitrage, European option quotes on a given asset must satisfy well-known inequalities, which have been described in the landmark paper of Merton [Merton, R., 1973. Theory of rational option pricing. Bell Journal of Economics and Management Science 4 (1), 141-183]. If we further assume that there is no interest rate volatility and that the underlying asset continuously pays deterministic dividends, cross-maturity inequalities must also be satisfied by the bid and ask option prices. In this paper, we show that there exists an arbitrage-free model, which is consistent with the option quotes, if these inequalities are satisfied. One implication is that all static arbitrage strategies are linear combinations, with positive weights, of those described here. We also characterize admissible default probabilities for models which are consistent with given option quotes.
Craig, B. and F. Fecht (2007). "The eurosystem money market auctions: A banking perspective." Journal of Banking & Finance 31(9): 2925-2944.
This paper analyzes the individual bidding behavior of German banks in the money market auctions conducted by the ECB from the beginning of 2000:IIIQ to the end of 2001:IQ. Our approach takes a variety of characteristics of the individual banks into account, particularly variables that capture the different use of liquidity and the different attitude towards liquidity risk of the individual banks. It turns out that these characteristics are reflected in banks' bidding behavior. Thus, our study contributes to a deeper understanding of the way liquidity risk is managed in the banking sector.
Craig, S. G. and P. Hardee (2007). "The impact of bank consolidation on small business credit availability." Journal of Banking & Finance 31(4): 1237-1263.
This paper examines how banking consolidation has affected small businesses credit. Using the Survey of Small Business Finances, the empirical model examines how credit supply to small firms responds to larger banks, and whether the non-bank supply of credit has offset decreases in credit from banks. Using an empirical model to correct for sample selection, large banks are found to lower the probability of obtaining credit for small businesses, and this lower probability is not offset by increased total loans. Non-bank institutions are found to make up much, but not all, of the decrease.
Cremers, M., J. Driessen, et al. (2008). "Individual stock-option prices and credit spreads." Journal of Banking & Finance 32(12): 2706-2715.
This paper introduces measures of volatility and jump risk that are based on individual stock options to explain credit spreads on corporate bonds. Implied volatilities of individual options are shown to contain useful information for credit spreads and improve on historical volatilities when explaining the cross-sectional and time-series variation in a panel of corporate bond spreads. Both the level of individual implied volatilities and (to a lesser extent) the implied-volatility skew matter for credit spreads. Detailed principal component analysis shows that a large part of the time-series variation in credit spreads can be explained in this way.
Csóka, P., P. J.-J. Herings, et al. (2007). "Coherent measures of risk from a general equilibrium perspective." Journal of Banking & Finance 31(8): 2517-2534.
Coherent measures of risk defined by the axioms of monotonicity, subadditivity, positive homogeneity, and translation invariance are recent tools in risk management to assess the amount of risk agents are exposed to. If they also satisfy law invariance and comonotonic additivity, then we get a subclass of them: spectral measures of risk. Expected shortfall is a well-known spectral measure of risk. We investigate the above mentioned six axioms using tools from general equilibrium (GE) theory. Coherent and spectral measures of risk are compared to the natural measure of risk derived from an exchange economy model, which we call the GE measure of risk. We prove that GE measures of risk are coherent measures of risk. We also show that spectral measures of risk are GE measures of risk only under stringent conditions, since spectral measures of risk do not take the regulated entity's relation to the market portfolio into account. To give more insights, we characterize the set of GE measures of risk via the pricing kernel property.
Cull, R., L. E. Davis, et al. (2006). "Historical financing of small- and medium-size enterprises." Journal of Banking & Finance 30(11): 3017-3042.
We focus on the economies of the North Atlantic Core during the 19th and early 20th centuries and find that an impressive variety of local financial institutions emerged to supply the needs of SMEs wherever there was sufficient demand for their services. Although these intermediaries had significant weaknesses, they were able to tap into local information networks and so extend credit to firms that were too young or small to secure funds from large regional or national institutions. In addition, by raising the return to savings for local households, they helped to mobilize significant new resources for economic development.
Cumming, D., G. Fleming, et al. (2005). "Venture capitalist value-added activities, fundraising and drawdowns." Journal of Banking & Finance 29(2): 295-331.
This paper is the first to introduce an analysis of the effect of different types of venture capitalist value-added activities (financial, administrative, marketing, strategic/management) on fundraising. In addition, we include an analysis of the functional difference between committed funds and drawdowns from capital commitments vis-à-vis pension funds and venture capital funds. The new comprehensive data, collected by the Australian Bureau of Statistics for 1999-2001, enable controls for venture capitalist performance, risk, investment activity, and management and performance fees. The results indicate that significantly more capital is allocated to venture capitalists that provide financial and strategic/management expertise to entrepreneurial firms (as opposed to marketing and administrative expertise). In addition, fundraising is greater among funds with higher returns and performance fees and lower fixed management fees. In contrast, drawdowns from capital commitments are greater among venture capital funds that provide financial and marketing expertise to investees (as opposed to strategic and administrative expertise), and among funds with higher performance fees and fixed management fees. Further, the results indicate an adverse impact on venture capital fundraising from illiquidity attributable to a 2-year lock-up period in IPO exits over the period considered.
Cumming, D. and S. Johan (2007). "Regulatory harmonization and the development of private equity markets." Journal of Banking & Finance 31(10): 3218-3250.
This paper introduces a new dataset from 100 Dutch institutional investors' domestic and international asset private equity allocations. The data indicate that the perceived comparative dearth of regulations of private equity funds impedes institutional investor participation in private equity funds, particularly in relation to the lack of transparency. The data further indicate that the perceived importance of regulatory harmonization of institutional investors has increased Dutch institutional investor allocations to domestic and international private equity funds. The Financieel Toetsingskader (regulation of portfolio management standards such as matching of assets and liabilities) has had the most pronounced and robust effect, followed by Basel II (regulation of risk management and disclosure standards) and the International Financial Reporting Standards (regulation of reporting standards and transparency).
Cummins, J. D. and G. Dionne (2008). "Dynamics of insurance markets: Structure, conduct, and performance in the 21st century." Journal of Banking & Finance32(1): 1-3.
Cummins, J. D. and P. Embrechts (2006). "Introduction: Special section on operational risk." Journal of Banking & Finance 30(10): 2599-2604.
Cummins, J. D., C. M. Lewis, et al. (2006). "The market value impact of operational loss events for US banks and insurers." Journal of Banking & Finance 30(10): 2605-2634.
This paper conducts an event study analysis of the impact of operational loss events on the market values of banks and insurance companies, using the OpVar database. We focus on financial institutions because of the increased market and regulatory scrutiny of operational losses in these industries. The analysis covers all publicly reported banking and insurance operational risk events affecting publicly traded US institutions from 1978 to 2003 that caused operational losses of at least $10 million - a total of 403 bank events and 89 insurance company events. The results reveal a strong, statistically significant negative stock price reaction to announcements of operational loss events. On average, the market value response is larger for insurers than for banks. Moreover, the market value loss significantly exceeds the amount of the operational loss reported, implying that such losses convey adverse implications about future cash flows. Losses are proportionately larger for institutions with higher Tobin's Q ratios, implying that operational loss events are more costly in market value terms for firms with strong growth prospects.
Cummins, J. D. and X. Xie (2008). "Mergers and acquisitions in the US property-liability insurance industry: Productivity and efficiency effects." Journal of Banking & Finance 32(1): 30-55.
This paper analyzes the productivity and efficiency effects of mergers and acquisitions (M&As) in the US property-liability insurance industry during the period 1994-2003 using data envelopment analysis (DEA) and Malmquist productivity indices. We seek to determine whether M&As are value-enhancing, value-neutral, or value-reducing. The analysis examines efficiency and productivity change for acquirers, acquisition targets, and non-M&A firms. We also examine the firm characteristics associated with becoming an acquirer or target through probit analysis. The results provide evidence that M&As in property-liability insurance were value-enhancing. Acquiring firms achieved more revenue efficiency gains than non-acquiring firms, and target firms experienced greater cost and allocative efficiency growth than non-targets. Factors other than efficiency enhancement are important factors in property-liability insurer M&As. Financially vulnerable insurers are significantly more likely to become acquisition targets, consistent with corporate control theory, and we also find evidence that M&As are motivated to achieve diversification. However, there is no evidence that scale economies played an important role in the insurance M&A wave.
Cuñado, J., L. A. Gil-Alana, et al. (2005). "A test for rational bubbles in the NASDAQ stock index: A fractionally integrated approach." Journal of Banking & Finance 29(10): 2633-2654.
In this paper we test for the presence of rational bubbles in the NASDAQ stock market index over the period 1994:06-2003:11 by means of a methodology based on fractional processes. The results suggest that the existence of bubbles depends on the sampling frequency used in the analysis. We cannot reject the unit root hypothesis when using monthly data on price-dividend ratios, which according to the present value model suggests the existence of rational bubbles. However, we reject this hypothesis in favor of fractional alternatives when using daily and weekly data. This might be explained by the temporal aggregation and/or the sample sizes used in the application.
Cuñat, V. and M. Guadalupe (2009). "Executive compensation and competition in the banking and financial sectors." Journal of Banking & Finance 33(3): 495-504.
This paper studies the effect of product market competition on the compensation packages that firms offer to their executives. We use a panel of US executives in the 1990s and exploit two deregulation episodes in the banking and financial sectors as quasi-natural experiments. We provide difference-in-differences estimates of their effect on (1) total pay, (2) estimated fixed pay and performance-pay sensitivities, and (3) the sensitivity of stock option grants. Our results indicate that the deregulations substantially changed the level and structure of compensation: the variable components of pay increased along with performance-pay sensitivities and, at the same time, the fixed component of pay fell. The overall effect on total pay was small.
Curry, T. J., G. S. Fissel, et al. (2008). "Equity market information, bank holding company risk, and market discipline." Journal of Banking & Finance 32(5): 807-819.
For market discipline to be effective, market factors such as changes in firm equity and debt values and returns, must influence firm decision making. In banking, this can occur directly via bank management or indirectly though supervisory examinations and oversight influencing bank management. In this study, we investigate whether equity market variables can provide timely information and add value to accounting models that predict changes in bank holding company (BOPEC) risk ratings over the 1988-2000 period. Using a variety of equity market indicators, the findings suggest that one-quarter lagged market data adds forecast value to lagged financial statement data and prior supervisory information in the logistic regressions. Furthermore, using extensive out-of-sample testing for the years 2001-2003, we find: (1) that multiple models estimated over different phases of the business and banking cycles are superior to a single model for forecasting BOPEC rating changes; (2) that equity data adds economically significant power in forecasting BOPEC rating upgrades and performs well for identifying no changes; (3) that for downgrades, the accounting model forecasts the best; (4) that modeling the three possible risk ratings categories simultaneously (downgrade, no change and upgrade) minimizes both Type I and Type II classification errors; and (5) that using multiple models to forecast risk ratings enhances the overall percentage of correct classifications.
Curry, T. J., G. S. Fissel, et al. (2008). "Is there cyclical bias in bank holding company risk ratings?" Journal of Banking & Finance 32(7): 1297-1309.
This paper examines whether bank holding company (BHC) risk ratings are asymmetrically assigned or biased over business cycles from 1986 to 2003. In a model of ratings determination which accounts for bank characteristics, financial market conditions, past supervisory information, and aggregate macro-economic factors, we find that bank exam ratings exhibit inter-temporal characteristics. First, exam ratings exhibit some evidence of examiner bias for several periods analyzed. When the business cycle turns, examiners sometime depart from standards that they set during the previous phases of the cycle. However, this bias is not widespread or systematic. Second, exam ratings exhibit some inertia. Our results suggest that examiners rate on the side of not changing (rather than upgrading or downgrading) an institution's exam rating. Third, we find robust evidence of a secular trend towards more stringent examination BHC ratings standards over time.
Cysne, R. P. (2006). "A note on the non-convexity problem in some shopping-time and human-capital models." Journal of Banking & Finance 30(10): 2737-2745.
Several works in the shopping-time and in the human-capital literature, due to the non-concavity of the underlying Hamiltonian, use first-order conditions in dynamic optimization to characterize necessity, but not sufficiency, in intertemporal problems. This note selects some works in these two areas and shows that optimality can be characterized, and some results quantitatively improved, by means of an application of Arrow's [Arrow, K. J., 1968. Applications of control theory to economic growth. In: Dantzig, G.B., Veinott Jr., A.F. (Eds.), Mathematics of the Decisions Sciences. American Mathematical Society, Providence, RI] sufficiency theorem.
Cysne, R. P. (2008). "A note on "Inflation and Welfare"." Journal of Banking & Finance 32(9): 1984-1987.
This note provides an analytical confirmation and a refinement of [Lucas Jr., R.E., 2000. Inflation and welfare. Econometrica 68 (62), 247-274 (March)] numerical findings regarding the characterization of optimality in the shopping-time model presented in that paper. The original numerical analysis concludes that a coefficient of risk aversion ([sigma]) greater than 0.01 is sufficient for optimality. Here we use Arrow's sufficiency theorem to confirm this result and, more importantly, to show without more calculations how changes in parameters can affect it.
Cysne, R. P. and D. Turchick (2009). "On the integrability of money-demand functions by the Sidrauski and the shopping-time models." Journal of Banking & Finance 33(9): 1555-1562.
This paper investigates which properties money-demand functions must satisfy so that they are consistent with Lucas's [Lucas Jr., R.E., 2000. Inflation and welfare. Econometrica 68, 247-274] versions of the Sidrauski and the shopping-time models. We conclude that shopping-time-integrable money-demand functions are necessarily also Sidrauski-integrable, but that the converse is not necessarily true, unless a boundedness assumption on the nominal interest rate is made. Both the log-log with an interest-rate elasticity greater than or equal to one and the semi-log money demands may serve as counterexamples. All the models and results are also extended to the case in which there are several assets in the economy performing monetary functions.
Daal, E., A. Naka, et al. (2007). "Volatility clustering, leverage effects, and jump dynamics in the US and emerging Asian equity markets." Journal of Banking & Finance 31(9): 2751-2769.
This paper proposes asymmetric GARCH-Jump models that synthesize autoregressive jump intensities and volatility feedback in the jump component. Our results indicate that these models provide a better fit for the dynamics of the equity returns in the US and emerging Asian markets, irrespective whether the volatility feedback is generated through a common GARCH multiplier or a separate measure of volatility in the jump intensity function. We also find that they can capture several distinguishing features of the return dynamics in emerging markets, such as, more volatility persistence, less leverage effects, fatter tails, and greater contribution and variability of the jump component.
d'Addona, S. and A. H. Kind (2006). "International stock-bond correlations in a simple affine asset pricing model." Journal of Banking & Finance 30(10): 2747-2765.
We use an affine asset pricing model to jointly value stocks and bonds. This enables us to derive endogenous correlations and to explain how economic fundamentals influence the correlation between stock and bond returns. The presented model is implemented for G7 post-war economies and its in-sample and out-of-sample performance is assessed by comparing the correlations generated by the model with conventional statistical measures. The affine framework developed in this paper is found to generate stock-bond correlations that are in line with empirically observed figures.
Daglish, T. (2009). "What motivates a subprime borrower to default?" Journal of Banking & Finance 33(4): 681-693.
This paper uses a real options approach to analyse the exercise of the default option embedded in mortgages. In particular, it examines a subprime household who borrows at a premium, but hopes to refinance at prime rates if their house appreciates. We show how these optimal default decisions can be used to calculate probabilities of default - an important input for risk management and pricing purposes. Numerical examples are provided, calibrated to US data. In a low interest rate environment, the credit-upgrade potential may discourage subprime borrowers from defaulting. However, default probabilities are highly sensitive to changes in interest rates and house prices. This provides a rational explanation for the prevalence of adjustable rate mortgages among subprime borrowers, and the subsequent large numbers of defaults, when interest rates rose and house prices declined.
Daníelsson, J. and J.-P. Zigrand (2006). "On time-scaling of risk and the square-root-of-time rule." Journal of Banking & Finance 30(10): 2701-2713.
Many financial applications, such as risk analysis, and derivatives pricing, depend on time scaling of risk. A common method for this purpose is the square-root-of-time rule where an estimated quantile of a return distribution is scaled to a lower frequency by the square root of the time horizon. This paper examines time scaling of quantiles when returns follow a jump diffusion process. We demonstrate that when jumps represent losses, the square-root-of-time rule leads to a systematic underestimation of risk, whereby the degree of underestimation worsens with the time horizon, the jump intensity and the confidence level.
Darrat, A. F., M. Zhong, et al. (2007). "Intraday volume and volatility relations with and without public news." Journal of Banking & Finance 31(9): 2711-2729.
This paper reexamines the dynamic relation between intraday trading volume and return volatility of large and small NYSE stocks in two partitioned samples, with and without identifiable public news. We argue that the sequential information arrival hypothesis (SIAH) can be tested only in periods containing public news. After partitioning the sample into periods with and without public news, we find bi-directional Granger-causality between volume and volatility in the presence of public information as hypothesized by the SIAH. Our analysis further suggests that return volatility is higher in the periods with public news, while trading volume is significantly higher in the no-news period; perhaps owing to the importance of private information for trading stocks. Using the sample without public news, we find evidence that volume Granger-causes volatility without feedback. These results are broadly consistent with behavioral models like the overconfidence and biased self-attribution model of [Daniel, K., Hirshleifer, D., Subrahmanyam, A., 1998. Investor psychology and security market under- and over-reactions. Journal of Finance 53, 1839-1885]. It appears that overconfident investors overrate the precision of their private news signals and therefore trade too aggressively in the absence of public news; when public news arrives, investors' biased self-attribution triggers excessive return volatility.
Darvas, Z. (2009). "Leveraged carry trade portfolios." Journal of Banking & Finance 33(5): 944-957.
Studying all possible pairs of 11 major currencies and 11 portfolios in 1976-2008 we show that, when there is no leverage, carry trade is significantly profitable for most currency pairs and portfolios. Positive returns do not diminish in time providing a strong case against the hypothesis of uncovered interest rate parity. We explain these findings with the leveraged nature of carry trade: leverage may increase profitability but it materially increases downside risk. We argue that market inefficiency is related to the level of leverage.
Das, S. R., P. Hanouna, et al. (2009). "Accounting-based versus market-based cross-sectional models of CDS spreads." Journal of Banking & Finance 33(4): 719-730.
Models of financial distress rely primarily on accounting-based information (e.g. [Altman, E., 1968. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance 23, 589-609; Ohlson, J., 1980. Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research 19, 109-131]) or market-based information (e.g. [Merton, R.C., 1974. On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance 29, 449-470]). In this paper, we provide evidence on the relative performance of these two classes of models. Using a sample of 2860 quarterly CDS spreads we find that a model of distress using accounting metrics performs comparably to market-based structural models of default. Moreover, a model using both sources of information performs better than either of the two models. Overall, our results suggest that both sources of information (accounting- and market-based) are complementary in pricing distress.
Daskalakis, G., D. Psychoyios, et al. (2009). "Modeling CO2 emission allowance prices and derivatives: Evidence from the European trading scheme." Journal of Banking & Finance 33(7): 1230-1241.
This paper studies the three main markets for emission allowances within the European Union Emissions Trading Scheme (EU ETS): Powernext, Nord Pool and European Climate Exchange (ECX). The analysis suggests that the prohibition of banking of emission allowances between distinct phases of the EU ETS has significant implications in terms of futures pricing. Motivated by these findings, we develop an empirically and theoretically valid framework for the pricing and hedging of intra-phase and inter-phase futures and options on futures, respectively.
De Giorgi, E. (2005). "Reward-risk portfolio selection and stochastic dominance." Journal of Banking & Finance 29(4): 895-926.
The portfolio selection problem is traditionally modelled by two different approaches. The first one is based on an axiomatic model of risk-averse preferences, where decision makers are assumed to possess a utility function and the portfolio choice consists in maximizing the expected utility over the set of feasible portfolios. The second approach, first proposed by Markowitz is very intuitive and reduces the portfolio choice to a set of two criteria, reward and risk, with possible tradeoff analysis. Usually the reward-risk model is not consistent with the first approach, even when the decision is independent from the specific form of the risk-averse expected utility function, i.e. when one investment dominates another one by second-order stochastic dominance. In this paper we generalize the reward-risk model for portfolio selection. We define reward measures and risk measures by giving a set of properties these measures should satisfy. One of these properties will be the consistency with second-order stochastic dominance, to obtain a link with the expected utility portfolio selection. We characterize reward and risk measures and we discuss the implication for portfolio selection.
De Giuli, M. E., M. A. Maggi, et al. (2009). "Deposit guarantee evaluation and incentives analysis in a mutual guarantee system." Journal of Banking & Finance33(6): 1058-1068.
This paper analyzes how the deposit guarantee value affects the risk incentives in a mutual guarantee system. We liken the guarantee's value to that of a European-style contingent claims portfolio. The main feature emerging from our model is that a mutual guarantee system would give banks an adverse incentive to increase riskiness. To mitigate this incentive, we introduce a regulatory provision modelled using a path-dependent contingent claim. By comparing the mutual guarantee system with a non-mutual one, we show that the former is less expensive, but implies higher adverse incentives for the banks, especially for undercapitalized institutions.
de Goeij, P. and W. Marquering (2006). "Macroeconomic announcements and asymmetric volatility in bond returns." Journal of Banking & Finance 30(10): 2659-2680.
This study analyses the impact of macroeconomic news announcements on the conditional volatility of bond returns. Using daily returns on the 1, 3, 5 and 10 year US Treasury bonds, we find that announcement shocks have a strong impact on the dynamics of bond market volatility. Our results provide empirical evidence that the bond market incorporates the implications of macroeconomic announcement news faster than other information. Moreover, after distinguishing between types of macroeconomic announcements, releases of the employment situation and producer price index are especially influential at the intermediate and long end of the yield curve, while monetary policy seem to affect short-term bond volatility.
De Graeve, F., O. De Jonghe, et al. (2007). "Competition, transmission and bank pricing policies: Evidence from Belgian loan and deposit markets." Journal of Banking & Finance 31(1): 259-278.
This paper addresses the pass-through from market interest rates to retail bank interest rates. The paper advocates a heterogeneous approach and applies it to the Belgian banking market. A substantial proportion of the heterogeneity in bank pricing policies can be explained by the bank lending channel and the relative market power hypothesis. The results also suggest that the long-term pass-through is typically less than one-for-one, rejecting the completeness hypothesis. While there is no convincing evidence for asymmetry in retail rates, large deviations from equilibrium mark-ups are faster reduced than small deviations. Overall, conditions for corporate loans are more competitive compared to consumer loans. Demand and savings deposits have, by far, the most rigid prices.
de Haas, R. and I. van Lelyveld (2006). "Foreign banks and credit stability in Central and Eastern Europe. A panel data analysis." Journal of Banking & Finance30(7): 1927-1952.
We examine whether foreign and domestic banks in Central and Eastern Europe react differently to business cycles and banking crises. Our panel dataset comprises data of more than 250 banks for the period 1993-2000, with information on bank ownership and mode of entry. During crisis periods domestic banks contracted their credit base, whereas greenfield foreign banks did not. Also, home country conditions matter for foreign bank growth, as there is a significant negative relationship between home country economic growth and host country credit by greenfields. Finally, greenfield foreign banks' credit growth is influenced by the health of the parent bank.
de Jong, A., R. Kabir, et al. (2008). "Capital structure around the world: The roles of firm- and country-specific determinants." Journal of Banking & Finance 32(9): 1954-1969.
We analyze the importance of firm-specific and country-specific factors in the leverage choice of firms from 42 countries around the world. Our analysis yields two new results. First, we find that firm-specific determinants of leverage differ across countries, while prior studies implicitly assume equal impact of these determinants. Second, although we concur with the conventional direct impact of country-specific factors on the capital structure of firms, we show that there is an indirect impact because country-specific factors also influence the roles of firm-specific determinants of leverage.
de Jong, P. J. and V. P. Apilado (2009). "The changing relationship between earnings expectations and earnings for value and growth stocks during Reg FD."Journal of Banking & Finance 33(2): 435-442.
Regulation Fair Disclosure (Reg FD) altered the voluntary disclosure practices of firms with publicly traded securities, thereby affecting relationships between value and growth stock expectations and actual earnings. The results show that earnings forecasts for both stock groups are biased but that bias is less after the introduction of Reg FD. In fact, the difference in pre/post FD forecast bias is larger for growth stocks, suggesting that before Reg FD, analysts did not just misinterpret news but consciously tried to maintain relationships with growth firm managers. However, Reg FD limited these relationships severing the monetary advantage that might be gained from manipulating forecasts.
De Jonghe, O. and R. V. Vennet (2008). "Competition versus efficiency: What drives franchise values in European banking?" Journal of Banking & Finance 32(9): 1820-1835.
This paper investigates how stock market investors perceive the impact of market structure and efficiency on the long-run performance potential of European banks. To that end, a modified Tobin's Q ratio is introduced as a measure of bank franchise value. This measure is applied to discriminate between the market structure and efficient-structure hypotheses in a coherent forward-looking framework, in which differences in banks' horizontal and vertical differentiation strategies are controlled for. The results show that banks with better management or production technologies possess a long-run competitive advantage. In addition, bank market concentration does not affect all banks equally. Only the banks with a large market share in a concentrated market are able to generate non-competitive rents. The paper further documents that the forward-looking, long-run perspective and the noise-adjustment of the performance measure overcome most of the drawbacks associated with testing these hypotheses in a multi-country set-up. Finally, notwithstanding the international expansion of bank activities, the harmonization of regulation and the macroeconomic convergence in the European Union (EU15), we still find that country-specific macroeconomic variables have a significant impact on bank performance. The findings indicate that there is a trade-off between competition and stability that should be taken into account when assessing mergers or acquisitions.
de la Torre, A., J. C. Gozzi, et al. (2007). "Stock market development under globalization: Whither the gains from reforms?" Journal of Banking & Finance 31(6): 1731-1754.
Over the past decades, many countries have implemented significant reforms (including financial liberalization, privatization, and regulatory and supervisory improvements) to foster domestic capital market development. Despite these policies, the performance of capital markets in several countries has been disappointing. To understand the effects of reforms, we study the impact of six capital market reforms on domestic stock market development and internationalization. We find that reforms tend to be followed by increases in domestic market capitalization and trading. But reforms are also followed by an increase in the share of activity in international equity markets, with potential negative spillover effects.
de Menil, G. (2005). "Why should the portfolios of mandatory, private pension funds be captive? (The foreign investment question)." Journal of Banking & Finance29(1): 123-141.
A model of portfolio optimization, which takes account of the difference between the private and social cost of foreign investment, is used to analyze the relationship between capital shortages and the international diversification of mandatory, private pension funds in developing and transition countries. The socially optimal rate of foreign portfolio investment may be positive, even when access to international capital markets is limited. I propose replacing investment limits with a tax on foreign investments, equal to the difference between their social and private cost. The use of international pension swap is seen to be formally equivalent to the imposition of such a tax.
de Palma, A. and J.-L. Prigent (2008). "Utilitarianism and fairness in portfolio positioning." Journal of Banking & Finance 32(8): 1648-1660.
The paper introduces the theory of optimal positioning of financial products. It is illustrated in the context of long-term intertemporal portfolio allocation and can be applied for example to asset allocation funds. We embed this problem in location theory: the portfolio is optimized within the investors'risk aversion dimension. For the CRRA utility functions, we compute explicitly the distance functions. For the first (utilitarian criterion), the average utility of the investors is maximized. For the second one (fairness criterion), the choice of portfolio is optimized so that the average monetary loss due to the lack of customization is minimized. Given the distribution of investors' risk aversion, we provide a solution method and an algorithm to optimally position standardized portfolio along one of these two criteria.
De Vries, C. G. (2005). "The simple economics of bank fragility." Journal of Banking & Finance 29(4): 803-825.
Banks are linked through the interbank deposit market, participations like syndicated loans and deposit interest rate risk. The similarity in exposures carries the potential for systemic breakdowns. This potential is either strong or weak, depending on whether the linkages remain or vanish asymptotically. It is shown that the linearity of the bank portfolios in the exposures, in combination with a condition on the tails of the marginal distributions of these exposures, determines whether the potential for systemic risk is weak or strong. We show that if the exposures have marginal normal distributions the potential for systemic risk is weak, while if e.g. the Student distributions apply the potential is strong.
D'Ecclesia, R. L. (2008). "Risk management in commodity and financial markets." Journal of Banking & Finance 32(10): 1989-1990.
Delgado, J., V. Salas, et al. (2007). "Joint size and ownership specialization in bank lending." Journal of Banking & Finance 31(12): 3563-3583.
During the period 1996-2003 consolidation reduces the size diversity of Spanish banks but diversity in ownership forms increases as savings banks and cooperatives gain market share. This paper examines the implications of these structural changes in Spanish credit markets in terms of banks' specialization (large or small borrowers, relational or transactional lending) and consequent credit availability for small and opaque firms. We find that size-of-the-borrower/size-of-the-bank specialization follows a different pattern in savings banks than in commercial banks, suggesting lower organizational diseconomies of size in the former than in the latter, which helps to explain the increase in ownership diversity over time. We also find that savings banks and cooperatives specialize relatively more in relational lending than commercial banks so ownership diversity assures funding for small firms even if bank consolidation continues.
Delis, M. D. and E. G. Tsionas "The joint estimation of bank-level market power and efficiency." Journal of Banking & Finance In Press, Corrected Proof.
The aim of this study is to provide a methodology for the joint estimation of efficiency and market power of individual banks. The proposed method utilizes the separate implications of the new empirical industrial organization and the stochastic frontier literatures and suggests identification using the local maximum likelihood (LML) technique. Through LML, estimation of market power of individual banks becomes feasible, while a number of restrictive theoretical and empirical assumptions are relaxed. The empirical analysis is carried out on the basis of EMU bank data. Market power estimates indicate fairly competitive conduct in general; however, heterogeneity in market power estimates is substantial across banks. The latter result suggests that the practice of some banks deviates from the average fairly competitive behavior, a finding that has important policy implications. Finally, efficiency and market power present a negative relationship, which is in line with the so-called "quiet life hypothesis".
Demiralp, S. and D. Farley (2005). "Declining required reserves, funds rate volatility, and open market operations." Journal of Banking & Finance 29(5): 1131-1152.
The standard view of the monetary transmission mechanism rests on the central bank's ability to manipulate the overnight interest rate by controlling reserve supply. In the 1990s, there was a significant decline in the level of reserve balances in the US accompanied at first by an increase in federal funds rate volatility. However, following this initial rise, volatility declined. In this paper, we find evidence of structural breaks in volatility. We estimate a Tobit model of temporary open market operations and conclude that there have been changes in the Desk's reaction function that played a major role in controlling volatility.
Demirguc-Kunt, A., I. Love, et al. (2006). "Business environment and the incorporation decision." Journal of Banking & Finance 30(11): 2967-2993.
Using firm-level data from 52 countries we investigate how a country's institutions and business environment affect firm's organizational choices and what impact the organizational form has on access to finance and growth. We find that businesses are more likely to choose the corporate form in countries with developed financial sectors and efficient legal systems, strong shareholder and creditor rights, low regulatory burdens and corporate taxes and efficient bankruptcy processes. Corporations report fewer financing, legal and regulatory obstacles than unincorporated firms and this advantage is greater in countries with more developed institutions and favourable business environments. We do find some evidence of higher growth of incorporated businesses in countries with good financial and legal institutions.
Dempster, M. A. H., E. Medova, et al. (2008). "Long term spread option valuation and hedging." Journal of Banking & Finance 32(12): 2530-2540.
This paper investigates the valuation and hedging of spread options on two commodity prices which in the long run are in dynamic equilibrium (i.e., cointegrated). The spread exhibits properties different from its two underlying commodity prices and should therefore be modelled directly. This approach offers significant advantages relative to the traditional two price methods since the correlation between two asset returns is notoriously hard to model. In this paper, we propose a two factor model for the spot spread and develop pricing and hedging formulae for options on spot and futures spreads. Two examples of spreads in energy markets - the crack spread between heating oil and WTI crude oil and the location spread between Brent blend and WTI crude oil - are analyzed to illustrate the results.
Deng, S., E. Elyasiani, et al. (2007). "Diversification and the cost of debt of bank holding companies." Journal of Banking & Finance 31(8): 2453-2473.
In this study, we investigate the relationship between various dimensions of diversification and the cost of debt for publicly traded bank holding companies (BHCs). We find that both domestic geographic diversification of deposits and diversification of assets lead to a lower bond yield-spread. Diversification of non-traditional banking activities leads to a lower cost of debt only when yield-spread and diversification are estimated simultaneously. In addition, we find that medium-sized BHCs experience a greater reduction in bond yield-spread than small-sized and large-sized BHCs. This is consistent with the too-big-to-fail (TBTF) effects in the banking industry. Furthermore, we document that the association between diversification and yield-spread is bidirectional with higher yield-spreads being associated with greater asset and activity diversification and lower geographic deposit dispersion. The effect of diversification on bond yield-spread is robust after accounting for cross-sectional and serial correlation, and the endogeneity of diversification.
Dentcheva, D. and A. Ruszczynski (2006). "Portfolio optimization with stochastic dominance constraints." Journal of Banking & Finance 30(2): 433-451.
We consider the problem of constructing a portfolio of finitely many assets whose return rates are described by a discrete joint distribution. We propose a new portfolio optimization model involving stochastic dominance constraints on the portfolio return rate. We develop optimality and duality theory for these models. We construct equivalent optimization models with utility functions. Numerical illustration is provided.
Derigs, U. and S. Marzban (2009). "New strategies and a new paradigm for Shariah-compliant portfolio optimization." Journal of Banking & Finance 33(6): 1166-1176.
In this paper we analyze the effects of different strategies to construct Shariah compatible financial portfolios. The difference between conventional and current Shariah portfolio management is the application of sector screens and financial screens by which the asset universe is reduced. Yet, here different schools of scholars define different screening rules leading to significant differences with respect to compliance, but also with respect to performance. After analyzing this discrepancy we propose several new strategies to apply the inconsistent rule systems and a new paradigm for defining Shariah-compliance. Under this new paradigm compliance is attributed to the portfolio and not to the individual assets of the universe. We report results of an empirical study analyzing the potentials of these strategies and of the paradigm. We can show that under the proposed concepts Shariah-compliant portfolios can be realized which have return and risk profiles comparable to the conventional non-constrained portfolios.
Dermine, J. and C. N. de Carvalho (2006). "Bank loan losses-given-default: A case study." Journal of Banking & Finance 30(4): 1219-1243.
The empirical literature on credit risk has relied mostly on the corporate bond market to estimate losses in the event of default. The reason for this is that, as bank loans are private instruments, few data on loan losses are publicly available. The contribution of this paper is to apply mortality analysis to a unique set of micro-data on defaulted bank loans of a European bank. The empirical results relate to the timing of recoveries on bad and doubtful bank loans, the distribution of cumulative recovery rates, their economic determinants and the direct costs incurred by that bank on recoveries on bad and doubtful loans.
Detemple, J., R. Garcia, et al. (2005). "Intertemporal asset allocation: A comparison of methods." Journal of Banking & Finance 29(11): 2821-2848.
This paper compares two recent Monte Carlo methods advocated for the computation of optimal portfolio rules. The candidate methods are the approach based on Monte Carlo with Malliavin Derivatives (MCMD) proposed by Detemple, Garcia and Rindisbacher [Detemple et al., 2003. A Monte-Carlo method for optimal portfolios. Journal of Finance 58, 401-406] and the approach based on Monte Carlo with regression (MCR) of Brandt, Goyal, Santa-Clara and Stroud [Brandt et al., 2003. A simulation approach to dynamic portfolio choice with an application to learning about return predictability. Working paper, Wharton School]. Our comparisons are carried out in the context of various intertemporal portfolio choice problems with two assets, a risky asset and a riskless asset, and different configurations of the state variables. The specifications studied include a linear model with a single state variable admitting an exact solution and a non-linear model with two state variables that requires a purely numerical resolution. The accuracies of the candidate methods are compared. We provide, in particular, efficiency plots displaying the speed-accuracy trade-off for various selections of the relevant simulation and discretization parameters. MCMD is shown to dominate in all the settings considered.
Deuskar, P., A. Gupta, et al. (2008). "The economic determinants of interest rate option smiles." Journal of Banking & Finance 32(5): 714-728.
We address three questions relating to the interest rate options market: What is the shape of the smile? What are the economic determinants of the shape of the smile? Do these determinants have predictive power for the future shape of the smile and vice versa? We investigate these issues using daily bid and ask prices of euro ([euro]) interest rate caps/floors. We find a clear smile pattern in interest rate options. The shape of the smile varies over time and is affected in a dynamic manner by yield curve variables and the future uncertainty in the interest rate markets; it also has information about future aggregate default risk. Our findings are useful for the pricing, hedging and risk management of these derivatives.
Devriese, J. and J. Mitchell (2006). "Liquidity risk in securities settlement." Journal of Banking & Finance 30(6): 1807-1834.
This paper studies the potential impact on securities settlement systems (SSSs) of a major market disruption, caused by the default of the largest player. A multi-period, multi-security model with intraday credit is used to simulate direct and second-round settlement failures triggered by the default, as well as the dynamics of settlement failures, arising from a lag in settlement relative to the date of trades. The effects of the defaulter's net trade position, the numbers of securities and participants in the market, and participants' trading behavior are also analyzed. We show that in SSSs - contrary to payment systems - large and persistent settlement failures are possible even when ample liquidity is provided. Central bank liquidity support to SSSs thus cannot eliminate settlement failures due to major market disruptions. This is due to the fact that securities transactions involve a cash leg and a securities leg, and liquidity can affect only the cash side of a transaction. Whereas a broad program of securities borrowing and lending might help, it is precisely during periods of market disruption that participants will be least willing to lend securities. Settlement failures can continue to occur beyond the period corresponding to the lag in settlement. This is due to the fact that, upon observation of a default, market participants must form expectations about the impact of the default, and these expectations affect current trading behavior. If, ex post, fewer of the previous trades settle than expected, new settlement failures will occur. This result has interesting implications for financial stability. On the one hand, conservative reactions by market participants to a default - for example by limiting the volume of trades - can result in a more rapid return of the settlement system to a normal level of efficiency. On the other hand, limitation of trading by market participants can reduce market liquidity, which may have a negative impact on financial stability.
DeYoung, R., W. W. Lang, et al. (2007). "How the Internet affects output and performance at community banks." Journal of Banking & Finance 31(4): 1033-1060.
Internet web sites have become an important alternative distribution channel for most banking institutions. However, we still know little about the impact of this delivery channel on bank performance. We observe 424 community banks among the first wave of US banks to adopt transactional banking web sites in the late-1990s, and compare the change in their 1999-2001 financial performance to that of 5175 branching-only community banks. Whereas today virtually all viable community banking franchises offer the Internet banking channel, studying this earlier time period allows us to make clean comparisons between subsamples of "brick-and-mortar" and "click-and-mortar" community banks. We find that Internet adoption improved community bank profitability, chiefly through increased revenues from deposit service charges. Internet adoption was also associated with movements of deposits from checking accounts to money market deposit accounts, increased use of brokered deposits, and higher average wage rates for bank employees. We find little evidence of changes in loan portfolio mix. Our findings suggest that these initial click-and-mortar banks (and their customers) used the Internet channel as a complement to, rather than a substitute for, physical branches.
Díaz, A., M. d. l. O. González, et al. "An evaluation of contingent immunization." Journal of Banking & Finance In Press, Corrected Proof.
This paper tests the effectiveness of contingent immunization, a stop loss strategy that allows portfolio managers to take advantage of their ability to forecast interest rate movements as long as their forecasts are successful, but switches to a pure immunization strategy should the stop loss limit be encountered. This study uses actual daily transactions in the Spanish Treasury market covering the period 1993-2003 and uses performance measures that accounts for skewness and kurtosis as well as mean variance. The main result of this paper is that contingent immunization provides excellent performance despite its simplicity.
Díaz, A., J. J. J. Merrick, et al. (2006). "Spanish Treasury bond market liquidity and volatility pre- and post-European Monetary Union." Journal of Banking & Finance 30(4): 1309-1332.
Spain enacted a number of important debt management initiatives in 1997 to prepare its Treasury bond market for European Monetary Union. We interpret the impacts of these changes through shifts in a bond liquidity "life cycle" function. Furthermore, we highlight the importance of expected average future liquidity in explaining Spanish bond liquidity premiums. We also uncover pricing biases that support the Spanish Treasury's tactical decision to target high-coupon, premium bonds in its pre-EMU debt exchanges. Finally, we show that EMU has been associated with both a decrease in bond yield volatility and an increase in pricing efficiency.
Dick, A. A. (2008). "Demand estimation and consumer welfare in the banking industry." Journal of Banking & Finance 32(8): 1661-1676.
This paper estimates a structural demand model for commercial bank deposit services in order to measure the effects on consumers given dramatic changes in bank services throughout US branching deregulation in the 1990s. Following the discrete choice literature, consumer decisions are based on prices and bank characteristics. Consumers are found to respond to deposit rates, and to a lesser extent, to account fees, in choosing a depository institution. Moreover, consumers respond favorably to the branch staffing and geographic density, as well as to the bank's age, size, and geographic diversification. Consumers in most markets experience a slight increase in welfare throughout the period.
Ding, B., H. A. Shawky, et al. (2009). "Liquidity shocks, size and the relative performance of hedge fund strategies." Journal of Banking & Finance 33(5): 883-891.
We examine whether the increase in the flow of capital to hedge funds over the period 1994-2005 had a negative impact on performance. More specifically, we study the relative performance of small versus large funds for each of the hedge fund strategies. Our results indicate that on an absolute return basis, small funds outperform large funds. On a risk-adjusted return basis, however, we find that large funds outperform small funds, and that large funds are also shown to hold less liquid assets and take on less systematic and idiosyncratic risk than small funds. Further, funds that experience positive liquidity shocks generally outperform those that experience negative liquidity shocks. We also find evidence that hedge fund managers that are aggressive in dealing with liquidity shocks perform better than hedge fund managers that are conservative in dealing with liquidity shocks.
Djankov, S., J. Jindra, et al. (2005). "Corporate valuation and the resolution of bank insolvency in East Asia." Journal of Banking & Finance 29(8-9): 2095-2118.
We examine the valuation effect of the resolution of a bank's insolvency on commercial clients. Our sample includes 29 insolvent banks in Indonesia, Korea, and Thailand that serve as main creditors for 269 publicly traded companies. Our findings suggest that a bank relationship adds value to a firm, and that this value depends on investors' certainty in the continuity of the banking relationship. Significant cumulative returns for 50 days following the event date suggest that the type of resolution has real effects on the performance of related firms above initial expectations.
D'Mello, R., S. Krishnaswami, et al. (2008). "Determinants of corporate cash holdings: Evidence from spin-offs." Journal of Banking & Finance 32(7): 1209-1220.
We study the factors that influence the cash allocation decision around a spin-off, using variables suggested by the trade-off theory, and controlling for the possible endogeneity of leverage and cash ratios. Spin-offs provide an opportunity to examine the determinants of cash allocation at the margin at the time of creation of a new entity. Our results indicate that managers allocate higher cash ratios to smaller firms, and firms with high research and development expense ratio, low net working capital ratio, and low leverage. Thus, higher cash ratios are correlated with difficulty of raising external capital and reduced availability of cash from internal sources. In addition, managers also base the cash allocation on observable immediate growth opportunities instead of on long-term possible growth. An analysis of excess cash ratios, defined as the difference between the actual and predicted cash ratios, indicate that firms are, on average, allocated less cash than suggested by trade-off models, and this deviation in allocated cash from predicted levels is explained only by concurrent profitability of the firms (a pecking order theory implication).
Doran, J. S. and E. I. Ronn (2008). "Computing the market price of volatility risk in the energy commodity markets." Journal of Banking & Finance 32(12): 2541-2552.
In this paper, we demonstrate the need for a negative market price of volatility risk to recover the difference between Black-Scholes [Black, F., Scholes, M., 1973. The pricing of options and corporate liabilities. Journal of Political Economy 81, 637-654]/Black [Black, F., 1976. Studies of stock price volatility changes. In: Proceedings of the 1976 Meetings of the Business and Economics Statistics Section, American Statistical Association, pp. 177-181] implied volatility and realized-term volatility. Initially, using quasi-Monte Carlo simulation, we demonstrate numerically that a negative market price of volatility risk is the key risk premium in explaining the disparity between risk-neutral and statistical volatility in both equity and commodity-energy markets. This is robust to multiple specifications that also incorporate jumps. Next, using futures and options data from natural gas, heating oil and crude oil contracts over a 10 year period, we estimate the volatility risk premium and demonstrate that the premium is negative and significant for all three commodities. Additionally, there appear distinct seasonality patterns for natural gas and heating oil, where winter/withdrawal months have higher volatility risk premiums. Computing such a negative market price of volatility risk highlights the importance of volatility risk in understanding priced volatility in these financial markets.
Dos Santos, M. B., V. R. Errunza, et al. (2008). "Does corporate international diversification destroy value? Evidence from cross-border mergers and acquisitions."Journal of Banking & Finance 32(12): 2716-2724.
This paper investigates the valuation effects of corporate international diversification by examining cross-border mergers and acquisitions of US acquirers over the period 1990-2000. We find that, on average, acquisitions of "fairly valued" foreign business units do not lead to value discounts. In contrast, unrelated cross-border acquisitions result in a significant diversification discount of about 24% after accounting for the valuation of foreign targets. Furthermore, significant wealth gains accrue to foreign target shareholders regardless of the type of acquisition. Overall, our results suggest that international diversification does not destroy value while industrial diversification leads to discounts even after controlling for the pre-acquisition value of the target.
Døskeland, T. M. and H. A. Nordahl (2008). "Optimal pension insurance design." Journal of Banking & Finance 32(3): 382-392.
In this paper we analyze how the traditional life and pension contracts with a guaranteed rate of return can be optimized to increase customers' welfare. Given that the contracts have to be priced correctly, we use individuals' preferences to find the preferred design. Assuming CRRA utility, we cannot explain the existence of any form of guarantees. Through numerical solutions we quantify the difference (measured in certainty equivalents) to the preferred Merton solution of direct investments in a fixed proportion of risky and risk free assets. The largest welfare loss seems to come from the fact that guarantees are effective by the end of each year, not only by the expiry of the contract. However, the demand for products with guarantees may be explained through behavioral models. We use cumulative prospect theory as an example, showing that the optimal design is a simple contract with a life-time guarantee and no default option.
Dotsis, G., D. Psychoyios, et al. (2007). "An empirical comparison of continuous-time models of implied volatility indices." Journal of Banking & Finance 31(12): 3584-3603.
We explore the ability of alternative popular continuous-time diffusion and jump-diffusion processes to capture the dynamics of implied volatility indices over time. The performance of the various models is assessed under both econometric and financial metrics. To this end, data are employed from major European and American implied volatility indices and the rapidly growing CBOE volatility futures market. We find that the addition of jumps is necessary to capture the evolution of implied volatility indices under both metrics. Mean reversion is of second-order importance though. The results are consistent across the various metrics, markets, and construction methodologies.
Doukas, J. A. and O. B. Kan (2008). "Investment decisions and internal capital markets: Evidence from acquisitions." Journal of Banking & Finance 32(8): 1484-1498.
In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders' core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of "corporate socialism" in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders' non-core business segments rely on both core and non-core cash flows.
Dow, S. and J. McGuire "Propping and tunneling: Empirical evidence from Japanese keiretsu." Journal of Banking & Finance In Press, Accepted Manuscript.
We examine the response of horizontal and vertical keiretsu to the changing economic and regulatory climate in Japan from 1987 to 2001. We find evidence of profit tunneling of more weakly affiliated keiretsu firms during strong economic times. We observe propping of weakly aligned firms during recession. Many horizontal keiretsu firms strengthened their degree of adhesion to the horizontal keiretsu in response to increasingly tightened credit conditions post-1991. The motivation behind strengthened affiliation appears primarily linked to the goal of overcoming financial constraints by accessing the internal capital market of the business group.
Doyle, J. R. and C. H. Chen (2009). "The wandering weekday effect in major stock markets." Journal of Banking & Finance 33(8): 1388-1399.
This paper reports a wandering weekday effect: the pattern of day seasonality in stock market returns is not fixed, as assumed in the Monday or weekend effects, but changes over time. Analysing daily closing prices in eleven major stock markets during 1993-2007, our results show that the wandering weekday is not conditional on average returns in the previous week (the "twist" in the Monday effect). Nor does it diminish through the period of analysis. The results have important implications for market efficiency, and help to reconcile mixed findings in previous studies, including the reported disappearance of the weekday effect in recent years.
Drake, L., M. J. B. Hall, et al. (2006). "The impact of macroeconomic and regulatory factors on bank efficiency: A non-parametric analysis of Hong Kong's banking system." Journal of Banking & Finance 30(5): 1443-1466.
This paper assesses the relative technical efficiency of institutions operating in a market that has been significantly affected by environmental and market factors in recent years, the Hong Kong banking system. These environmental factors are specifically incorporated into the efficiency analysis using the innovative slacks-based, second stage Tobit regression approach advocated by Fried et al. [Fried, H.O., Schmidt, S.S., Yaisawarng, S., 1999. Incorporating the operating environment into a nonparametric measure of technical efficiency. Journal of Productivity Analysis 12, 249-267]. A further innovation is that we also employ Tone's [Tone, K., 2001. A slacks-based measure of efficiency in data envelopment analysis. European Journal of Operational Research 130, 498-509] slacks-based model (SBM) to conduct the data envelopment analysis (DEA), in addition to the more traditional approach attributable to Banker, Charnes and Cooper (BCC) [Banker, R.D., Charnes, A., Cooper, W.W., 1984. Some models for estimating technical and scale efficiencies in data envelopment analysis. Management Science 30, 1078-1092]. The results indicate: high levels of technical inefficiency for many institutions; considerable variations in efficiency levels and trends across size groups and banking sectors; and also differential impacts of environmental factors on different size groups and financial sectors. Surprisingly, the accession of Hong Kong to the People's Republic of China, episodes of financial deregulation, and the 1997/1998 South East Asian crisis do not seem to have had a significant independent impact on relative efficiency. However, the results suggest that the impact of the last-mentioned may have come via the adverse developments in the macroeconomy and in the housing market.
Dreisbach, D. and F. Kindermann (2008). "A note on Chui, Gai and Haldane's "Sovereign liquidity crisis: Analytics and implications for public policy"." Journal of Banking & Finance 32(4): 624-629.
This note corrects the welfare calculations in Chui, Gai and Haldane's paper on sovereign liquidity crisis [Chui, M., Gai, P., Haldane, A.G., 2002. Sovereign liquidity crisis: Analytics and implications for public policy. Journal of Banking and Finance 26, 519-544]. We show that the exact formula not only dramatically reduces the computed welfare consequences from 66% of ex-ante expected output to roughly 13%, but also changes the direction of some reported comparative static results. In addition, we clarify the difference between fundamentals-driven and belief-driven welfare costs and extend some of the sensitivity calculations.
Driessen, J. and L. Laeven (2007). "International portfolio diversification benefits: Cross-country evidence from a local perspective." Journal of Banking & Finance31(6): 1693-1712.
We investigate how the benefits of international portfolio diversification differ across countries from the perspective of a local investor. We find that the benefits of investing abroad are largest for investors in developing countries, including when controlling for currency effects. Most of the benefits are obtained from investing outside the region of the home country. These global diversification benefits remain large when controlling for short-sales constraints in developing stock markets. The gains from international portfolio diversification appear to be largest for countries with high country risk. In addition to this cross-sectional evidence, we also provide evidence that diversification benefits vary over time as country risk changes. We find that diversification benefits have decreased for most countries in our sample over the past two decades.
Duan, J.-C. and J. Wei (2005). "Executive stock options and incentive effects due to systematic risk." Journal of Banking & Finance 29(5): 1185-1211.
Existing research on executive stock options mainly focuses on total risk when studying risk incentives. In this study, we use a GARCH option pricing framework to show that the incentive effects of executive stock options depend on the composition of risk. Controlling for total risk, the value of executive stock options increases with systematic risk and this effect is stronger when the total risk is low. Thus, when firms grant standard or non-indexed options, CEOs will have incentives to increase systematic risk even when the total risk remains constant. In contrast, indexed options will provide CEOs with incentives to reduce systematic risk. We therefore conclude that an optimal mix of indexed and non-indexed option grants will provide CEOs with incentives to take the desired level of systematic risk.
Duan, J.-C. and M.-T. Yu (2005). "Fair insurance guaranty premia in the presence of risk-based capital regulations, stochastic interest rate and catastrophe risk."Journal of Banking & Finance 29(10): 2435-2454.
A multiperiod model is developed to measure the costs posed to the guaranty fund in a setting that incorporates risk-based capital regulations, interest rate risk and the possibility of catastrophic losses. The guaranty contract is modeled as a put option on the asset of the insurance company with a stochastic strike price and an uncertain maturity. The impacts of the key factors of this model are examined numerically and shown to make material differences in the costs to the guaranty fund.
Dueker, M. and C. J. Neely (2007). "Can Markov switching models predict excess foreign exchange returns?" Journal of Banking & Finance 31(2): 279-296.
This paper merges the literature on technical trading rules with the literature on Markov switching to develop economically useful trading rules. The Markov models' out-of-sample, excess returns modestly exceed those of standard technical rules and are profitable over the most recent subsample. A portfolio of Markov and standard technical rules outperforms either set individually, on a risk-adjusted basis. The Markov rules' high excess returns contrast with mixed performance on statistical tests of forecast accuracy. There is no clear source for the trends, but permitting the mean to depend on higher moments of the exchange rate distribution modestly increases returns.
Duffie, D. (2005). "Credit risk modeling with affine processes." Journal of Banking & Finance 29(11): 2751-2802.
This article combines an orientation to credit risk modeling with an introduction to affine Markov processes, which are particularly useful for financial modeling. We emphasize corporate credit risk and the pricing of credit derivatives. Applications of affine processes that are mentioned include survival analysis, dynamic term-structure models, and option pricing with stochastic volatility and jumps. The default-risk applications include default correlation, particularly in first-to-default settings. The reader is assumed to have some background in financial modeling and stochastic calculus.
Duong, H. N. and P. S. Kalev (2008). "The Samuelson hypothesis in futures markets: An analysis using intraday data." Journal of Banking & Finance 32(4): 489-500.
This paper considers the Samuelson hypothesis, which argues that the futures price volatility increases as the futures contract approaches its expiration. Utilizing intraday data from 20 futures markets in six futures exchanges, we find strong support for the Samuelson hypothesis in agricultural futures. However, the Samuelson hypothesis does not hold for other futures contracts. We also provide supporting evidence that the [`]negative covariance' hypothesis is the key factor for the empirical support of the Samuelson hypothesis. In addition, our findings remain largely unaltered even after we control for seasonality and liquidity effects.
Dutordoir, M. and L. Van de Gucht (2007). "Are there windows of opportunity for convertible debt issuance? Evidence for Western Europe." Journal of Banking & Finance 31(9): 2828-2846.
This paper hypothesizes that hot convertible debt windows represent periods with lower convertible debt-related financing costs. Supporting this premise, we find that the stock price impact of Western European convertible debt announcements is significantly less negative during hot convertible debt windows. Importantly, this result holds while controlling for equity and straight debt issuance volumes and for macroeconomic conditions. In addition, stockholders are less sensitive to issuer- and issue-specific financing costs during hot convertible debt markets. Overall, these findings indicate that hot convertible debt markets represent windows of opportunity for convertible debt issuance. Firms with high idiosyncratic financing costs act accordingly by timing their convertible debt offering during a hot market.
Dutta, S. and V. Jog (2009). "The long-term performance of acquiring firms: A re-examination of an anomaly." Journal of Banking & Finance 33(8): 1400-1412.
In this paper, we investigate the long-term stock return performance of Canadian acquiring firms in the post-event period by using 1300 M&A events in the 1993-2002 period. We use both event-time and calendar-time approaches and conduct robustness tests for benchmarks, methodological choices, statistical techniques and other related factors such as payment methods. We also assess the role of governance variables. Contrary to stylized facts reported in US studies, neither do we find negative abnormal long-term abnormal stock market returns once we account for methodological discrepancies nor do we find negative long-term operating performance in the post-acquisition periods for the acquirer following an acquisition event. We also find that the Canadian market reacts positively to acquisition announcements but corrects for this reaction within a short period of time. Overall we find that Canadian acquisitions do not show value destruction or overpayment.
Dwyer, D. W. and R. M. Stein (2006). "Inferring the default rate in a population by comparing two incomplete default databases." Journal of Banking & Finance30(3): 797-810.
It is often the case in default modeling that the need arises to calibrate a model to some prior probability of default. In many situations, a researcher may not know the true prior default rate for the population because the data set at hand is itself incomplete, either with respect to default identification (hidden defaults) or default under reporting. In situations where a researcher has access to two incomplete default data sets, for example in the case of two banks that have merged, it is possible to infer the number of "missing" defaults, which we demonstrate in this short note. We discuss an approach to estimating this quantity and show an example in which we infer the number of missing defaults in the combined legacy databases of the former Moody's Risk Management Services and the former KMV Corporation. While calibration is one application of this approach, the method is a general one that can be applied in other settings as well.
Eberhart, A. C. (2005). "Employee stock options as warrants." Journal of Banking & Finance 29(10): 2409-2433.
Previous studies ignore the fact that employee stock options are warrants because these options have been an insignificant component of firms' capital structures. I show that this assumption is no longer correct. For example, for more than 36% of my sample firms, employee stock options represent a more significant claim on firm value than the firm's debt and preferred stock combined. Moreover, in contrast to the suggestions of previous research, I show that employee stock options are a significant claim on firms throughout the economy, including larger firms, older firms, and firms in "Old Economy" industries. Finally, I show that the presumption in prior studies that employee stock options are not warrants causes a potential misunderstanding of the risk-shifting interests of securityholders and biases the analysis of capital structure issues.
Ebnöther, S. and P. Vanini (2007). "Credit portfolios: What defines risk horizons and risk measurement?" Journal of Banking & Finance 31(12): 3663-3679.
The strong autocorrelation between economic cycles demands that we analyze credit portfolio risk in a multiperiod setup. We embed a standard one-factor model in such a setup. We discuss the calibration of the model to Standard & Poor's ratings data in detail. But because single-period risk measures cannot capture the cumulative effects of systematic shocks over several periods, we define an alternative risk measure, which we call the time-conditional expected shortfall (TES), to quantify credit portfolio risk over a multiperiod horizon.
Ederington, L. and W. Guan (2005). "The information frown in option prices." Journal of Banking & Finance 29(6): 1429-1457.
In the S&P 500 options market, the information content of implied volatilities differs by strike in a frown pattern that is a rough mirror image of the implied volatility smile. Implied volatilities calculated from moderately high strike price options are both unbiased and efficient predictors of future volatility. Implied volatilities calculated from low and at-the-money strikes are biased and less efficient. This bias cannot be explained by market imperfections but is consistent with the hedging pressure argument of Bollen and Whaley [J. Finan. 59 (2004) 711] and Ederington and Guan [J. Derivat. 10 (2002) (Winter) 9]. We also find that a serious estimation bias results when the relations are estimated using panel data.
Ederington, L. H. and J. M. Salas (2008). "Minimum variance hedging when spot price changes are partially predictable." Journal of Banking & Finance 32(5): 654-663.
In many markets, changes in the spot price are partially predictable. We show that when this is the case: (1) although unbiased, traditional regression estimates of the minimum variance hedge ratio are inefficient, (2) estimates of the riskiness of both hedged and unhedged positions are biased upward, and (3) estimates of the percentage risk reduction achievable through hedging are biased downward. For natural gas cross hedges, we find that both the inefficiency and bias are substantial. We further find that incorporating the expected change in the spot price, as measured by the futures-spot price spread at the beginning of the hedge, into the regression results in a substantial increase in efficiency and reduction in the bias.
Edirisinghe, N. C. P. and X. Zhang (2007). "Generalized DEA model of fundamental analysis and its application to portfolio optimization." Journal of Banking & Finance 31(11): 3311-3335.
Fundamental analysis is used in asset selection for equity portfolio management. In this paper, a generalized data envelopment analysis (DEA) model is developed to analyze a firm's financial statements over time in order to determine a relative financial strength indicator (RFSI) that is predictive of firm's stock price returns. RFSI is based on maximizing the correlation between the DEA-based score of financial strength and the stock market performance. This maximization involves a difficult binary nonlinear program that requires iterative re-configuration of parameters of financial statements as inputs and outputs. We utilize a two-step heuristic algorithm that combines random sampling and local search optimization. The proposed approach is tested with 230 firms from various US technology-industries to determine optimized RFSI indicators for stock selection. Then, those selected stocks are used within portfolio optimization models to demonstrate the usefulness of the scheme for portfolio risk management.
Egami, M. and K. Esteghamat (2006). "An approximation method for analysis and valuation of credit correlation derivatives." Journal of Banking & Finance 30(2): 341-364.
This paper presents a model for approximating the value of a basket of default-correlated assets and analyzes subordinate tranches in securitized debt obligations. The model is calibrated to an intensity-based simulation of correlated defaults and represents an alternative computation method to full Monte Carlo simulation. Timing of individual obligor defaults are driven by intensity processes and collateral value is modeled with a jump-diffusion process where the number of jumps corresponds to the total number of defaults in the asset pool. This approach allows decomposition of subordinate obligations in terms of a collection of simpler securities and yields useful risk management information.
Égert, B. and L. Halpern (2006). "Equilibrium exchange rates in Central and Eastern Europe: A meta-regression analysis." Journal of Banking & Finance 30(5): 1359-1374.
This paper analyses the ever-growing literature on equilibrium exchange rates in the new EU member states of Central and Eastern Europe in a quantitative manner using meta-regression analysis. The results indicate that the real misalignments reported in the literature are systematically influenced, inter alia, by the underlying theoretical concepts (Balassa-Samuelson effect, behavioral equilibrium exchange rate, fundamental equilibrium exchange rate) and by the econometric estimation methods. The important implication of these findings is that a systematic analysis is needed in terms of both alternative economic and econometric specifications to assess equilibrium exchange rates.
Égert, B., K. Lommatzsch, et al. (2006). "Real exchange rates in small open OECD and transition economies: Comparing apples with oranges?" Journal of Banking & Finance 30(12): 3393-3406.
We find that productivity gains in tradables cause an appreciation of the real exchange rate via both tradable and nontradable prices in the CEE-5 and have no affect in the Baltic countries, while they lead to a depreciation of the real exchange rate of tradables in OECD economies that overcompensates the appreciation due to nontradable prices. Rising net foreign liabilities lead to a real appreciation in the Baltic countries instead of the expected depreciation found in OECD and CEE-5 countries. These differences are due to the different impact of the fundamentals on the real exchange rate depending on the time horizon studied.
Egloff, D., M. Leippold, et al. (2007). "A simple model of credit contagion." Journal of Banking & Finance 31(8): 2475-2492.
We propose a simple model of credit contagion in which we include macro- and microstructural interdependencies among the debtors within a credit portfolio. The microstructure captures interdependencies between debtors that go beyond their exposure to common factors, e.g., business or legal interdependencies. We show that even for diversified portfolios, moderate microstructural interdependencies have a significant impact on the tails of the loss distribution. This impact increases dramatically for less diversified microstructures.
Eichengreen, B., K. Kletzer, et al. (2006). "The IMF in a world of private capital markets." Journal of Banking & Finance 30(5): 1335-1357.
In analyzing the IMF attempts to stabilize private capital flows, we contrast cases where banks and bondholders do the lending. Consistent with banks' natural advantage in monitoring, they reduce spreads as they obtain more information through repeat transactions with borrowers. By comparison, repeat borrowing has little influence in bond markets, where publicly-available information dominates. But spreads on bonds are lower when they are issued in conjunction with an IMF-supported program, as if the existence of a program conveys positive information to bondholders. The influence of IMF monitoring in bond markets is especially pronounced for countries vulnerable to liquidity crises.
Eichler, S., A. Karmann, et al. "The ADR shadow exchange rate as an early warning indicator for currency crises." Journal of Banking & Finance In Press, Corrected Proof.
We develop an indicator for currency crisis risk using price spreads between American Depositary Receipts (ADRs) and their underlyings. This risk measure represents the mean exchange rate ADR investors expect after a potential currency crisis or realignment. It makes crisis prediction possible on a daily basis as depreciation expectations are reflected in ADR market prices. Using daily data, we analyze the impact of several risk drivers related to standard currency crisis theories and find that ADR investors perceive higher currency crisis risk when export commodity prices fall, trading partners' currencies depreciate, sovereign yield spreads increase, or interest rate spreads widen.
Eikseth, H. M. and S. Lindset (2009). "A note on capital asset pricing and heterogeneous taxes." Journal of Banking & Finance 33(3): 573-577.
In this paper, we present a stylized model where we show how asset prices, i.e., required expected rates of returns, may be characterized in a world with heterogeneous asset taxes. Within a simple CAPM-like framework, we derive an after-tax beta equal to the pre-tax beta multiplied by a (non-obvious) asset specific tax adjustment. We further show in what sense the Security Market Line here can be replaced by a Security Market Fan. Well-known CAPM relations are obtained as special cases, and policy implications are analyzed.
Eldor, R., S. Hauser, et al. (2006). "The contribution of market makers to liquidity and efficiency of options trading in electronic markets." Journal of Banking & Finance 30(7): 2025-2040.
This paper examines the contribution of market makers to the liquidity and the efficiency of the options market in a unique setup of an order-driven computerized trading system, in which market makers and other participants operate under equitable conditions. The main findings are: (1) liquidity increased - a 60% increase in trading volume and a 35% decrease of bid-ask spreads; (2) the efficiency of shekel-euro options trading improved - deviations from put-call parity decreased significantly by 12%, and skewness decreased by about 30%. We also find that the net cost to the exchange is out weighted by the benefit to the trading public and that the presence of market makers encouraged trading between other participants far beyond their own trading.
Eleanor Xu, X., P. Chen, et al. (2006). "Time and dynamic volume-volatility relation." Journal of Banking & Finance 30(5): 1535-1558.
This paper examines volume and volatility dynamics by accounting for market activity measured by the time duration between two consecutive transactions. A time-consistent vector autoregressive (VAR) model is employed to test the dynamic relationship between return volatility and trades using intraday irregularly spaced transaction data. The model is used to identify the informed and uninformed components of return volatility and to estimate the speed of price adjustment to new information. It is found that volatility and volume are persistent and highly correlated with past volatility and volume. The time duration between trades has a negative effect on the volatility response to trades and correlation between trades. Consistent with microstructure theory, shorter time duration between trades implies higher probability of news arrival and higher volatility. Furthermore, bid-ask spreads are serially dependent and strongly affected by the informed trading and inventory costs.
Eleswarapu, V. R. and R. Thompson (2007). "Testing for negative expected market return premia." Journal of Banking & Finance 31(6): 1755-1770.
This paper tests the hypothesis that the expected return premium on the market portfolio is always non-negative. A violation of this lower bound restriction provides evidence against a broad class of risk-based equilibrium models in favor of bubble behavior. Our tests utilize information variables, identified in prior literature, that predict time variation in market return premia. We employ out-of-sample forecasts and bootstraps generated with parameters that are consistent with non-negativity but closest to the estimated parameters. We find statistically reliable evidence against non-negativity for the excess return on the value-weighted market index. The most negative out-of-sample prediction was -2.01% in September 1973.
Eling, M. and F. Schuhmacher (2007). "Does the choice of performance measure influence the evaluation of hedge funds?" Journal of Banking & Finance 31(9): 2632-2647.
The Sharpe ratio is adequate for evaluating investment funds when the returns of those funds are normally distributed and the investor intends to place all his risky assets into just one investment fund. Hedge fund returns differ significantly from a normal distribution. For this reason, other performance measures for hedge fund returns have been proposed in both the academic and practice-oriented literature. In conducting an empirical study based on return data of 2763 hedge funds, we compare the Sharpe ratio with 12 other performance measures. Despite significant deviations of hedge fund returns from a normal distribution, our comparison of the Sharpe ratio to the other performance measures results in virtually identical rank ordering across hedge funds.
Elliott, W. B., A. K. Prevost, et al. (2009). "The announcement impact of seasoned equity offerings on bondholder wealth." Journal of Banking & Finance 33(8): 1472-1480.
Previous studies document a negative return to equity on the announcement of an SEO. However, the effects of SEO announcements on bonds have received little attention. We find that bondholders experience a significant positive return on the announcement of an SEO and this effect is more pronounced for bonds with lower ratings. We examine alternate explanations for bond market reactions to SEO announcements including the leverage risk reduction, wealth transfer, and information signaling hypotheses. Overall, our results are most consistent with the leverage risk reduction hypothesis.
Elyasiani, E. and J. J. Jia (2008). "Institutional ownership stability and BHC performance." Journal of Banking & Finance 32(9): 1767-1781.
In this study, the association between performance of BHCs and institutional ownership stability is investigated and contrasted to those found for the less regulated utility and industrial firms in order to determine whether regulation displaces owner monitoring. We employ a simultaneous equations model treating firm performance and institutional ownership stability as endogenous variables. Several results are obtained. First, BHC performance is positively associated with institutional ownership stability. Second, this association is weaker for BHCs than for comparable utility and industrial firms, possibly because of the substitution of regulation for owner monitoring in banking. Third, this association is stronger in the recent deregulated years and for BHCs with lower likelihood of regulatory intervention.
Elyasiani, E., I. Mansur, et al. (2007). "Convergence and risk-return linkages across financial service firms." Journal of Banking & Finance 31(4): 1167-1190.
We examine the risk and return linkages across US commercial banks, securities firms, and life insurance companies during the 1991-2001 period. After controlling for changes in the broader stock market, interest rates, and foreign currency values, we find that return and risk interdependencies across these financial firms are significant and size-varying; larger institutions display stronger volatility transmission linkages, while smaller ones exhibit more prominent return-related linkages. The tighter link in risk among large financial institutions (FIs) suggests stronger convergence, employment of common models of risk measurement and risk management, and more intense inter-industry competition, particularly between large banks and large securities firms, compared to smaller institutions. Lack of risk spillover among smaller FIs confirms the intuition that they typically assume more localized and idiosyncratic risk. The co-movement of stock returns among smaller FIs has been helped by the effects of locally based factors, such as economic conditions and state regulations, on all such institutions, and a less diversified product set. Differences in spillover patterns between large and smaller institutions have implications on investment choices and mergers and acquisitions in the industry. Introduction of the Gramm-Leach-Bliley Act (1999) has had dissimilar effects on the riskiness of large versus smaller life insurance and securities firms, and an insignificant effect on commercial banks.
Emery, K. M. and R. Cantor (2005). "Relative default rates on corporate loans and bonds." Journal of Banking & Finance 29(6): 1575-1584.
We use two alternative matched-set methodologies to examine for differences in loan and bond default rates among US non-financial corporate issuers. Under both methodologies, the data indicate that loan default rates are roughly 20% lower than the bond default rates due to issuers that default on their bonds but avoid bankruptcy and avoid defaulting on their loans. For a small number of European issuers, the data suggest a similar reduction in loan default rates relative to bond default rates. However, the European results differ qualitatively from the US results, due likely to differences in US and European bankruptcy regimes, as well as the larger role of bank debt on most European issuers' balance sheets. These results have important implications for investors, bank supervisors, and rating agencies that assess the relative expected credit losses on loans versus bonds.
Engel, D. and T. Middendorf "Investment, internal funds and public banking in Germany." Journal of Banking & Finance In Press, Accepted Manuscript.
Previous studies supposed that low investment-cash flow sensitivities of German firms may be caused by a dominance of public banking. The paper addresses this assumption and applies a unique accounting dataset of German firms. Results from a dynamic version of the sales accelerator model show that the dependence of investment spending on internal funds does not significantly differ among firms attached to savings banks, cooperative banks or commercial banks. Thus, the importance of the public banking sector in Germany may not explain the rather low dependence of German firms on internal funds, and public ownership of banks does not seem to be important for reducing financing constraints.
Entrop, O., H. Scholz, et al. (2009). "The price-setting behavior of banks: An analysis of open-end leverage certificates on the German market." Journal of Banking & Finance 33(5): 874-882.
This paper presents the first analysis of open-end leverage certificates on the German market. The major innovations of these certificates are twofold. First, issuers announce a price-setting formula according to which they are willing to buy and sell the certificates over time. Second, the product's lifetime is potentially endless. Our main findings are that the price-setting formula is (i) designed to strongly favor the issuer and (ii) is consistent with the main outcome of the [`]life cycle hypothesis' for structured financial products [Stoimenov, P.A., Wilkens, S., 2005. Are structured products [`]fairly' priced? An analysis of the German market for equity-linked instruments. Journal of Banking and Finance 29, 2971-2993]. (iii) This holds for different product features and also in the presence of issuers' credit risk and jump risk in the underlying.
Episcopos, A. (2008). "Bank capital regulation in a barrier option framework." Journal of Banking & Finance 32(8): 1677-1686.
The barrier options theory of corporate security valuation is applied to the contingent claims of a regulated bank. The regulator/insurer of a bank owns a down-and-in call option on the bank assets which can be balanced against the expected coverage cost. Raising the regulatory barrier (critical asset level triggering bank closure) leads to a transfer of wealth from stockholders to the insurer and reduces stockholder incentives to increase asset risk. Empirical tests on a sample of 152 one-bank holding companies show that regulatory barriers are priced in the stock market and are inversely related to Tier 1 leverage ratios.
Ergungor, O. E. (2004). "Market- vs. bank-based financial systems: Do rights and regulations really matter?" Journal of Banking & Finance 28(12): 2869-2887.
In some countries, banks are firms' key source of financing. In others, firms look mainly to financial markets to meet their financial needs. Why should this be so? This paper provides an explanation tied to legal traditions. Civil-law courts are less effective than their common-law counterparts in resolving conflicts because they have less flexibility in interpreting the laws and creating new rules. Banks emerge in these economies as primary contract enforcers, leading to bank-oriented financial systems. Furthermore, because common-law courts enforce laws effectively, providing them with more detailed creditor and shareholder protection laws has a greater impact on the development of financial markets compared with civil-law systems.
Evren Damar, H. (2007). "Does post-crisis restructuring decrease the availability of banking services? The case of Turkey." Journal of Banking & Finance 31(9): 2886-2905.
This study examines the relationship between post-crisis bank consolidation and the number of bank branches in Turkey. Using a unique data set, the analysis addresses several issues related to the impact of market characteristics on branching behavior. The findings suggest that sales of failed institutions by the central authority lead to branch closures in small and uncompetitive markets where the buyer does not have a prior presence. Contrary to popular belief, mergers between healthy institutions do not always cause a decrease in the number of branches; rather, they are shown to increase the availability of banking services in concentrated markets.
Ewing, B. T. and F. Malik (2005). "Re-examining the asymmetric predictability of conditional variances: The role of sudden changes in variance." Journal of Banking & Finance 29(10): 2655-2673.
The existence of "spillover effects" in financial markets is well documented and multivariate time series techniques have been used to study the transmission of conditional variances among large and small market value firms. Earlier research has suggested that volatility surprises to large capitalization firms are a reliable predictor of the volatility of small capitalization firms. A related line of research has examined how regime shifts in volatility may account for a considerable amount of the persistence in volatility. However, these studies have focused on univariate modeling and many have imposed regime changes on a priori grounds. This paper re-examines the asymmetry in the predictability of the volatilities of large versus small market value firms allowing for sudden changes in variance. Our method of analysis extends the existing literature in two important ways. First, recent advances in time series econometrics allow us to detect the time periods of sudden changes in volatility of large cap and small cap stocks endogenously using the iterated cumulated sums of squares (ICSS) algorithm. Second, we directly incorporate the information obtained on sudden changes in volatility in a Bivariate GARCH model of small and large cap stock returns. Our findings indicate that accounting for volatility shifts considerably reduces the transmission in volatility and, in essence, removes the spillover effects. We conclude that ignoring regime changes may lead one to significantly overestimate the degree of volatility transmission that actually exists between the conditional variances of small and large firms.
Faff, R. and P. Gray (2006). "On the estimation and comparison of short-rate models using the generalised method of moments." Journal of Banking & Finance30(11): 3131-3146.
Subsequent to the influential paper of [Chan, K.C., Karolyi, G.A., Longstaff, F.A., Sanders, A.B., 1992. An empirical comparison of alternative models of the short-term interest rate. Journal of Finance 47, 1209-1227], the generalised method of moments (GMM) has been a popular technique for estimation and inference relating to continuous-time models of the short-term interest rate. GMM has been widely employed to estimate model parameters and to assess the goodness-of-fit of competing short-rate specifications. The current paper conducts a series of simulation experiments to document the bias and precision of GMM estimates of short-rate parameters, as well as the size and power of [Hansen, L.P., 1982. Large sample properties of generalised method of moments estimators. Econometrica 50, 1029-1054], J-test of over-identifying restrictions. While the J-test appears to have appropriate size and good power in sample sizes commonly encountered in the short-rate literature, GMM estimates of the speed of mean reversion are shown to be severely biased. Consequently, it is dangerous to draw strong conclusions about the strength of mean reversion using GMM. In contrast, the parameter capturing the levels effect, which is important in differentiating between competing short-rate specifications, is estimated with little bias.
Faff, R. and D. Hillier (2005). "Complete markets, informed trading and equity option introductions." Journal of Banking & Finance 29(6): 1359-1384.
This paper proposes and tests a new hypothesis concerning the price impact of option introductions on the underlying asset. We argue that the leverage properties of options induce a higher level of informed trading in the aggregate market (underlying plus derivative), resulting in excess listing-day price movements in the newly optioned equity. Using an alternative dataset, our results suggest that this may be an explanation for the observed positive than negative excess listing-day returns of US optioned stocks over the past thirty years.
Fan, E. and R. Zhao (2009). "Health status and portfolio choice: Causality or heterogeneity?" Journal of Banking & Finance 33(6): 1079-1088.
This paper explores the role of unobserved individual characteristics in the health-assets and health-portfolio correlations. We apply various econometrics models to a unique longitudinal dataset with rich information that allows for the exploitation of four different health indices. Our findings show strong cross-sectional correlations between health and both financial and non-financial assets, but these correlations seem to be mainly driven by heterogeneity as the correlations largely disappear in the fixed-effects model. Adverse health shocks, however, are found to motivate a safer portfolio choice even after individual fixed-effects are controlled for - a result consistent with the prediction made by the background risk theory. Our findings suggest that health shocks shift investment from risky assets toward other financial assets, but keep the total financial assets unchanged.
Fan, L. and C. Zhang (2007). "Beyond segmentation: The case of China's repo markets." Journal of Banking & Finance 31(3): 939-954.
This paper explores the reasons behind the discrepancy between interest rates in China's two repurchase agreement (repo) markets, the interbank repo market and the exchange-traded repo market. The repo rates in the exchange market are at times, significantly higher than those in the interbank market, especially in the first three years of the 2000-2005 sample period. While market segmentation clearly hinders arbitrage, the causes of the repo rate discrepancy are related to the alternative investment opportunities available to market participants and to the volatility differences in the repo rates.
Farinelli, S., M. Ferreira, et al. (2008). "Beyond Sharpe ratio: Optimal asset allocation using different performance ratios." Journal of Banking & Finance 32(10): 2057-2063.
As the assumption of normality in return distributions is relaxed, classic Sharpe ratio and its descendants become questionable tools for constructing optimal portfolios. In order to overcome the problem, asymmetrical parameter-dependent performance ratios have been recently proposed in the literature. The aim of this note is to develop an integrated decision aid system for asset allocation based on a toolkit of eleven performance ratios. A multi-period portfolio optimization up covering a fixed horizon is set up: at first, bootstrapping of asset return distributions is assessed to recover all ratios calculations; at second, optimal rebalanced-weights are achieved; at third, optimal final wealth is simulated for each ratios. Eventually, we make a robustness test on the best performance ratios. Empirical simulations confirm the weakness in forecasting of Sharpe ratio, whereas asymmetrical parameter-dependent ratios, such as the Generalized Rachev, Sortino-Satchell and Farinelli-Tibiletti ratios show satisfactorily robustness.
Fatum, R. and B. Scholnick (2008). "Monetary policy news and exchange rate responses: Do only surprises matter?" Journal of Banking & Finance 32(6): 1076-1086.
We use data from the Federal Funds Futures market to show that exchange rates respond to only the surprise component of an actual US monetary policy change and we illustrate that failure to disentangle the surprise component from the actual monetary policy change can lead to an underestimation of the impact of monetary policy, or even to a false rejection of the hypothesis that monetary policy impacts exchange rates. Unlike the recent contributions to the literature on exchange rates and monetary policy news, our testing method avoids the imposition of assumptions regarding exchange rate market efficiency. We also add to the debate on how quickly exchange rates respond to news by showing that the exchange rates under study absorb monetary policy surprises within the same day as the news are announced.
Fenn, P., D. Vencappa, et al. (2008). "Market structure and the efficiency of European insurance companies: A stochastic frontier analysis." Journal of Banking & Finance 32(1): 86-100.
This paper is motivated by the progressive liberalisation of the European insurance market in recent years. It uses stochastic frontier analysis to estimate Flexible Fourier cost functions for European insurance companies. Separate frontiers are estimated for life, non-life and composite companies. We adopt a maximum likelihood approach to estimation in which the variance of both one-sided and two-sided error terms is modelled jointly with the frontiers. This approach allows us to simultaneously control for the impact of heteroskedasticity on the estimation of scale economies as well as estimating the effect of firm size and market structure on X-inefficiency. The study draws on Standard & Poor's Eurothesys data set of financial reports for the period 1995 to 2001. This provides technical and non-technical accounts at year-end for life, non-life and composite insurance businesses in 14 major European countries. Our estimates suggest that over this period most European insurers were operating under conditions of decreasing costs (increasing returns to scale), and that company size and domestic market share were significant factors determining X-inefficiency. Larger firms, and those with high market shares, tend to have higher levels of cost inefficiency.
Ferland, R. and S. Lalancette (2006). "Dynamics of realized volatilities and correlations: An empirical study." Journal of Banking & Finance 30(7): 2109-2130.
This study examines two important issues underlying realized volatility and correlation estimators. First, an empirical inquiry is conducted to assess whether Bax and Eurodollar futures tick-by-tick data can be characterized as marked-point processes. Second, ARMA, neural network, GARCH-BEKK, and naive volatility and correlation forecasts are compared in an out-of-sample context when a trader prices an interest rate spread option based on those forecasts and simultaneously delta-hedges her position. Other loss functions are also considered. Competing volatility forecasts are also compared to implied volatilities.
Fermanian, J.-D. and O. Scaillet (2005). "Sensitivity analysis of VaR and Expected Shortfall for portfolios under netting agreements." Journal of Banking & Finance29(4): 927-958.
In this paper, we characterize explicitly the first derivative of the Value at Risk and the Expected Shortfall with respect to portfolio allocations when netting between positions exists. As a particular case, we examine a simple Gaussian example in order to illustrate the impact of netting agreements in credit risk management. Collateral issues are also dealt with. For practical purposes we further provide nonparametric estimators for sensitivities and derive their asymptotic distributions. An empirical application on a typical banking portfolio is finally provided.
Fernando, C. S., R. J. Herring, et al. (2008). "Common liquidity shocks and market collapse: Lessons from the market for perps." Journal of Banking & Finance32(8): 1625-1635.
We show how a high degree of commonality in investor liquidity shocks can diminish incentives for intermediaries to keep markets open and lead to market collapse, even without information asymmetry or news affecting fundamentals. We motivate our model using the perpetual floating-rate note market where two years of explosive growth - in which issues by high quality borrowers were placed with institutional investors and traded in a liquid secondary market - were followed by a precipitous collapse when market intermediaries withdrew due to large order imbalances. We shed new light on the trade-off between ownership concentration and market liquidity.
Ferreira, M. A. and P. M. Gama (2007). "Does sovereign debt ratings news spill over to international stock markets?" Journal of Banking & Finance 31(10): 3162-3182.
The evidence here indicates that sovereign debt rating and credit outlook changes of one country have an asymmetric and economically significant effect on the stock market returns of other countries over 1989-2003. There is a negative reaction of 51 basis points (two-day return spread vis-á-vis the US) to a credit ratings downgrade of one notch in a common information spillover around the world. Upgrades, however, have no significant impact on return spreads of countries abroad. Closeness (e.g., geographic proximity) and emerging market status amplify the effect of a spillover. Downgrade spillover effects at the industry level are more pronounced in traded goods and small industries.
Ferri, G. (2009). "Are New Tigers supplanting Old Mammoths in China's banking system? Evidence from a sample of city commercial banks." Journal of Banking & Finance 33(1): 131-140.
"New Tigers" (including city commercial banks) outperform state-owned commercial banks burdened with non-performing loans from unprofitable state-owned enterprises. We study whether this is solely due to superior corporate governance (multiple shareholders versus total government ownership) or also to the favorable environment (the New Tigers target affluent China, while state-owned commercial banks operate nationwide). Using a field survey on 20 city commercial banks from three provinces at different levels of economic development, we find better performance at those in the East and worse performance at those controlled by state-owned enterprises. Geography and policy do matter, and reform of state-owned commercial banks is necessary to bring better banking to China.
Ferris, S. P., N. Jayaraman, et al. (2009). "Catering effects in corporate dividend policy: The international evidence." Journal of Banking & Finance 33(9): 1730-1738.
This study tests for the international presence of dividend catering across a sample of twenty-three countries. We find evidence of catering among firms incorporated in common law countries but not for those in civil law nations. Catering persists even after controlling for the effect of the firm's lifecycle. We conclude that when the legal regime and its accompanying set of investor protections permit, investors force dividends from managers, but they also attempt to extract such payouts indirectly by placing a high value on dividend paying firms. The relative failure of civil law firms to cater might be explained by idiosyncratic behaviors in the consumption of the private benefits of control or a lack of interest in responding to temporary market misevaluations of their equity.
Ferris, S. P. and X. Yan (2009). "Agency costs, governance, and organizational forms: Evidence from the mutual fund industry." Journal of Banking & Finance 33(4): 619-626.
Using a comprehensive sample of mutual funds and fund families for the period 1992-2004, this study examines the impact of fund management companies' organizational forms on the level of agency costs within mutual funds. We find that, all else being equal: (1) funds managed by public fund families charge higher fees than those managed by private fund families; (2) public fund families acquire more funds than private fund families; and (3) funds of public fund families significantly underperform funds of private fund families. Collectively, these findings suggest that agency costs are higher in mutual funds managed by public fund families. Our results are consistent with the idea that the agency conflict between the fund management company and fund shareholders is more acute for public management companies because of their shorter-term focus.
Fields, L. P., D. R. Fraser, et al. (2007). "Bidder returns in bancassurance mergers: Is there evidence of synergy?" Journal of Banking & Finance 31(12): 3646-3662.
We provide evidence on the potential for bidder wealth gains in bancassurance mergers by examining a sample of such mergers in the United States and abroad. These combinations are expected to produce positive wealth gains if there are synergies between these two types of financial firms. We find positive bidder wealth effects that are significantly related to economies of scale (as measured by the size of the target relative to the bidder), potential economies of scope, and the locations of the bidders and targets. These results suggest that the bancassurance architectural structure for financial firms does offer some benefits and thus may become more prominent in future years.
Figà-Talamanca, G. and M. L. Guerra (2006). "Fitting prices with a complete model." Journal of Banking & Finance 30(1): 247-258.
The aim of this paper is to introduce some methodologies for parameter estimation in Hobson and Rogers stochastic volatility model (1998). We pay a specific attention to the so-called feedback parameter, which is shown to be crucial for the model to fit correctly the smile curve of implied volatility and we introduce different procedures for the estimation of the volatility parameters. We finally test the pricing capability of the model on market options prices on the FTSE100 and the S&P500 Indexes, according to the estimation methodologies introduced.
Fink, J., K. E. Fink, et al. (2006). "Competition on the Nasdaq and the growth of electronic communication networks." Journal of Banking & Finance 30(9): 2537-2559.
This paper examines the growth of electronic communication networks (ECNs) and their competitive impact on the Nasdaq. We find that the development of these alternative trading platforms is associated with tighter quoted, effective, and relative bid-ask spreads, greater depths, and less concentrated markets. Further, our results show that an increase in ECN trading may have caused some traditional market makers (wholesaler and national retail dealers) to exit the market for market making. Overall, our results suggest that ECNs provide a source of competition to traditional Nasdaq dealers.
Fiordelisi, F. (2007). "Shareholder value efficiency in European banking." Journal of Banking & Finance 31(7): 2151-2171.
This paper advances the studies of [Hughes, J.P., Lang W.W., Mester L.J., Moon C.G., Pagano M.S., 2003. Do bankers sacrifice value to build empires? Managerial incentives, industry consolidation, and financial performance. Journal of Banking and Finance 27, 417-447] by developing a new measure of bank performance which we refer to as "shareholder value efficiency" - a bank producing the maximum possible Economic Value Added (EVA), given particular inputs and outputs, is defined as "shareholder value efficient". This new efficiency measure is estimated using the stochastic frontier method focussing on the French, German, Italian and UK banking systems over the period 1997-2002 and includes both listed and non-listed banks. We find that European banks are, on average, 36% shareholder value inefficient. Shareholder value efficiency is found to be the most important factor explaining value creation in European banking, whereas cost and profit efficiency only have a marginal influence.
Firth, M., C. Lin, et al. (2009). "Inside the black box: Bank credit allocation in China's private sector." Journal of Banking & Finance 33(6): 1144-1155.
This study examines how the Chinese state-owned banks allocate loans to private firms. We find that the banks extend loans to financially healthier and better-governed firms, which implies that the banks use commercial judgments in this segment of the market. We also find that having the state as a minority owner helps firms obtain bank loans and this suggests that political connections play a role in gaining access to bank finance. In addition, we find that commercial judgments are important determinants of the lending decisions for manufacturing firms, large firms, and firms located in regions with a more developed banking sector; political connections are important for firms in service industries, large firms, and firms located in areas with a less developed banking sector.
Fissel, G. S., L. Goldberg, et al. (2006). "Bank portfolio exposure to emerging markets and its effects on bank market value." Journal of Banking & Finance 30(4): 1103-1126.
This study estimates a model of banking company equity returns taking into consideration book value and market value measures of their exposure to emerging markets debt. In this estimation, general systematic market factors, such as the rate of return on the S&P500 stock index and yields on a constant maturity 5-year Treasury note, are held constant such that the exposure variables are accounting for effects due to banks' exposure to emerging market debt. The results, although not uniform among banking companies, support the hypothesis that the extent of exposure to emerging market debt are factored into the valuation of banking company equity contemporaneously. The inclusion of a market value indicator adds to the explanation of equity returns of some banks. It is also clear that knowing the extent of the exposure on a book value basis is important information alone that may allow investors to take account of or evaluate the effects of changes in banking company equity valuation from LDC debt exposures. We also perform an event study for three major debt crises to determine whether the market recognizes the effects of these events on bank valuation. The event study results show that there is little information from identifying the time period of the crises on banking company equity returns. Explanations for this are that the information of these possible crises has been embedded in bank changes in exposure and that the market valuation of the emerging market debt is already accounted for by our model.
Fletcher, J. and J. Kihanda (2005). "An examination of alternative CAPM-based models in UK stock returns." Journal of Banking & Finance 29(12): 2995-3014.
We evaluate the performance of unconditional and conditional versions of seven stochastic discount factor models in UK stock returns between January 1975 and December 2001. We find that the conditional four-moment capital asset pricing model (CAPM) has the best performance among the models we consider in terms of the lowest [Hansen, L.P., Jagannathan, R., 1997. Assessing specification errors in stochastic discount factor models. Journal of Finance 52, 591-607] distance measure and explaining the time-series predictability of industry portfolio excess returns. Conditional models also do a better job than unconditional models. However we find that the superior performance of the conditional four-moment CAPM, and conditional models in general, arises in part due to overfitting the data.
Fluck, Z., K. John, et al. (2007). "Privatization as an agency problem: Auctions versus private negotiations." Journal of Banking & Finance 31(9): 2730-2750.
This paper investigates the design of privatization mechanisms in emerging market economies characterized by political constraints that limit the set of viable privatization options. Our objective is to explain the striking diversity of mechanisms observed in practice and the frequent use of an apparently sub-optimal privatization mechanism: private negotiations. We develop a simple model in which privatization is to be carried out by a government agent, who plays favorites among bidders but is potentially disciplined by losing his private benefits of staying in office. If the political environment is such that the privatization agent himself aims at raising the fair value for the company, then privatization auctions and private negotiations are equally successful in raising public revenues. If, however, political considerations distort the agent's incentives, it may be that a seemingly transparent auction will raise less revenue, than opaque private negotiations. We also show that information disclosure laws may have negative welfare implications: they may help the privatization agent to collude with some of the bidders to the disadvantage of non-colluding bidders.
Focarelli, D. and A. F. Pozzolo (2008). "Cross-border M&As in the financial sector: Is banking different from insurance?" Journal of Banking & Finance 32(1): 15-29.
This paper investigates what factors might help explain the internationalization strategy of banks and insurance companies, by comparing the determinants of cross-border M&As in the two sectors in a unified framework. The empirical analysis shows that between 1990 and 2003 the internationalization of banks and insurance companies followed similar patterns. Distance and economic and cultural integration are important determinants for both the banks' and the insurance companies' expansion abroad. Comparative advantage also has a prominent role, the more so for banks. The evidence is less supportive of the view that cross-border M&As are more frequent between similar countries, as predicted by the new trade theory. Finally, and most interestingly, we find indirect evidence consistent with the hypothesis that implicit barriers to foreign entry are more important in explaining the behavior of banks than that of insurance companies.
Fonseca, A. R. and F. González (2008). "Cross-country determinants of bank income smoothing by managing loan-loss provisions." Journal of Banking & Finance32(2): 217-228.
This paper studies the determinants of income smoothing by management of loan-loss provisions in banks around the world. Using a panel database of 3221 bank-year observations from 40 countries and controlling for unobservable bank effects and for the endogeneity of explanatory variables, we find that bank income smoothing depends on investor protection, disclosure, regulation and supervision, financial structure, and financial development. Results suggest there is less bank income smoothing not only with the strength of investor protection, but also with the extent of accounting disclosure, restrictions on bank activities, and official and private supervision, while there is more income smoothing with market orientation and development of a country's financial system.
Forte, S. and J. I. Peña "Credit spreads: An empirical analysis on the informational content of stocks, bonds, and CDS." Journal of Banking & Finance In Press, Corrected Proof.
This paper explores the dynamic relationship between stock market implied credit spreads, CDS spreads, and bond spreads. A general VECM representation is proposed for changes in the three credit spread measures which accounts for zero, one, or two independent cointegration equations, depending on the evidence provided by any particular company. Empirical analysis on price discovery, based on a proprietary sample of North American and European firms, and tailored to the specific VECM at hand, indicates that stocks lead CDS and bonds more frequently than the other way round. It likewise confirms the leading role of CDS with respect to bonds.
Francis, B., I. Hasan, et al. (2008). "Bank consolidation and new business formation." Journal of Banking & Finance 32(8): 1598-1612.
As the trend of bank consolidation activities continues to grow in the US and globally, the debate on the impact of such consolidation on small business credits and activities are still inconclusive. Building on the existing research [Berger, A.N., Saunders, A., Scalise, J.M., Udell, G.F., 1998. The effects of bank mergers and acquisitions on small business lending. Journal of Financial Economics 50, 187-229]; [Black, S.E., Strahan, P.E., 2002. Entrepreneurship and bank credit availability. Journal of Finance LVII (6), 2807-2833], this paper investigates the effects of the actual intensity of bank consolidation on the formation of new businesses in the US local markets. Evidence portrays that in the short-run, the overall intensity of bank consolidation is negatively related to the rate of new business formation, and this negative relationship is primarily driven by consolidations initiated by large acquirers. On the contrary, consolidations between small-to-medium sized banks show a positive impact on new business development and these results are consistent even when the M&As are distinguished with respect to in-market or out-of-market acquirers initiating the deals. However, two years after the consolidations, the evidence reveals a positive and significant impact on the rate of new business formation in the local markets for consolidations initiated by large in-market acquirers.
Francis, B. B., I. Hasan, et al. (2008). "Financial market integration and the value of global diversification: Evidence for US acquirers in cross-border mergers and acquisitions." Journal of Banking & Finance 32(8): 1522-1540.
In contrast to the previously documented cross-border discount, we find that there is positive cross-border effect for US acquirers during late 1990s and early 2000s. This is especially particular the case for those that acquire/merge with targets from segmented financial markets where acquirers experience significantly higher positive abnormal returns than those that acquire targets from integrated financial markets. Furthermore, firms acquiring segmented-market targets are also characterized by significantly higher post-merger operating performance improvement. The results indicate that the observed positive cross-border effect is mainly due to the increase in the number of transactions involving targets from segmented markets, in which the average firm experience significant financial constraints. We contend that value is created by a combination of firms with different financial market integration status, in which funds are provided to high cost firms. The finding that the value creation is even higher within the group of acquirers with a lower cost of capital provides additional support for our conjecture.
Fraser, D. R., H. Zhang, et al. (2006). "Capital structure and political patronage: The case of Malaysia." Journal of Banking & Finance 30(4): 1291-1308.
This paper extends prior work on the links between political patronage and capital structure in developing economies. Three proxies of political patronage are developed and applied to a group of Malaysian firms over a 10-year period. We find a positive and significant link between leverage and each of the three measures of political patronage. We also find evidence of an indirect link between political patronage and capital structure through firm size and profitability.
Frauendorfer, K., U. Jacoby, et al. (2007). "Regime switching based portfolio selection for pension funds." Journal of Banking & Finance 31(8): 2265-2280.
This paper shows how a mean variance criterion can be applied to a multi period setting in order to obtain efficient portfolios in an asset and liability context. The optimization model allows for rebalancing activities, transaction costs, stochastic volatilities for both assets and liabilities. Furthermore, a general framework for the projection of pension fund liabilities as well as for the generation of asset returns is given. In a further step the dynamics of the liability maturity structure is modeled as customized index, whose volatility and correlation with asset returns become integral components of the applied regime switching approach. The numerical results illustrate the diversification of the assets and its risk return pattern in dependency of the liability dynamics.
Friedman, C. and S. Sandow (2006). "Utility-based performance measures for regression models." Journal of Banking & Finance 30(2): 541-560.
We measure regression model performance (as perceived by a conservative investor betting on a complete market) via the out-of-sample expected utility for the allocation that maximizes expected utility under a most adverse model-consistent measure. This robust allocation is optimal under the minimum generalized relative entropy (MGRE) measure. We analyze our performance measure in the (practical) case of an investor whose utility function is a member of a three-parameter logarithmic family with a wide range of possible risk aversions. Here, our performance measure is independent of the market prices, and the MGRE measure minimizes the Kullback-Leibler relative entropy.
Fries, S. and A. Taci (2005). "Cost efficiency of banks in transition: Evidence from 289 banks in 15 post-communist countries." Journal of Banking & Finance 29(1): 55-81.
To understand the transformation of banking in the post-communist transition, we examine the cost efficiency of 289 banks in 15 East European countries. We find that banking systems in which foreign-owned banks have a larger share of total assets have lower costs and that the association between a country's progress in banking reform and cost efficiency is non-linear. Early stages of reform are associated with cost reductions, while costs tend to rise at more advanced stages. Private banks are more efficient than state-owned banks, but there are differences among private banks. Privatised banks with majority foreign ownership are the most efficient and those with domestic ownership are the least.
Friesen, G. C. and T. R. A. Sapp (2007). "Mutual fund flows and investor returns: An empirical examination of fund investor timing ability." Journal of Banking & Finance 31(9): 2796-2816.
We examine the timing ability of mutual fund investors using cash flow data at the individual fund level. Over 1991-2004 equity fund investor timing decisions reduce fund investor average returns by 1.56% annually. Underperformance due to poor timing is greater in load funds and funds with relatively large risk-adjusted returns. In particular, the magnitude of investor underperformance due to poor timing largely offsets the risk-adjusted alpha gains offered by good-performing funds. Investors in both actively managed funds and index funds exhibit poor investment timing. We demonstrate that our empirical results are consistent with investor return-chasing behavior.
Friesen, G. C. and C. Swift (2009). "Overreaction in the thrift IPO aftermarket." Journal of Banking & Finance 33(7): 1285-1298.
We study the initial returns and long-run performance of a unique sample of thrifts that have recently converted from mutual to stock form. In addition to a full claim on all IPO proceeds, new investors in a converted thrift also receive a claim on all pre-conversion market value at no cost. Thus, the average firm in our sample has a degree of underpricing automatically built into its offer price. We find that after removing the large initial returns, cumulative excess returns for the firms in our sample are positive for 12 months after the IPO. Beginning in the second year after the IPO, the average firm in our sample undergoes a significant price correction that lasts approximately 18 months and which produces negative cumulative abnormal returns for up to 5 years post-issue. Differences in risk-adjusted returns also indicate negative long-run returns, with poor performance concentrated in the second and third years following the IPO. The return differences are most pronounced among the small thrifts in our sample, and are broadly consistent with investor overreaction at the time of the IPO that continues for 6-12 months before prices begin reverting back to fundamental value.
Friesen, G. C., P. A. Weller, et al. (2009). "Price trends and patterns in technical analysis: A theoretical and empirical examination." Journal of Banking & Finance33(6): 1089-1100.
While many technical trading rules are based upon patterns in asset prices, we lack convincing explanations of how and why these patterns arise, and why trading rules based on technical analysis are profitable. This paper provides a model that explains the success of certain trading rules that are based on patterns in past prices. We point to the importance of confirmation bias, which has been shown to play a key role in other types of decision making. Traders who acquire information and trade on the basis of that information tend to bias their interpretation of subsequent information in the direction of their original view. This produces autocorrelations and patterns of price movement that can predict future prices, such as the "head-and-shoulders" and "double-top" patterns. The model also predicts that sequential price jumps for a particular stock will be positively autocorrelated. We test this prediction and find that jumps exhibit statistically and economically significant positive autocorrelations.
Frino, A., D. Gerace, et al. (2008). "Liquidity in auction and specialist market structures: Evidence from the Italian bourse." Journal of Banking & Finance 32(12): 2581-2588.
Several studies find that bid-ask spreads for stocks listed on the NYSE are lower than for stocks listed on NASDAQ. While this suggests that specialist market structures provide greater liquidity than competing dealer markets, the nature of trading on the NYSE, which comprises a specialist competing with limit order flow, obfuscates the comparison. In 2001, a structural change was implemented on the Italian Bourse. Many stocks that traded in an auction market switched to a specialist market, where the specialist controls order flow. Results confirm that liquidity is significantly improved when stocks commence trading in the specialist market. Analysis of the components of the bid-ask spread reveal that the adverse selection component of the spread is significantly reduced. This evidence suggests that specialist market structures provide greater liquidity to market participants.
Frino, A., A. Lepone, et al. (2009). "Derivative use, fund flows and investment manager performance." Journal of Banking & Finance 33(5): 925-933.
Prior literature which examines the use of derivatives by investment managers does not discern between different types of derivative trading strategies. This study is the first to examine and gather data on a particular type of derivative trading strategy undertaken by investment managers. We examine the extent to which equity fund managers use index futures to manage fund flows and the effect this has on their alpha and market timing measures of performance. Our results show that funds that do not use derivatives exhibit lower returns and negative market timing skills when they experience fund flow. The performance of funds that use derivatives, however, is independent of investor's liquidity demands. In fact, the unconditional performance of the average user fund is statistically equivalent to the performance of the average non-user fund conditional on zero fund flow. Our results provide evidence that derivatives can be beneficial for mutual fund holders under certain conditions.
Froot, K. A. and P. G. J. O'Connell (2008). "On the pricing of intermediated risks: Theory and application to catastrophe reinsurance." Journal of Banking & Finance 32(1): 69-85.
We model the equilibrium price and quantity of risk transfer between firms and financial intermediaries. Value-maximizing firms have downward sloping demands to cede risk, while intermediaries, who assume risk, provide less-than-fully-elastic supply. We show that equilibrium required returns will be "high" in the presence of financing imperfections that make intermediary capital costly. Moreover, financing imperfections can give rise to intermediary market power, so that small changes in financial imperfections can give rise to large changes in price. We develop tests of this alternative against the null that the supply of intermediary capital is perfectly elastic. We take the US catastrophe reinsurance market as an example, using detailed data from Guy Carpenter & Co., covering a large fraction of the catastrophe risks exchanged during 1970-94. Our results suggest that the price of reinsurance generally exceeds "fair" values, particularly in the aftermath of large events, that market power of reinsurers is not a complete explanation for such pricing, and that reinsurers' high costs of capital appear to play an important role.
Frydman, H. and T. Schuermann (2008). "Credit rating dynamics and Markov mixture models." Journal of Banking & Finance 32(6): 1062-1075.
Despite mounting evidence to the contrary, credit migration matrices, used in many credit risk and pricing applications, are typically assumed to be generated by a simple Markov process. Based on empirical evidence, we propose a parsimonious model that is a mixture of (two) Markov chains, where the mixing is on the speed of movement among credit ratings. We estimate this model using credit rating histories and show that the mixture model statistically dominates the simple Markov model and that the differences between two models can be economically meaningful. The non-Markov property of our model implies that the future distribution of a firm's ratings depends not only on its current rating but also on its past rating history. Indeed we find that two firms with identical current credit ratings can have substantially different transition probability vectors. We also find that conditioning on the state of the business cycle or industry group does not remove the heterogeneity with respect to the rate of movement. We go on to compare the performance of mixture and Markov chain using out-of-sample predictions.
Fu, X. and S. Heffernan (2009). "The effects of reform on China's bank structure and performance." Journal of Banking & Finance 33(1): 39-52.
This paper investigates the relationship between market structure and performance in China's banking system from 1985 to 2002, a period when this sector was subject to gradual but notable reform. Using panel data estimation techniques, both the market-power and efficient-structure hypotheses are tested. In addition, the model is extended to consider issues such as the impact of bank size/ownership and whether the big four banks enjoy a "quiet life". On average, X-efficiency declined significantly and most banks were operating below scale efficient levels. Estimation of the structure-performance models lends some support to the relative market-power hypothesis in the early period. The reforms had little impact on the structure of China's banking sector, though the "joint stock" banks became relatively more X-efficient. There was no evidence to support the quiet-life hypothesis, probably because strict interest rate controls prevented the state banks from earning monopoly profits. Thus the ongoing liberalisation of interest rates should be accompanied by reduced concentration. Overall, to improve competitive structure, new policies should be directed at encouraging market entry and increasing the market share of the most efficient banks.
Fuertes, A.-M. and D. C. Thomas (2006). "Large market shocks and abnormal closed-end-fund price behaviour." Journal of Banking & Finance 30(9): 2517-2535.
This paper investigates the short-term price behaviour of closed-end funds following eight large market-wide shocks. The findings, from a sample of 63 funds continuously traded on the London Stock Exchange, indicate that prices overreact relative to equilibrium given by net asset values. The speed of reversion in discounts following market-wide shocks is slower than that following fund-specific shocks of a similar magnitude. The post-shock persistence in discounts is related more to the ease of arbitrage rather than to liquidity, as proxied by fund size, or to the speed of recovery in the broader market. The discount decays more slowly for those funds that are difficult to arbitrage.
Fung, M. K. (2006). "Are labor-saving technologies lowering employment in the banking industry?" Journal of Banking & Finance 30(1): 179-198.
Labor statistics show that the average labor hours per dollar of banking output fell by more than 30% between 1992 and 2002. The proliferation of labor-saving technologies was widely believed to be the major reason. While the first-round effect of a labor-saving technology with a given level of output is a reduction in required labor per unit of output, the second-round effect is a reduction in wage costs that will increase output. Analytically, a given type of labor-saving technology is more likely to have a positive effect on employment if the elasticity of substitution between capital and labor, the price elasticity of demand, and the cost-reducing impact of the new technology are sufficiently large. The main empirical findings of this study are that labor-saving technologies, and the spillovers of these technologies, are associated with higher firm-level employment. These results seem robust to a wide range of specifications and controls.
Fung, M. K. (2006). "Scale economies, X-efficiency, and convergence of productivity among bank holding companies." Journal of Banking & Finance 30(10): 2857-2874.
Are the less productive banks catching up to the more productive ones and, if so, how quickly and by what means? The objective of this study is to answer these questions by looking for convergence in productivity among bank holding companies (BHCs) in the US Past research has identified two major factors governing productivity in the banking sector - scale economies and X-efficiency. If the gains from scale economies decline with firm size and if the only difference between BHCs lies in their initial size, then the initially smaller BHCs should eventually catch up to the initially larger ones because the former tend to grow more quickly. However, the findings from this study do not support this hypothesis of "absolute convergence". Indeed, the findings show strong evidence for "conditional convergence", which means that the steady-state productivity to which a BHC is converging is conditional on the BHCs own level of X-efficiency. Conditional convergence implies that initial differences in X-efficiency among BHCs can, between them, create permanent differences in steady-state productivity.
Fusai, G., M. Marena, et al. (2008). "Analytical pricing of discretely monitored Asian-style options: Theory and application to commodity markets." Journal of Banking & Finance 32(10): 2033-2045.
We compute an analytical expression for the moment generating function of the joint random vector consisting of a spot price and its discretely monitored average for a large class of square-root price dynamics. This result, combined with the Fourier transform pricing method proposed by Carr and Madan [Carr, P., Madan D., 1999. Option valuation using the fast Fourier transform. Journal of Computational Finance 2(4), Summer, 61-73] allows us to derive a closed-form formula for the fair value of discretely monitored Asian-style options. Our analysis encompasses the case of commodity price dynamics displaying mean reversion and jointly fitting a quoted futures curve and the seasonal structure of spot price volatility. Four tests are conducted to assess the relative performance of the pricing procedure stemming from our formulae. Empirical results based on natural gas data from NYMEX and corn data from CBOT show a remarkable improvement over the main alternative techniques developed for pricing Asian-style options within the market standard framework of geometric Brownian motion.
Fusai, G. and A. Meucci (2008). "Pricing discretely monitored Asian options under Lévy processes." Journal of Banking & Finance 32(10): 2076-2088.
We present methodologies to price discretely monitored Asian options when the underlying evolves according to a generic Lévy process. For geometric Asian options we provide closed-form solutions in terms of the Fourier transform and we study in particular these formulas in the Lévy-stable case. For arithmetic Asian options we solve the valuation problem by recursive integration and derive a recursive theoretical formula for the moments to check the accuracy of the results. We compare the implementation of our method to Monte Carlo simulation implemented with control variates and using different parametric Lévy processes. We also discuss model risk issues.
Gagliardini, P. and C. Gouriéroux (2005). "Migration correlation: Definition and efficient estimation." Journal of Banking & Finance 29(4): 865-894.
The aim of this paper is to explain why cross-sectional estimated migration correlations displayed in the academic and professional literature can be either not consistent, or inefficient, and to discuss alternative approaches. The analysis relies on a model with stochastic migration in which the parameters of interest, that are migration correlations, are precisely defined. The impossibility of estimating consistently the migration correlations from cross-sectional data only is emphasized. We explain how to handle with individual rating histories, how to weight appropriately the cross-sectional estimators and how to estimate efficiently the joint migration probabilities at longer horizons.
Gajewski, J.-F. and C. Gresse (2007). "Centralised order books versus hybrid order books: A paired comparison of trading costs on NSC (Euronext Paris) and SETS (London Stock Exchange)." Journal of Banking & Finance 31(9): 2906-2924.
This article compares the cost of trading large capitalisation equities on the hybrid order-driven segment of the London Stock Exchange and the centralised electronic order book of Euronext. Using samples of stocks matched according to economic sector, free float capitalisation, and trading volume, our study shows that transaction costs are lower on the centralised order book than on the hybrid order book. The presence of dealers outside the electronic order book favours the frequency of large trades, but is associated with higher execution costs for all other trades and higher adverse selection and inventory costs inside the order book.
Galai, D., A. Raviv, et al. (2007). "Liquidation triggers and the valuation of equity and debt." Journal of Banking & Finance 31(12): 3604-3620.
Many bankruptcy codes implicitly or explicitly contain net-worth covenants, which provide the firm's bondholders with the right to force reorganization or liquidation if the value of the firm falls below a certain threshold. In practice, however, default does not necessarily lead to immediate change of control or to liquidation of the firm's assets by its debtholders. To consider the impact of this on the valuation of corporate securities, we develop a model in which liquidation is driven by a state variable that accumulates with time and severity of distress. We model a dynamic grace period for the liquidation event. Recent or severe distress events may have greater impact on the liquidation trigger. Our model can be applied to a wide array of bankruptcy codes and jurisdictions.
Galema, R., A. Plantinga, et al. (2008). "The stocks at stake: Return and risk in socially responsible investment." Journal of Banking & Finance 32(12): 2646-2654.
We relate US portfolio returns, book-to-market values and excess stock returns to different dimensions of socially responsible performance. We find that socially responsible investing (SRI) impacts on stock returns by lowering the book-to-market ratio and not by generating positive alphas. Our result is consistent with the theoretical work suggesting that SRI is reflected in demand differences between SRI and non-SRI stock. It also explains why so few studies are able to establish a link between alpha's and SRI.
Galluccio, S. and A. Roncoroni (2006). "A new measure of cross-sectional risk and its empirical implications for portfolio risk management." Journal of Banking & Finance 30(8): 2387-2408.
Litterman et al. [Litterman, R., Scheinkman, J., Weiss, L., 1991. Volatility and the yield curve. Journal of Fixed Income 1 (June), 49-53] and Engle and Ng [Engle, R.F., Ng, V.K., 1993. Time-varying volatility and the dynamic behavior of the term structure. Journal of Money, Credit and Banking 25(3), 336-349] provide empirical evidence of a relation between yield curve shape and volatility. This study offers theoretical support for that finding in the general context of cross-sectional time series. We introduce a new risk measure quantifying the link between cross-sectional shape and market risk. A simple econometric procedure allows us to represent the risk experienced by cross-sections over a time period in terms of independent factors reproducing possible cross-sectional deformations. We compare our risk measure to the traditional cross-yield covariance according to their relative performance. Empirical investigation in the US interest rate market shows that (1) cross-shape risk factors outperform cross-yield risk factors (i.e., yield curve level, slope, and convexity) in explaining the market risk of yield curve dynamics; (2) hedging multiple liabilities against cross-shape risk delivers superior trading strategies compared to those stemming from cross-yield risk management.
García-Herrero, A., S. Gavilá, et al. "What explains the low profitability of Chinese banks?" Journal of Banking & Finance In Press, Accepted Manuscript.
This paper analyzes empirically what explains the low profitability of Chinese banks for the period 1997-2004. We find that better capitalized banks tend to be more profitable. The same is true for banks with a relatively larger share of deposits and for more X-efficient banks. In addition, a less concentrated banking system increases bank profitability, which basically reflects that the four state-owned commercial banks --China's largest banks-- have been the main drag for system's profitability. We find the same negative influence for China's development banks (so called Policy Banks), which are fully state-owned. Instead, more market oriented banks, such as joint-stock commercial banks, tend to be more profitable, which again points to the influence of government intervention in explaining bank performance in China. These findings should not come as a surprise for a banking system which has long been functioning as a mechanism for transferring huge savings to meet public policy goals.
Gatzert, N. and H. Schmeiser (2008). "Combining fair pricing and capital requirements for non-life insurance companies." Journal of Banking & Finance 32(12): 2589-2596.
The aim of this article is to identify fair equity-premium combinations for non-life insurers that satisfy solvency capital requirements imposed by regulatory authorities. In particular, we compare target capital derived using the value at risk concept as planned for Solvency II in the European Union with the tail value at risk concept as required by the Swiss Solvency Test. The model framework uses Merton's jump-diffusion process for the market value of liabilities and a geometric Brownian motion for the asset process; fair valuation is conducted using option pricing theory. We show that even if regulatory requirements are satisfied under different risk measures and parameterizations, the associated costs of insolvency - measured with the insurer's default put option value - can differ substantially.
Ge, Y. and J. Qiu (2007). "Financial development, bank discrimination and trade credit." Journal of Banking & Finance 31(2): 513-530.
Non-state owned firms in China grow tremendously with limited support from banks. This provides a unique setting to test how firms in a country with poorly developed financial institutions fund their prosperous growth opportunities. This paper compares the use of an important non-formal financial channel, trade credit, between state and non-state owned firms in China. We find that, compared to state owned firms, non-state owned firms use more trade credit. We further show that this higher usage is primarily for financing rather than transactional purposes. The results suggest that, in a country with a poorly developed formal financial sector, firms can support their growth through non-formal financial channels that largely rely on implicit contractual relation.
Geman, H. (2005). "From measure changes to time changes in asset pricing." Journal of Banking & Finance 29(11): 2701-2722.
The goal of the paper is to review the last 35 years of continuous-time finance by focusing on two major advances: (i) The powerful elegance of the martingale representation for primitive assets and attainable contingent claims in more and more general settings, thanks to the probabilistic tool of probability change and the economic flexibility in the choice of the numéraire relative to which prices are expressed. This numéraire evolved over time from the money market account to a zero-coupon bond or a stock price, lastly to strictly positive quantities involved in the Libor or swap market models and making the pricing of caps or swaptions quite efficient. (ii) The persistent central role of Brownian motion in finance across the 20th century: even when the underlying asset price is a very general semi-martingale, the no-arbitrage assumption and Monroe theorem [Monroe, I., 1978. Processes that can be embedded in Brownian motion. Annals of Probability 6, 42-56] allow us to write it as Brownian motion as long as we are willing to change the time. The appropriate stochastic clock can be shown empirically to be driven by the cumulative number of trades, hence by market activity. Consequently, starting with a general multidimensional stochastic process S defined on a probability space ([Omega], , P) and representing the prices of primitive securities, the no-arbitrage assumption allows, for any chosen numéraire, to obtain a martingale representation for S under a probability measure QS equivalent to P. This route will be particularly beneficiary for the pricing of complex contingent claims. Alternatively, changing the clock, i.e., changing the filtration (), we can recover the Brownian motion and normality of returns. In all cases martingales appear as the central representation of asset prices, either through a measure change or through a time change.
Geman, H. (2008). "Editorial." Journal of Banking & Finance 32(12): 2501-2501.
Geman, H. and C. Kharoubi (2008). "WTI crude oil Futures in portfolio diversification: The time-to-maturity effect." Journal of Banking & Finance 32(12): 2553-2559.
The aim of the paper is to analyze the diversification effect brought by crude oil Futures contracts, the most liquid commodity Futures, into a portfolio of stocks. The studies that have documented the very low- and essentially negative-correlations between commodities and equities typically rely on normally distributed returns, which is not the case for crude oil Futures and stocks indexes. Moreover, the particular time-to-maturity chosen for the Future contract used as an investment vehicle is an important matter that needs to be addressed, in presence of forward curves switching between backwardation and contango shapes. Our goal in this paper is twofold: (a) we introduce copula functions to have a better representation of the dependence structure of oil Futures with equity indexes; (b) using this copula representation, we are able to analyze in a precise manner the "maturity effect" in the choice of crude oil Future contract with respect to its diversification benefits. Our finding is that, in the case of distant maturities Futures, e.g., 18 months, the negative correlation effect is more pronounced whether stock prices increase or decrease. This property has the merit to avoid the hurdles of a frequent roll over while being quite desirable in the current trendless equity markets. Empirical evidence is exhibited on a database comprising the NYMEX WTI crude oil Futures and S&P 500 index over a 15 year-time period.
Geman, H. and S. Ohana (2008). "Time-consistency in managing a commodity portfolio: A dynamic risk measure approach." Journal of Banking & Finance 32(10): 1991-2005.
We address the problem of managing a storable commodity portfolio, that includes physical assets and positions in spot and forward markets. The vast amount of capital involved in the acquisition of a power plant or storage facility implies that the financing period stretches over a period of several quarters or years. Hence, an intertemporally consistent way of optimizing the portfolio over the planning horizon is required. We demonstrate the temporal inconsistency of static risk objectives based on final wealth and advocate the validity in our setting of a new class of recursive risk measures introduced by Epstein and Zin [Epstein, G., Zin, S., 1989. Substitution, risk aversion, and the temporal behavior of consumption and asset returns: A theoretical framework. Econometrica, 57 (4) 937-969] and Wang [Wang, T., 2000. A class of dynamic risk measures University of British Columbia]. These risk measures provide important insights on the trade-offs between date-specific risks (i.e., losses occurring at a point in time) and time-duration risks represented by the pair (return, risk) over a planning horizon; in a number of situations, they dramatically improve the efficiency of static risk objectives, as exhibited in numerical examples.
Gereben, Á. (2007). "Elements of the Euro Area - Integrating Financial Markets, J. Berg, M. Grande, F.P. Mongelli, Ashgate Publishing (2005). p. 264, ISBN: 0 7546 4320 4." Journal of Banking & Finance 31(12): 3907-3908.
Gerlach, S. and W. Peng (2005). "Bank lending and property prices in Hong Kong." Journal of Banking & Finance 29(2): 461-481.
This paper studies the relationship between residential property prices and bank lending in Hong Kong. This is an interesting topic for three reasons. First, swings in property prices have been extremely large and frequent in Hong Kong. Second, under the currency board regime, monetary policy cannot be used to guard against asset price swings. Third, despite the collapse in property prices since 1998, the banking sector remains sound. While the contemporaneous correlation between lending and property prices is large, our results suggest that the direction of influence goes from property prices to bank credit rather than conversely.
Ghosh, C., J. Harding, et al. (2008). "Does liberalization reduce agency costs? Evidence from the Indian banking sector." Journal of Banking & Finance 32(3): 405-419.
On February 16, 2002, the Reserve Bank of India issued a circular that signaled a policy liberalization facilitating acquisition of private sector banks in India by foreign entities. Portfolios of private sector and nationalized banks posted significant value gains in the days surrounding the announcement. The gains by private sector banks were almost double those of nationalized banks. We further analyze the firm specific abnormal returns using cross-sectional regressions and find a significant relation between firm-specific abnormal returns and factors typically associated with a bank's potential for takeover. These results provide the first empirical support for Stulz's hypothesis that one cause of the valuation gains associated with liberalization is the expected gain from a reduction of agency costs.
Giambona, E. and J. Golec (2009). "Mutual fund volatility timing and management fees." Journal of Banking & Finance 33(4): 589-599.
This paper shows that compensation incentives partly drive fund managers' market volatility timing strategies. Larger incentive management fees lead to less counter-cyclical or more pro-cyclical volatility timing. But fund styles or aggregate fund flows could also account for this relation; therefore, we control for them and find that the relation between fees and volatility timing still holds. Results show that less aggressive fund styles are associated with pro-cyclical volatility timing, and that volatility timing and flow timing are negatively related. We also find that pro-cyclical timing mostly improves funds' average excess returns, Sharpe ratios, and alphas.
Giamouridis, D. and I. D. Vrontos (2007). "Hedge fund portfolio construction: A comparison of static and dynamic approaches." Journal of Banking & Finance31(1): 199-217.
This article studies the impact of modeling time-varying covariances/correlations of hedge fund returns in terms of hedge fund portfolio construction and risk measurement. We use a variety of static and dynamic covariance/correlation prediction models and compare the optimized portfolios' out-of-sample performance. We find that dynamic covariance/correlation models construct portfolios with lower risk and higher out-of-sample risk-adjusted realized return. The tail-risk of the constructed portfolios is also lower. Using a mean-conditional-value-at-risk framework we show that dynamic covariance/correlation models are also successful in constructing portfolios with minimum tail-risk.
Giannopoulos, K. (2008). "Nonparametric, conditional pricing of higher order multivariate contingent claims." Journal of Banking & Finance 32(9): 1907-1915.
This paper describes and applies a nonparametric model for pricing multivariate contingent claims. Multivariate contingent claims are contracts whose payoffs depend on the future prices of more than one underlying variable. The pricing however of these kinds of contracts represents a challenge. All known models are adaptations of earlier ones that have been introduced to price plain vanilla calls and puts. They are imposing strong assumptions on the distributional properties of the underlying variables. In contrast, this study adopts a methodology that relaxes such restrictions. Following [Barone-Adesi, G., Bourgoin, F., Giannopoulos, K., 1998. Don't Look Back, Risk 11 (August), 100-104; Barone-Adesi, G., Engle, R., Mancini, L., 2004. GARCH Options in Incomplete Markets, mimeo, University of Applied Sciences of Southern Switzerland; Long, X., 2004. Semiparametric Multivariate GARCH Model, mimeo, University of California, Riverside], multivariate pathways for a set of underlying variables are constructed before the option payoffs are computed. This enables the covariances, in addition to the means and variances, to be modelled in a dynamic and nonparametric manner. The model is particular suitable for options whose payoffs depend on variables that are characterised by high nonlinearities and extremes and on higher order multivariate options whose underlying variables are more unlikely to conform to a common theoretical distribution.
Giannopoulos, K. and R. Tunaru (2005). "Coherent risk measures under filtered historical simulation." Journal of Banking & Finance 29(4): 979-996.
Recent studies have strongly criticised conventional VaR models for not providing a coherent risk measure. Acerbi provides the intuition for an entire family of coherent measures of risk known as "spectral risk measures" [Spectral measures of risk: A coherent representation of subjective risk aversion. Journal of Banking and Finance 26 (7) (2002) 1505-1518]. In this study we illustrate how the Filtered Historical Simulation [Barone-Adesi, G., Bourgoin, F., Giannopoulos, K., 1998. Don't look back. Risk 11, 100-104; Barone-Adesi, Giannopoulos, K., Vosper, L., 1999. VaR without correlations for non-linear portfolios. Journal of Futures Markets 19, 583-602], can provide an improved methodology for calculating the Expected Shortfall. Thereafter, we prove that these new risk measures are spectral and are coherent as well, following Acerbi. Furthermore, we provide the statistical error formula that allows to calculate the error for our model.
Ginglinger, E. and J. Hamon (2007). "Actual share repurchases, timing and liquidity." Journal of Banking & Finance 31(3): 915-938.
Research on the impact of open market share repurchases has been hindered by the lack of data available on actual share repurchases in many countries, including the US. Using a previously unused database containing detailed information on 36,848 repurchases made by 352 French firms, we show that corporate share repurchases have a significant adverse effect on liquidity as measured by bid-ask spread or depth. Our results also indicate that share repurchases largely reflect contrarian trading rather than managerial timing ability.
Giot, P. and A. Schwienbacher (2007). "IPOs, trade sales and liquidations: Modelling venture capital exits using survival analysis." Journal of Banking & Finance31(3): 679-702.
This paper examines the dynamics of exit options for US venture capital funds. Using a sample of more than 20,000 investment rounds, we analyze the time to [`]IPO', [`]trade sale' and [`]liquidation' for 6000 VC-backed firms. We model these exit times using competing risks models, which allow for a joint analysis of exit type and exit timing. The hazard rate for IPOs are clearly non-monotonic with respect to time. As time flows, VC-backed firms first exhibit an increased likelihood of exiting to an IPO. However, after having reached a plateau, non-exited investments have fewer possibilities of IPO exits as time increases. This sharply contrasts with trade sale exits, where the hazard rate is less time-varying. We further provide evidence on the impact of economic factors such as syndicate size and composition, geographical location and VC value adding, on exit outcomes.
Glasserman, P. and S. Suchintabandid (2007). "Correlation expansions for CDO pricing." Journal of Banking & Finance 31(5): 1375-1398.
This paper develops numerical approximations for pricing collateralized debt obligations (CDOs) and other portfolio credit derivatives in the multifactor Normal Copula model. A key aspect of pricing portfolio credit derivatives is capturing dependence between the defaults of the elements of the portfolio. But, compared with an independent-obligor model, pricing in a model with correlated defaults is more challenging. Our approach strikes a balance by reducing the problem of pricing in a model with correlated defaults to calculations involving only independent defaults. We develop approximations based on power series expansions in a parameter that scales the underlying correlations. These expansions express a CDO tranche price in a multifactor model as a series of prices in independent-obligor models, which are easy to compute. The approach builds on a classical approximation for multivariate Gaussian probabilities; we introduce an alternative representation that greatly reduces the number of terms required to evaluate the coefficients in the expansion. We also apply this method to the underlying problem of computing joint probabilities of multivariate normal random variables for which the correlation matrix has a factor structure.
Gleason, K., J. E. McNulty, et al. (2005). "Returns to acquirers of privatizing financial services firms: An international examination." Journal of Banking & Finance29(8-9): 2043-2065.
While the literature reports improved performance for privatizing firms, banking markets are different. Many privatizing financial services firms face unique problems such as an overhang of problem loans and weak credit cultures and legal systems. We investigate the returns to successful bidders in privatization acquisitions of financial services firms, examine short-horizon performance, and test whether such acquisitions result in a change in risk for the bidding firm. Our results show that the cumulative abnormal returns to shareholders of bidding firms are positive, perhaps reflecting initial optimism that the foreign firm acquiring the privatizing firm would share in the success associated with privatization. Bidders also experience an increase in their total risk following the acquisition.
Gleason, K. C., J. Madura, et al. (2007). "Stock exchange governance initiatives: Evidence from the Italian STARs." Journal of Banking & Finance 31(1): 141-159.
Can a stock exchange improve corporate governance and transparency by designating companies that exhibit superior corporate governance? In 2000, the Borsa Italiana created a mid-cap segment with strong listing standards, which is composed of firms (called STARS) that follow stricter standards of transparency, disclosure, monitoring and liquidity. We find that STAR firms exhibit governance characteristics not observed in non-STAR firms, such as a higher incidence of audit and executive committees and higher debt ratios. They experienced a modestly favorable share price response upon the implementation of the STAR initiative. Moreover, they experienced significantly higher buy and hold returns and transparency after the initiative. Several governance characteristics are cross-sectionally associated with performance following the STAR initiative. Overall, the results suggest that firms may be willing to improve governance when they are endorsed by a credible agency for doing so, and such improvements may lead to better performance. The STAR initiative may serve as a model that can be adapted by other stock exchanges to promote transparency and governance.
Goddard, J., D. McKillop, et al. (2008). "The diversification and financial performance of US credit unions." Journal of Banking & Finance 32(9): 1836-1849.
For US credit unions, revenue from non-interest sources has increased significantly in recent years. We investigate the impact of revenue diversification on financial performance for the period 1993-2004. The impact of a change in strategy that alters the share of non-interest income is decomposed into a direct exposure effect, reflecting the difference between interest and non-interest bearing activities, and an indirect exposure effect which reflects the effect of the institution's own degree of diversification. On both risk-adjusted and unadjusted returns measures, a positive direct exposure effect is outweighed by a negative indirect exposure effect for all but the largest credit unions. This may imply that similar diversification strategies are not appropriate for large and small credit unions. Small credit unions should eschew diversification and continue to operate as simple savings and loan institutions, while large credit unions should be encouraged to exploit new product opportunities around their core expertise.
Goddard, J., P. Molyneux, et al. (2007). "European banking: An overview." Journal of Banking & Finance 31(7): 1911-1935.
Against a background of far-reaching structural change in the banking sector, this article reviews the recent academic literature on developments in European banking. European banking markets have become increasingly integrated in recent years, but barriers to full integration, especially in retail banking, still remain. European integration has possible implications for systemic risk, and poses various challenges for the current supervisory framework. The banks' responses to the changing competitive environment include the pursuit of strategies of diversification, vertical product differentiation and consolidation. European integration has implications for competition in banking markets, for the nature of long-term borrower-lender relationships, and for the relationships between ownership structure, technological change and bank efficiency. The article concludes by reviewing recent literature on the credit channel in the monetary transmission mechanism, and interest rate pass-through.
Goldberg, L. G., R. J. Sweeney, et al. (2007). "Evaluating the Nordea experiment: Evidence from market and accounting data." Journal of Banking & Finance 31(4): 1265-1286.
This paper discusses results and difficulties of comparing banks' performance based on publicly available data for the case of Nordea, a pan-Nordic bank created through mergers of important national banks. The objective is to determine whether Nordea's unique strategy of functional integration across four countries can be advantageous. For stock-market data, however, Nordea does not have stable betas on risk factors, and thus the comparables method must be used with great care. The Nordea holding company performed about as well as the comparables, both in terms of stock-market and accounting data. Nordea banks in individual countries outperformed comparable holding companies; by arithmetic, Nordea non-bank operations are not as profitable as its bank operations. In event studies, the data lend only the weakest support to the hypothesis that the market viewed Nordea's acquisitions as adding value.
Golinelli, R. and R. Rovelli (2005). "Monetary policy transmission, interest rate rules and inflation targeting in three transition countries." Journal of Banking & Finance29(1): 183-201.
In 1991, the rate of inflation in the Czech Republic, Hungary and Poland was 57%, 35% and 70%. At the end of 2001, it was everywhere below 8%. We set up a small structural macro model of these three economies to account for the process of disinflation. We show that a simple macro model, with forward-looking inflation and exchange rate expectations, can adequately characterize the relationship between the output gap, inflation, the real interest rate and the exchange rate during this period. This model allows us to assess the relative importance of the interest rate and exchange rate channels in determining the path of disinflation.
Gomes, F. J. (2007). "Exploiting short-run predictability." Journal of Banking & Finance 31(5): 1427-1440.
This paper measures the utility gains from exploiting short-run predictability in the volatility of stock returns in a dynamic model in the the presence of transaction costs, short-selling constraints and estimation risk. We find that utility gains are quite significant, both ex ante and out-of-sample.
Gómez-Valle, L. and J. Martínez-Rodríguez (2008). "Modelling the term structure of interest rates: An efficient nonparametric approach." Journal of Banking & Finance 32(4): 614-623.
We propose a new approach for estimating the coefficients of the term structure equation by means of the volatility of the interest rates and the slope of the yield curve. One advantage of this approach consists in the fact that the drift and the market price of risk are jointly estimated and need not be individually specified. We then generate trajectories in a test problem to investigate the finite properties of this approach. Our simulation results show that this new approach outperforms the classic nonparametric models in the literature. Finally, an application to USA Treasury Bill data is also illustrated.
González, F. (2005). "Bank regulation and risk-taking incentives: An international comparison of bank risk." Journal of Banking & Finance 29(5): 1153-1184.
This paper uses a panel database of 251 banks in 36 countries to analyze the impact of bank regulation on bank charter value and risk-taking. After controlling for deposit insurance and for the quality of a country's contracting environment, the results indicate that regulatory restrictions increase banks' risk-taking incentives by reducing their charter value. Banks in countries with stricter regulation have a lower charter value, which increases their incentives to follow risky policies. These results corroborate a negative relation between regulatory restrictions and the stability of a banking system. Deposit insurance has a positive influence on bank charter value, mitigating the risk-shifting incentives it creates. This positive influence disappears when we control for the possible endogeneity of deposit insurance.
Goodhart, C. A. E. (2006). "A framework for assessing financial stability?" Journal of Banking & Finance 30(12): 3415-3422.
I worked as a consultant in the Financial Stability Department (FSD) of the Bank of England for several years (2002-2004). In this paper I reflect on issues relating to the work of such an FSD, starting with the difficulty of defining or measuring [`]financial stability'. Stress tests are commonly used, but, for an FSD, should relate to the system as a whole, not just to individual institutions. FSDs need to assess the probability, virulence and speed of occurrence of potential shocks. There is a need to develop appropriate analytical models. The focus on capital adequacy has diverted attention from concern about having sufficient liquidity.
Goodhart, C. A. E. and H. Huang (2005). "The lender of last resort." Journal of Banking & Finance 29(5): 1059-1082.
This paper develops a model of the lender of last resort (LOLR) from a Central Bank (CB) viewpoint. The model in a static setting suggests that the CB would only rescue banks which are above a threshold size, consistent with the insight of "too big to fail". In a dynamic setting, CB's optimal policy in liquidity support depends on the trade off between contagion and moral hazard effects. Our results show that contagion is the key factor affecting CB's incentives in providing LOLR and they also provide a rationalization for "constructive ambiguity".
Gottesman, A. A. and G. Jacoby (2006). "Payout policy, taxes, and the relation between returns and the bid-ask spread." Journal of Banking & Finance 30(1): 37-58.
Recent evidence demonstrates that corporate payout policy has shifted from the nearly exclusive use of dividend payout to the inclusion of stock repurchase, primarily through open markets. This trend has been attributed to the tax advantages associated with repurchase relative to dividends. In this paper, we introduce personal taxation and stock repurchase to reexamine the relation between returns and the bid-ask spread. Our model provides insight into the nature of this relation. Tests performed using NYSE, AMEX, and NASDAQ data provide empirical support of our theoretical conclusions. We conclude that the firm's choice of payout policy influences the relation between returns and spreads.
Grace, M. F. and R. D. Phillips (2008). "Regulator performance, regulatory environment and outcomes: An examination of insurance regulator career incentives on state insurance markets." Journal of Banking & Finance 32(1): 116-133.
In this paper we test whether the past or future labor market choices of insurance commissioners provide incentives for regulators in states with price regulation to either favor or oppose the industry by allowing prices that differ significantly from what would otherwise be the competitive market outcome. Using biographical data on insurance regulators, economic and state specific market structure and regulatory variables, and state premium and loss data on the personal automobile insurance market, we find no evidence consumers in prior approval states paid significantly different "unit prices" for insurance than consumers in states that allow competitive market forces to determine equilibrium prices during the time period 1985-2002. We do, however, find evidence regulators who obtained the position of insurance commissioner by popular election and those who seek higher elective office following their tenure as insurance commissioner allow higher overall "unit prices" relative to competitive market states. The "unit price" of insurance in regulated states is not statistically different from the competitive market outcome for regulators that make lateral moves back into state government and it is mildly higher for regulators who enter the insurance industry following their tenure. Finally, we find some evidence regulators who describe themselves as consumer advocates are successful reducing the price of insurance in favor of consumers in regulated markets. Overall the results are consistent with the existence of asymmetric information in the regulatory process that agents use to enhance their career aspirations.
Grané, A. and H. Veiga (2008). "Accurate minimum capital risk requirements: A comparison of several approaches." Journal of Banking & Finance 32(11): 2482-2492.
In this paper we estimate, for several investment horizons, minimum capital risk requirements for short and long positions, using the unconditional distribution of three daily indexes futures returns and a set of short and long memory stochastic volatility and GARCH-type models. We consider the possibility that errors follow a t-Student distribution in order to capture the kurtosis of the returns' series. The results suggest that accurate modelling of extreme observations obtained for long and short trading investment positions is possible with an autoregressive stochastic volatility model. Moreover, modelling futures returns with a long memory stochastic volatility model produces, in general, excessive volatility persistence, and consequently, leads to large minimum capital risk requirement estimates. Finally, the models' predictive ability is assessed with the help of out-of-sample conditional tests.
Grant, J. L., A. Wolf, et al. (2005). "Intraday price reversals in the US stock index futures market: A 15-year study." Journal of Banking & Finance 29(5): 1311-1327.
This paper gives a long-term assessment of intraday price reversals in the US stock index futures market following large price changes at the market open. We find highly significant intraday price reversals over a 15-year period (November 1987-September 2002) as well as significant intraday reversals in our yearly and day-of-the-week investigations. Moreover, the strength of the intraday overreaction phenomenon seems more pronounced following large positive price changes at the market open. That being said, the question of whether a trader can consistently profit from this information remains open as the significance of intraday price reversals is sharply reduced when gross trading results are adjusted by a bid-ask proxy for transactions costs.
Grauer, R. R. and J. A. Janmaat (2004). "The unintended consequences of grouping in tests of asset pricing models." Journal of Banking & Finance 28(12): 2889-2914.
We identify a number of unintended consequences of grouping when the capital asset pricing model is true and when it is false. When the model is true, grouping may cause fundamental problems with the most basic capital asset pricing and cross-sectional regression relationships. For example, with traditional grouping, the market portfolio is super-efficient--unless securities in each group are value weighted. Yet, when the model is grossly false, grouping may cause the model to appear to be absolutely correct. Ironically, the only way this can occur is when securities in each group are value weighted. To make matters worse, when the model is false, the slope of a cross-sectional regression of expected returns on betas fitted to grouped data may be either steeper or flatter than when the regression is fitted to ungrouped data. In other words, grouping may exacerbate the very problem it was meant to alleviate.
Grauer, R. R. and J. A. Janmaat (2009). "On the power of cross-sectional and multivariate tests of the CAPM." Journal of Banking & Finance 33(5): 775-787.
This paper examines the power of the cross-sectional and multivariate tests of the CAPM under ideal conditions. When the CAPM is true the positively weighted market portfolio is MV-efficient and securities plot on the security market line. When the CAPM is false an alternative asset pricing model determines prices. An examination of the population intercepts, slopes and R2 from cross-sectional regressions of expected returns on betas indicates that all three are unreliable indicators of whether the CAPM holds. Simulation analysis of the power of the cross-sectional tests expands on and reinforces the analysis based on the population values. The Gibbons et al. (1989) multivariate test fares much better.
Greene, J. T., C. W. Hodges, et al. (2007). "Daily mutual fund flows and redemption policies." Journal of Banking & Finance 31(12): 3822-3842.
We examine how redemption policies affect daily fund flows in open-end mutual funds. Since short-term trading of fund shares, as manifested in daily fund flows, can have an adverse impact on returns to the fund's shareholders, mutual funds might find it desirable to discourage short-term trading through the use of redemption fees. However, if daily fund flows are due to fund shareholders' legitimate liquidity demands, the redemption fee would have little effect on daily fund flows and possibly adversely affect fund shareholders by imposing a liquidity cost on them. We find that the likelihood of a fund charging a redemption fee is largely a function of its overall fee structure. We also use a sample of funds that imposed redemption fees to examine whether the distribution of daily fund flows changes after the initiation of the redemption fee. We find that the redemption fee is an effective tool in controlling the volatility of fund flows.
Greyserman, A., D. H. Jones, et al. (2006). "Portfolio selection using hierarchical Bayesian analysis and MCMC methods." Journal of Banking & Finance 30(2): 669-678.
This paper contributes to portfolio selection methodology using a Bayesian forecast of the distribution of returns by stochastic approximation. New hierarchical priors on the mean vector and covariance matrix of returns are derived and implemented. Comparison's between this approach and other Bayesian methods are studied with simulations on 25 years of historical data on global stock indices. It is demonstrated that a fully hierarchical Bayes procedure produces promising results warranting more study. We carried out a numerical optimization procedure to maximize expected utility using the MCMC (Monte Carlo Markov Chain) samples from the posterior predictive distribution. This model resulted in an extra 1.5 percentage points per year in additional portfolio performance (on top of the Hierarchical Bayes model to estimate [mu] and [Sigma] and use the Markowitz model), which is quite a significant empirical result. This approach applies to a large class of utility functions and models for market returns.
Grunert, J., L. Norden, et al. (2005). "The role of non-financial factors in internal credit ratings." Journal of Banking & Finance 29(2): 509-531.
Internal credit ratings are expected to gain in importance because of their potential use for determining regulatory capital adequacy and banks' increasing focus on the risk-return profile in commercial lending. Whereas the eligibility of financial factors as inputs for internal credit ratings is widely accepted, the role of non-financial factors remains ambiguous. Analyzing credit file data from four major German banks, we find evidence that the combined use of financial and non-financial factors leads to a more accurate prediction of future default events than the single use of each of these factors.
Grunert, J. and M. Weber (2009). "Recovery rates of commercial lending: Empirical evidence for German companies." Journal of Banking & Finance 33(3): 505-513.
There are very few studies concerning the recovery rate of bank loans. Prediction models of recovery rates are increasing in importance because of the Basel II-framework, the impact on credit risk management, and the calculation of loan rates. In this study, we focus the analyses on the distribution of recovery rates and the impact of the quota of collateral, the creditworthiness of the borrower, the size of the company and the intensity of the client relationship on the recovery rate. All our hypotheses can be confirmed. A higher quota of collateral leads to a higher recovery rate, whereas the risk premium of the borrower and the size of the company is negatively related to the recovery rate. Borrowers with an intense client relationship with the bank exhibit a higher recovery rate.
Guan, L. K., C. Ting, et al. (2005). "The implied jump risk of LIBOR rates." Journal of Banking & Finance 29(10): 2503-2522.
This paper examines implied parameters from options on LIBOR futures. Jump-diffusion models are found to offer superior in-sample and out-of-sample performance when compared to their pure diffusion counterpart. The need to incorporate stochastic jump magnitudes into LIBOR dynamics is also documented. In addition, empirical evidence reveals that the jump component in LIBOR rates is important for pricing their derivatives. Furthermore, variation in jump risk often coincides with Federal Open Market Committee (FOMC) decisions and a small subset of macroeconomic announcements.
Guariglia, A. (2008). "Internal financial constraints, external financial constraints, and investment choice: Evidence from a panel of UK firms." Journal of Banking & Finance 32(9): 1795-1809.
This paper uses a panel of 24,184 UK firms over the period 1993-2003 to study the extent to which the sensitivity of investment to cash flow differs at firms facing different degrees of internal and external financial constraints. Our results suggest that when the sample is split on the basis of the level of internal funds available to the firms, the relationship between investment and cash flow is U-shaped. On the other hand, the sensitivity of investment to cash flow tends to increase monotonically with the degree of external financial constraints faced by firms. Combining the internal with the external financial constraints, we find that the dependence of investment on cash flow is strongest for those externally financially constrained firms that have a relatively high level of internal funds.
Guariglia, A. and S. Mateut (2006). "Credit channel, trade credit channel, and inventory investment: Evidence from a panel of UK firms." Journal of Banking & Finance 30(10): 2835-2856.
In this paper, we use a panel of 609 UK firms over the period 1980-2000 to test for the existence of a trade credit channel of transmission of monetary policy, and for whether this channel plays an offsetting effect on the traditional credit channel. We estimate error-correction inventory investment equations augmented with the coverage ratio and the trade credit to assets ratio, differentiating the effects of the latter variables across firms more or less likely to face financing constraints, and firms making a high or low use of trade credit. Our results suggest that both the credit and the trade credit channels operate in the UK, and that the latter channel tends to weaken the former.
Guibourg, G. and B. Segendorff (2007). "A note on the price- and cost structure of retail payment services in the Swedish banking sector 2002." Journal of Banking & Finance 31(9): 2817-2827.
We estimate private costs in the Swedish banking sector for the production of payment services and investigate to what extent the price structure reflects the estimated cost structure. We find that (i) banks tend to use two-part tariffs but (ii) variable costs are poorly reflected in transaction fees towards both consumers and corporate customers. (iii) There exist large cross subsidies between different payment services, foremost from acquiring card payments to cash distribution to the public, while payment services as a whole are not subsidized.
Guo, H. (2006). "Time-varying risk premia and the cross section of stock returns." Journal of Banking & Finance 30(7): 2087-2107.
This paper develops and estimates a heteroskedastic variant of Campbell's [Campbell, J., 1993. Intertemporal asset pricing without consumption data. American Economic Review 83, 487-512] ICAPM, in which risk factors include a stock market return and variables forecasting stock market returns or variance. Our main innovation is the use of a new set of predictive variables, which not only have superior forecasting abilities for stock returns and variance, but also are theoretically motivated. In contrast with the early authors, we find that Campbell's ICAPM performs significantly better than the CAPM. That is, the additional factors account for a substantial portion of the two CAPM-related anomalies, namely, the value premium and the momentum profit.
Guo, H. and R. Savickas (2008). "Forecasting foreign exchange rates using idiosyncratic volatility." Journal of Banking & Finance 32(7): 1322-1332.
Average idiosyncratic stock volatility forecasts the bilateral exchange rates of the US dollar against major foreign currencies in and out of sample. The US dollar tends to appreciate after an increase in US idiosyncratic volatility. Similarly, ceteris paribus, German and Japanese idiosyncratic volatilities positively and significantly correlate with future US dollar prices of the Deutsche mark and the Japanese yen, respectively. Our results suggest that exchange rates are predictable.
Gupta, A. and M. G. Subrahmanyam (2005). "Pricing and hedging interest rate options: Evidence from cap-floor markets." Journal of Banking & Finance 29(3): 701-733.
We examine the pricing and hedging performance of interest rate option pricing models using daily data on US dollar cap and floor prices across both strike rates and maturities. Our results show that fitting the skew of the underlying interest rate probability distribution provides accurate pricing results within a one-factor framework. However, for hedging performance, introducing a second stochastic factor is more important than fitting the skew of the underlying distribution. This constitutes evidence against claims in the literature that correctly specified and calibrated one-factor models could replace multi-factor models for consistent pricing and hedging of interest rate contingent claims.
Gurevich, G., D. Kliger, et al. (2009). "Decision-making under uncertainty - A field study of cumulative prospect theory." Journal of Banking & Finance 33(7): 1221-1229.
The presented research tests cumulative prospect theory (CPT, [Kahneman, D., Tversky, A., 1979. Prospect theory: An analysis of decision under risk. Econometrica 47, 263-291; Tversky, A., Kahneman, D., 1981. The framing of decisions and the psychology of choice. Science 211, 453-480]) in the financial market, using US stock option data. Option prices possess information about actual investors' preferences in such a way that an exploitation of conventional option analysis, along with theoretical relationships, makes it possible to elicit investor preferences. The option data in this study serve for estimating the two essential elements of the CPT, namely, the value function and the probability weighting function. The main part of the work focuses on the functions' simultaneous estimation under CPT original parametric specification. The shape of the estimated functions is found to be in line with theory. Comparing to results of laboratory experiments, the estimated functions are closer to linearity and loss aversion is less pronounced.
Güttler, A. and M. Wahrenburg (2007). "The adjustment of credit ratings in advance of defaults." Journal of Banking & Finance 31(3): 751-767.
This paper assesses biases in credit ratings and lead-lag relationships for near-to-default issuers with multiple ratings by Moody's and S&P. Based on defaults from 1997 to 2004, we find evidence that Moody's seems to adjust its ratings to increasing default risk in a timelier manner than S&P. Second, credit ratings by the two US-based agencies are not subject to any home preference. Third, given a downgrade (upgrade) by the first rating agency, subsequent downgrades (upgrades) by the second rating agency are of greater magnitude in the short term. Fourth, harsher rating changes by one agency are followed by harsher rating changes in the same direction by the second agency. Fifth, rating changes by the second rating agency are significantly more likely after downgrades than after upgrades by the first rating agency. Additionally, we find evidence for serial correlation in rating changes up to 90 days subsequent to the rating change of interest after controlling for rating changes by the second rating agency.
Haber, S. (2005). "Mexico's experiments with bank privatization and liberalization, 1991-2003." Journal of Banking & Finance 29(8-9): 2325-2353.
During the 1990s Mexico conducted two experiments with its banking system. In the first experiment (1991-96) it privatized the banks. This experiment took place with weak institutions to enforce contract rights. It also took place without institutions that encourage prudent behavior by bankers. The result was reckless behavior by banks, and a collapse of the banking system. In the second experiment (1997-2003), Mexico reformed many of the institutions that promoted bank monitoring and it opened up the industry to foreign investment. It was less successful, however, in reforming the institutions that promote the enforcement of contract rights. The result was that bankers behaved prudently, but prudent behavior in the context of weak contract rights implies that banks are reluctant to extend credit to firms and households.
Hagendorff, J., M. Collins, et al. (2008). "Investor protection and the value effects of bank merger announcements in Europe and the US." Journal of Banking & Finance 32(7): 1333-1348.
Investor protection regimes have been shown to partly explain why the same type of corporate event may attract different investor reactions across countries. We compare the value effects of large bank merger announcements in Europe and the US and find an inverse relationship between the level of investor protection prevalent in the target country and abnormal returns that bidders realize during the announcement period. Accordingly, bidding banks realize higher returns when targeting low protection economies (most European economies) than bidders targeting institutions which operate under a high investor protection regime (the US). We argue that bidding bank shareholders need to be compensated for an increased risk of expropriation by insiders which they face in a low protection environment where takeover markets are illiquid and there are high private benefits of control.
Hale, G. and J. A. C. Santos (2008). "The decision to first enter the public bond market: The role of firm reputation, funding choices, and bank relationships." Journal of Banking & Finance 32(9): 1928-1940.
This paper uses survival analysis to investigate the timing of a firm's decision to issue for the first time in the public bond market. We find that firms that are more creditworthy and have higher demand for external funds issue their first public bond earlier. We also find that issuing private bonds or taking out syndicated loans is associated with a faster entry to the public bond market. According to our results, the relationships that firms develop with investment banks in connection with their private bond issues and syndicated loans further speed up their entry to the public bond market. Finally, we find that a firm's reputation has a "U-shaped" effect on the timing of a firm's bond IPO. Consistent with Diamond's reputational theory, firms that establish a track record of high creditworthiness as well as those that establish a track record of low creditworthiness enter the public bond market earlier than firms with intermediate reputation.
Han, L., S. Fraser, et al. (2009). "Are good or bad borrowers discouraged from applying for loans? Evidence from US small business credit markets." Journal of Banking & Finance 33(2): 415-424.
This paper takes the concept of a discouraged borrower originally formulated by Kon and Storey [Kon, Y., Storey, D.J., 2003. A theory of discouraged borrowers. Small Business Economics 21, 37-49] and examines whether discouragement is an efficient self-rationing mechanism. Using US data it finds riskier borrowers have higher probabilities of discouragement, which increase with longer financial relationships, suggesting discouragement is an efficient self-rationing mechanism. It also finds low risk borrowers are less likely to be discouraged in concentrated markets than in competitive markets and that, in concentrated markets, high risk borrowers are more likely to be discouraged the longer their financial relationships. We conclude discouragement is more efficient in concentrated, than in competitive, markets.
Hannan, T. H. (2006). "Retail deposit fees and multimarket banking." Journal of Banking & Finance 30(9): 2561-2578.
This paper reports a systematic examination of the determinants of deposit-related retail banking fees using a set of survey data that is unusual for its size, specificity, and sampling properties. The analysis focuses explicitly on six different fees associated with checking accounts and automated teller machine (ATM) usage. A preliminary analysis documents that, on average, multimarket banks charge substantially higher fees than do typically smaller, single-market banks. A more detailed econometric analysis yields results consistent with predictions of recent models. In particular, it finds that the greater the presence of multimarket banks in the local market, the higher are the retail deposit fees of single-market banks (except in highly concentrated markets) and the weaker is the positive relationship between those fees and market concentration.
Hannan, T. H. (2007). "ATM surcharge bans and bank market structure: The case of Iowa and its neighbors." Journal of Banking & Finance 31(4): 1061-1082.
It is frequently claimed that high ATM surcharges actually attract customers to the banks that impose them, particularly if they operate large ATM networks. By exploiting as "natural experiments" two events associated with the lifting of surcharge bans in Iowa and in the states that neighbor Iowa, this paper seeks to test for the implications of this phenomenon as it applies to the market shares of banking institutions and to several aspects of market structure. Consistent with predictions, results of "difference-in-difference" analyses suggest that the retail account shares of larger market participants increased relative to those of smaller competitors, market concentration increased, and the number of market competitors decreased after the lifting of surcharge bans - all relative to what would have occurred had there been no change in authority to surcharge.
Hannan, T. H. and R. A. Prager (2009). "The profitability of small single-market banks in an era of multi-market banking." Journal of Banking & Finance 33(2): 263-271.
This paper examines the relationship between the profitability of small single-market banks and the presence in the market of large banking organizations and banking organizations that operate primarily outside of the local banking market. We find that, in rural banking markets, the profitability of small single-market banks is significantly related to the presence of both large and small primarily-out-of-market banks. We also find that an increased presence of large or small primarily-out-of-market banks in rural banking markets reduces the positive effect of an increase in concentration on small single-market bank profits. This finding is consistent with theoretical predictions reported in the recent literature and has important implications for antitrust policy. In urban banking markets, we find little evidence of any relationship between the profitability of small single-market banks and the presence of large or primarily-out-of-market banks.
Hanson, S. and T. Schuermann (2006). "Confidence intervals for probabilities of default." Journal of Banking & Finance 30(8): 2281-2301.
In this paper we conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD) using several analytical approaches as well as parametric and nonparametric bootstrap methods. We do so for two different PD estimation methods, cohort and duration (intensity), with 22 years of credit ratings data. We find that the bootstrapped intervals for the duration-based estimates are relatively tight when compared to either analytic or bootstrapped intervals around the less efficient cohort estimator. We show how the large differences between the point estimates and confidence intervals of these two estimators are consistent with non-Markovian migration behavior. Surprisingly, even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings, e.g. a PDAA- from a PDA+. However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated PDs. Conditioning on the state of the business cycle helps: it is easier to distinguish adjacent PDs in recessions than in expansions.
Harrington, S. E., P. M. Danzon, et al. (2008). ""Crises" in medical malpractice insurance: Evidence of excessive price-cutting in the preceding soft market." Journal of Banking & Finance 32(1): 157-169.
Prior work suggests that heterogeneous information or weak incentives for solvency could have caused some general liability insurers to charge low ex ante prices during the early 1980s and mid-to-late 1990s, putting downward pressure on other firms' prices and plausibly aggravating subsequent periods of rapid premium growth. We analyse whether the 1994-1999 "soft" market in medical malpractice insurance led some firms to underprice, grow rapidly, and subsequently experience upward revisions in loss forecasts ("loss development"), which could have aggravated subsequent market "crises". Consistent with the underpricing hypothesis, the results indicate a positive relation between loss development and premium growth among growing firms. Underpricing was likely more prevalent among non-specialist malpractice insurers.
Harris, O. and C. Glegg (2009). "Governance quality and privately negotiated stock repurchases: Evidence of agency conflict." Journal of Banking & Finance 33(2): 317-325.
This study examines the impact of shareholder rights on the wealth effects of privately negotiated stock repurchases. Our results show that wealth gains are lower when shareholder rights are more suppressed. We also find that the premium paid for shares is inversely related to the strength of shareholder rights, and this suggests that managers pay higher premiums when shareholder rights are more restricted. These findings imply that managers use shareholders' funds to eliminate blockholders who are more likely to monitor them when shareholder rights are relatively weak, thereby entrench themselves. Consistent with this view, we further show that significant positive abnormal long-run returns after private stock repurchases are limited to firms with stronger shareholder protection. Overall, the evidence is consistent with the predictions of agency theory.
Harris, R. D. F. and F. Yilmaz (2009). "A momentum trading strategy based on the low frequency component of the exchange rate." Journal of Banking & Finance33(9): 1575-1585.
In this paper, we develop a momentum trading strategy based on the low frequency trend component of the spot exchange rate. Using kernel regression and the high-pass filter of Hodrick and Prescott [Hodrick, R., Prescott, E., 1997. Post-war US business cycles: An empirical investigation. Journal of Money, Credit and Banking 29, 1-16], we recover the non-linear trend in the monthly exchange rate and use short-term momentum in this to generate buy and sell signals. The low frequency momentum trading strategy offers greater directional accuracy, higher returns and Sharpe ratios, lower maximum drawdown and less frequent trading than traditional moving average rules. Moreover, unlike traditional moving average rules, the performance of the low frequency momentum trading strategy is relatively robust across different time periods. The low frequency momentum trading strategy is also robust to the choice of smoothing parameter (in the case of the HP filter) and the distribution and bandwidth parameter (in the case of kernel regression) over a wide range of values.
Hartmann-Wendels, T., T. Mählmann, et al. (2009). "Determinants of banks' risk exposure to new account fraud - Evidence from Germany." Journal of Banking & Finance 33(2): 347-357.
This paper studies empirically the determinants of new account fraud risk within two dimensions: the probability of fraud, and the expected and unexpected (monetary) loss-per-account due to fraud. By fraud risk, we mean the risk that a bank fails to enforce a debt because the identity of the person incurring the debt cannot be ascertained. Using a unique and rich data set of account applicants, provided by a German Internet-only bank, we find that fraud risk is highly sensitive to demographic and socio-economic variables like nationality, gender, marital status, age, occupation, and urbanisation. For example, foreigners are 22.25 times more likely to commit account fraud than Germans, and men are 2.5 times more risky than women.
Hasan, I., M. Koetter, et al. (2009). "Regional growth and finance in Europe: Is there a quality effect of bank efficiency?" Journal of Banking & Finance 33(8): 1446-1453.
In this study, we test whether regional growth in 11 European countries depends on financial development and suggest the use of cost- and profit-efficiency estimates as quality measures of financial institutions. Contrary to the usual quantitative proxies of financial development, the quality of financial institutions is measured in this study as the relative ability of banks to intermediate funds. An improvement in bank efficiency spurs five times more regional growth then an identical increase in credit does. More credit provided by efficient banks exerts an independent growth effect in addition to direct quantity and quality channel effects.
Hasan, I., P. Wachtel, et al. (2009). "Institutional development, financial deepening and economic growth: Evidence from China." Journal of Banking & Finance33(1): 157-170.
There have been profound changes in both political and economic institutions in China over the last 20 years. Moreover, the pace of transition has led to variation across the country in the level of development. In this paper, we use panel data for the Chinese provinces to study the role of legal institutions, financial deepening and political pluralism on growth rates. The most important institutional developments for a transition economy are the emergence and legalization of the market economy, the establishment of secure property rights, the growth of a private sector, the development of financial sector institutions and markets, and the liberalization of political institutions. We develop measures of these phenomena, which are used as explanatory variables in regression models to explain provincial GDP growth rates. Our evidence suggests that the development of financial markets, legal environment, awareness of property rights and political pluralism are associated with stronger growth.
Hasman, A. and M. Samartín (2008). "Information acquisition and financial contagion." Journal of Banking & Finance 32(10): 2136-2147.
This paper incorporates costly voluntary acquisition of information à la Nikitin and Smith (2007) [Nikitin, M., Smith, R.T., 2007. Information acquisition, coordination, and fundamentals in a financial crisis. Journal of Banking and Finance, in press, doi:10.1016/j.jbankfin.2007.04.031], in a framework similar to Allen and Gale (2000) [Allen, F., Gale, D., 2000. Financial contagion. Journal of Political Economy 108, 1-33], without relying on any unexpected shock to model contagion. In this framework, contagion and financial crises are the result of information gathering by depositors, weak fundamentals and an incomplete market structure of banks. It also shows how financial systems entering a recession can affect others with apparently stronger economic conditions (contagion). Finally, this is the first paper to investigate the effectiveness of the Contingent Credit Line procedures, introduced by the IMF at the end of the nineties, as a mechanism to prevent the propagation of crises.
Haubrich, J. G. and J. A. C. Santos (2005). "Banking and commerce: A liquidity approach." Journal of Banking & Finance 29(2): 271-294.
This paper looks at the advantages and disadvantages of mixing banking and commerce, using the "liquidity" approach to financial intermediation. Bringing a nonfinancial firm into a banking conglomerate may be advantageous because it makes it easier for the bank to dispose of assets seized in a loan default. The conglomerate's internal market increases the liquidity of such assets and improves the bank's ability to perform financial intermediation. More generally, owning a nonfinancial firm may act either as a substitute or a complement to commercial lending. In some cases, a bank will voluntarily refrain from making loans, choosing to become a non-bank bank in an unregulated environment.
Hauner, D. (2008). "Credit to government and banking sector performance." Journal of Banking & Finance 32(8): 1499-1507.
The impact of credit to government on three aspects of banking sector performance - its deepening over time, profitability, and efficiency - is examined for 142 countries. Country regressions suggest a sizeable negative effect of credit to government on bank deepening in developing countries, but no impact in advanced economies. Bank regressions find that credit to government raises the profitability but reduces the efficiency of banks in developing countries; in advanced economies, there appears to be no impact on profitability but a positive one on efficiency.
Havrylchyk, O. (2006). "Efficiency of the Polish banking industry: Foreign versus domestic banks." Journal of Banking & Finance 30(7): 1975-1996.
The present paper investigates the efficiency of the Polish banking industry between 1997 and 2001. Our preferred methodology is Data Envelopment Analysis, which allows us to distinguish between cost, allocative, technical, pure technical, and scale efficiency. Additionally, we perform a number of tests to investigate whether domestic and foreign banks come from the same population. Finally, we attempt to shed light on the determinants of efficiency. Our results indicate that bank efficiency has not improved during the years analyzed. Whereas greenfield banks have achieved higher levels of efficiency than domestic banks, foreign banks that acquired domestic institutions have not succeeded in enhancing their efficiency.
Heffernan, S. (2005). "The effect of UK building society conversion on pricing behaviour." Journal of Banking & Finance 29(3): 779-797.
The Building Society Act, 1986, allowed British building societies to convert from mutual to plc bank status - quoted on the stock market. Eight mutuals converted in the period 1995-2000. This study examines the pricing behaviour of the converted mutuals and remaining building societies to address the question of whether a change in ownership structure caused managers of the new stock banks to place profit/shareholder concerns ahead of the interests of the customer/owners of mutual building societies. Econometric tests using monthly interest rate data (1995-2001) on deposit products and mortgages confirm that managers began to set prices which would improve profits, at the expense of depositors and mortgagees. Deposit/mortgage rates were found to be permanently lower/higher post-conversion, the converts responded more rapidly to changes in the market rate of interest, and the new banks offered proportionately more rip-offs than the remaining building societies.
Heffernan, S. (2006). "UK bank services for small business: How competitive is the market?" Journal of Banking & Finance 30(11): 3087-3110.
This study is the first to employ an econometric model to examine the pricing behaviour of British financial institutions with respect to key bank products/services offered to small and medium sized enterprises (SMEs) including current accounts, investment accounts, business loans, and mortgages. A mean group approach is used on a panel of monthly data to gauge individual banks' reactions to identify factors influencing the setting of deposit and loan rates, and to assess the competitive structure that best describes the UKs SME banking market. Though the results should be interpreted with caution, the empirical evidence is suggestive of a complex oligopoly. Policies directed at improving information and making it easier for small businesses to change banks/accounts would reduce inertia and improve competition among financial institutions.
Heid, F. (2007). "The cyclical effects of the Basel II capital requirements." Journal of Banking & Finance 31(12): 3885-3900.
Capital requirements play a key role in the supervision and regulation of banks. The Basel Committee on Banking Supervision is in the process of changing the current framework by introducing risk sensitive capital charges. Some fear that this will unduly increase the volatility of regulatory capital. Furthermore, by limiting the banks' ability to lend, capital requirements may exacerbate an economic downturn. The paper examines the problem of capital-induced lending cycles and their pro-cyclical effect on the macroeconomy in greater detail. It finds that the capital buffer that banks hold on top of the required minimum capital plays a crucial role in mitigating the impact of the volatility of capital requirements.
Henry, Ó. T. (2009). "Regime switching in the relationship between equity returns and short-term interest rates in the UK." Journal of Banking & Finance 33(2): 405-414.
This paper examines the relationship between UK equity returns and short-term interest rates using a two regime Markov-Switching EGARCH model. The results suggest one high-return, low variance regime within which the conditional variance of equity returns responds persistently but symmetrically to equity return innovations. In the other, low-mean, high variance, regime equity volatility responds asymmetrically and without persistence to shocks to equity returns. There is evidence of a regime dependent relationship between shorter maturity interest rate differentials and equity return volatility. Furthermore, there is evidence that events in the money markets influence the probability of transition across regimes.
Hernando, I. and M. J. Nieto (2007). "Is the Internet delivery channel changing banks' performance? The case of Spanish banks." Journal of Banking & Finance31(4): 1083-1099.
In spite of the conspicuous use of the Internet as a delivery channel, there is a relative dearth of empirical studies that provide a quantitative analysis of the impact of the Internet on banks' financial performance. This paper attempts to fill this gap by identifying and estimating the impact of the adoption of a transactional web site on financial performance using a sample of 72 commercial banks operating in Spain over the period 1994-2002. The impact on banks' performance of transactional web adoption takes time to appear. The adoption of the Internet as a delivery channel involves a gradual reduction in overhead expenses (particularly, staff, marketing and IT). This effect is statistically significant after one and a half years after adoption. The cost reduction translates into an improvement in banks' profitability, which becomes significant after one and a half years in terms of ROA and after three years in terms of ROE. The paper also concludes that the Internet is being used as a complement to, rather than a substitute for, physical branches.
Hernando, I., M. J. Nieto, et al. (2009). "Determinants of domestic and cross-border bank acquisitions in the European Union." Journal of Banking & Finance 33(6): 1022-1032.
This paper analyzes the determinants of bank acquisitions both within and across countries in the EU-25 over the period 1997-2004. Our results suggest poorly managed banks (high cost to income) and larger banks are more likely to be acquired by other banks in the same country. The probability of being a target in a cross-border deal is larger for banks that are quoted in the stock market. Finally, banks operating in more concentrated markets are less likely to be acquired by other banks in the same country but are more likely to be acquired by banks in other EU-25 countries.
Herrero, A. G. and M. S. Martínez Pería (2007). "The mix of international banks' foreign claims: Determinants and implications." Journal of Banking & Finance31(6): 1613-1631.
We analyze the cross-country determinants and financial stability implications of the mix of international banks' foreign claims. We distinguish between local claims - extended by host country affiliates - and cross-border claims - booked outside the receiving country. Using data on Italian, Spanish, and US banks' foreign claims, we find that the share of local claims is driven by restrictions on banking sector openness and by local scale economies/business opportunities. The impact of limits on property rights, entry requirements, start-up and informational costs is less robust. Finally, foreign claim volatility is lower in countries with a larger share of local claims.
Hibbert, A. M., R. T. Daigler, et al. (2008). "A behavioral explanation for the negative asymmetric return-volatility relation." Journal of Banking & Finance 32(10): 2254-2266.
We examine the short-term dynamic relation between the S&P 500 (Nasdaq 100) index return and changes in implied volatility at both the daily and intraday level. Neither the leverage hypothesis nor the volatility feedback hypothesis adequately explains the results. Alternatively, we propose that the behavior of traders (from the representativeness, affect, and extrapolation bias concepts of behavioral finance) is consistent with our empirical results of a strong daily and intraday negative return-implied volatility relation. Moreover, both the presence and magnitude of the negative relation and the asymmetry between return and implied volatility are most closely associated with extreme changes in the index returns. We also show that the strength of the relation is consistent with the implied volatility skew.
Hibiki, N. (2006). "Multi-period stochastic optimization models for dynamic asset allocation." Journal of Banking & Finance 30(2): 365-390.
Institutional investors manage their strategic asset mix over time to achieve favorable returns subject to various uncertainties, policy and legal constraints, and other requirements. One may use a multi-period portfolio optimization model in order to determine an optimal asset mix. The concept of scenarios is typically employed for modeling random parameters in a multi-period stochastic programming model, and scenarios are constructed via a tree structure. Recently, an alternative stochastic programming model with simulated paths was proposed by Hibiki [Hibiki, N., 2001b. A hybrid simulation/tree multi-period stochastic programming model for optimal asset allocation. In: Takahashi, H. (Ed.), The Japanese Association of Financial Econometrics and Engineering. JAFEE Journal 89-119 (in Japanese); Hibiki, N., 2003. A hybrid simulation/tree stochastic optimization model for dynamic asset allocation. In: Scherer, B. (Ed.), Asset and Liability Management Tools: A Handbook for Best Practice, Risk Books, pp. 269-294], and it is called a hybrid model. The advantage of the simulated path structure compared to the tree structure is to give a better accuracy to describe uncertainties of asset returns. In this paper, we compare the two types of multi-period stochastic optimization models, and clarify that the hybrid model can evaluate and control risk better than the scenario tree model using some numerical tests. According to the numerical results, an efficient frontier of the hybrid model with the fixed-proportion strategy dominates that of the scenario tree model when we evaluate them on simulated paths. Moreover, optimal solutions of the hybrid model are more appropriate than those of the scenario tree model.
Hinnerich, M. (2008). "Inflation-indexed swaps and swaptions." Journal of Banking & Finance 32(11): 2293-2306.
This article considers the pricing and hedging of inflation-indexed swaps, and the pricing of inflation-indexed swaptions, and options on inflation-indexed bonds. To price the inflation-indexed swaps, we suggest an extended HJM model. The model allows both the forward rates and the consumer price index to be driven, not only by a standard multidimensional Wiener process but also by a general marked point process. Our model is an extension of the HJM approach proposed by Jarrow and Yildirim [Jarrow, R., Yildirim, Y., 2003. Pricing treasury inflation protected securities and related derivatives using an HJM model. Journal of Financial and Quantitative Analysis 38, 409-430] and later also used by Mercurio [Mercurio, F., 2005. Pricing inflation-indexed derivatives. Quantitative Finance 5 (3), 289-302] to price inflation-indexed swaps. Furthermore we price options on so called TIPS-bonds assuming the model is purely Wiener driven. We then introduce an inflation swap market model to price inflation-indexed swaptions. All prices derived have explicit closed-form solutions. Furthermore, we formally prove the validity of the so called foreign-currency analogy.
Hiraguchi, R. (2009). "Non-concavity problems in the dynamic macroeconomic models: A note." Journal of Banking & Finance 33(3): 568-572.
This note provides a method to convert the dynamic models in Cysne [Cysne, Rubens P., 2006. A note on the non-convexity problem in some shopping-time and human-capital models. Journal of Banking and Finance 30 (10), 2737-2745] and in Cysne [Cysne, Rubens P., 2008. A note on "inflation and welfare". Journal of Banking and Finance 32 (9), 1984-1987] to concave optimization problems. We do this by introducing new control and state variables in the models. Cysne (2006, 2008) restrict attention to continuous time models and derive parametric conditions to use Arrow's sufficiency theorem. When the sufficient conditions presented in Cysne (2006) are satisfied (but not under the sharper sufficient conditions presented in Cysne (2008)) we can rewrite these models as concave optimization problems even if time is discrete.
Hirtle, B. (2007). "The impact of network size on bank branch performance." Journal of Banking & Finance 31(12): 3782-3805.
Despite significant technological innovation in retail banking services delivery, the number of US bank branches has grown steadily over time. Further, more and more of these branches are held by banks with large branch networks. This paper assesses the implications of these developments by examining measures of branch performance and asking how these measure vary across institutions with different branch network sizes. Our findings suggest that banks with mid-sized branch networks may be at a competitive disadvantage in branching activities. We find no systematic relationship between branch network size and overall institutional profitability, perhaps because banking organizations optimize the size of their branch network operations as part of an overall strategy involving both branch-based and non-branch-based activities.
Hirtle, B. J. and K. J. Stiroh (2007). "The return to retail and the performance of US banks." Journal of Banking & Finance 31(4): 1101-1133.
The US banking industry is experiencing a renewed focus on retail banking, a trend often attributed to the stability and profitability of retail activities. This paper examines the impact of banks' retail intensity on performance from 1997 to 2004 by developing three complementary definitions of retail intensity (retail loan share, retail deposit share, and branches per dollar of assets) and comparing these measures with both equity market and accounting measures of performance. We find that an increased focus on retail banking across US banks is linked with significantly lower equity market and accounting returns for all banks, but lower volatility for only the largest banking companies. We conclude that retail banking may be a relatively stable activity, but it is also a low return one.
Hjalmarsson, E. and R. Hjalmarsson "Efficiency in housing markets: Which home buyers know how to discount?" Journal of Banking & Finance In Press, Accepted Manuscript.
We test for efficiency in the Swedish co-op market by examining the negative relationship between the sales price and the present value of future monthly payments or [`]rents'. If the co-op housing market is efficient, the present value of co-op rental payments due to underlying debt obligations of the cooperative should be fully reflected in the sales price. However, a one hundred kronor increase in the present value of future rents only leads to an approximately 75 kronor reduction in the sales price. These inefficiencies are larger at the lower end of the housing market and in poorer, less educated regions and appear to reflect both liquidity constraints and the existence of more [`]sophisticated' buyers in higher educated areas. Overall, our findings suggest that there is some systematic failure to properly discount the future stream of rent payments relative to the up front sales price.
Ho, C. and C.-H. Hung (2009). "Investor sentiment as conditioning information in asset pricing." Journal of Banking & Finance 33(5): 892-903.
This paper assesses whether incorporating investor sentiment as conditioning information in asset-pricing models helps capture the impacts of the size, value, liquidity and momentum effects on risk-adjusted returns of individual stocks. We use survey sentiment measures and a composite index as proxies for investor sentiment. In our conditional framework, the size effect becomes less important in the conditional CAPM and is no longer significant in all the other models examined. Furthermore, the conditional models often capture the value, liquidity and momentum effects.
Hoggarth, G., P. Jackson, et al. (2005). "Banking crises and the design of safety nets." Journal of Banking & Finance 29(1): 143-159.
Governments face conflicting objectives in terms of the provision and design of safety nets for banking systems. Safety nets may reduce market discipline and can thus increase the likelihood of a banking crisis. But safety nets are adopted because of the perceived benefits they will confer in either preventing a weak banking system from spilling over into a full-blown crisis or in enabling the government to handle a crisis more effectively. This paper provides evidence on the effects of government safety nets on both these aspects and discusses implications for policy.
Holmen, M., J. D. Knopf, et al. (2008). "Inside shareholders' effective tax rates and dividends." Journal of Banking & Finance 32(9): 1860-1869.
Using information collected from the Swedish tax authorities, we calculate insiders' actual effective tax rates on dividends. With this unique dataset, we find a significant negative cross-sectional relationship between insiders' effective tax rates and dividend payout. This result is consistent with a tax-induced clientele effect for dividends. We also look at the impact of large block trades on dividends. We find that when insiders with zero effective taxes sell blocks, subsequent dividend payments are significantly more likely to decrease. This provides evidence that large shareholders are adjusting dividends for their individual tax situations.
Holod, D. and J. Peek (2007). "Asymmetric information and liquidity constraints: A new test." Journal of Banking & Finance 31(8): 2425-2451.
Using a novel measure of the degree of information asymmetry across firms, this study shows that information-related financial market imperfections do matter for a firm's access to external finance. Prior studies of the importance of liquidity constraints faced by nonfinancial firms have suffered from a glaring weakness. They have been based on a sample of publicly traded firms, omitting precisely those firms most likely to be liquidity constrained. Furthermore, they have tended to rely on indirect measures of the degree of information asymmetry, such as firm size. We overcome these limitations by focusing on the banking sector. Unlike the nonfinancial sector, the banking sector has balance sheet and income data available for all firms, whether or not they are publicly traded. This allows the use of a superior measure of the degree of information asymmetry across firms by distinguishing between publicly traded and non-publicly traded banks. We focus on changes in monetary policy that represent exogenous (to the banks) changes in the financing constraints they face. We find that publicly traded banks, which exhibit a lower degree of information asymmetry, are better able to overcome information-based financial market frictions, compared to the relatively opaque non-publicly traded banks, when monetary policy is tightened. Lending by the more transparent publicly traded banks is less affected by a monetary policy tightening in large part due to their relative advantage in raising external funds by issuing uninsured large time deposits. These results are obtained controlling for bank (and bank holding company) size, a dimension commonly used in the literature as the measure of the degree of firm access to external finance. Moreover, we show that the distinction between publicly traded and non-publicly traded banks dominates bank size as an indicator of the degree of access to external funds.
Hong, G. and S. Sarkar (2008). "Commodity betas with mean reverting output prices." Journal of Banking & Finance 32(7): 1286-1296.
This paper provides a theoretical derivation of commodity beta (stock price sensitivity to commodity price) using a contingent-claim model. The model incorporates operating leverage, financial leverage, costly financial distress, and mean reverting commodity prices; and highlights the important role played by the speed of reversion of the commodity price. It is used to identify theoretically the main determinants of commodity beta. Commodity beta is predicted to be an increasing function of the operating and financial leverage of the firm, and a decreasing function of the company's tax rate and the level, volatility and speed of reversion of the commodity price. Empirical tests with a sample of gold mining firms provide support for these predictions, particularly the new implications of the model (the effect of the commodity price's speed of reversion and the company's tax rate).
Honig, A. (2008). "Do improvements in government quality necessarily reduce the incidence of costly sudden stops?" Journal of Banking & Finance 32(3): 360-373.
Sudden stops have been linked to a number of financial crises in emerging market countries. While a large literature has developed emphasizing the importance of institutions and governance in reducing economic volatility, this paper finds that the effect of government quality on the incidence of sudden stops is non-linear. Initial improvements in governance actually increase the incidence of costly sudden stops. A possible explanation is that improved governance encourages capital inflows that can overwhelm banking systems in countries with weak institutions. What is striking is that this result holds for a large number of countries including those with average levels of institutional quality that already receive considerable inflows. Eventually, however, improving institutions does reduce the frequency of sudden stops, allowing countries to enjoy the benefits of financial globalization with fewer risks.
Honohan, P. (2008). "Cross-country variation in household access to financial services." Journal of Banking & Finance 32(11): 2493-2500.
This paper presents estimates, for more than 160 countries, of the fraction of the adult population using formal financial intermediaries. The estimates are constructed by combining information on account numbers at banks and microfinance institutions (together with banking depth and GDP data) with estimates from household surveys for a smaller set of countries. An illustrative application of the data compares them with information on poverty: there is a correlation, but it is not clearly causal.
Horneff, W. J., R. H. Maurer, et al. (2009). "Asset allocation and location over the life cycle with investment-linked survival-contingent payouts." Journal of Banking & Finance 33(9): 1688-1699.
This paper shows how survival-contingent investment-linked payouts can enhance investor wellbeing in the context of a portfolio choice model which integrates uninsurable labor income and asymmetric mortality expectations. In exchange for illiquidity, these products provide the consumer with access to mutual-fund style portfolio choice, as well as the survival credit generated from pooling mortality risk. Our model generates optimal asset location patterns indicating how much to hold in liquid versus illiquid survival-contingent payouts over the lifetime, and also asset allocation paths, showing how to invest in stocks versus bonds. We show that the investor who moves her money out of liquid saving into survival-contingent assets gradually from middle age to retirement and beyond, will enhance her welfare by as much as 50%. The results are robust to the introduction of uninsurable consumption shocks in housing expenses, income flows during the worklife and retirement, sudden changes in health status, and medical expenses.
Houweling, P., A. Mentink, et al. (2005). "Comparing possible proxies of corporate bond liquidity." Journal of Banking & Finance 29(6): 1331-1358.
We consider nine different proxies (issued amount, listed, euro, on-the-run, age, missing prices, yield volatility, number of contributors and yield dispersion) to measure corporate bond liquidity and use a four-variable model to control for interest rate risk, credit risk, maturity and rating differences between bonds. The null hypothesis that liquidity risk is not priced in our data set of euro corporate bonds is rejected for eight out of nine liquidity proxies. We find significant liquidity premia, ranging from 13 to 23 basis points. A comparison test between liquidity proxies shows limited differences between the proxies.
Hsieh, J. and R. A. Walkling (2006). "The history and performance of concept stocks." Journal of Banking & Finance 30(9): 2433-2469.
This study investigates the performance of firms with extremely high levels of market to sales value ("concept stocks"). To many observers, these stocks appear overvalued. However, proponents argue that because of their unique characteristics, traditional pricing models fail to value these firms correctly. Ex post, the debate can be resolved through an analysis of the long-term performance of concept stocks. En route to testing the implied overpricing hypothesis we document several important findings. First, the identity and characteristics of concept stocks have changed markedly over time. Although the obvious recent examples are internet and biotech stocks, concept stocks vary widely by industry over the past four decades. The industries containing the most popular concept stocks evolve from oil and gas extraction in the 1960s and 1970s, to computer and office equipment in the 1980s, and to computer-related services in the 1990s. Second, although concept stocks tend to be young, small, growth stocks in the 1990s, they exhibit a wide range of characteristics throughout the sample period. Third, the relative pricing of concept stocks (compared to either a control sample or the entire population) has changed dramatically over time. The average concept stock sold for approximately three times sales in the late 1960s and 1970s, five times sales in the 1980s and nearly 17 times sales in the 1990s. Finally, we find evidence supporting the overpricing hypothesis. Concept stocks under-perform significantly in the long run. This under-performance is more severe for Nasdaq firms and in the most recent two decades. The results are separate from glamour, IPO, industry, or contrarian effects and remain after an extensive sensitivity analysis.
Hu, Y. and X. Zhou (2008). "The performance effect of managerial ownership: Evidence from China." Journal of Banking & Finance 32(10): 2099-2110.
By examining a sample of non-listed Chinese firms, we provide the first evidence from China for the effect of managerial ownership on firm performance. In matching-sample comparisons, we find that firms of significant managerial ownership outperform firms whose managers do not own equity shares. Our further results indicate the relation between firm performance and managerial ownership is nonlinear, and the inflection point at which the relation turns negative occurs at ownership above 50%. Compared with previous studies, our results are less likely to suffer from an endogeneity problem due to the non-list nature of our sample and the unique institutional environment in China.
Huang, H. and M. A. Milevsky (2008). "Portfolio choice and mortality-contingent claims: The general HARA case." Journal of Banking & Finance 32(11): 2444-2452.
We solve a portfolio choice problem that includes mortality-contingent claims and labor income under general HARA preferences. Our contribution beyond existing literature is to (i) focus on the covariance between shocks to human capital and financial capital, to (ii) model the utility of a family with basic needs and (iii) include life insurance and pension annuity claims in one unified life-cycle model. Our solution employs a "similarity reduction" mapping which reduces the two-dimensional HJB equation into one dimension. This allows for the implementation of a quick numerical scheme. And, when shocks to human capital and financial capital are perfectly correlated, a closed-form expression is obtained as a special case.
Huang, H.-H. (2005). "Comment on "Optimal portfolio selection in a value-at-risk framework"." Journal of Banking & Finance 29(12): 3181-3185.
This comment discusses some errors in [Journal of Banking and Finance 25 (2001) 1789]. Given the portfolio rate of return is normally distributed, the following can be inferred. First, taking expected portfolio return rate as the benchmark of value-at-risk (VaR), the risk-return ratio collapses to a multiple of the Sharpe index. However, using risk-free rate as the benchmark, then above inference does not hold. Second, whether the benchmark of VaR is expected portfolio return rate or the risk-free rate, the optimal asset allocations for maximizing the risk-return ratio and Sharpe index are identical.
Huang, P., Y. Zhang, et al. (2009). "Do artificial income smoothing and real income smoothing contribute to firm value equivalently?" Journal of Banking & Finance33(2): 224-233.
This paper examines the potential impacts of artificial smoothing (abnormal accruals) and real smoothing (derivatives) on firm value. We find that the value of the firm decreases with the magnitude of abnormal accruals and increases with the level of derivative use. Moreover, the accrual discount is more pronounced in firms with weak investor protection and the hedging premium is greater for poorly governed firms. These results suggest that although managers can engage in real smoothing to improve the informativeness of firms' earnings and thus reduce agency costs, they might use artificial techniques to cosmetically improve the income stream in order to expropriate minority shareholders. In further support of agency theories, we report that poor corporate governance motivates the use of abnormal accruals and discourages derivative use.
Huang, R. D. and H. Li (2009). "Does the market dole out collective punishment? An empirical analysis of industry, geography, and Arthur Andersen's reputation."Journal of Banking & Finance 33(7): 1255-1265.
Arthur Andersen's reputation was tarnished following news that its Houston office had shredded documents related to the auditing of energy giant Enron. Earlier studies documented widespread spillover of the reputation effect, suggesting a strong commonality in Big 5 audit practices. We examine whether the market is more discriminating in its assessments. We focus on the roles industry specialization of auditors and the geography of clients' audit offices play in accounting for the contagion. Our results are supportive of investors who differentiate audit practices by industry and who account for the location of the specific office where the audit work is done. We find that losses suffered by energy firms or firms located close to Houston are equivalent to approximately 90% of the aggregate abnormal losses suffered by Big 5 clients. Our evidence suggests the possibility of more localized impact of accounting scandals and supports accounting regulations targeted at individual industries.
Huang, T.-H. and Y.-H. Chen (2009). "A study on long-run inefficiency levels of a panel dynamic cost frontier under the framework of forward-looking rational expectations." Journal of Banking & Finance 33(5): 842-849.
This paper aims to provide a theoretical underpinning of the dynamic efficiency model pioneered by [Ahn, S.C., Good, D.H., Sickles, R.C., 2000. Estimation of long-run inefficiency levels: A dynamic frontier approach. Econometric Reviews 19, 461-492]. In the context of a quadratic loss function this paper formulates a multi-period forward-looking rational expectations model on the evolution of the technical inefficiency level, which correctly produces a dynamic panel data model. The model is illustrated using panel data of 112 French banks. Encouraging evidence of superiority in favor of the model is reached. Substantial cost inefficiency prevails in this industry, where the constituent banks are characterized as having volatile adjustment speeds toward their long-run steady states. The sample banks exhibit increasing returns to scale and product-mix economies.
Huang, X., H. Zhou, et al. "A framework for assessing the systemic risk of major financial institutions." Journal of Banking & Finance In Press, Accepted Manuscript.
In this paper we propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Importantly, using realized correlations estimated from high-frequency equity return data can significantly improve the accuracy of forecasted correlations. Our stress testing methodology, using an integrated micro-macro model, takes into account dynamic linkages between the health of major US banks and macro-financial conditions. Our results suggest that the theoretical insurance premium that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms stood at $110 billion in March 2008 and had a projected upper bound of $250 billion in July 2008.
Huang, Z. and X. Xu (2009). "Marketability, control, and the pricing of block shares." Journal of Banking & Finance 33(1): 88-97.
Unlike in other countries, negotiated block shares have huge discounts in China. We argue that trading restrictions help to explain this puzzle. Block shares in China face trading restrictions in the open market and can only be traded in the form of block transfers at negotiated prices. Using a dataset of 233 block transfers in China between 2002 and 2003, we find that discounts on block share prices increase with the proportion of restricted shares in the ownership. The likelihood of private benefit of control has positive impact on block prices, but the effect diminishes when there are other large shareholders. Furthermore, private institutions offer a higher price than state-owned institutions.
Huij, J. and J. Derwall (2008). ""Hot Hands" in bond funds." Journal of Banking & Finance 32(4): 559-572.
We investigate persistence in the relative performance of 3549 bond mutual funds from 1990 to 2003. We show that bond funds that display strong (weak) performance over a past period continue to do so in future periods. The out-of-sample difference in risk-adjusted return between the top and bottom decile of funds ranked on past alpha exceeds 3.5 percent per year. We demonstrate that a strategy based on past fund returns earns an economically and statistically significant abnormal return, suggesting that bond fund investors can exploit the observed persistence. Our results are robust to a wide range of model specifications and bootstrapped test statistics.
Huij, J. and M. Verbeek (2007). "Cross-sectional learning and short-run persistence in mutual fund performance." Journal of Banking & Finance 31(3): 973-997.
Using monthly return data of more than 6400 US equity mutual funds we investigate short-run performance persistence over the period 1984-2003. We sort funds into rank portfolios based on past performance, and evaluate the portfolios' out-of-sample performance. To cope with short ranking periods, we employ an empirical Bayes approach to measure past performance more efficiently. Our main finding is that when funds are sorted into decile portfolios based on 12-month ranking periods, the top decile of funds earns a statistically significant, abnormal return of 0.26 percent per month. This effect persists beyond load fees, and is mainly concentrated in relatively young, small cap/growth funds.
Huizinga, H. and G. Nicodème (2006). "Deposit insurance and international bank liabilities." Journal of Banking & Finance 30(3): 965-987.
This paper examines the responsiveness of external bank liabilities to deposit insurance policies for a sample of developed countries. External bank liabilities held by non-banks are found to increase after the introduction of explicit deposit insurance. Deposit insurance schemes tend to exclude interbank deposits from coverage and the response of external interbank liabilities to deposit insurance appears to be varied. Neither external non-bank nor external interbank liabilities are found to be materially affected by deposit insurance design. This suggests that international competition in the area of deposit insurance design - as possible under the EU deposit insurance directive of 1994 - would be fruitless.
Hülsewig, O., E. Mayer, et al. (2006). "Bank loan supply and monetary policy transmission in Germany: An assessment based on matching impulse responses."Journal of Banking & Finance 30(10): 2893-2910.
This paper addresses the credit channel in Germany by using aggregate data. We present a stylized model of the banking firm in which banks decide on their loan supply in the light of expectations about the future course of monetary policy. Applying a VAR model, we estimate the response of bank loans to a monetary policy shock taking account of the reaction of the output level and the loan rate. We estimate our model to evaluate the response of bank loans by matching the theoretical impulse responses with the empirical impulse responses to a monetary policy shock. Evidence in support of the credit channel can be reported.
Humphrey, D., M. Willesson, et al. (2006). "Benefits from a changing payment technology in European banking." Journal of Banking & Finance 30(6): 1631-1652.
An "output characteristics" cost function is used to identify payment sources of technical change in European banking and estimate associated benefits. As the share of electronic payments in 12 European countries rose from 0.43 in 1987 to 0.79 in 1999 and ATMs expanded while the number of branch offices was constant, bank operating costs are $32 billion lower than they otherwise might have been, saving 0.38% of the 12 nations' GDP. Policies facilitating these changes (antitrust exemptions to weakly coordinate implementation of payment service pricing) would permit benefits to be more fully realized.
Hunter, D. M. and D. P. Simon (2005). "Are TIPS the "real" deal?: A conditional assessment of their role in a nominal portfolio." Journal of Banking & Finance29(2): 347-368.
This paper documents predictable time-variation in the real return beta of US Treasury Inflation Protected Securities (TIPS) and in the Sharpe ratios of both indexed and conventional bonds. The conditional mean and volatility of both bonds and their conditional correlation first are estimated from predetermined variables. These estimates then are used to compute conditional real return betas and Sharpe ratios. The time-variation in real return betas and the correlation between TIPS and nominal bonds coincides with major developments in the fixed-income market. One implication of this predictability is that portfolio managers can assess more efficiently the risk of investing in TIPS versus conventional bonds. Conditional Sharpe ratios indicate that over the sample period, TIPS had superior volatility-adjusted returns relative to nominal bonds. This finding is striking in view of the absence of a major inflation scare during the sample period from February 1997 through August 2001, but is loosely consistent with the possibility that TIPS elevated rather than reduced Treasury borrowing costs. On the other hand, mean-variance spanning tests indicate that TIPS did not enhance the mean-variance efficiency of diversified portfolios.
Hutson, E., C. Kearney, et al. (2008). "Volume and skewness in international equity markets." Journal of Banking & Finance 32(7): 1255-1268.
We examine the relation between trading volume and skewness in 11 international stock markets using daily and monthly data from January 1980 to August 2004. We construct single equation and VAR models of the relation between the first three moments of market returns and trading volumes. Our results show hitherto unrecognised channels of influence, and support the investor heterogeneity approach to explaining return asymmetries.
Hwang, D.-Y., F.-S. Shie, et al. "The pricing of deposit insurance considering bankruptcy costs and closure policies." Journal of Banking & Finance In Press, Corrected Proof.
The paper aims to study the pricing issue of deposit insurance with explicit consideration of bankruptcy costs and closure policies. Full coverage from deposit insurance is imposed by many regulators to stabilize the banking system in the current financial crisis, despite of the potential moral hazard problems. We argue that bankruptcy cost is an important factor in pricing deposit insurance, especially when the insured institution is insolvent. Applying the isomorphic relationship between deposit insurance and put option, we first derive a closed-form solution for the pricing model with bankruptcy costs and closure policies. Then, we modify the barrier option approach to price the deposit insurance in which the bankruptcy cost is set as a function of asset return volatility and more realistic closure policies considering possible forbearance can be accounted for. The properties of the models are supported by numerical simulations and are consistent with the risk-based pricing scheme.
Hwang, S., A. Keswani, et al. (2008). "Surprise vs anticipated information announcements: Are prices affected differently? An investigation in the context of stock splits." Journal of Banking & Finance 32(5): 643-653.
We compare the long run reaction to anticipated and surprise information announcements using stock splits. Although there is underreaction in both cases, anticipated splits are treated differently to those that are unforeseen. After anticipated splits, cumulative abnormal returns peak at one-and-a-half times the level observed after unanticipated splits although the time taken for the announcement to be absorbed into prices is the same. We explain the difference in underreaction by the degree to which split announcements are believed and hence invested in. The favorable signal conveyed in forecast splits is more credible owing to their better pre-split performance, resulting in a far more pronounced underreaction effect.
Hyytinen, A. and M. Pajarinen (2008). "Opacity of young businesses: Evidence from rating disagreements." Journal of Banking & Finance 32(7): 1234-1241.
A conventional wisdom in the contemporary corporate finance literature argues that small and medium-sized enterprises (SMEs) are informationally opaque. We use data from two credit information companies and in particular their disagreements over the creditworthiness of SMEs to study the empirical relevance of this often invoked assumption. Our panel data analysis shows that once unobserved firm-effects are controlled for, the disagreements (i.e., rating splits) are inversely related to the age of firms. We are not able to document such a robust relationship between the disagreements and the size of firms. This finding holds a lesson for empirical corporate finance researchers who need firm-level proxies for informational imperfections and asymmetries: of the two often-used proxies, firm size is not as closely related to informational opacity as firm age is.
Iannotta, G., G. Nocera, et al. (2007). "Ownership structure, risk and performance in the European banking industry." Journal of Banking & Finance 31(7): 2127-2149.
We compare the performance and risk of a sample of 181 large banks from 15 European countries over the 1999-2004 period and evaluate the impact of alternative ownership models, together with the degree of ownership concentration, on their profitability, cost efficiency and risk. Three main results emerge. First, after controlling for bank characteristics, country and time effects, mutual banks and government-owned banks exhibit a lower profitability than privately owned banks, in spite of their lower costs. Second, public sector banks have poorer loan quality and higher insolvency risk than other types of banks while mutual banks have better loan quality and lower asset risk than both private and public sector banks. Finally, while ownership concentration does not significantly affect a bank's profitability, a higher ownership concentration is associated with better loan quality, lower asset risk and lower insolvency risk. These differences, along with differences in asset composition and funding mix, indicate a different financial intermediation model for the different ownership forms.
Ibáñez, A. (2008). "Factorization of European and American option prices under complete and incomplete markets." Journal of Banking & Finance 32(2): 311-325.
In a standard option-pricing model, with continuous-trading and diffusion processes, this paper shows that the price of one European-style option can be factorized into two intuitive components: One robust, X0, which is priced by arbitrage, and a second, [Pi]0, which depends on a risk orthogonal to the traded securities. This result implies the following: (1) In an incomplete market, these parts represent the price of a hedging portfolio, which is unique, and a premium, which depends only on the risk premiums associated with the residual risk, respectively. (2) In a complete market, it allows factoring the contribution of the different sources of risk to the final option price. For example, in a stochastic volatility model, we can quantify the impact on the option price of volatility risk relative to market risk, [Pi]0 and X0, respectively. Hence, certain misspricings in option markets can be directly related to the premium, [Pi]0. (3) Moreover, these results extend to American securities, which have a third component - an additional early-exercise premium.
Ibragimov, R. and J. Walden (2007). "The limits of diversification when losses may be large." Journal of Banking & Finance 31(8): 2551-2569.
Recent results in value at risk analysis show that, for extremely heavy-tailed risks with unbounded distribution support, diversification may increase value at risk, and that generally it is difficult to construct an appropriate risk measure for such distributions. We further analyze the limitations of diversification for heavy-tailed risks. We provide additional insight in two ways. First, we show that similar non-diversification results are valid for a large class of risks with bounded support, as long as the risks are concentrated on a sufficiently large interval. The required length of the support depends on the number of risks available and on the degree of heavy-tailedness. Second, we relate the value at risk approach to more general risk frameworks. We argue that in markets for risky assets where the number of assets is limited compared with the (bounded) distribution support of the risks, unbounded heavy-tailed risks may provide a reasonable approximation. We suggest that this type of analysis may have a role in explaining various types of market failures in markets for assets with possibly large negative outcomes.
Imai, M. (2006). "Market discipline and deposit insurance reform in Japan." Journal of Banking & Finance 30(12): 3433-3452.
On April 1, 2002, the Japanese government lifted a blanket guarantee of all deposits and began limiting the coverage of time deposits. This paper uses this deposit insurance reform as a natural experiment to investigate the relationship between deposit insurance coverage and market discipline. I find that the reform raised the sensitivity of interest rates on deposits, and that of deposit quantity to default risk. In addition, the interest rate differentials between partially insured large time deposits and fully insured ordinary deposits increased for risky banks. These results suggest that the deposit insurance reform enhanced market discipline in Japan. I also find, however, that too-big-to-fail (TBTF) policy became a more important determinant of interest rates and deposit allocation after the reform, thereby partially offsetting the positive effects of the deposit insurance reform on overall market discipline.
Imai, M. (2007). "The emergence of market monitoring in Japanese banks: Evidence from the subordinated debt market." Journal of Banking & Finance 31(5): 1441-1460.
This paper uses a unique data set on the spreads of subordinated debts issued by Japanese banks to investigate the presence of market monitoring. The results show that subordinated debt investors punished weak banks by requiring higher interest rates. Moreover, I find that the spreads and the sensitivity of spreads to Moody's bank ratings both increased dramatically after the Japanese government allowed a large city bank, Hokkaido Takushoku Bank, to fail and passed the Financial Reform Act and the Rapid Revitalization Act in the late 1990s. These results suggest that the decline of conjectural guarantee led to the emergence of market monitoring. In addition, I find the relationship between spreads and accounting measures of bank risk to be quite fragile.
Inoue, K., H. K. Kato, et al. (2008). "Corporate restructuring in Japan: Who monitors the monitor?" Journal of Banking & Finance 32(12): 2628-2635.
Peek and Rosengren [Peek, J., Rosengren, E., 2005. Unnatural selection: Perverse incentives and the misallocation of credit in Japan. American Economic Review 95, 1144-1166] showed that, when the bubble economy era ended, regulatory forbearance and perverse incentives allowed Japanese banks to engage extensively in evergreening. This is the first comprehensive study to empirically analyze the economics of private debt restructurings of financially distressed companies in Japan, where the corporate monitoring mechanism is not market based but large-stakeholder based - typically, banks and affiliated companies. These stakeholders are expected to efficiently resolve potential bankruptcy or collapse with better information resulting from long-term relationships with the distressed firms. Our study, however, finds that private restructurings led by them failed because of delays in implementing fundamental solutions. Forbearance in addressing the needs of distressed firms demonstrates the weakness of such stakeholders in instituting discipline, hence the need for a system to "monitor the monitor".
Instefjord, N. (2005). "Risk and hedging: Do credit derivatives increase bank risk?" Journal of Banking & Finance 29(2): 333-345.
The objective of this paper is to investigate whether financial innovation of credit derivatives makes banks more exposed to credit risk. Although credit derivatives are important for hedging and securitizing credit risk - and thereby likely to enhance the sharing of such risk - some commentators have raised concerns that they may destabilize the banking sector. This paper investigates this issue in a simple model driven by costs of financial distress. The analysis identifies two effects of credit derivatives innovation - they enhance risk sharing as suggested by the hedging argument - but they also make further acquisition of risk more attractive. The latter effect, if dominant, can therefore destabilize the banking sector. The critical factor is, perhaps surprisingly, the competitive nature of the existing underlying credit markets. As these markets become more elastic the threat of destabilization increases. The paper discusses issues related to bank regulation within the context of the model.
Inui, K. and M. Kijima (2005). "On the significance of expected shortfall as a coherent risk measure." Journal of Banking & Finance 29(4): 853-864.
This article shows that any coherent risk measure is given by a convex combination of expected shortfalls, and an expected shortfall (ES) is optimal in the sense that it gives the minimum value among the class of plausible coherent risk measures. Hence, it is of great practical interest to estimate the ES with given confidence level from the market data in a stable fashion. In this article, we propose an extrapolation method to estimate the ES of interest. Some numerical results are given to show the efficiency of our method.
Iscoe, I. and A. Kreinin (2007). "Valuation of synthetic CDOs." Journal of Banking & Finance 31(11): 3357-3376.
In this paper, we consider the valuation of a synthetic collateralized debt obligation (CDO), a pool of underlying credit risky securities, "partitioned" into several tranches, each of which absorbs losses in accordance with its size and seniority. We derive a closed-form solution for credit spreads of the tranches of homogeneous pools and find an approximation for the credit spreads of inhomogeneous pools. The method leads to an accurate estimation of the credit spreads of synthetic CDOs and can be used in risk management applications.
Islam, S. S. and A. Mozumdar (2007). "Financial market development and the importance of internal cash: Evidence from international data." Journal of Banking & Finance 31(3): 641-658.
We examine the impact of financial market development on the extent to which firms have to rely on internal capital for making investments. Using international data from 31 countries for the 1987-1997 period, we find evidence of a negative relationship between financial market development and the importance of internal capital. The evidence is consistent across different estimation procedures, alternative measures of financial constraints and cash flow, and the use of bootstrapped standard errors. Finally, we find that the distortionary effect of negative cash flow observations reported earlier for US data extends to international data as well.
Jacobsen, B. and W. Marquering (2008). "Is it the weather?" Journal of Banking & Finance 32(4): 526-540.
We show that results in the recent strand of the literature, which tries to explain stock returns by weather induced mood shifts of investors, might be data-driven inference. More specifically, we consider two recent studies [Kamstra, Mark J., Kramer, Lisa A., Levi, Maurice D., 2003a. Winter blues: A SAD stock market cycle. American Economic Review 93(1), 324-343; Cao, Melanie, Wei, Jason, 2005. Stock market returns: A note on temperature anomaly. Journal of Banking and Finance 29(6), 1559-1573] that claim that a seasonal anomaly in stock returns is caused by mood changes of investors due to lack of daylight and temperature variations, respectively. While we confirm earlier results in the literature that there is indeed a strong seasonal effect in stock returns in many countries: stock market returns tend to be significantly lower during summer and fall months than during winter and spring months as documented by Bouman and Jacobsen [Bouman, Sven, Jacobsen, Ben, 2002. The Halloween indicator, Sell in May and go away: Another puzzle. American Economic Review, 92(5), 1618-1635], there is little evidence in favor of a SAD or temperature explanation. In fact, we find that a simple winter/summer dummy best describes this seasonality. Our results suggest that without any further evidence the correlation between weather-related variables and stock returns might be spurious and the conclusion that weather affects stock returns through mood changes of investors is premature.
Jacobsen, B. and W. Marquering (2009). "Is it the weather? Response." Journal of Banking & Finance 33(3): 583-587.
Kamstra, Kramer and Levi (KKL) in their comment seem to miss the main point of our paper. Many things are correlated with the seasons so it is difficult to distinguish between them when we try to explain the well-known summer winter pattern in stock returns. Finding an isolated seasonal affective disorder (SAD) effect without proper control variables does not disprove our point but strengthens it. To sidestep all of the issues they raise and take our point to the extreme, we show using plain vanilla regressions that the seasonal stock market pattern they attribute to SAD can also be "explained" by variables like ice cream consumption or airline travel. The new variations of SAD variables ("onset" and "incidence") KKL propose in their recent work for North America are even more problematic than the original SAD variables. We find that these new SAD proxies are not significant in countries where according to KKL they should be: Canada and the United States.
Jacobson, T., J. Lindé, et al. (2006). "Internal ratings systems, implied credit risk and the consistency of banks' risk classification policies." Journal of Banking & Finance 30(7): 1899-1926.
This paper aims at improving our understanding of internal risk rating systems (IRS) at large banks, of the way in which they are implemented, and at verifying if IRS produce consistent estimates of banks' loan portfolio credit risk. An important property of our work is that the size of our data set allows us to derive measures of credit risk without making any assumptions about correlations between loans, by applying Carey's [Carey, Mark, 1998. Credit risk in private debt portfolios. Journal of Finance LIII (4), 1363-1387] non-parametric Monte Carlo re-sampling method. We find substantial differences between the implied loss distributions of two banks with equal "regulatory" risk profiles; both expected losses and the credit loss rates at a wide range of loss distribution percentiles vary considerably. Such variation will translate into different levels of required economic capital. Our results also confirm the quantitative importance of size for portfolio credit risk: for common parameter values, we find that tail risk can be reduced by up to 40% by doubling portfolio size. Our analysis makes clear that not only the formal design of a rating system, but also the way in which it is implemented (e.g. a rating grade composition; the degree of homogeneity within rating classes) can be quantitatively important for the shape of credit loss distributions and thus for banks' required capital structure. The evidence of differences between lenders also hints at the presence of differentiated market equilibria, that are more complex than might otherwise be supposed: different lending or risk management "styles" may emerge and banks strike their own balance between risk-taking and (the cost of) monitoring (that risk).
James, C. and J. Karceski (2006). "Investor monitoring and differences in mutual fund performance." Journal of Banking & Finance 30(10): 2787-2808.
A number of mutual funds cater exclusively to institutional investors. Although institutional funds might be a natural place to look for "smart money", agency costs associated with delegated monitoring may lead to less monitoring and worse overall performance. We split institutional funds based on proxies for the degree of investor oversight, and we find that institutional funds with low initial investment requirements and funds with retail mates perform significantly worse than other institutional funds both before and after adjusting for risk and expenses. Tracking error is especially important in the flow-performance relationship of institutional funds with high minimum investment requirements.
Jankowitsch, R., S. Pichler, et al. (2007). "Modelling the economic value of credit rating systems." Journal of Banking & Finance 31(1): 181-198.
In this paper we develop a model of the economic value of credit rating systems. Increasing international competition and changes in the regulatory framework driven by the Basel Committee on Banking Supervision (Basel II) called forth incentives for banks to improve their credit rating systems. An improvement of the statistical power of a rating system decreases the potential effects of adverse selection, and, combined with meeting several qualitative standards, decreases the amount of regulatory capital requirements. As a consequence, many banks have to make investment decisions where they have to consider the costs and the potential benefits of improving their rating systems. In our model the quality of a rating system depends on several parameters such as the accuracy of forecasting individual default probabilities and the rating class structure. We measure effects of adverse selection in a competitive one-period framework by parameterizing customer elasticity. Capital requirements are obtained by applying the current framework released by the Basel Committee on Banking Supervision. Results of a numerical analysis indicate that improving a rating system with low accuracy to medium accuracy can increase the annual rate of return on a portfolio by 30-40 bp. This effect is even stronger for banks operating in markets with high customer elasticity and high loss rates. Compared to the estimated implementation costs banks could have a strong incentive to invest in their rating systems. The potential of reduced capital requirements on the portfolio return is rather weak compared to the effect of adverse selection.
Jankowitsch, R., R. Pullirsch, et al. (2008). "The delivery option in credit default swaps." Journal of Banking & Finance 32(7): 1269-1285.
Under standard assumptions the reduced-form credit risk model is not capable of accurately pricing the two fundamental credit risk instruments - bonds and credit default swaps (CDS) - simultaneously. Using a data set of euro-denominated corporate bonds and CDS our paper quantifies this mispricing by calibrating such a model to bond data, and subsequently using it to price CDS, resulting in model CDS spreads up to 50% lower on average than observed in the market. An extended model is presented which includes the delivery option implicit in CDS contracts emerging since a basket of bonds is deliverable in default. By using a constant recovery rate standard models assume equal recoveries for all bonds and hence zero value for the delivery option. Contradicting this common assumption, case studies of Chapter 11 filings presented in the paper show that corporate bonds do not necessarily trade at equal levels following default. Our extension models the implied expected recovery rate of the cheapest-to-deliver bond and, applied to data, largely eliminates the mispricing. Calibrated recovery values lie between 8% and 47% for different obligors, exhibiting strong variation among rating classes and industries. A cross-sectional analysis reveals that the implied recovery parameter depends on proxies for the delivery option, primarily the number of available bonds and bond pricing errors. No evidence is found for a direct influence of the bid-ask spread, notional amount, coupon, or rating used as proxies for bond market liquidity.
Jarrow, R. and P. Protter (2005). "Large traders, hidden arbitrage, and complete markets." Journal of Banking & Finance 29(11): 2803-2820.
This paper studies hidden arbitrage opportunities in markets where large traders affect the price process, and where the market is complete (in the classical sense). The arbitrage opportunities are "hidden" because they occur on a small set of times (typically of Lebesgue measure zero). These arbitrage opportunities occur naturally in markets where a large trader supports the price of some asset or commodity, for example corporate stock repurchase plans, government interest rate or foreign currency intervention, and price support by investment banks in IPOs. We also illustrate immediate arbitrage opportunities generated by usual market activity at specific points in time, for example the issuance date of an IPO or the inclusion date of a new stock in the S&P 500 index.
Jarrow, R. A. (2008). "Operational risk." Journal of Banking & Finance 32(5): 870-879.
This paper provides an economic and mathematical characterization of operational risk useful for clarifying the issues related to estimation and the determination of economic capital. The insights for this characterization originate in the corporate finance literature. Operational risk is subdivided into two types, either: (i) the risk of a loss due to the firm's operating technology, or (ii) the risk of a loss due to agency costs. These two types of operational risks generate loss processes with different economic characteristics. We argue that the current methodology for the determination of economic capital for operational risk is overstated. It is biased high because the computation omits the bank's net present value (NPV) generating process. We also show that although it is conceptually possible to estimate the operational risk processes' parameters using only market prices, the non-observability of the firm's value makes this an unlikely possibility, except in rare cases. Instead, we argue that data internal to the firm, in conjunction with standard hazard rate estimation procedures, provides a more fruitful alternative.
Jeitschko, T. D. and S. D. Jeung (2005). "Incentives for risk-taking in banking - A unified approach." Journal of Banking & Finance 29(3): 759-777.
It is often claimed that well-capitalized banks are less inclined to increase asset risk, because the option value of deposit insurance decreases with capitalization. However, bankers, regulators and some academics challenge this view. Since the traditional view relies on studies that neglect the managerial agency problem and do not consider "higher-risk, higher-return" assets, we revisit the issue assuming that three agents - deposit insurers, shareholders, and managers - all influence banks' risk levels. We examine four distinct assumptions on the characteristics of risk-return profiles and derive conditions under which banks' risk decreases or increases with capitalization.
Jha, R., B. Korkie, et al. "Measuring performance in a dynamic world: Conditional mean-variance fundamentals." Journal of Banking & Finance In Press, Corrected Proof.
We develop conditional alpha performance measures that are consistent with conditional mean-variance analysis and the magnitude and sign of the implied true conditional time-varying alphas. The sequence of conditional alphas and betas is estimable from surprisingly simple unconditional regressions. Other common performance measures are derivable from the conditional investment opportunity set based on its conditional asset return moments. Our bootstrap analysis of Morningstar mutual fund returns data demonstrates that the differences between existing conditional alpha measures and our proposed alpha are substantive for typical parameterizations.
Jia, C. (2009). "The effect of ownership on the prudential behavior of banks - The case of China." Journal of Banking & Finance 33(1): 77-87.
Although the relationship between bank ownership and performance is the current focus of much research, this paper investigates the relationship between ownership and the prudential behavior of banks. Using Chinese data, I show that lending by state-owned banks has been less prudent than lending by joint-equity banks, but has improved over time. This is consistent with the hypothesis that accountability to shareholders and depositors gives joint-equity banks a better incentive than state-owned banks to engage in prudent lending, and with the hypothesis that the reform of the banking system has improved the incentive for state-owned banks to behave more prudently in their lending.
Jiang, G. and S. Yan (2009). "Linear-quadratic term structure models - Toward the understanding of jumps in interest rates." Journal of Banking & Finance 33(3): 473-485.
We study linear-quadratic term structure models with random jumps in the short rate process where the jump arrival rate follows a stochastic process. Empirical results based on the US data show that incorporating stochastic jump intensity significantly improves model fit to the dynamics of both interest rate and volatility term structure. Our results also show that jump intensity is negatively correlated with interest rate changes and the average size is larger on the downside than upside. Examining the relation between jump intensity and macroeconomic shocks, we find that at monthly frequency, jumps are neither triggered by nor predictive of changes in macroeconomic variables. At daily frequency, however, we document interesting patterns for jumps associated with information shocks.
Jiang, X. and B.-S. Lee (2007). "Stock returns, dividend yield, and book-to-market ratio." Journal of Banking & Finance 31(2): 455-475.
A dividend yield model has been widely used in previous research that relates stock market valuations to cash flow fundamentals. Given controversies about using dividends as a proxy for cash flows, a loglinear book-to-market model has recently been proposed. However, these models rely on the assumption that dividend yield and book-to-market ratio are both stationary, and empirical evidence for this is, at best, mixed. We develop a new model, the loglinear cointegration model, that explains future profitability and excess stock returns in terms of a linear combination of log book-to-market ratio and log dividend yield. The loglinear cointegration model performs better than the log dividend yield model and the log book-to-market model in terms of cross-equation restriction tests and forecasting performance comparisons. The superior performance of the loglinear cointegration model suggests that the linear combination may be a better indicator of intrinsic fundamentals than the dividend yield or the book-to-market ratio separately.
Jiménez, G., V. Salas, et al. (2009). "Organizational distance and use of collateral for business loans." Journal of Banking & Finance 33(2): 234-243.
This paper examines the effect of organizational distance (i.e. distance between the headquarters of the bank that grants a loan and the location of the borrower) on the use of collateral for business loans by Spanish banks on the basis of the recent lender-based theory of collateral [Inderst, R., Mueller, H.M., 2007. A lender-based theory of collateral. Journal of Financial Economics 84, 826-859.]. We find that, for the average borrower, the use of collateral is higher for loans granted by local lenders than by distant ones. We also show that the difference in the likelihood of collateral in loans granted by local lenders, relative to distant lenders, is higher among older and larger firms, than, respectively, younger and smaller firms. We also find that banks use lending technologies that are different for near and for distant firms, in response to organizational diseconomies.
Jiraporn, P., Y. S. Kim, et al. (2006). "Corporate governance, shareholder rights and firm diversification: An empirical analysis." Journal of Banking & Finance 30(3): 947-963.
Grounded in agency theory, this study investigates how the strength of shareholder rights influences the extent of firm diversification and the excess value attributable to diversification. The empirical evidence reveals that the strength of shareholder rights is inversely related to the probability to diversify. Furthermore, firms where shareholder rights are more suppressed by restrictive corporate governance suffer a deeper diversification discount. Specifically, we document a 1.1-1.4% decline in firm value for each additional governance provision imposed on shareholders. An explicit distinction is made between global and industrial diversification. Our results support agency theory as an explanation for the value reduction in diversified firms. The evidence in favor of agency theory appears to be more pronounced for industrial diversification than for global diversification.
Jiraporn, P., M. Singh, et al. (2009). "Ineffective corporate governance: Director busyness and board committee memberships." Journal of Banking & Finance 33(5): 819-828.
Our paper examines whether holding multiple outside board seats compromises a director's ability to effectively perform monitoring duties. Analyzing over 1400 firms, we report that individuals who hold more outside directorships serve on fewer board committees. The relation, however, appears non-linear, U-shaped, and in support for both the busyness and the reputation hypotheses. In addition, we find that holding more outside board seats decreases the likelihood of membership on compensation and audit committees. The findings substantiate evidence [Akhigbe, A., Martin, A.D., 2006. Valuation impact of Sarbanes-Oxley: Evidence from disclosure and governance within the financial services industry. Journal of Banking and Finance 30 (3), 989-1006] of value relevance of board committee structures. Additional analysis of committee memberships suggests that women and ethnic minorities are placed on more board committees. Also, directors on smaller and independent boards serve on more committees. Finally, it appears that the Sarbanes-Oxley act had a material impact on the association between the number of multiple board seats and committee memberships.
Jobst, N. J., G. Mitra, et al. (2006). "Integrating market and credit risk: A simulation and optimisation perspective." Journal of Banking & Finance 30(2): 717-742.
We introduce a modelling paradigm which integrates credit risk and market risk in describing the random dynamical behaviour of the underlying fixed income assets. We then consider an asset and liability management (ALM) problem and develop a multistage stochastic programming model which focuses on optimum risk decisions. These models exploit the dynamical multiperiod structure of credit risk and provide insight into the corrective recourse decisions whereby issues such as the timing risk of default is appropriately taken into consideration. We also present an index tracking model in which risk is measured (and optimised) by the CVaR of the tracking portfolio in relation to the index. In-sample as well as out-of-sample (backtesting) experiments are undertaken to validate our approach. The main benefits of backtesting, that is, ex-post analysis are that (a) we gain insight into asset allocation decisions, and (b) we are able to demonstrate the feasibility and flexibility of the chosen framework.
Johnston, M. (2009). "Extending the Basel II approach to estimate capital requirements for equity investments." Journal of Banking & Finance 33(6): 1177-1185.
Under the Basel II banking regulatory capital regime the capital requirements for credit exposures are calculated using the Asymptotic Single Risk Factor (ASRF) approach. The capital requirement is taken to be the contribution of an exposure to the unexpected loss on the bank's diversified portfolio. Here we extend this approach to calculate capital requirements for equity investments. We show that in the case when asset values have a normal distribution an analytical formula for the unexpected loss contribution may be developed. We show that the capital requirements for equity investments are quite different to those of credit exposures, since equity investments can suffer substantial loss of value even when the underlying company has not defaulted. Unexpected loss is commonly used as a measure of capital requirements, but it ignores the ability of earnings to absorb loss. We propose a definition of capital requirement that recognises the expected earnings on assets, and show how to combine the ASRF model and the Capital Asset Pricing Model to compute this quantity for credit and equity exposures.
Jokipii, T. and A. Milne (2008). "The cyclical behaviour of European bank capital buffers." Journal of Banking & Finance 32(8): 1440-1451.
Using an unbalanced panel of accounting data from 1997 to 2004 and controlling for individual bank costs and risk, we find capital buffers of the banks in the EU15 have a significant negative co-movement with the cycle. For banks in the accession countries there is significant positive co-movement. Capital buffers of commercial and savings banks, and of large banks, exhibit negative co-movement. Those of co-operative and smaller banks exhibit positive co-movement. Speeds of adjustment are fairly slow. We interpret these results and discuss policy implications, noting that negative co-movement of capital buffers will exacerbate the pro-cyclical impact of Basel II.
Jones, B. E., D. H. Dutkowsky, et al. (2005). "Sweep programs and optimal monetary aggregation." Journal of Banking & Finance 29(2): 483-508.
This paper examines the admissibility of monetary aggregate groupings for the US over 1993-2001, based upon weak separability. We investigate the impact of retail and commercial demand deposit sweep programs on the separability of monetary asset groupings. Weak separability is tested using the Swofford-Whitney and Fleissig-Whitney tests. We use Varian's measurement error adjustment procedure to eliminate violations of the Generalized Axiom of Revealed Preference (GARP). When funds from both retail and commercial demand deposit sweep programs are placed within checkable deposits, all groupings, narrow and broad, pass GARP and weak separability. For groupings based on conventional money measures, tests tend to favor broad aggregates.
Jørgensen, P. L. (2007). "Traffic light options." Journal of Banking & Finance 31(12): 3698-3719.
This paper introduces, prices, and analyzes traffic light options. The traffic light option is an innovative structured OTC derivative developed independently by several London-based investment banks to suit the needs of Danish life and pension (L&P) companies, which must comply with the traffic light solvency stress test system introduced by the Danish Financial Supervisory Authority (DFSA) in June 2001. This monitoring system requires L&P companies to submit regular reports documenting the sensitivity of the companies' base capital to certain pre-defined market shocks - the red and yellow light scenarios. These stress scenarios entail drops in interest rates as well as in stock prices, and traffic light options are thus designed to pay off and preserve sufficient capital when interest rates and stock prices fall simultaneously. Sweden's FSA implemented a traffic light system in January 2006, and supervisory authorities in many other European countries have implemented similar regulation. Traffic light options are therefore likely to attract the attention of a wider audience of pension fund managers in the future. Focusing on the valuation of the traffic light option we set up a Black-Scholes/Hull-White model to describe stock market and interest rate dynamics, and analyze the traffic light option in this framework.
Jostarndt, P. and Z. Sautner (2008). "Financial distress, corporate control, and management turnover." Journal of Banking & Finance 32(10): 2188-2204.
We empirically investigate the effect of financial distress on corporate ownership and control. Our analysis is based on a panel of 267 German firms that suffered from repeated interest coverage shortfalls between 1996 and 2004. We track each firm's development over the distress cycle with particular attention to corporate ownership, restructuring, and management turnover. We find a significant decrease in ownership concentration. Private investors gradually give up their dominating role and thereby cease to be an effective source of managerial control. By contrast, ownership representation by banks and outside investors almost doubles. Shareholdings by executive and non-executive directors also substantially increase but have no effect on managerial tenure. Forced management turnover is mostly initiated by outside investors and banks and often occurs subsequent to debt restructurings, block investments, and takeovers.
Junker, M., A. Szimayer, et al. (2006). "Nonlinear term structure dependence: Copula functions, empirics, and risk implications." Journal of Banking & Finance30(4): 1171-1199.
This paper documents nonlinear cross-sectional dependence in the term structure of US-Treasury yields and points out risk management implications. The analysis is based on a Kalman filter estimation of a two-factor affine model which specifies the yield curve dynamics. We then apply a broad class of copula functions for modeling dependence in factors spanning the yield curve. Our sample of monthly yields in the 1982-2001 period provides evidence of upper tail dependence in yield innovations; i.e., large positive interest rate shocks tend to occur under increased dependence. In contrast, the best-fitting copula model coincides with zero lower tail dependence. This asymmetry has substantial risk management implications. We give an example in estimating bond portfolio loss quantiles and report the biases which result from an application of the normal dependence model.
Kabir, M. H. and M. K. Hassan (2005). "The near-collapse of LTCM, US financial stock returns, and the fed." Journal of Banking & Finance 29(2): 441-460.
We examine both the contagion and the "too-big-to-fail" hypotheses in the context of the long-term capital management (LTCM) crisis in the US financial services industry. Our results show that those commercial and investments banks that were exposed to LTCM lost market values significantly around important events surrounding the near collapse of LTCM, but the losses experienced by investment banks are much higher than the losses faced by commercial banks. Smaller S&L institutions and bigger insurance companies were also affected by the crisis, implying a form of contagion effect in the financial sector. We find some evidence of a [`]too-big-to-fail' policy with the involvement of the Fed in LTCM, as perceived by the markets.
Kadam, A. and P. Lenk (2008). "Bayesian inference for issuer heterogeneity in credit ratings migration." Journal of Banking & Finance 32(10): 2267-2274.
Rating transition matrices for corporate bond issuers are often based on fitting a discrete time Markov chain model to homogeneous cohorts. Literature has documented that rating migration matrices can differ considerably depending on the characteristics of the issuers in the pool used for estimation. However, it is also well known in the literature that a continuous time Markov chain gives statistically superior estimates of the rating migration process. It remains to verify and quantify the issuer heterogeneity in rating migration behavior using a continuous time Markov chain. We fill this gap in the literature. We provide Bayesian estimates to mitigate the problem of data sparsity. Default data, especially when narrowing down to issuers with specific characteristics, can be highly sparse. Using classical estimation tools in such a situation can result in large estimation errors. Hence we adopt Bayesian estimation techniques. We apply them to the Moodys corporate bond default database. Our results indicate strong country and industry effects on the determination of rating migration behavior. Using the CreditRisk+ framework, and a sample credit portfolio, we show that ignoring issuer heterogeneity can give erroneous estimates of Value-at-Risk and a misleading picture of the risk capital. This insight is consistent with some recent findings in the literature. Therefore, given the upcoming Basel II implementation, understanding issuer heterogeneity has important policy implications.
Kadapakkam, P.-R. and V. Martinez (2008). "Ex-dividend returns: The Mexican puzzle." Journal of Banking & Finance 32(11): 2453-2461.
We study ex-dividend returns in Mexico, where an imputation system entitles individual investors to a net dividend tax credit. Based on taxation, we expect ex-day abnormal returns to be negative or at most zero in Mexico. However, they are significantly positive. Because ex-day returns are positive even for stocks restricted to Mexican nationals, they are not attributable to foreign stockholders' tax considerations. None of the market microstructure-based hypothesis in the literature can explain these positive ex-day returns. Ex-day returns in Mexico are a puzzle.
Kalev, P. S., A. H. Nguyen, et al. (2008). "Foreign versus local investors: Who knows more? Who makes more?" Journal of Banking & Finance 32(11): 2376-2389.
This paper examines the nature of information asymmetry between foreign and local investors on the Helsinki stock exchange (HEX) for the period 1999-2004. We take into account the differences in informational characteristics by partitioning stocks into single-listed, cross-listed and internationally well-known stock categories, after which we compare foreign and local investors' performance and trading advantages. Local investors have trading advantages in the short term in all stock categories. However, such local advantages diminish for Nokia, the only internationally well-known stock on HEX.
Kallio, M. and W. T. Ziemba (2007). "Using Tucker's theorem of the alternative to simplify, review and expand discrete arbitrage theory." Journal of Banking & Finance 31(8): 2281-2302.
For valuing derivatives and other assets in securities and commodities markets, arbitrage pricing theory has been a major approach for decades. This paper derives fundamental arbitrage pricing results in finite dimensions in a simple unified framework using Tucker's theorem of the alternative. Frictionless results, that is perfect market results, plus imperfect market results such as those with dividends, periodic interest payments, transaction costs, different interest rates for lending and borrowing, shorting costs and constrained short selling are presented. While the results are mostly known and appear in various places, our contribution is to present them in a coherent and comprehensive fashion with very simple proofs. The analysis yields a simple procedure to prove new results and some are presented for cases with imperfect market frictions.
Kalotay, E., P. Gray, et al. (2007). "Consumer expectations and short-horizon return predictability." Journal of Banking & Finance 31(10): 3102-3124.
Lettau and Ludvigson [Lettau, M., Ludvigson, S, 2001. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56, 815-849] argue that fluctuations from the equilibrium ratio of consumption to wealth (cây) reflect changing expectations of asset returns and document significant short-horizon predictability based on cây. This paper further explores the role of consumer expectations in modeling time variation of expected equity returns by considering two measures of consumer expectations: (i) consumer behavior as reflected in cây, and (ii) a more-direct measure of expectations captured by the Index of Consumer Sentiment (ICS). We report strong regression-based evidence of return predictability based on cây, which remains evident even after accounting for various sources of estimation risk. However, the regression-based evidence of predictability does not necessarily imply that shifts in aggregate consumption and the components of aggregate wealth give rise to economically significant investment signals. The survey-based measure of expectations (ICS) is shown to complement the behavioral measure (cây) but has no apparent stand-alone predictive value in forecasting equity returns.
Kamstra, M. J., L. A. Kramer, et al. (2009). "Is it the weather? Comment." Journal of Banking & Finance 33(3): 578-582.
This comment discusses some errors in a recent paper by Jacobsen and Marquering [Jacobsen, B., Marquering, W., 2008. Is it the weather? Journal of Banking and Finance 32 (4), 526-540], in which the authors challenge our previous finding that stock market returns exhibit seasonal patterns consistent with the influence of seasonal affective disorder on investor risk aversion. We find that we cannot replicate the authors' findings, even after corresponding with them. Furthermore, we document several problems with their methodology, including misspecification of their economic model, misspecification of their econometric model, and use of inappropriate data. While we agree that seasonal affective disorder is not an explanation for all variation in equity markets, we do maintain that careful analysis leads to economically and statistically significant evidence of the effect we originally documented.
Kanagaretnam, K., G. V. Krishnan, et al. (2009). "Is the market valuation of banks' loan loss provision conditional on auditor reputation?" Journal of Banking & Finance 33(6): 1039-1047.
We examine how auditor reputation conditions the market valuation of banks' loan loss provision (LLP). The inherent uncertainty associated with and discretion permitted in estimating the LLP contributes to information asymmetry. The auditor's certification and monitoring roles influence firm value by mitigating this information asymmetry. We examine two aspects of auditor reputation, auditor type (Big 5 vs. non-Big 5) and auditor expertise, in the banking industry. We find a significant, positive association between the discretionary component of LLP and stock return for banks audited by the Big 5 auditors. Further analysis indicates that auditor expertise within banking and not auditor type drives this significant, positive association. Overall, our results are consistent with auditor expertise in the banking industry mitigating information asymmetry between bank managers and investors and enhancing the information conveyed by discretionary loan loss provision.
Kanas, A. (2008). "On real interest rate dynamics and regime switching." Journal of Banking & Finance 32(10): 2089-2098.
We find evidence of regime switching dynamics in the USA and the UK real interest rates over the period 1881-2003. For the UK, there is a regime in which the real interest rate displays a relatively stronger mean-reversion and a regime in which it displays a relatively weaker mean-reversion. The former regime is characterized by a relatively larger error in the estimation of the reversion parameter, and higher volatility. For the USA, the two regimes differ in volatility. The probability of transition from one regime to another is found to be significantly related to the inflation rate regime, and to the political regime. The results highlight the importance of regime switching in the dynamics of the real interest rate, as well as the role of inflation and political regimes in explaining this switching.
Kang, J.-K. and W.-L. Liu (2008). "Bank incentives and suboptimal lending decisions: Evidence from the valuation effect of bank loan announcements in Japan."Journal of Banking & Finance 32(6): 915-929.
Using a sample of bank loan announcements in Japan, we examine whether or not banks have incentives to engage in suboptimal lending that results in wealth transfer from the banks to the borrowing firms. We find that abnormal returns for borrowing firms are significantly positive, but those for lending banks are sometimes significantly negative. Furthermore, the announcement returns for borrowing firms are negatively related to those for lending banks, especially when poorly performing firms borrow from financially healthy (low-risk) banks. Our results suggest that the positive valuation effect of bank loan announcements for borrowing firms is mainly due to a wealth transfer from lending banks.
Kaniovski, Y., M. Murgia, et al. (2007). "Introduction." Journal of Banking & Finance 31(8): 2231-2232.
Kaniovski, Y. M. and G. C. Pflug (2007). "Risk assessment for credit portfolios: A coupled Markov chain model." Journal of Banking & Finance 31(8): 2303-2323.
Credit portfolios, as for instance Collateralized Debt Obligations (CDO's) consist of credits that are heterogeneous both with respect to their ratings and the involved industry sectors. Estimates for the transition probabilities for different rating classes are well known and documented. We develop a Markov chain model, which uses the given transition probability matrix as the marginal law, but introduces correlation coefficients within and between industry sectors and between rating classes for the joint law of migration of all components of the portfolio. We have found a generating function for the one step joint distribution of all assets having non-default credit ratings and a generating function of the loss distribution. The numerical simulations presented here verify that the average number of defaults is not affected by the correlation coefficients, but the percentiles of the number of defaults are heavily dependent upon them. In particular, for strongly correlated assets, the distribution of the number of defaults follows a "cascade" pattern nesting in non-overlapping intervals. As a result, the probability of a large number of defaults is higher for correlated assets than for non-correlated ones.
Kao, J. L., D. Wu, et al. (2009). "Regulations, earnings management, and post-IPO performance: The Chinese evidence." Journal of Banking & Finance 33(1): 63-76.
In this study, we examine whether government regulatory initiatives in China involving IPO by SOEs may have contributed to opportunistic behaviors by the issuer. We focus on two sets of IPO regulations issued between January 1, 1996 and February 11, 1999: pricing regulations, which stipulate that IPO prices be a function of accounting performance, and penalty regulations, which penalize IPO firms for overly optimistic forecasts. We find that IPO firms that report better pricing-period accounting performance have larger declines in post-IPO profitability, lower first-day stock returns and worse long-run post-IPO stock performance. Furthermore, IPO firms that make overoptimistic forecasts also have lower first-day returns and worse post-IPO stock performance. Using non-core earnings as the proxy for earnings management, we document some evidence that IPO firms that report higher pricing-period accounting performance have engaged in more income-increasing earnings management. Hence, pricing regulations may have induced IPO firms to inflate pricing-period earnings and affect the post-IPO performance negatively. On the other hand, penalty regulations have deterred IPO firms from making overoptimistic earnings forecast and therefore have a positive impact on the behavior of IPO firms.
Kaplanski, G. and H. Levy (2007). "Basel's value-at-risk capital requirement regulation: An efficiency analysis." Journal of Banking & Finance 31(6): 1887-1906.
We analyze the optimal portfolio policies of expected utility maximizing agents under VaR Capital Requirement (VaR-CR) regulation in comparison to the optimal policy under exogenously-imposed VaR Limit (VaR-L) and Limited-Expected-Loss (LEL) regulations. With VaR-CR regulation the agent strategy consists of simultaneous decisions on both the portfolio VaR and on the implied amount of required eligible capital. As a result, the performance of VaR-CR regulation depends on its design (the parameter n) and the agent preferences. We show that an optimal VaR-CR regulation allows the regulator on the one hand, to completely eliminate the exposure to the largest losses, which may jeopardize the existence of the institution, and on the other hand, to restrain the portfolio exposure to all other losses. These results rationalize the current Basel regulations. However, the analysis shows also that there is an optimal level of required eligible capital from the regulator standpoint. Counter-intuitively, any requirement above this optimal level is inefficient as it leads to a smaller amount of actually maintained eligible capital and thereby to a larger exposure to the most adverse states of the world. Unfortunately, the current Basel's range of required levels (n = 3-4) is within this inefficient range. Moreover, with an inefficient regulation the agent might employ an inefficient reporting and disclosure procedure.
Karlsson, A. and L. Nordén (2007). "Home sweet home: Home bias and international diversification among individual investors." Journal of Banking & Finance31(2): 317-333.
A striking feature of international portfolio investment is the extent to which equity portfolios are concentrated in the domestic market of the investor. We investigate differences in home bias on an individual level by studying portfolios formed as a part of the new defined contribution pension plan in Sweden. We estimate the likelihood of home bias and use individuals' demographic and socioeconomic features as explanatory variables. Our findings indicate that the likelihood of home bias is caused by both rational and irrational factors. Moreover, we relate home bias to investors' desire to hedge against inflation, sophistication and overconfidence.
Kaufman, G. (2006). "Gerald O. Bierwag (February 4, 1936-February 15, 2005)." Journal of Banking & Finance 30(7): iii-iv.
Kauko, K. (2007). "Interlinking securities settlement systems: A strategic commitment?" Journal of Banking & Finance 31(10): 2962-2977.
Central securities depositories (CSDs) in Europe have opened mutual links, but most of them are seldom used. Why are idle links established? By allowing a foreign CSD to offer services through the link, the domestic CSD invites competition. By inviting competition the domestic CSD can commit itself not to charge monopoly fees for secondary market services. This enables it to charge higher fees for securities issuance in the primary market. It is shown that commitment via an idle link can be optimal for a profit maximising CSD.
Kauko, K. (2009). "Managers and efficiency in banking." Journal of Banking & Finance 33(3): 546-556.
This paper presents evidence on the impact of managers on cost efficiency in banking. Stochastic frontier analysis is applied to a unique Finnish data set. Manager age and education have strong yet complicated effects on efficiency. The impact of age on efficiency depends on education. A university degree is useful mainly in the largest banks of the sample. Educational background seems to be less important for young managers than for mature ones. Managing director changes are systematically followed by efficiency changes. Retirement typically causes an efficiency improvement whereas other manager changes can either improve or weaken efficiency. However, in many cases mature managers outperform their young colleagues.
Kaul, A. and S. Sapp "Trading activity, dealer concentration and foreign exchange market quality." Journal of Banking & Finance In Press, Accepted Manuscript.
We study the relation between foreign exchange market quality and both trading activity and dealer concentration by considering two currency pairs with significant differences along both dimensions - the Euro-U.S. dollar and Canadian dollar-U.S. dollar. A variance ratio test reveals over-reaction in currency prices, but that this is smallest when trading activity is high and dealer concentration at its peak. A GARCH model shows that over-reaction declines as trading activity and dealer concentration increase, with the results being stronger for the Euro. Our results confirm that trading activity is an important determinant of market quality, but also point to a significant role for dealer concentration.
Ke, M.-C., Y.-C. Chiang, et al. (2007). "Day-of-the-week effect in the Taiwan foreign exchange market." Journal of Banking & Finance 31(9): 2847-2865.
This study uses stochastic dominance with and without risk-free assets to examine whether trading days can affect patterns of the day-of-the-week effect in the Taiwan foreign exchange market. Our results generally indicate that higher returns appear on the first three days of the week across different trading-day regimes in the Taiwan foreign exchange market, confirming day-of-the-week effect. Allocating part of investors' assets in risk-free assets is useful in distinguishing returns among weekdays for all currencies.
Kedia, S. (2006). "Estimating product market competition: Methodology and application." Journal of Banking & Finance 30(3): 875-894.
In oligopolies, firms behave strategically and commit to actions that elicit favorable responses from rivals. Firm actions consequently are a function of the nature of these strategic interactions. In this paper, we develop a methodology for the empirical estimation of strategic interactions in product markets. We then apply our measure of strategic interactions to CEO compensation. We use quarterly data on profits and sales from Compustat to estimate the slope of firm's reaction function. When the slope is negative and marginal profits decrease with an increase in the rival's actions the firm is classified as a strategic substitute. When the slope is positive and marginal profits increase with an increase in the rival's actions the firm is classified as a strategic complement. As predicted by theory, we find significant evidence that strategic substitutes decrease the pay for performance incentives of their CEOs. On the other hand, strategic complements significantly increase CEO pay for performance incentives. The empirical measure developed can be used to test a wide variety of strategic models.
Kessler, D. (2008). "Insurance market mechanisms and government interventions." Journal of Banking & Finance 32(1): 4-14.
The expansion of the State-as-insurer has played a major role in the long-term growth of the public sector, but we are probably reaching the turning point. Because of its manifold failures, the State-as-insurer is facing crisis all around the world, with exploding expenditures. This will probably induce a shift in the private-public frontier, which makes it much more important than in the past to regulate the insurance industry efficiently. Coming back to the failures of the State-as-insurer, we should underline the role played by this flawed hypothesis that sets market logic and private interest against public interest.
Kessler, S. and B. Scherer (2009). "Varying risk premia in international bond markets." Journal of Banking & Finance 33(8): 1361-1375.
Cochrane and Piazzesi [Cochrane, J.H., Piazzesi, M., 2005. Bond risk premia. American Economic Review 95, 138-160] use forward rates to forecast future bond returns. We extend their approach by applying their model to international bond markets. Our results indicate that the unrestricted Cochrane and Piazzesi (2005) model has a reasonable forecasting power for future bond returns. The restricted model, however, does not perform as well on an international level. Furthermore, we cannot confirm the systematic tent shape of the estimated parameters found by Cochrane and Piazzesi (2005). The forecasting models are used to implement various trading strategies. These strategies exhibit high information ratios when implemented in individual countries or on an international level and outperform alternative approaches. We introduce an alternative specification to forecast future bond returns and achieve superior risk-adjusted returns in our trading strategy. Bayesian model averaging is used to enhance the performance of the proposed trading strategy.
Khaliq, A. Q. M., D. A. Voss, et al. (2006). "A linearly implicit predictor-corrector scheme for pricing American options using a penalty method approach." Journal of Banking & Finance 30(2): 489-502.
Pricing of an American option is complicated since at each time we have to determine not only the option value but also whether or not it should be exercised (early exercise constraint). This makes the valuation of an American option a free boundary problem. Typically at each time there is a particular value of the asset, which marks the boundary between two regions: to one side one should hold the option and to other side one should exercise it. Assuming that investors act optimally, the value of an American option cannot fall below the value that would be obtained if it were exercised early. Effectively, this means that the American option early exercise feature transforms the original linear pricing partial differential equation into a nonlinear one. We consider a penalty method approach in which the free and moving boundary is removed by adding a small and continuous penalty term to the Black-Scholes equation; consequently,the problem can be solved on a fixed domain. Analytical solutions of the Black-Scholes model of American option problems are seldom available and hence such derivatives must be priced by stable and efficient numerical techniques. Standard numerical methods involve the need to solve a system of nonlinear equations, evolving from the finite difference discretization of the nonlinear Black-Scholes model, at each time step by a Newton-type iterative procedure. We implement a novel linearly implicit scheme by treating the nonlinear penalty term explicitly, while maintaining superior accuracy and stability properties compared to the well-known [theta]-methods.
Khaliq, A. Q. M., D. A. Voss, et al. (2007). "Pricing exotic options with L-stable Padé schemes." Journal of Banking & Finance 31(11): 3438-3461.
In this paper we develop a strongly stable (L-stable) and highly accurate method for pricing exotic options. The method is based on Padé schemes and also utilizes partial fraction decomposition to address issues regarding accuracy and computational efficiency. Due to non-smooth payoffs, which cause discontinuities in the solution (or its derivatives), standard A-stable methods are prone to produce large and spurious oscillations in the numerical solutions which would mislead to estimating options accurately. The proposed method does not suffer these drawbacks while being easy to implement on concurrent processors. Numerical results are presented for digital options, butterfly spread and barrier options in one and two assets. In addition, the methods are tested on the Heston stochastic volatility model.
Kibzun, A. I. and E. A. Kuznetsov (2006). "Analysis of criteria VaR and CVaR." Journal of Banking & Finance 30(2): 779-796.
Criteria VaR (Value-at-Risk) and CVaR (Conditional Value-at-Risk), which are well-known in financial mathematics, are compared. Some connection between them is established. Ways of choice a level of confidence probability for the quantile optimization problem are suggested. The ways are based on some equations of balance between VaR and CVaR. Examples are discussed.
Kim, M., E. G. Kristiansen, et al. (2005). "Endogenous product differentiation in credit markets: What do borrowers pay for?" Journal of Banking & Finance 29(3): 681-699.
This paper studies strategies pursued by banks in order to differentiate their services and soften competition. More specifically we analyze whether bank's ability to avoid losses, its capital ratio, or bank size can be used as strategic variables to make banks different and increase the interest rates banks can charge their borrowers in equilibrium. Using a panel of data covering Norwegian banks between 1993 and 1998 we find empirical support that the ability to avoid losses, measured by the ratio of loss provisions, may act as such a strategic variable. A likely interpretation is that borrowers use high-quality low-loss banks to signal their creditworthiness to other stakeholders. This supports the hypothesis that high-quality banks serve as certifiers for their borrowers. Furthermore, this suggests that not only lenders and supervisors but also borrowers may discipline banks to avoid losses.
Kim, M. A., B.-G. Jang, et al. (2008). "A first-passage-time model under regime-switching market environment." Journal of Banking & Finance 32(12): 2617-2627.
In this paper, we suggest a first-passage-time model which can explain default probability and default correlation dynamics under stochastic market environment. We add a Markov regime-switching market condition to the first-passage-time model of Zhou [Zhou, C., 2001. An analysis of default correlations and multiple defaults. Review of Financial Studies 14, 555-576]. Using this model, we try to explain various relationship between default probability, default correlation, and market condition. We also suggest a valuation method for credit default swap (CDS) with (or without) counterparty default risk (CDR) and basket default swap under this model. Our numerical results provide us with several meaningful implications. First, default swap spread is higher in economic recession than in economic expansion across default swap maturity. Second, as the difference of asset return volatility between under bear market and under bull market increases, CDS spread increases regardless of maturity. Third, the bigger the intensity shifting from bull market to bear market, the higher the spread for both CDS without CDR and basket default swap.
Kim, S. J., F. Moshirian, et al. (2005). "Dynamic stock market integration driven by the European Monetary Union: An empirical analysis." Journal of Banking & Finance 29(10): 2475-2502.
We examine the influence of the European Monetary Union (EMU) on the dynamic process of stock market integration over the period 2 January 1989-29 May 2003 using a bivariate EGARCH framework with time-varying conditional correlations. We find that there has been a clear regime shift in European stock market integration with the introduction of the EMU. The EMU has been necessary for stock market integration as unidirectional causality was found. Linear systems regression analysis shows that the increase in both regional and global stock market integration over this period was significantly driven in part, by macroeconomic convergence associated with the introduction of the EMU and financial development levels.
Kim, S.-J., F. Moshirian, et al. (2006). "Evolution of international stock and bond market integration: Influence of the European Monetary Union." Journal of Banking & Finance 30(5): 1507-1534.
This paper examines the dynamic relationship between daily stock and government bond returns of selected countries over the past decade to infer the state and progress of inter-financial market integration. We proceed to empirically investigate the influence of the European Monetary Union (EMU) on time variations in inter-stock-bond market integration/segmentation dynamics using a two-step procedure: First, we document the downward trends in time-varying conditional correlations between stock and bond market returns in European countries, Japan and the US. Second, we investigate the causality and determinants of this interdependent relationship, in particular, whether the various macroeconomic convergence criteria associated with the EMU have played a significant role. We find that real economic integration and the reduction in currency risk have generally had the desired effect on financial integration but monetary policy integration may have created uncertain investor sentiments on the economic future of the EMU, thereby stimulating a flight to quality phenomenon.
Kim, S.-J. and J. Sheen (2006). "Interventions in the Yen-dollar spot market: A story of price, volatility and volume." Journal of Banking & Finance 30(11): 3191-3214.
We test the effectiveness of Bank of Japan (BOJ)'s foreign exchange interventions on conditional first and second moments of exchange rate returns and traded volumes, using a bivariate EGARCH model of the Yen/USD market from 5-13-1991 to 3-16-2004. We also estimate a friction model of BOJ's intervention reaction function based on reducing short-term market disorderliness and supplementing domestic monetary policy. Important finding of this study are that: (i) we find ineffectiveness of BOJ interventions in influencing exchange rate trends pre-1995, in general, but effectiveness post-1995; (ii) FED intervention amplified the effectiveness of the BOJ transactions; (iii) interventions amplified market volatility and volumes through a [`]learning by trading' process; (iv) BOJ's interventions were based on [`]leaning against the wind' motivations on the exchange rate trend and volumes; and (v) BOJ interventions were vigorously used in support of domestic monetary policy objectives post-1995. Though some of our findings confirm recent studies, our analysis goes deeper to provide new findings with important implications for central banks and foreign exchange market participants.
Kim, Y. and B. S. Lee (2007). "Limited participation and the closed-end fund discount." Journal of Banking & Finance 31(2): 381-399.
In this paper, we present economic forces that affect the closed-end fund share price using a simple two-period model with limited participation. We characterize three economic forces: management fee, principal-agent problem effect and diversification benefit effect. The role of the management fee is consistent with recent studies by Ross [Ross S., 2002. Neoclassical finance, alternative finance and the closed end fund puzzle. European Financial Management 8, 129-137, Ross, S., 2002. A neoclassical look at behavioral finance: closed end funds. The Princeton lectures in finance III] and findings of various empirical studies [e.g., Kumar, R., Noronha, G.M., 1992. A re-examination of the relationship between closed-end fund discounts and expenses. Journal of Financial Research 15(2) Summer, 139-147; Russel, P.S., 2005. Closed-end fund pricing: The puzzle, the explanations, and some new evidence, Journal of Business and Economic Studies 11(1), 34-49; Gemmill, G., Thomas, D.C., 2002. Noise trading, costly arbitrage, and asset prices: Evidence from closed end funds. Journal of Finance 57(6), 2571-2594]. The model's principal-agent problem effect is consistent with empirical findings by Brickley et al. [Brickley, James, Steven Manaster, Schallheim, James, 1991. The tax-timing option and the discounts on closed-end investment companies. Journal of Business 64, 287-312] of positive relation between the fund discount and the average variance of the constituent assets in the fund portfolio. In addition, it provides a theoretical framework for empirical studies, which examine the role of agency costs [Barclay, Michael J., Clifford G. Holderness, Jeffrey Pontiff, 1993. Private benefits from block ownership and discounts on closed-end funds. Journal of Financial Economics 33, 263-291] and compensation contracts [Coles, J., Suay, J., Woodbury, D., 2000. Fund advisor compensation in closed-end funds. Journal of Finance 55 (3), 1385-1414; Deli, Daniel N., 2002. Mutual fund advisory contracts: An empirical Investigation. Journal of Finance 57(1), 109-133] on the behavior of fund managers and fund discounts. The model's diversification benefit effect supports the result in [Bonser-Neal C., Brauer,G., Neal, R.., Wheatley, S., 1990. International investment restrictions and closed-end country fund prices. Journal of Finance 45, 523-547] that announcement of financial market liberalization is associated with a decrease in the fund premium. It also supports the findings of [Kumar, R., Noronha, G.M., 1992. A re-examination of the relationship between closed-end fund discounts and expenses. Journal of Financial Research 15(2) Summer, 139-147; Chay, J.B., Trzcinka, Charles A., 1999. Managerial performance and the cross-sectional pricing of closed-end funds. Journal of Financial Economics 52, 379-408] of a positive relation between current premium and the risk-adjusted return over the following year.
Kim, Y. and S. Nabar (2007). "Bankruptcy probability changes and the differential informativeness of bond upgrades and downgrades." Journal of Banking & Finance 31(12): 3843-3861.
Prior studies have found that stock returns around announcements of bond upgrades are insignificant, but that stock prices respond negatively to announcements of bond downgrades. This asymmetric stock market reaction suggests either that bond downgrades are timelier than upgrades, or that voluntary disclosures by managers preempt upgrades but not downgrades. This study investigates these conjectures by examining changes in firms' probabilities of bankruptcy (assessed using bankruptcy prediction models) and voluntary disclosure activity around rating change announcements. The results indicate that the assessed probability of bankruptcy decreases before bond upgrades, but not after. By contrast, the assessed probability of bankruptcy increases both before and after bond downgrades. We also find that controlling for potential wealth-transfer related rating actions, which can impact stock returns differently, does not alter our results. Tests of press releases and earnings forecasts issued by firms suggest that the differential informativeness of upgrades and downgrades is not caused by differences in pre-rating change voluntary disclosures by upgraded and downgraded firms. The results support the hypothesis that downgrades are timelier than upgrades.
Kim, Y. S., S. T. Rachev, et al. (2008). "Financial market models with Lévy processes and time-varying volatility." Journal of Banking & Finance 32(7): 1363-1378.
Asset management and pricing models require the proper modeling of the return distribution of financial assets. While the return distribution used in the traditional theories of asset pricing and portfolio selection is the normal distribution, numerous studies that have investigated the empirical behavior of asset returns in financial markets throughout the world reject the hypothesis that asset return distributions are normally distribution. Alternative models for describing return distributions have been proposed since the 1960s, with the strongest empirical and theoretical support being provided for the family of stable distributions (with the normal distribution being a special case of this distribution). Since the turn of the century, specific forms of the stable distribution have been proposed and tested that better fit the observed behavior of historical return distributions. More specifically, subclasses of the tempered stable distribution have been proposed. In this paper, we propose one such subclass of the tempered stable distribution which we refer to as the "KR distribution". We empirically test this distribution as well as two other recently proposed subclasses of the tempered stable distribution: the Carr-Geman-Madan-Yor (CGMY) distribution and the modified tempered stable (MTS) distribution. The advantage of the KR distribution over the other two distributions is that it has more flexible tail parameters. For these three subclasses of the tempered stable distribution, which are infinitely divisible and have exponential moments for some neighborhood of zero, we generate the exponential Lévy market models induced from them. We then construct a new GARCH model with the infinitely divisible distributed innovation and three subclasses of that GARCH model that incorporates three observed properties of asset returns: volatility clustering, fat tails, and skewness. We formulate the algorithm to find the risk-neutral return processes for those GARCH models using the "change of measure" for the tempered stable distributions. To compare the performance of those exponential Lévy models and the GARCH models, we report the results of the parameters estimated for the S&P 500 index and investigate the out-of-sample forecasting performance for those GARCH models for the S&P 500 option prices.
King, M. R. and E. Santor (2008). "Family values: Ownership structure, performance and capital structure of Canadian firms." Journal of Banking & Finance 32(11): 2423-2432.
This study examines how family ownership affects the performance and capital structure of 613 Canadian firms from 1998 to 2005. In particular, we distinguish the effect of family ownership from the use of control-enhancing mechanisms. We find that freestanding family owned firms with a single share class have similar market performance than other firms based on Tobin's q ratios, superior accounting performance based on ROA, and higher financial leverage based on debt-to-total assets. By contrast, family owned firms that use dual-class shares have valuations that are lower by 17% on average relative to widely held firms, despite having similar ROA and financial leverage.
King, T.-H. D. (2007). "Are embedded calls valuable? Evidence from agency bonds." Journal of Banking & Finance 31(1): 57-79.
This paper examines the call option values embedded in callable agency bonds. For FHLB, FNMA, and SLMA bonds, call value estimates range from 1.23% of par to 1.47% on average, which are between those for the treasury and corporate debt securities. FHLMC bonds, on the other hand, have an average call value estimate of 2.85%. Call values are significantly larger for bonds with a longer remaining maturity and greater default risk. Most interestingly, call values in the call protection period are significantly larger than those in the callable period except for the SLMA bonds, whereas previous studies on corporate debt find no significant difference in call values between these two periods. In general, call value exhibits a downward trend over time as the callable bond approaches maturity. Also, call value is inversely related to the level of interest rates. Interest rate drops are usually accompanied by an increase in call values. An analysis of the determinants of call values suggests the following conclusions. First, call values are negatively related to short-term interest rates and the slope of the yield curve, and positively related to coupon rate and remaining maturity. Second, bonds with a greater amount of call protection have smaller call values, which is in contrast with the finding in a previous study on corporate debt that call protection period has little effect on call value.
King, T.-H. D. and K. Khang (2005). "On the importance of systematic risk factors in explaining the cross-section of corporate bond yield spreads." Journal of Banking & Finance 29(12): 3141-3158.
In this paper we examine the importance of systematic equity market factors in explaining the cross-sectional variation in yield spreads on corporate debt. Based on a sample of 1771 corporate bonds over the period from January 1985 to March 1998, we find that once the default-related variables are controlled for, bond betas or sensitivities to aggregate equity market risks have very limited explanatory power. This is in contrast to [Elton, E.J., Gruber, M.J., 2001. Explaining the rate spread on corporate bonds. Journal of Finance 56, 247-277] who find that market factors tied to expected returns are predominantly important, but who do not control for these variables (i.e. the relevant variables from structural models), possibly biasing their estimates. On the other hand, our finding that the systematic factors exhibit some limited explanatory power suggests that the standard contingent claims approach may not fully apply. This finding is consistent with previous research that bond betas are not completely irrelevant once market frictions are introduced. Overall, the evidence provides empirical support for the proposition that structural models capture important elements of corporate bond yield spread determination and equity market systematic factors are by no means predominant.
Kishan, R. P. and T. P. Opiela (2006). "Bank capital and loan asymmetry in the transmission of monetary policy." Journal of Banking & Finance 30(1): 259-285.
Utilizing a bank-lending channel framework, we investigate the effects of expansionary and contractionary policy separately on the loan behavior of low-capital and high-capital banks, and between pre-Basel/FDICIA and post-Basel/FDICIA periods. Our results show that low-capital banks are adversely affected by contractionary policy. Expansionary policy, however, is not effective in stimulating the loan growth of low-capital banks. These results are consistent with lending channel predictions, but only hold in the post-Basel/FDICIA period when the capital constraint is stringent relative to the pre-Basel/FDICIA period. These asymmetric policy results have implications for the interaction of monetary and capital regulatory policies.
Klapper, L. (2006). "The role of factoring for financing small and medium enterprises." Journal of Banking & Finance 30(11): 3111-3130.
Factoring is explicitly linked to the value of a supplier's accounts receivable and receivables are sold, rather than collateralized, and factored receivables are not part of the estate of a bankrupt firm. Therefore, factoring may allow a high-risk supplier to transfer its credit risk to higher quality buyers. Empirical tests find that factoring is larger in countries with greater economic development and growth and developed credit information bureaus. "Reverse factoring" may mitigate the problem of borrowers' informational opacity if only receivables from high-quality buyers are factored. We illustrate the case of the Nafin reverse factoring program in Mexico.
Kleimeier, S. and H. Sander (2006). "Expected versus unexpected monetary policy impulses and interest rate pass-through in euro-zone retail banking markets."Journal of Banking & Finance 30(7): 1839-1870.
This paper investigates the interest rate pass-through in the euro-zone's retail banking markets by differentiating between expected and unexpected monetary policy impulses. The paper introduces interest futures as measures of expected interest rates into pass-through studies. By allowing various specifications of the pass-through process, including asymmetric adjustment, we find a faster pass-through in loan markets when interest rate changes are correctly anticipated. In contrast, deposit markets are found to be more rigid. Overall, our results suggest that a well-communicated monetary policy is important for a speedier and a more homogenous pass-through but may also be complemented by competition policies.
Kliger, D. and A. Kudryavtsev (2008). "Reference point formation by market investors." Journal of Banking & Finance 32(9): 1782-1794.
The disposition effect [Shefrin, H., Statman M., 1985, The disposition to sell winners too early and ride losers too long. Journal of Finance, 40, 777-790], investors' tendency to sell gaining assets and hold on to loosing assets, relies on the notion of a reference point distinguishing between losses and gains. While literature using aggregated market data documented the existence of such a reference point affecting investors' decisions, it had not pinpointed it. The main goal of our work is to shed light on the mechanism of reference point formation. We hypothesize that salient events taking place during a stock's holding period influence investors' perceptions and make them update the stock's reference point. Using analysts' earnings forecasts, stock price data, and firms' quarterly earnings announcements, we document that company-specific events indeed affect the reference points. We discover that the earnings announcements played a role in reference point formation when they were not anticipated, i.e., when (i) analysts' earnings forecasts failed to provide accurate predictions; and (ii) the earnings announcements were followed by market price reactions. Moreover, the reference points were affected more profoundly for low market capitalization, high beta firms, pointing that the reference point updating process is more reactive to events when information flow is low and prices are sensitive to market fluctuations. Our results also corroborate the attention hypothesis, i.e., the observation that agents facing numerous alternatives may consider primarily those that have caught their attention.
Knapp, M., A. Gart, et al. (2006). "The impact of mean reversion of bank profitability on post-merger performance in the banking industry." Journal of Banking & Finance 30(12): 3503-3517.
This research study examines the tendency for serial correlation in bank holding company profitability, finding significant evidence of reversion to the industry mean in profitability. The paper then considers the impact of mean reversion on the evaluation of post-merger performance of bank holding companies. The research concludes that when an adjustment is made for the mean reversion, post-merger results significantly exceed those of the industry in the first 5 years after the merger.
Knyazeva, A., D. Knyazeva, et al. "Ownership changes and access to external financing." Journal of Banking & Finance In Press, Corrected Proof.
This paper examines access to external financing in the privatization context and provides new evidence on the effects of financing constraints on performance and investment. Ownership reforms increase firms' reliance on external financing. Empirically, performance and investment changes around ownership reforms are increasing in country-level measures of access to credit. The presence of a severe prior public financing constraint contributes to stronger investment growth after privatization. Privatized enterprises do not outperform publicly owned industries, all else given. Our analyses rely on new international sector- and firm-level data and correct for potential endogeneity of ownership changes.
Kocenda, E. and T. Poghosyan "Macroeconomic sources of foreign exchange risk in new EU members." Journal of Banking & Finance In Press, Accepted Manuscript.
We address the issue of foreign exchange risk and its macroeconomic determinants in several new EU members. We derive the observable macroeconomic factors--consumption and inflation--using the stochastic discount factor (SDF) approach. The joint distribution of excess returns in the foreign exchange market and the factors are modeled using a multivariate GARCH-in-mean specification. Our findings show that both real and nominal factors play important roles in explaining the variability of the foreign exchange risk premium. Both types of factors should be included in monetary general equilibrium models employed to study excess returns. To contribute to the further stability of domestic currencies, the new EU members should strive to implement stabilization policies aimed at achieving nominal as well as real convergence with the core EU members.
Koetter, M., J. W. B. Bos, et al. (2007). "Accounting for distress in bank mergers." Journal of Banking & Finance 31(10): 3200-3217.
Most bank merger studies do not control for hidden bailouts, which may lead to biased results. In this study we employ a unique data set of approximately 1000 mergers to analyze the determinants of bank mergers. We use undisclosed information on banks' regulatory intervention history to distinguish between distressed and non-distressed mergers. Among merging banks, we find that improving financial profiles lower the likelihood of distressed mergers more than the likelihood of non-distressed mergers. The likelihood to acquire a bank is also reduced but less than the probability to be acquired. Both distressed and non-distressed mergers have worse CAMEL profiles than non-merging banks. Hence, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.
Koetter, M. and T. Poghosyan (2009). "The identification of technology regimes in banking: Implications for the market power-fragility nexus." Journal of Banking & Finance 33(8): 1413-1422.
Neglecting the existence of different technologies in banking can contaminate efficiency, market power, and other performance measures. By simultaneously estimating (i) technology regimes conditional on exogenous factors, (ii) efficiency conditional on risk management, and (iii) Lerner indices of German banks, we identify three distinct technology regimes: Public & Retail, Small & Specialized, and Universal & Relationship. System estimation at the regional level reveals that greater bank market power increases bank profitability but also fosters corporate defaults. Corporate defaults, in turn, lead to higher probabilities of bank distress, which supports the market power-fragility hypothesis.
Kole, E., K. Koedijk, et al. (2006). "Portfolio implications of systemic crises." Journal of Banking & Finance 30(8): 2347-2369.
Systemic crises can have grave consequences for investors in international equity markets, because they cause the risk-return trade-off to deteriorate severely for a longer period. We propose a novel approach to include the possibility of systemic crises in asset allocation decisions. By combining regime switching models with Merton [Merton, R.C., 1969. Lifetime portfolio selection under uncertainty: The continuous time case. Review of Economics and Statistics 51, 247-257]-style portfolio construction, our approach captures persistence of crises much better than existing models. Our analysis shows that incorporating systemic crises greatly affects asset allocation decisions, while the costs of ignoring them is substantial. For an expected utility maximizing US investor, who can invest globally these costs range from 1.13% per year of his initial wealth when he has no prior information on the likelihood of a crisis, to over 3% per month if a crisis occurs with almost certainty. If a crisis is taken into account, the investor allocates less to risky assets, and particularly less to the crisis prone emerging markets.
Kole, E., K. Koedijk, et al. (2007). "Selecting copulas for risk management." Journal of Banking & Finance 31(8): 2405-2423.
Copulas offer financial risk managers a powerful tool to model the dependence between the different elements of a portfolio and are preferable to the traditional, correlation-based approach. In this paper, we show the importance of selecting an accurate copula for risk management. We extend standard goodness-of-fit tests to copulas. Contrary to existing, indirect tests, these tests can be applied to any copula of any dimension and are based on a direct comparison of a given copula with observed data. For a portfolio consisting of stocks, bonds and real estate, these tests provide clear evidence in favor of the Student's t copula, and reject both the correlation-based Gaussian copula and the extreme value-based Gumbel copula. In comparison with the Student's t copula, we find that the Gaussian copula underestimates the probability of joint extreme downward movements, while the Gumbel copula overestimates this risk. Similarly we establish that the Gaussian copula is too optimistic on diversification benefits, while the Gumbel copula is too pessimistic. Moreover, these differences are significant.
Kondor, I., S. Pafka, et al. (2007). "Noise sensitivity of portfolio selection under various risk measures." Journal of Banking & Finance 31(5): 1545-1573.
We study the sensitivity to estimation error of portfolios optimized under various risk measures, including variance, absolute deviation, expected shortfall and maximal loss. We introduce a measure of portfolio sensitivity and test the various risk measures by considering simulated portfolios of varying sizes N and for different lengths T of the time series. We find that the effect of noise is very strong in all the investigated cases, asymptotically it only depends on the ratio N/T, and diverges (goes to infinity) at a critical value of N/T, that depends on the risk measure in question. This divergence is the manifestation of a phase transition, analogous to the algorithmic phase transitions recently discovered in a number of hard computational problems. The transition is accompanied by a number of critical phenomena, including the divergent sample to sample fluctuations of portfolio weights. While the optimization under variance and mean absolute deviation is always feasible below the critical value of N/T, expected shortfall and maximal loss display a probabilistic feasibility problem, in that they can become unbounded from below already for small values of the ratio N/T, and then no solution exists to the optimization problem under these risk measures. Although powerful filtering techniques exist for the mitigation of the above instability in the case of variance, our findings point to the necessity of developing similar filtering procedures adapted to the other risk measures where they are much less developed or non-existent. Another important message of this study is that the requirement of robustness (noise-tolerance) should be given special attention when considering the theoretical and practical criteria to be imposed on a risk measure.
Konstantinidi, E., G. Skiadopoulos, et al. (2008). "Can the evolution of implied volatility be forecasted? Evidence from European and US implied volatility indices."Journal of Banking & Finance 32(11): 2401-2411.
We address the question whether the evolution of implied volatility can be forecasted by studying a number of European and US implied volatility indices. Both point and interval forecasts are formed by alternative model specifications. The statistical and economic significance of these forecasts is examined. The latter is assessed by trading strategies in the recently inaugurated CBOE volatility futures markets. Predictable patterns are detected from a statistical point of view. However, these are not economically significant since no abnormal profits can be attained. Hence, the hypothesis that the volatility futures markets are efficient cannot be rejected.
Koopman, S. J., A. Lucas, et al. (2005). "Empirical credit cycles and capital buffer formation." Journal of Banking & Finance 29(12): 3159-3179.
We model 1927-1997 US business failure rates using an unobserved components time series model. Clear evidence is found of cyclical behavior in default rates. We also detect significant longer term movements in default rates and default correlations. In a multi-year backtest experiment we show that accommodation of default rate dynamics has important consequences for credit risk capitalization requirements. Static or myopic variants of credit portfolio models miss significant periods of credit risk accumulation. Empirically congruent dynamic models by contrast provide more timely warning signals of credit risk build-up. In this way they may mitigate some of the pro-cyclicality concerns.
Kopecky, K. J. and D. VanHoose (2006). "Capital regulation, heterogeneous monitoring costs, and aggregate loan quality." Journal of Banking & Finance 30(8): 2235-2255.
This paper develops a banking-sector framework with heterogeneous loan monitoring costs. Banks are exposed to the moral hazard behavior of borrowers and endogenously choose whether to monitor their loans to eliminate this exposure. After analyzing an unregulated banking system, we examine several cases in which regulatory capital requirements bind the notional loan supplies of various subsets of banks. To gauge the impact of capital requirements, we define loan [`]quality' in terms of either the ratio of monitored to total loans or the ratio of monitoring banks to total bank population. Under the assumption of a specific cross-sectional distribution of banks, our simulations show that the imposition of binding capital requirements on a previously unregulated banking system unambiguously increases the market loan rate and reduces aggregate lending, but has an ambiguous effect on loan [`]quality'. Nevertheless, once capital requirements are in place, the simulations indicate that regulators can contribute to higher overall loan [`]quality' by toughening capital requirements.
Köppl, T. V. and C. Monnet (2007). "Guess what: It's the settlements! Vertical integration as a barrier to efficient exchange consolidation." Journal of Banking & Finance 31(10): 3013-3033.
Exchanges and other trading platforms are often vertically integrated to carry out trading and settlement as one operation. We show that these vertical silos can prevent the full realization of efficiency gains from horizontal consolidation of trading and settlement platforms. When costs of settlement are private information, a merger of vertical silos cannot be designed to always ensure efficient trading and settlement after the merger. We also show, however, that efficiency can be guaranteed either by merging the trading platforms and delegating the operation of settlement platforms to independent agents or by forcing competition across vertical silos through cross-listings.
Kotomin, V., S. D. Smith, et al. (2008). "Preferred habitat for liquidity in international short-term interest rates." Journal of Banking & Finance 32(2): 240-250.
Risk-shifting window dressing and a preferred habitat for liquidity have been offered as possible explanations as to why US money market rates are higher before the year-end than afterwards. The two hypotheses differ in the timing of the rate decline at the year-end and the evidence on the timing of the decline supports the preferred habitat hypothesis in US money markets. This paper extends this line of research to the behavior of international short-term interest rates at year-ends and quarter-ends using London interbank offer rates (LIBOR) for 11 different currencies. The results suggest that the behavior of LIBOR for five currencies: the US Dollar, Euro, Japanese Yen, Swiss Franc, and German Mark is consistent with year-end or quarter-end preferred habitats for liquidity. Other currencies do not demonstrate consistently distinct patterns in turn-of-the-year and turn-of-the-quarter yields. None of the results provides any support for risk-shifting window dressing.
Koustas, Z. and A. Serletis (2005). "Rational bubbles or persistent deviations from market fundamentals?" Journal of Banking & Finance 29(10): 2523-2539.
Tests for fractional integration in the S&P 500 log dividend yield are conducted in order to test the proposition that exogenous shocks have permanent effects. The presence of a unit root in the log dividend yield is consistent with [`]rational bubbles' in stock prices. Our findings, based on tests for fractional integration, yield robust rejections of the null hypothesis of rational bubbles. The results strongly suggest that the log dividend yield is mean reverting.
Koutsomanoli-Filippaki, A. and E. Mamatzakis "Performance and Merton-type default risk of listed banks in the EU: A panel VAR approach." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper provides empirical evidence that sheds new light into the dynamic interactions between risk and efficiency, a highly debated issue. First, we estimate three alternative measures of bank performance, by employing a directional distance function framework, along with a cost frontier and a profit function. As a second step, we calculate a Merton type bank default risk. Then, we employ a Panel-VAR analysis, which allows the examination of the underlying relationships between efficiency and risk without applying any a-priori restrictions. Most evidence shows that the effect of a one standard deviation shock of the distance to default on inefficiency is negative and substantial. There is some evidence of a reverse causation. As part of a sensitivity analysis, we extent our study to investigate the relationship between efficiency and default risk for banks with different types of ownership structures and across financial systems with different levels of development.
Koutsomanoli-Filippaki, A., D. Margaritis, et al. (2009). "Efficiency and productivity growth in the banking industry of Central and Eastern Europe." Journal of Banking & Finance 33(3): 557-567.
We employ the directional technology distance function and provide estimates of bank efficiency and productivity change across Central and Eastern European (CEE) countries and across banks with different ownership status for the period 1998-2003. Our results demonstrate the strong links of competition and concentration with bank efficiency. They also show that productivity for the whole region initially declined but has improved more recently with further progress on institutional and structural reforms. Input-biased technical change has been consistently positive throughout the entire period suggesting that the reforms have induced favorable changes in relative input prices and input mix. However we find evidence of diverging trends in productivity growth patterns across banking industries and that foreign banks outperform domestic private and state-owned banks both in terms of efficiency and productivity gains. Overall, we find that productivity change in CEE is driven by technological change rather than efficiency change.
Kouwenberg, R. and W. T. Ziemba (2007). "Incentives and risk taking in hedge funds." Journal of Banking & Finance 31(11): 3291-3310.
We study how incentive fees and manager's own investment in the fund affect the investment strategy of hedge fund managers. We find that loss averse managers increase the risk of the fund's investment strategy with higher incentive fees. However, risk taking is greatly reduced if a substantial amount of the manager's own money (at least 30%) is in the fund. Using the Zurich hedge fund universe, we test the relation between risk taking and incentive fees empirically. Hedge funds with incentive fees have significantly lower mean returns (net of fees), while downside risk is positively related to the incentive fee level. Fund of funds charging large incentive fees achieve relatively high mean returns, but with significantly higher risk as well.
Koziol, C. and J. Lawrenz (2009). "What makes a bank risky? Insights from the optimal capital structure of banks." Journal of Banking & Finance 33(5): 861-873.
Assessing the risk of bank failures is the paramount concern of bank regulation. This paper argues that in order to assess the default risk of a bank, it is important to consider its financing decisions as an endogenous dynamic process. We provide a continuous-time model, where banks choose the deposit volume in order to trade off the benefits of earning deposit premiums against the costs that occur at future capital structure adjustments. The bank's asset value may suffer from shocks and follows a jump-diffusion process. Our main finding is that the dynamic endogenous financing decision introduces an important self-regulation mechanism, where it is crucial to distinguish between the diffusion risk and the jump risk component.
Kraft, E. and L. Jankov (2005). "Does speed kill? Lending booms and their consequences in Croatia." Journal of Banking & Finance 29(1): 105-121.
Recent research connects lending booms with increased risks of banking and currency crisis. Another strand of literature connects financial deepening with long-term growth. Together, these findings pose dilemmas for policymakers. In the case of Croatia, we find that rapid loan growth increased the probability of credit quality deterioration and stimulated current account and foreign debt problems. Conventional monetary tightening was not very effective, due to capital inflows. Unconventional measures such as capital controls also had limited effectiveness. We propose limiting negative impacts by pro-active monetary policy, more restrictive fiscal policy and increased capital requirements for fast-growing banks, rather than measures to prevent lending booms ex-ante.
Kraft, H. and C. Munk (2007). "Bond durations: Corporates vs. Treasuries." Journal of Banking & Finance 31(12): 3720-3741.
We compare the durations (the percentage price sensitivity with respect to the default-free short rate) of corporate and Treasury bonds in the reduced-form, intensity-based credit risk modeling framework. In a frequently used intensity-based model for corporate bond valuation we provide an example showing that, given the parameter estimates found in empirical studies, the duration of a corporate coupon bond may very well be larger than the duration of a similar Treasury bond. This finding contrasts with conclusions of previous studies. In a general, intensity-based recovery of market value framework we provide a simple sufficient condition for when the duration of a corporate bond will be smaller than that of a similar Treasury bond. We also provide an upper bound on the duration of the corporate coupon bond.
Krink, T., S. Paterlini, et al. (2008). "The optimal structure of PD buckets." Journal of Banking & Finance 32(10): 2275-2286.
In designing credit rating systems under the new Basel Accord, considerable effort has been devoted to rating assignment and quantification, while the choice of the optimal bucket structure has received less attention. To fill this gap, we propose two "bucketing" strategies based on constrained optimisation, paying attention to the implications of rating buckets for loan-pricing and adverse selection phenomena. We compare them with some more naïve approaches, based on a sample of about 100,000 European companies. We also analyse the persistence of our performance measures over time, as well as the effect of large exposures being associated with low-PD obligors.
Krishnaswami, S. and D. Yaman (2007). "Contracting costs and the window of opportunity for straight debt issues." Journal of Banking & Finance 31(3): 869-888.
We analyze whether fluctuation in economy-wide factors cause time-series variation in the contracting costs of moral hazard, adverse selection, and financial distress for a sample of straight debt issues. We find that the announcement period abnormal returns to debt issues are more negative in periods of higher interest rates and in industry downturns. When we partition the impact of each issue- and firm-specific measure of contracting costs across high and low levels of each economy-wide variable, we find that only the measures of agency cost are significant in general, and measures of financial distress become relevant for those debt issues that constitute a leverage increase for the firms.
Krohmer, P., R. Lauterbach, et al. (2009). "The bright and dark side of staging: Investment performance and the varying motivations of private equity firms." Journal of Banking & Finance 33(9): 1597-1609.
Previous papers that examined investment decisions by private equity funds are divided on whether staging has a positive or negative effect on returns. We believe these opposing views can be reconciled by studying when staging is used during the life of the investment relationship: We find that staging has a positive effect on investment returns in the beginning of the investment relationship, consistent with the notion that staging helps mitigate information asymmetry. However, staging appears to be negatively associated with returns when used prior to the exit decision. Our unique dataset allows us to measure these intertemporal effects precisely.
Krokhmal, P., R. T. Rockafellar, et al. (2006). "Risk management and optimization in finance." Journal of Banking & Finance 30(2): 315-315.
Kutsuna, K., J. K. Smith, et al. (2007). "Banking relationships and access to equity capital markets: Evidence from Japan's main bank system." Journal of Banking & Finance 31(2): 335-360.
We study the role of banking relationships in IPO underwriting. When a firm in Japan goes public, it can engage an investment bank that is related through a common main bank, or can select an alternative investment bank. The main bank relationship can be an efficient way for the investment bank to acquire information generated by the main bank, but may give rise to conflicts of interest. We find that main bank relationships give small issuers increased access to equity capital markets, but that issuers of large IPOs often switch to non-related investment banks that are capable of managing large offerings. While investment banks seek to exploit bargaining power with related issuers, issuers respond to expected high issue cost by switching to non-related investment banks. The net result is that total issue costs through related and non-related investment banks are similar. With respect to aftermarket performance and use of proceeds, we find no evidence of conflict of interest or self-dealing for either the main bank or the investment bank.
Kwan, S. H. (2006). "The X-efficiency of commercial banks in Hong Kong." Journal of Banking & Finance 30(4): 1127-1147.
Using the stochastic frontier approach to investigate the cost efficiency of commercial banks in Hong Kong, this paper found that the average X-efficiency of Hong Kong banks was about 16-30% of observed total costs. However, X-efficiency was found to decline over time, indicating that Hong Kong banks were operating closer to the cost frontier than before, consistent with technological innovations in the banking industry. Furthermore, the average large bank was found to be less efficient than the average small bank, but the size effect appears to be related to differences in portfolio characteristics among different size banks.
Laeven, L. and G. Majnoni (2005). "Does judicial efficiency lower the cost of credit?" Journal of Banking & Finance 29(7): 1791-1812.
We investigate the effect of judicial efficiency on banks' lending spreads for a large cross-section of countries. We measure bank interest rate spreads for 106 countries at the country level and for 32 countries at the level of individual banks. We find that judicial efficiency and inflation rates are the main drivers of interest rate spreads across countries. Our results suggest that improvements in judicial efficiency and judicial enforcement of debt contracts are critical to lowering the cost of financial intermediation for households and firms.
Landon, S. "The capitalization of taxes in bond prices: Evidence from the market for Government of Canada bonds." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper provides estimates of the extent to which corporate and personal income taxes are capitalized in bond prices. The methodology yields estimates of the degree of tax capitalization, rather than an implied tax rate. This makes it straightforward to identify the marginal investor and test for changes in tax capitalization. The empirical approach also makes it unnecessary to jointly estimate the degree of tax capitalization and the entire yield curve. Corporate taxes are found to have been fully capitalized in pre-tax Government of Canada bond yields during the period 1986-1993. Since 1994, taxes have not been capitalized in yields. These results are consistent with the existence of a marginal investor, but the identity of the marginal investor changed from a financial sector firm to a non-taxed entity in the early 1990s.
Landschoot, A. V. (2008). "Determinants of yield spread dynamics: Euro versus US dollar corporate bonds." Journal of Banking & Finance 32(12): 2597-2605.
This paper presents a systematic comparison between the determinants of euro and US dollar yield spread dynamics. The results show that US dollar yield spreads are significantly more affected by changes in the level and the slope of the default-free term structure and the stock market return and volatility. Surprisingly, euro yield spreads are strongly affected by the US (and not the euro) level and slope. This confirms the dominance of US interest rates in the corporate bond markets. Interestingly, I find that liquidity risk is higher for US dollar corporate bonds than euro corporate bonds. For both regions, the effect of changes in the bid-ask spread is mainly significant during periods of high liquidity risk. Finally, the results indicate that the credit cycle as measured by the region-specific default probability significantly increases US yield spreads. This is not the case for euro yield spreads.
Lee, C.-F., K.-W. Lee, et al. (2009). "Investor protection and convertible debt design." Journal of Banking & Finance 33(6): 985-995.
An important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio, maturity date and call period. Following Lewis et al. [Lewis, M., Rogalski, R., Seward, J., 2003. Industry conditions, growth opportunities and market reactions to convertible debt financing decisions. Journal of Banking and Finance 27, 153-181], we employ a single measure that simultaneously considers all of these features: the expected probability (measured at issue date) that the convertible will be converted to equity at maturity. We find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity. The positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs. Specifically, in countries with stronger shareholder rights, firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion. Furthermore, we find that large non-management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights. In contrast, firms in countries with stronger creditor rights issue convertibles with lower probability of conversion. We also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights.
Lee, S., K. Park, et al. (2009). "Disappearing internal capital markets: Evidence from diversified business groups in Korea." Journal of Banking & Finance 33(2): 326-334.
This paper examines how the onset of a financial crisis affects the operation of internal capital markets among firms within a diversified business group. We find that active internal capital markets within Korean business groups (chaebols) attenuate the financial constraints of the group-affiliated firms, allowing them to make efficient capital allocations during the early 1990s. However, these markets barely function after the financial crisis of 1997. Instead, we observe public debt markets serving as a substitute for internal capital markets. Our results suggest that chaebol firms' coordinated attempts to achieve healthier financial structures in the wake of the crisis have taken place at the expense of investment efficiency.
Lee, Y.-T., Y.-J. Liu, et al. (2006). "Taxes and dividend clientele: Evidence from trading and ownership structure." Journal of Banking & Finance 30(1): 229-246.
Although dividend clientele have been studied over several decades, their existence remains controversial. We study the interaction of dividends and taxes by exploiting a unique dataset from Taiwan, where the capital gains tax is zero. We find strong evidence of a clientele effect. Agents subject to high rates of taxation on dividends tend to hold stocks with lower dividends and sell (buy) stocks that raise (lower) dividends. Agents in lower tax brackets behave in the opposite manner. After legalization of repurchases in 2000, firms with higher concentrations of more heavily taxed shareholders were more apt to begin repurchase programs.
Lehar, A. (2005). "Measuring systemic risk: A risk management approach." Journal of Banking & Finance 29(10): 2577-2603.
This paper proposes a new method to measure and monitor the risk in a banking system. Standard tools that regulators require banks to use for their internal risk management are applied at the level of the banking system to measure the risk of a regulator's portfolio. Using a sample of international banks from 1988 until 2002, I estimate the dynamics and correlations between bank asset portfolios. To obtain measures for the risk of a regulator's portfolio, I model the individual liabilities that the regulator has to each bank as contingent claims on the bank's assets. The portfolio aspect of the regulator's liability is explicitly considered and the methodology allows a comparison of sub-samples from different countries. Correlations, bank asset volatility, and bank capitalization increase for North American and somewhat for European banks, while Japanese banks face deteriorating capital levels. In the sample period, the North American banking system gains stability while the Japanese banking sector becomes more fragile. The expected future liability of the regulator varies substantially over time and is especially high during the Asian crisis starting in 1997. Further analysis shows that the Japanese banks contribute most to the volatility of the regulator's liability at that time. Larger and more profitable banks have lower systemic risk and additional equity capital reduces systemic risk only for banks that are constrained by regulatory capital requirements.
Lehner, M. "Entry mode choice of multinational banks." Journal of Banking & Finance In Press, Corrected Proof.
When expanding abroad, a multinational bank faces a trade-off between accessing a foreign country via cross border lending or financial foreign direct investment, i.e. greenfield or acquisition entry. We analyze the entry mode choice of multinational banks and explicitly derive the entry mode pattern in the banking industry. Moreover, we show that in less developed banking markets, a trend towards cross border lending and acquisition entry exists. Greenfield entry prevails in more developed markets. Furthermore, we identify a tendency towards acquisition entry in smaller host countries and towards greenfield entry in larger host countries.
Leippold, M., P. Vanini, et al. (2006). "Optimal credit limit management under different information regimes." Journal of Banking & Finance 30(2): 463-487.
Credit limit management is of paramount importance for successful short-term credit risk management, even more so when the situation in credit and financial markets is tense. We consider a continuous-time model where the credit provider and the credit taker interact within a game-theoretic framework under different information structures. The model with complete information provides decision-theoretic insights into the problem of optimal limit policies and motivates more complicated information structures. Moving to a partial information setup, incentive distortions emerge that are not in the bank's interest. We discuss how these distortions can effectively be reduced by an incentive-compatible contract. Finally, we provide some practical implications of our theoretical results.
Lensink, R., A. Meesters, et al. (2008). "Bank efficiency and foreign ownership: Do good institutions matter?" Journal of Banking & Finance 32(5): 834-844.
This paper contributes to the literature on foreign ownership and bank efficiency by examining whether the efficiency of foreign banks depends on the institutional quality of the host country and on institutional differences between the home and host country. Using stochastic frontier analysis for a sample of 2095 commercial banks in 105 countries for the years 1998-2003, we find that foreign ownership negatively affects bank efficiency. However, in countries with good governance this negative effect is less pronounced. We also find that higher quality of the institutions in the home country and higher similarity between home and host country institutional quality reduce foreign bank inefficiency.
León, Á., J. M. Nave, et al. (2007). "The relationship between risk and expected return in Europe." Journal of Banking & Finance 31(2): 495-512.
We employ MIDAS (mixed data sampling) to study the risk-expected return trade-off in several European stock indices. Using MIDAS, we report that in most indices there is a significant positive relationship between risk and expected return. This strongly contrasts with the result we obtain when we employ both symmetric and asymmetric GARCH models for conditional variance. We also find that asymmetric specifications of the variance process within the MIDAS framework improve the relationship between risk and expected return. As an additional application, we analyze the extent to which European stock markets are integrated, which is a particularly relevant issue, especially following the launch of the Euro in January 1999. Finally, we propose a bivariate MIDAS specification to test the pricing significance of the hedging component within an intertemporal risk-return trade-off with multiple European market indices.
León, A. and A. Vaello-Sebastià (2009). "American GARCH employee stock option valuation." Journal of Banking & Finance 33(6): 1129-1143.
We implement a flexible simulation-based approach for the fair value of employee stock option (ESO) that accounts for the vesting period, departure risk and voluntary suboptimal early exercise. We introduce GARCH effects on the underlying asset and we analyze the price bias with respect to the constant volatility case. We also perform a sensitivity analysis with respect to changes in several ESO characteristics. We compare this valuation with FAS 123 method revealing a FAS overvaluation. Finally, we value a real ESO plan providing the confidence intervals for the estimated ESO prices.
Lepetit, L., E. Nys, et al. (2008). "Bank income structure and risk: An empirical analysis of European banks." Journal of Banking & Finance 32(8): 1452-1467.
The purpose of this paper is to investigate the relationship between bank risk and product diversification in the changing structure of the European banking industry. Based on a broad set of European banks for the period 1996-2002, our study first shows that banks expanding into non-interest income activities present higher risk and higher insolvency risk than banks which mainly supply loans. However, considering size effects and splitting non-interest activities into both trading activities and commission and fee activities we show that the positive link with risk is mostly accurate for small banks and essentially driven by commission and fee activities. A higher share of trading activities is never associated with higher risk and for small banks it implies, in some cases, lower asset and default risks.
Lepetit, L., E. Nys, et al. (2008). "The expansion of services in European banking: Implications for loan pricing and interest margins." Journal of Banking & Finance32(11): 2325-2335.
Our study of 602 European banks over 1996-2002 investigates how the banks' expansion into fee-based services has affected their interest margins and loan pricing. We find that higher income share from commissions and fees is associated with lower margins and loan spreads. The higher the commission and fee income share, moreover, the weaker the link between bank loan spreads and loan risk. The latter result is consistent with the conjecture that banks price (or misprice) loans to increase sales of other services. That loss leader (or cross selling) hypothesis has implications for bank regulation and competition with (non-bank) lenders.
Levine, R. and S. L. Schmukler (2007). "Migration, spillovers, and trade diversion: The impact of internationalization on domestic stock market activity." Journal of Banking & Finance 31(6): 1595-1612.
This paper studies the relation between internationalization (firms cross-listing, issuing depositary receipts, or raising capital in international stock markets) and the trading activity of the remaining firms in domestic markets. Using a panel of 3000 firms from 55 emerging economies during 1989-2000, we find that internationalization is negatively related to the trading activity of domestic firms. We identify two channels. First, the trading of international firms migrates from domestic to international markets and this migration along with the reduction in domestic trading of international firms has negative spillover effects on domestic firm trading activity. Second, there is trade diversion within domestic markets as trading activity shifts out of domestic firms and into international firms.
Levy, H. and M. Levy (2009). "The safety first expected utility model: Experimental evidence and economic implications." Journal of Banking & Finance 33(8): 1494-1506.
Roy's [Roy, A., 1952. Safety first and the holding of assets. Econometrica 20 (3), 431-449] safety first criterion advocates the minimization of the probability of outcomes below a certain "disaster" level. This paper examines safety first theoretically and experimentally. We find that safety first plays a crucial role in decision-making, inducing choices that cannot be explained by, and even contradict, risk-aversion, Prospect Theory, and loss-aversion in general. Yet, safety first alone cannot explain individual choice. Therefore, we propose an expected utility - safety first (EU-SF) model where decisions are made based on a weighted average of the safety first criterion and standard expected utility maximization. We experimentally estimate these relative weights, and discuss their economic implications.
Lewis, D. and J. R. Webb (2007). "Potential cost synergies from banks acquiring real estate brokerage services." Journal of Banking & Finance 31(8): 2347-2363.
National banks and Financial Holding Companies (FHC) solicited permission from the Federal Reserve Board and the Treasury Department to add real estate brokerage and management services to list of permissible business activities under the 1999 Gramm-Leach-Bliley Act (GLB). To date, permission has been denied due to the Community Choice in Real Estate Act, HR 111 and S 98. This study offers a method of combining the financial data of two independent industries. Additionally, this study identifies the scale returns and cost complementarities that may occur if banks offered real estate brokerage services under a single organization. Considerable evidence suggests that joining bank and real estate activities under a single organization would continue to generate increasing returns to scale for banks even when large levels of real estate brokerage services are offered by the joint institution. In addition, the results indicate evidence that bank acquisitions of real estate brokerages do create some cost saving synergies from cost complementarities between product lines. Finally, complementarities exist between traditional bank services and real estate services most at low levels of real estate outputs.
Li, G. (2007). "Time-varying risk aversion and asset prices." Journal of Banking & Finance 31(1): 243-257.
This paper uses a variant of the consumption-based representative agent model in Campbell and Cochrane [Campbell, J.Y., Cochrane, J.H., 1999. By force of habit: Consumption-based explanation of aggregate stock market behavior. Journal of Political Economy 107, 205-251] to study how investors' time-varying risk aversion affects asset prices. First, we show that a countercyclical variation of risk aversion drives a procyclical conditional risk premium. Second, we show that with a small value for the volatility of the log surplus consumption ratio, a large value of risk aversion may not determine whether the equity premium and the risk-free rate puzzles can be resolved or not. Third, we show that countercyclical risk aversion may not help explain the predictability of long-horizon stock returns, the univariate mean-reversion of stock prices and the "leverage effect" in return volatility.
Li, J., Y. S. Shin, et al. (2006). "Reactions of Japanese markets to changes in credit ratings by global and local agencies." Journal of Banking & Finance 30(3): 1007-1021.
We examine data from the mid-1980s to 2003 to investigate whether stock prices set on the Tokyo Stock Exchange for Japanese firms react more strongly to changes in credit ratings of global rating agencies than of local agencies. This offers a strong test of relative influence of the two groups of rating agencies. We hypothesize that global raters will have more influence, but given that the two global agencies, Moody's and Standard and Poors, are headquartered in the United States, analysis of stocks of Japanese firms listed on US exchanges would confound the results to the extent there is a home bias for raters. We find that global agencies are more influential than the two major local raters, Japan Rating and Investment Information and Japan Credit Rating Agency, for rating downgrades. Thus for credit downgrades, global raters are more influential than local ones even in the local market. Consistent with previous research, we find that upgrades are benign events, and this holds true for global as well as local agencies.
Li, X., J. Miffre, et al. (2008). "Momentum profits and time-varying unsystematic risk." Journal of Banking & Finance 32(4): 541-558.
This study assesses whether the widely documented momentum profits can be attributed to time-varying risk as described by a GJR-GARCH(1,1)-M model. We reveal that momentum profits are a compensation for time-varying unsystematic risks, which are common to the winner and loser stocks but affect the former more than the latter. In addition, we find that, perhaps because losers have a higher propensity than winners to disclose bad news, negative return shocks increase their volatility more than they increase those of the winners. The volatility of the losers is also found to respond to news more slowly, but eventually to a greater extent, than that of the winners.
Li, X.-M. and L.-P. Zou (2008). "How do policy and information shocks impact co-movements of China's T-bond and stock markets?" Journal of Banking & Finance 32(3): 347-359.
We investigate the impacts of policy and information shocks on the correlation of China's T-bond and stock returns, using originally the asymmetric dynamic conditional correlation (DCC) model that allows for the coexistence of opposite-signed asymmetries. The co-movements of China's capital markets react to large macroeconomic policy shocks as evidenced by structural breaks in the correlation following the drastic 2004 macroeconomic austerity. We show that the T-bond market and the bond-stock correlations bear more of the brunt of the macroeconomic contractions. We also find that the bond-stock correlations respond more strongly to joint negative than joint positive shocks, implying that investors tend to move both the T-bond and stock prices in the same direction when the two asset classes have been hit concurrently by bad news, but tend to shift funds from one asset class to the other when hit concurrently by good news. However, the stock-stock correlation is found to increase for joint positive shocks, indicating that investors tend to herd more for joint bullish than joint bearish stock markets in Shanghai and Shenzhen.
Li, Y. and M. Zhong (2005). "Consumption habit and international stock returns." Journal of Banking & Finance 29(3): 579-601.
We use the consumption-based asset pricing model with habit formation to study the predictability and cross-section of returns from the international equity markets. We find that the predictability of returns from many developed countries' equity markets is explained in part by changing prices of risks associated with consumption relative to habit at the world as well as local levels. We also provide an exploratory investigation of the cross-sectional implications of the model under the complete world market integration hypothesis and find that the model performs mildly better than the traditional consumption-based model, the unconditional and conditional world CAPMs and a three-factor international asset pricing model.
Liao, H.-H., T.-K. Chen, et al. (2009). "Bank credit risk and structural credit models: Agency and information asymmetry perspectives." Journal of Banking & Finance 33(8): 1520-1530.
This work investigates the effects of agency and information asymmetry issues embedded in structural form credit models on bank credit risk evaluation, using American bank data from 2001 to 2005. Findings show that both the agency problem and information asymmetry significantly cause deviations in the credit risk evaluation of structural form models from agency ratings. Five independent factors explain a deviation of 42.6-78.3% and should be incorporated into future credit risk modeling. Additionally, both the effects of information asymmetry and debt-equity agency positively relate to the deviation while that of management-equity agency relates to it negatively.
Liebig, T., D. Porath, et al. (2007). "Basel II and bank lending to emerging markets: Evidence from the German banking sector." Journal of Banking & Finance31(2): 401-418.
This paper investigates whether the new Basel Accord will induce a change in bank lending to emerging markets using a comprehensive new data set on German banks' foreign exposure. We test two interlinked hypotheses on the conditions under which the change in the regulatory capital would leave lending flows unaffected. This would be the case if (i) the new regulatory capital requirement remains below the economic capital and (ii) banks' economic capital to emerging markets already adequately reflects risk. On both accounts the evidence indicates that the new Basel Accord should have a limited effect on lending to emerging markets.
Lien, D. and L. Yang (2008). "Asymmetric effect of basis on dynamic futures hedging: Empirical evidence from commodity markets." Journal of Banking & Finance32(2): 187-198.
The dynamic minimum variance hedge ratios (MVHRs) have been commonly estimated using the Bivariate GARCH model that overlooks the basis effect on the time-varying variance-covariance of spot and futures returns. This paper proposes an alternative specification of the BGARCH model in which the effect is incorporated for estimating MVHRs. Empirical investigation in commodity markets suggests that the basis effect is asymmetric, i.e., the positive basis has greater impact than the negative basis on the variance and covariance structure. Both in-sample and out-of-sample comparisons of the MVHR performance reveal that the model with the asymmetric effect provides greater risk reduction than the conventional models, illustrating importance of the asymmetric effect when modeling the joint dynamics of spot and futures returns and hence estimating hedging strategies.
Lin, C.-M., R. D. Phillips, et al. (2008). "Hedging, financing, and investment decisions: Theory and empirical tests." Journal of Banking & Finance 32(8): 1566-1582.
In this paper we theoretically and empirically examine the interaction between hedging, financing, and investment decisions. A simple equilibrium model with costly financial distress suggests that as firms become more efficient at risky investments vis a vis low risk investments, they will borrow less, invest more in risky assets, and hedge more. The model also predicts a positive relationship between hedging and leverage - a result consistent with debt capacity arguments. We test the model empirically using a simultaneous equations framework to investigate the determinants of firm-level hedging, financing and investing decisions. The results strongly support the hypothesis that the hedging, financing and investment decisions are jointly determined. In addition, we find strong support for the central hypothesis that firms more efficient investing in risky technologies more aggressively hedge and use less debt financing in order to maximize their comparative advantage.
Lin, J. B., C. Pantzalis, et al. (2007). "Corporate use of derivatives and excess value of diversification." Journal of Banking & Finance 31(3): 889-913.
We provide a link between diversification discount and corporate use of financial derivatives. We show that diversified firms benefit from financial risk management. Our findings are consistent with the notion that derivative usage lowers information asymmetry and thereby reduces the negative valuation effects of diversification. Our evidence complements the earlier findings of both the risk management literature and diversification discount literature and is robust to controls for endogeneity and information asymmetry levels.
Lin, J.-C., Y.-T. Lee, et al. (2007). "IPO auctions and private information." Journal of Banking & Finance 31(5): 1483-1500.
IPO auctions, which provide an impartial way of determining IPO pricing and share allocations, offer a natural setting for examining whether institutional investors possess private information, and for measuring how valuable their information is. Analyzing detailed bidding data from Taiwan's discriminatory (pay-as-bid) auctions, we find that, relative to retail investors, institutional investors tend to bid higher in auctions when IPO shares are more valuable, and that underpricing is larger in auctions with relatively higher institutional bids. These results imply that institutional investors are better informed about IPO value, and that they obtain higher information rents when they bid higher relative to retail investors. We estimate the value of institutional investors' private information to be worth about 8.68% of return, which is the extra rate of return they command on their informational advantages over retail investors.
Lin, X. and Y. Zhang (2009). "Bank ownership reform and bank performance in China." Journal of Banking & Finance 33(1): 20-29.
Using a panel of Chinese banks over the 1997-2004 period, we assess the effect of bank ownership on performance. Specifically, we conduct a joint analysis of the static, selection, and dynamic effects of (domestic) private, foreign and state ownership. We find that the "Big Four" state-owned commercial banks are less profitable, are less efficient, and have worse asset quality than other types of banks except the "policy" banks (static effect). Further, the banks undergoing a foreign acquisition or public listing record better pre-event performance (selection effect); however, we find little performance change in either the short or the long term.
Linn, S. C. and D. R. Stock (2005). "The impact of junior debt issuance on senior unsecured debt's risk premiums." Journal of Banking & Finance 29(6): 1585-1609.
Numerous studies have examined the impact of security issuance upon the value of pre-existing debt and equity but the focus has largely been on changes in equity value. We examine changes in senior unsecured debt risk premiums that accompany new junior debt issues. Additionally, we test several hypotheses regarding the potential impacts of junior debt issues. Extant theory suggests senior debt value may be threatened under certain conditions by the issuance of junior debt. Our results indicate that when junior debt replaces bank debt, senior default risk premiums experience abnormal declines. The result is broadly consistent with the elevation of the senior unsecured debt by way of the elimination of a separate and more senior class of debt claimants. In contrast, we also find that larger junior bond issues are associated with abnormal increases in senior risk premiums, broadly consistent with issue size being correlated with negative information about firm cash flows. We find strong evidence of interaction effects. For example, replacement of bank debt results in greater changes in default risk premiums the larger the issue size. We also find lower credit ratings magnify other effects. For example, if the junior debt issued matures before the outstanding senior unsecured bond, senior risk premiums experience abnormal increases for lower rated debt.
Linzert, T., D. Nautz, et al. (2007). "Bidding behavior in the longer term refinancing operations of the European Central Bank: Evidence from a panel sample selection model." Journal of Banking & Finance 31(5): 1521-1543.
This paper analyzes individual bidding data of the longer term refinancing operations (LTROs) of the European Central Bank. We investigate how banks' bidding behavior is related to a series of exogenous variables including collateral costs, interest rate expectations, market volatility and to individual bank characteristics like country of origin, size, and experience. A specific feature of these auctions is that the number and composition of bidders varies over time. Therefore, we estimate panel sample selection models to control for a bank's endogenous participation decision. We find that bidding strategies depend on the banks' attributes. Yet, different bidding behavior generally does not translate into differences concerning bidder success. There is evidence for the winner's curse effect in LTROs indicating a common value component in banks' demand for longer term refinancing.
Lioui, A. and P. Poncet (2005). "General equilibrium pricing of CPI derivatives." Journal of Banking & Finance 29(5): 1265-1294.
We examine the issue of pricing forward futures and option contracts written on the Consumer Price Index (CPI), the change of which is a measure of inflation affecting the economy. Traditional approaches postulate an exogenous process for the price level and then derive CPI derivatives prices by standard arbitrage arguments. By contrast, we build the general equilibrium of a continuous time monetary economy that is affected by both real and nominal shocks. The price level and thus the inflation rate are found endogenously and solutions for the prices of CPI derivatives are obtained, which are in closed form in a specialized version of the economy.
Liu, M.-H., D. Margaritis, et al. (2008). "Monetary policy transparency and pass-through of retail interest rates." Journal of Banking & Finance 32(4): 501-511.
This paper examines the degree of pass-through and adjustment speed of retail interest rates in response to changes in benchmark market rates in New Zealand during the period 1994-2004. We consider the effects of policy transparency and financial structure of the monetary transmission mechanism. New Zealand is the first OECD country to adopt a full-fledged inflation targeting regime with specific accountability and transparency provisions. Policy transparency was further enhanced by a shift from quantity (settlement cash) to price (interest rate) operating targets in 1999. Using Phillips-Loretan estimates of cointegrating regressions we find complete long-term pass-through for some but not all retail rates. Our results also show that the introduction of the Official Cash Rate (OCR) increased the pass-through of floating and deposit rates but not fixed mortgage rates. In line with previous studies we find the immediate pass-through of market interest rates to bank retail rates to be incomplete. Although we find no statistical evidence for asymmetric response of retail rates to changes in market rates other than for business lending rates in the pre OCR period, differences in the magnitude of mean adjustment lags indicate that banks appear to pass on decreases to fixed mortgage rates faster. Overall, our results confirm that monetary policy rate has more influence on short-term interest rates and that increased transparency has lowered instrument volatility and enhanced the efficacy of policy.
Liu, P., Y. Shao, et al. (2009). "Did the repeated debt ceiling controversies embed default risk in US Treasury securities?" Journal of Banking & Finance 33(8): 1464-1471.
We examine whether the financial market charged a default risk premium to US Treasury securities when the US Federal government repeatedly reached the legally binding debt limits between 2002 and 2006. We show that for the first two of the four recurrences since the first episode in 1996, the financial market charged a small default risk premium to the Treasury securities. However, we find no significant evidence of a pricing effect in the last two recurrences. The results suggest that the financial market gradually perceived the budget standoffs as the boy who cried wolf.
Liu, X., M. B. Shackleton, et al. (2007). "Closed-form transformations from risk-neutral to real-world distributions." Journal of Banking & Finance 31(5): 1501-1520.
Risk-neutral and real-world densities are derived from option prices and risk assumptions, and are compared with historical densities obtained from time series. Two parametric risk-transformations are used to convert risk-neutral densities into real-world densities. Both transformations are estimated by maximizing the likelihood of observed index levels, for two parametric density families. Results for the FTSE-100 index show that parametric densities derived from option prices have more explanatory power than historical densities and higher likelihoods than densities estimated by spline methods. A combination of parametric real-world and historical densities provides the preferred predictive densities.
Liu, Y.-C. (2009). "The slicing approach to valuing tax shields." Journal of Banking & Finance 33(6): 1069-1078.
The literature develops the theoretical rationale for the Value of Tax Shields (VTS) on the following misguided basis: it uses required rate of return on assets (or WACC) as the discount rate for capitalization, it uses expected rate of return on assets ( or as a proxy for WACC, and it is not aware of (1) the influence of the difference between "expected rate of return on equity" and "Required rate of Return On Equity (RROE)" on VTS, (2) the fact that RROE is equity normal profit which is not measurable, (3) the economic content of the weight attached to the VTS capacity, and (4) the co-definition of "tax shield and leverage return." This paper takes tax shields and leverage return as a system and provides a knife, "interest rate/ROI = Cost/Price", to slice the VTS capacity into "earned VTS" and "unearned VTS." Earned VTS is VTS. Unearned VTS is the value of leverage return, because leverage return is tax payable.
Livingston, M., A. Naranjo, et al. (2008). "Split bond ratings and rating migration." Journal of Banking & Finance 32(8): 1613-1624.
This paper examines the relationships between split ratings and ratings migration. We find that bonds with split ratings are more likely to have future rating changes. A one-notch (more-than-one-notch) split rating increases the probability of rating change within one year of initial issuance by about 3% (6%). Furthermore, we find that about 30% of split rated bonds have their two ratings converge after four years of initial issuance. The rating convergence tapers off after three years, and the rating agency with a higher (lower) initial rating generally maintains a higher (lower) rating in subsequent years if the two ratings do not converge. We also show that rating transition estimation can be improved by taking into consideration split ratings. We find that one-year rating transition matrices are significantly different between non-letter-split rated bonds and letter-split rated bonds, and we show that the difference has an economically significant impact on the pricing of credit spread options and VaR-based risk management models. Overall, our results suggest that split ratings contain important information about subsequent rating changes.
Longin, F. (2005). "The choice of the distribution of asset returns: How extreme value theory can help?" Journal of Banking & Finance 29(4): 1017-1035.
One of the issues of risk management is the choice of the distribution of asset returns. Academics and practitioners have assumed for a long time (for more than three decades) that the distribution of asset returns is a Gaussian distribution. Such an assumption has been used in many fields of finance: building optimal portfolio, pricing and hedging derivatives and managing risks. However, real financial data tend to exhibit extreme price changes such as stock market crashes that seem incompatible with the assumption of normality. This article shows how extreme value theory can be useful to know more precisely the characteristics of the distribution of asset returns and finally help to chose a better model by focusing on the tails of the distribution. An empirical analysis using equity data of the US market is provided to illustrate this point.
Los, C. A. (2006). "System identification in noisy data environments: An application to six Asian stock markets." Journal of Banking & Finance 30(7): 1997-2024.
This paper analyzes the systematic relationship between the stock market valuations, the nominal GDPs and the interest rates of six Asian countries, using not "single equation regression", but an alternative methodology based on complete, multidirectional, least squares projections in the tradition of Frisch (1934). We compare the results with the spectral analysis of the information matrices and determine the noise levels. The objective is to extract the multidimensional economic system structures from the noisy empirical observations. This complete methodology sharply contrasts with the incomplete methodology of Fama [Fama, E.F., 1990. Stock returns, expected returns, and real activity. Journal of Finance 45, 1089-1108] and Schwert [Schwert, G.W., 1990. Stock returns and real activity: A century of evidence. Journal of Finance 45, 1237-1257], etc., who presume planal relations, fit them to the multidimensional data by only one prejudiced unidirectional projection, thereby ignoring between 75% and 92% of the available covariance information and not publishing all possible model projections. The results in this paper show that the analyzed countries are better analyzed using such complete multidirectional LS projections, even though the analysis is combinatorially much more complex. All six Asian financial-economic systems are high data noise environments, in which it is very difficult to separate the systematic signals from the noise. Because of these high noise levels, spectral analysis is very unreliable. We identify Taiwan's stock market, economy and financial market to be rationally coherent. In contrast, Malaysia, Singapore, Philippines and Indonesia show only partially coherent systems, while no coherent system can be identified among Japan's data.
Luca, A. and I. Petrova (2008). "What drives credit dollarization in transition economies?" Journal of Banking & Finance 32(5): 858-869.
This paper provides an in-depth analysis of the use of foreign currencies in the lending activities of banks in transition economies. The impact of bank and firm variables on credit dollarization is studied in an optimal portfolio allocation model and estimated using new aggregate data for 21 transition economies for the period 1990-2003. Empirical results provide evidence that credit dollarization is the combined outcome of domestic deposit dollarization and banks' desire for currency-matched portfolios beyond regulatory requirements. The effects of international financial factors and natural hedges are less robust across alternative specifications. The paper further discusses the role of regulations in affecting the impact of these factors on credit dollarization and calls for more developed domestic forward foreign exchange markets.
Lucas, A. and P. Klaassen (2006). "Discrete versus continuous state switching models for portfolio credit risk." Journal of Banking & Finance 30(1): 23-35.
Dynamic models for credit rating transitions are important ingredients for dynamic credit risk analyses. We compare the properties of two such models that have recently been put forward. The models mainly differ in their treatment of systematic risk, which can be modeled either using discrete states (e.g., expansion versus recession) or continuous states. It turns out that the implied asset correlations and default rate volatilities for discrete state switching models are implausibly low compared to empirical estimates from the literature. We conclude that care has to be taken when discrete state regime switching models are employed for dynamic credit risk management. As a side result of our analysis, we obtain indirect evidence that asset correlations may change over the business cycle.
MacLean, L., Y. Zhao, et al. (2006). "Dynamic portfolio selection with process control." Journal of Banking & Finance 30(2): 317-339.
The risk inherent in the accumulation of investment capital depends on the true return distributions of the risky assets, the accuracy of estimated returns, and the investment strategy. This paper considers risk control with Value-at-Risk and Conditional Value-at-Risk, using control limits to determine times for portfolio rebalancing. Optimal strategies and control limits are determined for a geometric Brownian motion asset pricing model with random parameters. The approaches to risk control are applied to the fundamental problem of investment in stocks, bonds, and cash over time.
MacLean, L. C., M. E. Foster, et al. (2007). "Covariance complexity and rates of return on assets." Journal of Banking & Finance 31(11): 3503-3523.
This paper considers the estimation of the expected rate of return on a set of risky assets. The approach to estimation focuses on the covariance matrix for the returns. The structure in the covariance matrix determines shared information which is useful in estimating the mean return for each asset. An empirical Bayes estimator is developed using the covariance structure of the returns distribution. The estimator is an improvement on the maximum likelihood and Bayes-Stein estimators in terms of mean squared error. The effect of reduced estimation error on accumulated wealth is analyzed for the portfolio choice model with constant relative risk aversion utility.
Maechler, A. M. and K. M. McDill (2006). "Dynamic depositor discipline in US banks." Journal of Banking & Finance 30(7): 1871-1898.
This paper captures banks' dynamic response to depositor discipline. Recognizing that the price and quantity response of uninsured deposits in the face of deteriorating fundamentals needs to be modeled as an endogenous process, we investigate how depositor discipline constrains banks' behavior by extracting the impact of an exogenous rise in interest rates on the quantity of uninsured deposits. We find that good banks can raise uninsured deposits by raising their price, while weak banks cannot. This suggests that depositor discipline not only raises the cost of choosing a higher level of risk but also may, at very high levels of risk, effectively constrain bank managers' behavior.
Magri, S., A. Mori, et al. (2005). "The entry and the activity level of foreign banks in Italy: An analysis of the determinants." Journal of Banking & Finance 29(5): 1295-1310.
Although the theory of multinational banking has pointed out the importance of local profit opportunities, the empirical evidence is still poor and deserves further investigation. To this end, we analyse entry decisions and activity levels of foreign banks operating in Italy between 1983 and 1998. We consider 22 OECD countries, 10 of which had at least one bank (branch or subsidiary) in Italy. Entries and activity levels were related to the degree of economic integration as well as to the financial market features of the home country relative to Italy. Unlike other studies, besides economic integration, the relative profitability of the banking activity proves to be a significant variable in that it highlights the importance of local market conditions. In the past decade, increased competition in the Italian banking sector has reduced these profit opportunities, driving foreign banks towards more innovative sectors of financial intermediation.
Mahajan, A. and S. Tartaroglu (2008). "Equity market timing and capital structure: International evidence." Journal of Banking & Finance 32(5): 754-766.
We investigate the equity market timing hypothesis of capital structure in major industrialized (G-7) countries. As claimed by its proponents, we find that leverage of firms is negatively related to the historical market-to-book ratio in all G-7 countries. However, this negative relationship cannot be attributed to equity market timing. We find no association between equity issues and market-to-book ratios at the time of equity financing decisions by Japanese firms. Firms in all G-7 countries, except Japan, undo the effect of equity issuance and the impact of equity market timing attempts on leverage is short lived. This is inconsistent with the prediction of the equity market timing hypothesis and more in line with dynamic trade-off model.
Mählmann, T. (2006). "Estimation of rating class transition probabilities with incomplete data." Journal of Banking & Finance 30(11): 3235-3256.
This paper shows that the well known "duration" and "cohort" methods for estimating transition probabilities of external bond ratings are not suitable for internal rating data. More precisely, the duration method cannot and the cohort method should not be used in connection with banks' ratings generated from internal models. Structural differences within the borrower monitoring process of banks and rating agencies are responsible for this result. A Maximum Likelihood (ML) estimation procedure, which accounts for the peculiarities of internal bank ratings, is introduced and applied to data from a German bank. The empirical results indicate that the differences between cohort and ML transition matrices are both, statistically and economically significant. Furthermore, evidence of rating reversals, business cycle dependent transition probabilities and on the factors which determine the borrower monitoring intensity of banks is provided.
Mählmann, T. (2008). "Rating agencies and the role of rating publication rights." Journal of Banking & Finance 32(11): 2412-2422.
While credit rating agencies disclose all public ratings as a matter of policy, a firm can choose whether to make a so called private rating public or to keep it confidential. This paper analyzes the economic role of such rating publication rights. In particular, the paper tries to answer the following two questions: (1) If firms have scope to disclose agency ratings at their own discretion, can they use this discretion strategically and conceal low-quality ratings?, and (2), if this is the case, what are the economic implications for rated firms, unrated firms and the rating agency, resulting from strategically motivated selective rating disclosures? Using a theoretical model, it is shown that an equilibrium with partial nondisclosure of low-quality ratings can emerge whenever investors cannot be sure whether rating nondisclosure is due to the firm being not rated, or due to the rating's adverse content. Moreover, since from an investors' perspective, strategically acting rated firms and unrated firms are pooled, unrated firms' debt is always under-valued (compared to a situation in which investors know that the firm is not rated), and the debt of firms concealing their rating is always over-valued.
Mahrt-Smith, J. (2006). "Should banks own equity stakes in their borrowers? A contractual solution to hold-up problems." Journal of Banking & Finance 30(10): 2911-2929.
This paper develops a model to answer the question whether a bank should hold a share of the equity of a borrowing firm. The model shows that a small equity stake held by the bank can have a significant and positive impact on the lending relationship. The benefit of bank equity participation arises from the reduced ability of the bank to extract rents from the firm in multiple rounds of financing. This, in turn, improves the firm's incentive to make investments in profitable projects that require future outside finance. The benefit is likely to be significant for small to medium size firms, growth firms, and firms with ongoing capital needs. The paper addresses, from a corporate finance perspective, the current debate about whether banks should be allowed to own equity stakes in corporations - and how large these equity stakes should be.
Malliaris, A. G. and M. E. Malliaris (2008). "Investment principles for individual retirement accounts." Journal of Banking & Finance 32(3): 393-404.
The phenomenal growth of individual retirement accounts in the US, and globally, challenges both individuals and their advisors to rationally manage these investments. The two essential differences between an individual retirement account and an institutional portfolio are the length of the investment horizon and the regularity of monthly contributions. The purpose of this paper is to contrast principles of institutional investing with the management of individual retirement accounts. Using monthly historical data from 1926 to 2005 we evaluate the suitability for managing individual retirement portfolios of seven principles employed in institutional investing. We discover that some of these guidelines can be beneficially applied to the investment management of individual retirement accounts while others need to be reconsidered.
Mann, S. V. and E. A. Powers (2007). "Determinants of bond tender premiums and the percentage tendered." Journal of Banking & Finance 31(3): 547-566.
We analyze a large sample of US corporate bond tender offers to understand what affects tender premiums as well as the percentage of bonds tendered. For the average (median) tender offer, the tender price is 5.55% (3.24%) greater than the pre-tender market price while the percentage of bonds tendered is 82.3% (94.6%). Premiums offered by firms are greater when the firm is simultaneously soliciting consents to amend restrictive covenants and when the bond has a greater number of restrictive covenants. Premiums are also greater when long-term risk-free yields are low and the yield curve is flatter - conditions where a firm might want to lock in favorable long-term rates by issuing new debt and retiring old debt. Bondholders respond to higher tender premiums by tendering a greater percentage of their bonds - a 1% increase in tender premium increases the tendering rate by approximately 9%. Bondholders also tender a greater percentage of bonds possessing less desirable characteristics such as a short remaining maturity or bonds that are simultaneously undergoing consent solicitations. Finally, we find that tender offers are easier to complete when bond ownership concentration is greater.
Männasoo, K. and D. G. Mayes (2009). "Explaining bank distress in Eastern European transition economies." Journal of Banking & Finance 33(2): 244-253.
This paper considers the joint role of macroeconomic, structural and bank-specific factors in explaining the occurrence of banking problems in the nineteen Eastern European transition countries over the last decade. With data at the individual bank level we show, using a discrete time survival model, that all three factors interact in their impact and have a rich dynamic profile, which underlines the highly volatile cycles challenging the stability of banks in this region. A fragile funding basis accompanied by high exposure to market risk in an environment of reforms and macroeconomic disturbances is the typical precursor of bank distress.
Mantecon, T. (2008). "An analysis of the implications of uncertainty and agency problems on the wealth effects to acquirers of private firms." Journal of Banking & Finance 32(5): 892-905.
Extensive empirical work shows that bidders do not gain from the acquisition of publicly traded targets but experience positive excess returns in the acquisition of privately held firms. This study investigates how two important differences between private and public firms, namely, informational uncertainty and ownership characteristics, impact the returns to acquirers. A sample of targets that were acquired shortly after filing for an IPO was collected to circumvent the lack of information on private firms. In spite of the special characteristics of these targets, the listing effect is still prevalent in this sample. The results of the analysis are consistent with the hypothesis that acquirers gain in the acquisition of private firms because these targets have a relatively weaker bargaining position due to informational and agency problems and costly access to external capital markets to finance growth opportunities.
Mantecon, T. (2009). "Mitigating risks in cross-border acquisitions." Journal of Banking & Finance 33(4): 640-651.
Compared to domestic acquisitions, cross-border acquisitions present greater challenges for buyers. This article analyzes the use of contingent payments, joint ventures, and toehold investments as potential mechanisms for reducing uncertainty in cross-border acquisitions. Toehold investments and earnout payments are associated with larger gains to buyers in domestic acquisitions, but not in cross-border acquisitions. The results indicate that joint ventures can be an effective mechanism to ameliorate the uncertainty associated with cross-border acquisitions in the presence of severe valuation uncertainties and country investment risks.
Mantecon, T. and R. E. Chatfield (2007). "An analysis of the disposition of assets in a joint venture." Journal of Banking & Finance 31(9): 2591-2611.
The final disposition of assets at the conclusion of joint venture arrangements is important to an understanding of the motivation to pursue a joint venture and the wealth created by these collaborations. A comparison between conventional asset sales and asset sales occurring within a joint venture structure shows that the total wealth created is larger if the assets have been under shared control in a joint venture. Our results support the contention that the establishment of a joint venture creates an opportunity for a relationship-based exchange of information that can serve as a mechanism to transfer assets in the presence of a high degree of asymmetric information.
Mantecon, T. and P. Poon (2009). "An analysis of the liquidity benefits provided by secondary markets." Journal of Banking & Finance 33(2): 335-346.
Listing shares in liquid secondary markets either to facilitate acquisitions or to diversify owner's personal wealth are among the most important reasons for firms to go public [Brau, J.C., Fawcett, S.E., 2006. Initial public offerings: An analysis of theory and practice. Journal of Finance 61, 399-436]. We contend that the expected benefits derived from the liquidity provided by secondary markets are relevant for understanding important decisions made in preparation for an IPO. We hypothesize that the potential losses caused by an IPO failure induce firms that benefit more from going public to hire more reputable underwriters and to adopt more conservative pricing policies. We use several proxies for the benefits firms derive from post-IPO liquidity. The results indicate that firms that benefited more from liquidity were taken public by more prestigious underwriters and exhibited substantially larger levels of price revisions and underpricing. Post-IPO liquidity is also important for understanding the decision to retain the lead underwriter in subsequent SEOs.
Marcucci, J. and M. Quagliariello (2009). "Asymmetric effects of the business cycle on bank credit risk." Journal of Banking & Finance 33(9): 1624-1635.
Prior empirical research on the relation between credit risk and the business cycle has failed to properly investigate the presence of asymmetric effects. To fill this gap, we examine this relation both at the aggregate and the bank level exploiting a unique dataset on Italian banks' borrowers' default rates. We employ threshold regression models that allow to endogenously establish different regimes identified by the thresholds over/below which credit risk is more/less cyclical. We find that not only are the effects of the business cycle on credit risk more pronounced during downturns but cyclicality is also higher for those banks with riskier portfolios.
Marini, F. (2005). "Banks, financial markets, and social welfare." Journal of Banking & Finance 29(10): 2557-2575.
This paper constructs a general equilibrium model of banking and financial markets. The model allows to compare financial systems in which banks have access to financial markets with financial systems in which banks do not have access to financial markets. Allen and Gale [A welfare comparison of intermediaries and financial markets in Germany and the US. European Economic Review 39 (1995) 179-209] find that the Anglo-Saxon model of financial intermediation in which financial markets play a dominant role does not necessarily improve social welfare in comparison with the German model in which banks dominate. Our model provides a theoretical foundation for this view.
Markwat, T., E. Kole, et al. "Contagion as a domino effect in global stock markets." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper shows that stock market contagion occurs as a domino effect, where confined local crashes evolve into more widespread crashes. Using a novel framework based on ordered logit regressions we model the occurrence of local, regional and global crashes as a function of their past occurrences and financial variables. We find significant evidence that global crashes do not occur abruptly but are preceded by local and regional crashes. Besides this form of contagion, interdependence shows up by the effect of interest rates, bond returns and stock market volatility on crash probabilities. When it comes to forecasting global crashes, our model outperforms a binomial model for global crashes only.
Marossy, Z. (2007). "Commodities and Commodity Derivatives, Modeling and Pricing for Agriculturals, Metals and Energy, Hélyette Geman, Wiley Finance (2005). 416 pages, ISBN: 978-0-470-01218-5." Journal of Banking & Finance 31(12): 3904-3906.
Marshall, B. R., R. H. Cahan, et al. (2008). "Can commodity futures be profitably traded with quantitative market timing strategies?" Journal of Banking & Finance32(9): 1810-1819.
Quantitative market timing strategies are not consistently profitable when applied to 15 major commodity futures series. We conduct the most comprehensive study of quantitative trading rules in this market setting to date. We consider over 7000 rules, employ two alternative bootstrapping methodologies, account for data-snooping bias, and consider different time periods. We cannot rule out the possibility that trading rules compliment some other trading strategy or that some traders may have success using a specific rule on its own, but we do conclusively show that none of these rules beat the market any more than expected given random data variation.
Marshall, B. R., M. R. Young, et al. (2006). "Candlestick technical trading strategies: Can they create value for investors?" Journal of Banking & Finance 30(8): 2303-2323.
We conduct the first robust study of the oldest known form of technical analysis, candlestick charting. Candlestick technical analysis is a short-term timing technique that generates signals based on the relationship between open, high, low, and close prices. Using an extension of the bootstrap methodology, which allows for the generation of random open, high, low and close prices, we find that candlestick trading strategies do not have value for Dow Jones Industrial Average (DJIA) stocks. This is further evidence that this market is informationally efficient.
Martynova, M. and L. Renneboog (2008). "A century of corporate takeovers: What have we learned and where do we stand?" Journal of Banking & Finance32(10): 2148-2177.
This paper reviews the vast academic literature on the market for corporate control. Our main focus is the cyclical wave pattern that this market exhibits. We address the following questions: Why do we observe recurring surges and downfalls in M&A activity? Why do managers herd in their takeover decisions? Is takeover activity fuelled by capital market developments? Does a transfer of control generate shareholder gains and do such gains differ across takeover waves? What caused the formation of conglomerate firms in the wave of the 1960s and their de-conglomeration in the 1980s and 1990s? And, why do we observe time- and country-clustering of hostile takeover activity? We find that the patterns of takeover activity and their profitability vary significantly across takeover waves. Despite such diversity, all waves still have some common factors: they are preceded by technological or industrial shocks, and occur in a positive economic and political environment, amidst rapid credit expansion and stock market booms. Takeovers towards the end of each wave are usually driven by non-rational, frequently self-interested managerial decision-making.
Massa, M. and A. Simonov (2005). "Is learning a dimension of risk?" Journal of Banking & Finance 29(10): 2605-2632.
We empirically assess how the uncertainty induced by investors' learning about the fundamentals affects stock returns. We identify two components of induced uncertainty: learning uncertainty and dispersion of beliefs. We characterize these in terms of their relationship to uncertainty about the fundamentals as estimated by surveys of economic forecasters and to measures of uncertainty embedded in derivative markets (open interest and implied volatility). We show that both learning uncertainty and dispersion of beliefs are conditionally priced.
Massoud, N. (2005). "How should Central Banks determine and control their bank note inventory?" Journal of Banking & Finance 29(12): 3099-3119.
This paper looks at a relatively unresearched but important area in money and banking - namely the provision of currency by the Central Bank. One of the most important functions of Central Banking is the provision of liquidity to the economy. However, in fulfilling this function, Central Banks have to be prepared for unexpected money demand shocks as well as production, transportation and cost of capital constraints. The paper develops a dynamic cost minimizing note inventory model that solves for the Central Bank's optimal note order size and frequency. As part of the modeling exercise a value at risk model is used to solve for an inventory "cushion."
Matteo, T. D., T. Aste, et al. (2005). "Long-term memories of developed and emerging markets: Using the scaling analysis to characterize their stage of development." Journal of Banking & Finance 29(4): 827-851.
The scaling properties encompass in a simple analysis many of the volatility characteristics of financial markets. That is why we use them to probe the different degree of markets development. We empirically study the scaling properties of daily Foreign Exchange rates, Stock Market indices and fixed income instruments by using the generalized Hurst approach. We show that the scaling exponents are associated with characteristics of the specific markets and can be used to differentiate markets in their stage of development. The robustness of the results is tested by both Monte Carlo studies and a computation of the scaling in the frequency domain.
Matthews, K., V. Murinde, et al. (2007). "Competitive conditions among the major British banks." Journal of Banking & Finance 31(7): 2025-2042.
This paper reports an empirical assessment of competitive conditions among the major British banks, during a period of major structural change. Specifically, estimates of the Rosse-Panzar H-statistic are reported for a panel of 12 banks for the period 1980-2004. The sample banks correspond closely to the major British banking groups specified by the British Banking Association. The robustness of the results of the Rosse-Panzar methodology is tested by estimating the ratio of Lerner indices obtained from interest rate setting equations. The results confirm the consensus finding that competition in British banking is most accurately characterised by the theoretical model of monopolistic competition. There is evidence that the intensity of competition in the core market for bank lending remained approximately unchanged throughout the 1980s and 1990s. However, competition appears to have become less intense in the non-core (off-balance sheet) business of British banks.
Maudos, J. and J. F. de Guevara (2007). "The cost of market power in banking: Social welfare loss vs. cost inefficiency." Journal of Banking & Finance 31(7): 2103-2125.
This paper analyses the relationship between market power in the loan and deposit markets and efficiency in the EU-15 countries over 1993-2002. Results show the existence of a positive relationship between market power and cost X-efficiency, allowing rejection of the so-called quiet life hypothesis [Berger, A.N., Hannan, T.H., 1998. The efficiency cost of market power in the banking industry: A test of the [`]quiet life' and related hypotheses. Review of Economics and Statistics 8 (3), 454-465]. The social welfare loss attributable to market power in 2002 represented 0.54% of the GDP of the EU-15. Results show that the welfare gains associated with a reduction of market power are greater than the loss of bank cost efficiency, showing the importance of economic policy measures aimed at removing the barriers to outside competition.
Maudos, J. and L. Solís "The determinants of net interest income in the Mexican banking system: An integrated model." Journal of Banking & Finance In Press, Corrected Proof.
This paper analyzes net interest income in the Mexican banking system over the period 1993-2005. Taking as reference the seminal work by Ho and Saunders [Ho, T., Saunders, A., 1981. The determinants of banks interest margins: theory and empirical evidence. Journal of Financial and Quantitative Analysis XVI (4), 581-600] and subsequent extensions by other authors, our study models the net interest margin simultaneously including operating costs and diversification and specialization as determinants of the margin. The results referring to the Mexican case show that its high margins can be explained mainly by average operating costs and by market power. Although non-interest income has increased in recent years, its economic impact is low.
Mauer, D. C. and S. Sarkar (2005). "Real options, agency conflicts, and optimal capital structure." Journal of Banking & Finance 29(6): 1405-1428.
We examine the impact of a stockholder-bondholder conflict over the timing of the exercise of an investment option on firm value and corporate financial policy. We find that an equity-maximizing firm exercises the option too early relative to a value-maximizing strategy, and we show how this problem can be characterized as one of overinvestment in risky investment projects. Equityholders' incentive to overinvest significantly decreases firm value and optimal leverage, and significantly increases the credit spread of risky debt. Numerical solutions illustrate how the agency cost of overinvestment and its effect on corporate financial policy vary with firm and project characteristics.
Maury, B. and A. Pajuste (2005). "Multiple large shareholders and firm value." Journal of Banking & Finance 29(7): 1813-1834.
This paper investigates the effects of having multiple large shareholders on the valuation of firms. Using data on Finnish listed firms, we show, consistent with our model, that a more equal distribution of votes among large blockholders has a positive effect on firm value. This result is particularly strong in family-controlled firms suggesting that families (which typically have managerial or board representation) are more prone to private benefit extraction if they are not monitored by another strong blockholder. We also show that the relation between multiple blockholders and firm value is significantly affected by the identity of these blockholders.
Mayes, D. G. (2005). "Who pays for bank insolvency in transition and emerging economies?" Journal of Banking & Finance 29(1): 161-181.
This paper explores the equity of the way losses from bank insolvencies and their avoidance through intervention by the authorities have been distributed over creditors, depositors, owners and the population at large in transition and emerging economies. It suggests a number of regulatory reforms that would alter the balance between seeking to avoid insolvency and lowering the costs of insolvency should it occur. It considers whether a lex specialis for dealing with problem banks by prompt corrective action and if necessary resolving them if their net worth falls to zero, at little or no cost to the taxpayer can be applied in the circumstances of transition and emerging economies.
Mazouz, K., N. L. Joseph, et al. (2009). "Stock price reaction following large one-day price changes: UK evidence." Journal of Banking & Finance 33(8): 1481-1493.
We examine the short-term price reaction of 424 UK stocks to large one-day price changes. Using the GJR-GARCH(1,1), we find no statistical difference amongst the cumulative abnormal returns (CARs) of the Single Index, the Fama-French and the Carhart-Fama-French models. Shocks [greater-or-equal, slanted]5% are followed by a significant one-day CAR of 1% for all the models. Whilst shocks [less-than-or-equals, slant]-5% are followed by a significant one-day CAR of -0.43% for the Single Index, the CARs are around -0.34% for the other two models. Positive shocks of all sizes and negative shocks [less-than-or-equals, slant]-5% are followed by return continuations, whilst the market is efficient following larger negative shocks. The price reaction to shocks is unaffected when we estimate the CARs using the conditional covariances of the pricing variables.
Mazzotta, S. (2008). "How important is asymmetric covariance for the risk premium of international assets?" Journal of Banking & Finance 32(8): 1636-1647.
This paper empirically investigates the importance of asymmetric conditional covariance when computing the risk premium of international assets. Conditional second moment asymmetry of equity indices is significant and varies over time. The risk premia estimated allowing for asymmetry are statistically and economically different from risk premia estimated without allowing for asymmetry. In particular, an international investor who ignores covariance asymmetry overestimates required returns for equities of the G4 countries and for the world market, on average.
McAndrew, C. and R. Thompson (2007). "The collateral value of fine art." Journal of Banking & Finance 31(3): 589-607.
In this paper, we examine the effect of implicit seller reserves on the estimation of value-at-risk based on historical asset sales data. We direct our examination toward how and whether fine art might prove an appropriate form of loan collateral for banks and other financial institutions. Using a data set of French Impressionist paintings brought to auction from 1985 to 2001, we control for the effect of works that are bought in-house to construct a distribution of potential sale values that corrects for sample selection bias. It turns out that the downside risk surrounding deviations of auction prices from expert presale estimates depends critically on how buy-ins are incorporated. If downside risk is assessed solely on historical experience with successful auction sales, the data appear to support loan-to-value ratios between 50% and a 100% larger than loan-to-value ratios that countenance the existence of seller reserves. The auction process, however, is quantifiable and can reveal the necessary risk information required for loan consideration.
McMillan, D. G. (2007). "Bubbles in the dividend-price ratio? Evidence from an asymmetric exponential smooth-transition model." Journal of Banking & Finance31(3): 787-804.
Recent stock price movements have led to a re-examination of the present value model. An increasing belief is that although dividends and prices are indeed cointegrated, they may exhibit non-linear dynamics in the process of reversion. This paper implements an empirical model designed to capture two possible explanations for such non-linearity, namely transaction costs and noise traders. Utilising data from a number of countries we show that the dynamics of the log dividend yield are, first, characterised by an inner random walk regime, where the benefits of engaging in trade do not outweigh the costs and so the process moves randomly. Second, a reverting outer regime where the dynamics of reversion differ between positive and negative deviations, such that price rises greater than the level supported by dividends exhibit a greater degree of persistence than price falls relative to dividends.
McNally, W. J. and B. F. Smith (2007). "Long-run returns following open market share repurchases." Journal of Banking & Finance 31(3): 703-717.
Past studies find abnormal returns to buying after repurchase program announcements. We analyze the profitability of trading after both program announcements and individual repurchase trade publication using different trading strategies - market and limit orders. The analysis of trades is possible because of a unique Canadian data set. The highest abnormal returns are earned by companies on their own repurchase trades which benefits the non-tendering shareholders. For the public investor, we find no strategies that, in practice, would earn abnormal returns to buying after program announcements. However, there is qualified evidence of abnormal returns to a limit order strategy following publication of individual repurchase trades.
Medema, L., R. H. Koning, et al. (2009). "A practical approach to validating a PD model." Journal of Banking & Finance 33(4): 701-708.
The capital adequacy framework Basel II aims to promote the adoption of stronger risk management practices by the banking industry. The implementation makes validation of credit risk models more important. Lenders therefore need a validation methodology to convince their supervisors that their credit scoring models are performing well. In this paper we take up the challenge to propose and implement a simple validation methodology that can be used by banks to validate their credit risk modelling exercise. We will contextualise the proposed methodology by applying it to a default model of mortgage loans of a commercial bank in the Netherlands.
Megginson, W. L. (2005). "The economics of bank privatization." Journal of Banking & Finance 29(8-9): 1931-1980.
This paper surveys the empirical literature examining bank privatization. We begin by documenting the extent of, theoretical rationale for, and measured performance of state-owned banks around the world, and then assess why many governments have chosen to privatize their often very large state-owned banking sectors. The empirical evidence clearly shows that state-owned banks are less efficient than privately owned banks, and that state domination of banking imposes increasingly severe penalties on those countries with the largest state banking sectors. On the other hand, there is little in the empirical record to suggest that privatization alone transforms the efficiency of divested banks, especially when these are only partially privatized. Privatization generally improves performance, but by far less than is typically observed in studies of non-financial industries. An increasingly common outcome of large-scale bank privatization programs is foreign ownership of many nations' banking sector, which evidence suggests is usually positive in an economic sense, but problematic politically.
Meligkotsidou, L. and I. D. Vrontos (2008). "Detecting structural breaks and identifying risk factors in hedge fund returns: A Bayesian approach." Journal of Banking & Finance 32(11): 2471-2481.
Extending previous work on asset-based style factor models, this paper proposes a model that allows for the presence of structural breaks in hedge fund return series. We consider a Bayesian approach to detecting structural breaks occurring at unknown times and identifying relevant risk factors to explain the monthly return variation. Exact and efficient Bayesian inference for the unknown number and positions of the breaks is performed by using filtering recursions similar to those of the forward-backward algorithm. Existing methods of testing for structural breaks are also used for comparison. We investigate the presence of structural breaks in several hedge fund indices; our results are consistent with market events and episodes that caused substantial volatility in hedge fund returns during the last decade.
Melnik, A. and D. Nissim (2006). "Issue costs in the Eurobond market: The effects of market integration." Journal of Banking & Finance 30(1): 157-177.
This study compares the issuance costs of Eurobonds before and after the completion of the Economic and Monetary Union (EMU) in 2002. We find that the introduction of the Euro has significantly reduced the issue cost of Euro-denominated bonds compared to bonds denominated in the legacy currencies. The reduction in issue cost is not due to a decrease in underwriter compensation, but rather to the elimination of underpricing (the difference between the market price after trading commences and the offering price). Underwriter fee has declined substantially after the completion of the EMU, but this decline has been offset by an increase in underwriter spread (the difference between the offering price and the guaranteed price to the issuer), leaving total underwriter compensation unchanged. The EMU is also associated with significant reductions in bond maturity and syndicate size, consistent with its expected effects on liquidity and issue costs in the Eurobond market.
Menkhoff, L., D. Neuberger, et al. (2006). "Collateral-based lending in emerging markets: Evidence from Thailand." Journal of Banking & Finance 30(1): 1-21.
This paper examines the role and determinants of collateral in emerging markets compared to mature ones. Analyzing a data set of 560 credit files of Thai commercial banks, we find that both the incidence and degree of collateralization are higher there than in developed markets. Thai banks use collateral primarily to reduce the higher credit risks of small and relatively young firms. Long credit relationships do not reduce collateral requirements by lowering information asymmetry. Market imperfections result from housebanks demanding higher collateral than non-housebanks, suggesting a lock-in effect for their borrowers, and from larger banks realizing higher collateral claims.
Mercieca, S., K. Schaeck, et al. (2007). "Small European banks: Benefits from diversification?" Journal of Banking & Finance 31(7): 1975-1998.
Motivated by the liberalisation and harmonisation of financial systems in Europe, we investigate whether the observed shift into non-interest income activities improves performance of small European credit institutions. Using a sample of 755 small banks for the period 1997-2003, we find no direct diversification benefits within and across business lines and an inverse association between non-interest income and bank performance. Our findings are robust to a set of sensitivity analyses using alternative samples and controlling for the regulatory environment. Furthermore, the results provide circumstantial evidence for the presence of economies of scale. The absence of benefits of diversification confirms findings for other banking markets and suggests small European banks enter lines of business where they currently lack expertise and experience. These results have implications for bank supervisors, regulators and bank managers.
Mersland, R. and R. Øystein Strøm (2009). "Performance and governance in microfinance institutions." Journal of Banking & Finance 33(4): 662-669.
We examine the relationship between firm performance and corporate governance in microfinance institutions (MFI) using a self-constructed global dataset on MFIs collected from third-party rating agencies. Using random effects panel data estimations, we study the effects of board and CEO characteristics, firm ownership type, customer-firm relationship, and competition and regulation on an MFI's financial performance and outreach to poor clients. We find that financial performance improves with local rather than international directors, an internal board auditor, and a female CEO. The number of credit clients increase with CEO/chairman duality. Outreach is lower in the case of lending to individuals than in the case of group lending. We find no difference between non-profit organisations and shareholder firms in financial performance and outreach, and we find that bank regulation has no effect. The results underline the need for an industry specific approach to MFI governance.
Micco, A., U. Panizza, et al. (2007). "Bank ownership and performance. Does politics matter?" Journal of Banking & Finance 31(1): 219-241.
This paper uses a new dataset to reassess the relationship between bank ownership and bank performance, providing separate estimations for developing and industrial countries. It finds that state-owned banks located in developing countries tend to have lower profitability and higher costs than their private counterparts, and that the opposite is true for foreign-owned banks. The paper finds no strong correlation between ownership and performance for banks located in industrial countries. Next, in order to test whether the differential in performance between public and private banks is driven by political considerations, the paper checks whether this differential widens during election years; it finds strong support for this hypothesis.
Miffre, J. and G. Rallis (2007). "Momentum strategies in commodity futures markets." Journal of Banking & Finance 31(6): 1863-1886.
The article tests for the presence of short-term continuation and long-term reversal in commodity futures prices. While contrarian strategies do not work, the article identifies 13 profitable momentum strategies that generate 9.38% average return a year. A closer analysis of the constituents of the long-short portfolios reveals that the momentum strategies buy backwardated contracts and sell contangoed contracts. The correlation between the momentum returns and the returns of traditional asset classes is also found to be low, making the commodity-based relative-strength portfolios excellent candidates for inclusion in well-diversified portfolios.
Milesi-Ferretti, G. M. and K. Moriyama (2006). "Fiscal adjustment in EU countries: A balance sheet approach." Journal of Banking & Finance 30(12): 3281-3298.
Several European Union countries have recently implemented or are envisaging fiscal operations which improve budgetary figures but have no structural impact on government finances. We evaluate some of these measures using a balance sheet approach. In particular, we examine the degree to which reductions in government debt in EU countries has been accompanied by a decumulation of government assets. In the runup to Maastricht we find a strong correlation between changes in government liabilities and government assets, and larger declines in government assets in countries starting from higher public debt levels.
Milne, A. (2006). "What is in it for us? Network effects and bank payment innovation." Journal of Banking & Finance 30(6): 1613-1630.
The developed world exhibits substantial but poorly understood differences in the efficiency and quality of low value payment services. This paper compares payment arrangements in the UK, Norway, Sweden, and Finland, and discusses the impact of network effects on incentives to adopt new payments technology. A model is presented, in which private benefits for investment in shared inter-bank payments infrastructure are weak. In contrast, due to [`]account externalities', there are strong incentives for investment in intra-bank payment systems. These two features, distinguishing bank payments from other network industries, can help explain some of the observed cross-country differences in payment arrangements.
Milne, A. (2007). "The industrial organization of post-trade clearing and settlement." Journal of Banking & Finance 31(10): 2945-2961.
The introduction to this special issue reviews the literature on the industrial organization of securities market clearing and settlement, covering institutional, theoretical, and empirical contributions, including both papers in this special issue and previous studies. Clearing and settlement is an important but under-researched network industry. Recent theoretical research has characterized the network externalities in clearing and settlement and explored the economic efficiency of various alternative industrial structures. Initial empirical research has identified substantial economies of both scale and scope and important interactions with trading platforms. More research is needed to elaborate these theoretical insights and improve our understanding of the economics of this major industry.
Minenna, M. and P. Verzella (2008). "A revisited and stable Fourier transform method for affine jump diffusion models." Journal of Banking & Finance 32(10): 2064-2075.
In the last decade, fast Fourier transform methods (i.e. FFT) have become the standard tool for pricing and hedging with affine jump diffusion models (i.e. AJD), despite the FFT theoretical framework is still in development and it is known that the early solutions have serious problems in terms of stability and accuracy. This fact depends from the relevant computational gain that the FFT approach offers with respect to the standard Fourier transform methods that make use of a canonical inverse Levy formula. In this work we revisit a classic FT method and find that changing the quadrature algorithm and using alternative, less flawed, representation for the pricing formulas can improve the computational performance up to levels that are only three time slower than FFT can achieve. This allows to have at the same time a reasonable computational speed and the well known stability and accuracy of canonical FT methods.
Mitchell, H. and M. D. McKenzie (2006). "A note on the Wang and Wang measure of the quality of the compass rose." Journal of Banking & Finance 30(12): 3519-3524.
H. Wang and C. Wang [Visibility of the compass rose in financial asset returns: A quantitative study, J. Bank. Financ. 26 (2002), 1099-1111] derive a measure of the visibility of the radial patterns that appear in a plot of current and past returns, which are more commonly known as the compass rose. In theory, this measure should be positively related to the tick/volatility ratio. In practice however, we find that this relationship does not hold for higher tick/volatility ratios that are common to stock market data. Thus, the use of this measure is limited in real world applications. We propose a correction factor that improves the behaviour of the quality measure over higher tick/volatility ratios, however, further research is required to fully identify and correct the problem.
Miyajima, H. and Y. Yafeh (2007). "Japan's banking crisis: An event-study perspective." Journal of Banking & Finance 31(9): 2866-2885.
We calculate abnormal stock returns for Japanese non-financial companies around major events associated with the banking crisis (1995-2000), and find that not all companies were equally sensitive to the malaise of the banking sector: the most affected were small, leveraged, low-tech companies with low credit ratings and low market to book ratios. This is consistent with "credit crunch" theories (companies with limited access to financial markets are sensitive to changes in bank lending) and with claims that innovation is rarely financed by bank debt. We do not find much evidence on the alleged misallocation of loans to support ailing bank clients.
Mizrach, B. and C. J. Neely (2008). "Information shares in the US Treasury market." Journal of Banking & Finance 32(7): 1221-1233.
This paper highlights the previously neglected role of the futures markets in US Treasury price discovery. The estimates of 5- and 10-year GovPX spot market information shares typically fail to reach 50% from 1999 on. The GovPX information shares for the 2-year contract are higher than those of the 5- and 10-year maturities but also decline after 1998. Relative bid-ask spreads, number of trades, and realized volatility are statistically significant and explain up to 21% of daily information shares. In roughly 1/4 of cases when public information is released, the futures market gains information share, but macroeconomic announcements rarely explain information shares independently of liquidity.
Moeller, S. B. and F. P. Schlingemann (2005). "Global diversification and bidder gains: A comparison between cross-border and domestic acquisitions." Journal of Banking & Finance 29(3): 533-564.
We provide empirical evidence on how cross-border acquisitions from the perspective of an US acquirer differ from domestic transactions based on stock and operating performance measures. For a sample of 4430 acquisitions between 1985 and 1995 and controlling for various factors we find that US firms who acquire cross-border targets relative to those that acquire domestic targets experience significantly lower announcement stock returns of approximately 1% and significantly lower changes in operating performance. Stock returns are negatively associated with an increase in both global and industrial diversification. Cross-border takeover activity has increased during the past decade and the observed difference in bidder gains is more pronounced for the latter half of the sample period. We find that bidder returns are positively related to takeover activity in the target country and to a legal system offering better shareholder rights. With the exception of the UK, the target country's degree of economic restrictiveness is negatively related to bidder returns.
Moller, N. and S. Zilca (2008). "The evolution of the January effect." Journal of Banking & Finance 32(3): 447-457.
This paper extends recent studies of the January effect by investigating the evolution of the daily pattern of the effect across size deciles. Our evidence documents a sizable mean reverting component beginning in the latter part of January and a shorter duration of the seasonal effect. Despite lower abnormal returns in the second part of January, higher abnormal returns in the first part of January keep the magnitude of the January effect unchanged. Further analysis of daily trading volumes suggests a stable trading volume intensity in the first part of January and a substantial decline in trading volume intensity in the second part of January.
Molyneux, P. and J. O. S. Wilson (2007). "Developments in European banking." Journal of Banking & Finance 31(7): 1907-1910.
Mora, N. (2006). "Sovereign credit ratings: Guilty beyond reasonable doubt?" Journal of Banking & Finance 30(7): 2041-2062.
This paper questions the view that credit rating agencies aggravated the East Asian crisis by excessively downgrading those countries. I find that ratings are, if anything, sticky rather than procyclical. Assigned ratings exceeded predicted ratings before the crisis, mostly matched predicted ratings during the crisis period, and did not increase as much as predictions in the period after the crisis. Ratings are also found to react to non-macroeconomic factors such as lagged spreads and a country's default history. Therefore it is questionable that ratings exacerbate the boom-bust cycle if they are simply reacting to news, whether macroeconomic or market.
Moreno, D. and R. Rodríguez (2009). "The value of coskewness in mutual fund performance evaluation." Journal of Banking & Finance 33(9): 1664-1676.
Recent asset pricing studies demonstrate the relevance of incorporating coskewness in asset pricing models, and illustrate how this component helps to explain the time variation of ex-ante market risk premiums. This paper analyzes the role of coskewness in mutual fund performance evaluation and finds evidence that adding a coskewness factor is economically and statistically significant. It documents that coskewness is sometimes managed and shows persistence of the coskewness policy over time. One of the most striking results is that many negative (positive) alpha funds, measured relative to the CAPM risk adjustments, would be reclassified as positive (negative) alpha funds using a model with coskewness. Therefore, performance ranking based on risk-adjusted returns without considering coskewness could generate an erroneous classification. Moreover, some fund characteristics, such as turnover ratio or category, are related to the likelihood of managing coskewness.
Moretto, M. and R. Tamborini (2007). "Firm value, illiquidity risk and liquidity insurance." Journal of Banking & Finance 31(1): 103-120.
Our interest here concerns liquidity supply to firms. We first examine the relation between firm value and access to liquidity supply, and then we investigate the existence conditions and efficiency properties of financial contracts with a liquidity covenant in a continuous-time, infinite-horizon stochastic model of a repeated firm-investors relationship where the key problem is the mutual commitment between the two parties. To model this problem we consider liquidity supply as a stochastic "regulator mechanism" that prevents the firm's ability to pay from falling below a predefined threshold (here the market fixed coupon), and we then apply recent developments in dynamic programming techniques for "regulated processes" to obtain a close form solution for the firm's value. Our main finding is that efficient, i.e. actuarially fair and renegotiation-proof contracts emerge in the absence of perfect commitment as the firm and the investor can exert mutual threat of termination.
Morey, M., A. Gottesman, et al. (2009). "Does better corporate governance result in higher valuations in emerging markets? Another examination using a new data set." Journal of Banking & Finance 33(2): 254-262.
This paper utilizes a new data set from AllianceBernstein that, unlike other corporate governance data, has monthly-updated firm-level governance ratings for 21 emerging markets countries for almost a five year period. With these unique data, we examine how changes in corporate governance ratings impact firm valuation. Using this test we find evidence that improvements in corporate governance result in significantly higher valuations.
Morton, D. P., E. Popova, et al. (2006). "Efficient fund of hedge funds construction under downside risk measures." Journal of Banking & Finance 30(2): 503-518.
We consider portfolio allocation in which the underlying investment instruments are hedge funds. We consider a family of utility functions involving the probability of outperforming a benchmark and expected regret relative to another benchmark. Non-normal return vectors with prescribed marginal distributions and correlation structure are modeled and simulated using the normal-to-anything method. A Monte Carlo procedure is used to obtain, and establish the quality of, a solution to the associated portfolio optimization model. Computational results are presented on a problem in which we construct a fund of 13 CSFB/Tremont hedge-fund indices.
Moshirian, F. (2006). "Aspects of international financial services." Journal of Banking & Finance 30(4): 1057-1064.
The purpose of this paper is to discuss the issues related to international financial services, particularly foreign direct investment in banking. The paper discusses the challenges of measuring incomes generated from the activities of multinational banks, including their international lending and direct investment in host countries. The paper highlights the complementary role of FDI and trade in financial services and discusses investment in banking services. The patterns of FDI in banking in Eastern European countries, Latin America and East Asia are also analysed with a focus on the costs and benefits of FDI in banking in the emerging countries.
Moshirian, F. (2006). "Editorial." Journal of Banking & Finance 30(4): 1055-1056.
Moshirian, F. (2007). "Editorial." Journal of Banking & Finance 31(6): 1577-1577.
Moshirian, F. (2007). "Editorial." Journal of Banking & Finance 31(1): 1-1.
Moshirian, F. (2007). "Global financial services and a global single currency." Journal of Banking & Finance 31(1): 3-9.
The purpose of this paper is to highlight the evolution of financial institutions in the context of increasingly volatile foreign exchange markets. The paper discusses the importance of the formation of a single currency in the US in the 19th century and the formation of the Euro in the 20th century for reducing volatility in foreign exchange markets that have assisted financial institutions' international business expansion. The paper also considers some of the key assumptions of an optimal currency theorem such as labour mobility and argues that in the 21st century, more comprehensive financial market integration and a single global currency could emerge, provided that capital mobility and hence foreign capital flows continue meeting labour in the host countries for production rather than the other way round.
Moshirian, F. (2007). "Globalisation and the role of effective international institutions." Journal of Banking & Finance 31(6): 1579-1593.
Since empirical research has demonstrated that a sound financial system drives economic growth and the reverse causality alone is not causing this relationship, one can well extend this causal relationship to a global financial system and also argue that those factors that are limiting stronger economic growth and financial globalisation are partly related to deficiencies of the current global financial system. In the same way that some studies have argued for the significance of high quality national institutions as a way of addressing some of the national social and economic bottlenecks and also as a way of creating the right environment for sustained economic growth and integration into the global markets, high quality international institutions with adequate mandates and effective executive power can also influence the process of regional and global financial integration. These international institutions can accelerate the process of national institutional reforms. The paper argues that a number of financial barriers limiting financial globalisation have in essence international, regional and national components and hence without a globally coordinated strategy and framework to have parallel reforms at three levels, the limits to financial globalisation may remain for the foreseeable future.
Moshirian, F. (2008). "Editorial." Journal of Banking & Finance 32(11): 2287-2287.
Moshirian, F. (2008). "Editorial." Journal of Banking & Finance 32(8): 1431-1431.
Moshirian, F. (2008). "Financial globalization and growth." Journal of Banking & Finance 32(4): 471-471.
Moshirian, F. (2008). "Financial services in an increasingly integrated global financial market." Journal of Banking & Finance 32(11): 2288-2292.
This paper discusses aspects of global financial services. As part of financial globalisation, financial institutions have evolved both nationally and internationally. FDI is becoming an important vehicle for multinational banks to enter developing countries. This in turn is changing the composition of trade in financial services. The experience of regional integration in Europe and the emergence of large multinational European banks signal a new era of global competition and consolidation of financial institutions. Home bias in international financial services is much less where financial integration is taking place. With financial globalisation, one should expect more diversification of ownership of multinational banks around the world, particularly when China and India are now able to have strategic investment in some of the key investment banks around the world. Financial globalisation requires stronger and more effective international institutions as a way of monitoring the activities of multinational financial institutions at both the national and international levels.
Moshirian, F. (2008). "Globalisation, growth and institutions." Journal of Banking & Finance 32(4): 472-479.
We are currently in the second wave of globalisation. Despite the fact that over the past two decades a number of national financial and other barriers have been removed, there are still a number of national, regional and global factors that are slowing down the process of financial globalisation from trickling down to all parts of the world. This paper briefly discusses the process of globalisation and considers the human development index including education as a way of measuring economic growth and financial wealth in different parts of the world. The paper analyses the process of financial globalisation and the way some nations have become the recipients of more foreign capital than others. As a way of seeing the importance of both national and international economic and financial integration as important ingredients for sustained economic growth, the process of financial integration in Europe is analysed as a model for acceleration of the process of globalisation and sustained economic growth in this century. The 21st century is referred to as the Pacific century and hence financial integration in the Asia Pacific region (APEC) could create a new impetus for the EU to increase its internal integration including its fiscal policies as a way of remaining competitive in the global economy.
Moshirian, F. (2008). "The significance of a world government in the process of globalization in the 21st century." Journal of Banking & Finance 32(8): 1432-1439.
This paper discusses the process of globalization and analyses those pressing global issues that have been unresolved due to the lack of an integrated global system and effective international institutions. It highlights a number of global issues that require global ethics and global action. The paper discusses how a globally integrated system, with a world government, a world parliament and a world central bank as its components, is no longer an idealistic concept. The paper highlights the dynamic gains of the transformation of nations and the future of this planet, once an integrated global system is in place. It analyses the challenges overcome during the integration of the US in the 19th century and the process of the formation of the EU in the 20th century. It argues that the creation of a globally integrated system, based on new and effective international institutions would be easier to implement than the formation of the US in the 19th Century or the EU in the 20th century, as we now have technology that did not exist in the 19th century and the process of globalization has already removed many previous financial, technological, cultural, language and other barriers to integration.
Moshirian, F. (2009). "Can an Asia Pacific Community, similar to the European Community, emerge?" Journal of Banking & Finance 33(1): 2-8.
The purpose of this paper is to analyse whether the Asia Pacific region could form a union similar to the one now established in Europe. To this end, it analyses some of the major challenge faced by the US prior to its union in the 19th century and the way countries such as France and Germany contributed to the formation of the EU, despite their past animosity. The paper proposed a two tier system for the emergence of a union in the Asia Pacific region in which all countries could become part of a regional framework for regional security and free trade and some of the more advanced countries in the region could start the process of financial integration and invite other member countries to join them over time. The paper argues that in the 2st century, unlike the claim of the "currency optimum theory," there is no need for labour mobility amongst Asian countries for the formation of a union in this region and hence Australia should not expect millions of workers from China to migrate there. The paper argues that the role of Japan and China in the process of regional integration has been underestimated, due to the claim that the former is a monoculture and the latter is too nationalistic. The paper highlights how diversity in the region could be seen as a strength in the Asia Pacific region. It also shows how the process of globalisation has already overcome differences in culture, religion and race which used to be stumbling blocks for more regional or global integration. The paper argues that a union in the Asia Pacific region would reduce "home bias" for international capital flows and hence there would be significant financial transformation of countries in this region.
Moshirian, F. (2009). "Editorial." Journal of Banking & Finance 33(1): 1-1.
Muller, A. and W. F. C. Verschoor "The effect of exchange rate variability on US shareholder wealth." Journal of Banking & Finance In Press, Corrected Proof.
We examine the relationship between financial crisis exchange rate variability and equity return volatility for US multinationals. Empirical analysis of the major financial crises of the last decades reveals that stock return variability increases significantly in the aftermath of a crisis, even relative to the increase in stock return volatility for other firms belonging to the same industry and market capitalization class. In conjunction with this increase in total volatility, there is also an increase in stock market risk ([beta]) for multinational firms. Moreover, trade and service oriented industries appear to be particularly sensitive to these changing exchange rate conditions.
Mulvey, J. M. and H. G. Erkan (2006). "Applying CVaR for decentralized risk management of financial companies." Journal of Banking & Finance 30(2): 627-644.
Over the past decade, financial companies have merged diverse areas including investment banking, insurance, retail banking, and trading operations. Despite this diversity, many global financial firms suffered severe losses during the recent recession. To reduce enterprise risks and increase profits, we apply a decentralized risk management strategy based on a stochastic optimization model. We extend the decentralized approach with the CVaR risk-metric, showing the advantages of CVaR over traditional risk measures such as value-at-risk. An example taken from the earthquake insurance area illustrates the concepts.
Murphy, A. and Y. Zhu (2008). "Unraveling the complex interrelationships between exchange rates and fundamentals." Journal of Banking & Finance 32(6): 1150-1160.
This research investigates the intrinsic characteristics of currency values by fundamentally decomposing investor expectations on 16 currencies. The results on 195 exchange rates over several decades indicate investors perceive countries to be more likely to choose devaluation solutions to BOP problems when inflation is lower and when an alternative drop in real income growth is more "painful". In addition, empirical support is provided for the hypothesis that forward rates often appear biased because the distributional expectations incorporated into them include, for a country with a current account deficit, a small probability of a large spot decline that does not actually occur in most finite samples.
Nakane, M. I. and D. B. Weintraub (2005). "Bank privatization and productivity: Evidence for Brazil." Journal of Banking & Finance 29(8-9): 2259-2289.
Over the last decade, the Brazilian banking industry has undergone major and deep transformations with several privatizations of state-owned banks, mergers and acquisitions, closing down of troubled banks, entry by foreign banks, etc. The purpose of this paper is to evaluate the impacts of these changes in banking total factor productivity. We first obtain measures of bank-level productivity by employing the techniques due to Levinsohn and Petrin [Levinsohn, J., Petrin, A., 2003. Estimating production functions using inputs to control for unobservables. Review of Economic Studies 70, 317-342]. We then relate such measures to a set of bank characteristics. Our main results indicate that state-owned banks are less productive than their private peers, and that privatization has increased productivity.
Nam, K., K. M. Washer, et al. (2005). "Asymmetric return dynamics and technical trading strategies." Journal of Banking & Finance 29(2): 391-418.
We investigate the profitability of technical trading strategies based on an asymmetric reverting property of stock returns. We identify an asymmetry in return dynamics for daily returns on the S&P 500 index. Return dynamics evolve along a positive (negative) unconditional mean after a prior positive (negative) return. The trading strategies based on this asymmetry generate a positive return for buy signals, a negative return for sell signals, and a positive return for the spread between buy and sell signals. Our results imply that the observed asymmetry in return dynamics is the main source of profitability for the implied strategies, thereby corroborating arguments for the usefulness of technical trading strategies.
Naszódi, A. (2007). "R.J. Sweeney, Editor, Foreign Exchange Markets (International Library of Critical Writings in Financial Economics), Edward Elgar Publishing Ltd (2005) ISBN 1-84064-831-7 432 pp." Journal of Banking & Finance 31(12): 3901-3903.
Nautz, D. and S. Schmidt (2009). "Monetary policy implementation and the federal funds rate." Journal of Banking & Finance 33(7): 1274-1284.
This paper investigates how the implementation of monetary policy affects the dynamics and the volatility of the federal funds rate. Since the early 1980s, the most important changes in the Fed's conduct of monetary policy refer to the role of the federal funds rate target and the reserve requirement system. We show that the improved communication and transparency regarding the federal funds rate target has significantly increased the Fed's influence on the federal funds rate since 1994. By contrast, the declining role of required reserves in the US has contributed to higher federal funds rate volatility. Our results suggest that the introduction of remunerated required reserves will further enhance the controllability of the federal funds rate.
Neanidis, K. C. and C. S. Savva "Financial dollarization: Short-run determinants in transition economies." Journal of Banking & Finance In Press, Corrected Proof.
This paper examines the determinants of financial dollarization in transition economies from a short-run perspective. Using aggregate monthly data of deposit and loan dollarization we study the drivers of short-term fluctuations in dollarization and test their importance at different levels of dollarization. The results provide evidence that (a) the positive (negative) short-run effects of depreciation (monetary expansion) on deposit dollarization are exacerbated in high-dollarization countries; (b) short-run loan dollarization is mainly driven by banks matching of domestic loans and deposits, currency matching of assets and liabilities, international financial integration, and institutional quality; and (c) both types of short-run dollarization are affected by interest rate differentials and deviations from desired dollarization.
Ng, L. and F. Wu (2007). "The trading behavior of institutions and individuals in Chinese equity markets." Journal of Banking & Finance 31(9): 2695-2710.
This paper employs a unique data set to analyze the trading behavior of 4.74 million individual and institutional investors across Mainland China. Results show that groups of individual investors with varying trade values (as proxies for wealth levels) engage in different trading strategies. Chinese institutions are momentum investors, while less wealthy Chinese individual investors at large are contrarian investors. The results also indicate that a small group of wealthiest Chinese individuals tend to behave like institutions when they buy stocks, and behave like less wealthy individuals when they sell. Furthermore, only the trading activities of institutions and of wealthiest individuals can affect future stock volatility, but those of Chinese individual investors at large have no predictive power for future stock returns.
Nicoló, G. D., P. Honohan, et al. (2005). "Dollarization of bank deposits: Causes and consequences." Journal of Banking & Finance 29(7): 1697-1727.
This paper assesses the benefits and risks associated with dollarization of bank deposits. We provide novel empirical evidence on the determinants of deposit dollarization, its role in promoting financial development, and on whether dollarization is associated with financial instability. We find that: (a) the credibility of macroeconomic policy and the quality of institutions are both key determinants of cross-country variations in dollarization; (b) dollarization is likely to promote financial deepening only in a high inflation environment; and (c) financial instability is likely higher in dollarized economies. The implications of these findings for financial sector and monetary policies are briefly discussed.
Niemann, M., J. H. Schmidt, et al. (2008). "Improving performance of corporate rating prediction models by reducing financial ratio heterogeneity." Journal of Banking & Finance 32(3): 434-446.
We introduce a new approach to improve the performance of rating prediction models for multinational corporations. In this segment, the low number of defaults poses a challenge, as it prevents rating models to be constructed for individual industry sectors or regions. We show that reducing group-level heterogeneity in financial ratios results in a rating prediction model with better performance than both unadjusted models and models adjusted by including industry dummies or other simpler procedures. Our approach fills a gap in cases where a limited dataset does not permit the construction of separate models for individual industries or regions.
Niinimäki, J. P. (2009). "Does collateral fuel moral hazard in banking?" Journal of Banking & Finance 33(3): 514-521.
This paper presents two models in which the fluctuating value of loan collateral (real estate) generates the problem of moral hazard between a bank and a deposit insurance agent. The bank finances risky projects against collateral and relies on the rising collateral value. If the collateral value later appreciates, the bank enjoys handsome profits; otherwise, the bank fails. The findings are rather consistent with the characteristics of the topical subprime mortgage crisis.
Nikitin, M. and R. T. Smith (2008). "Information acquisition, coordination, and fundamentals in a financial crisis." Journal of Banking & Finance 32(6): 907-914.
This paper reconciles the two explanations of a financial crisis, the self-fulfilling prophecy and the fundamental causes, in an empirically-relevant framework, by explicitly modeling the costly voluntary acquisition of information about fundamentals in a variant of Diamond and Dybvig [Diamond, D., Dybvig, P., 1983. Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91, 401-419]. The model exhibits strategic complementarity in information acquisition. In the "partial run" equilibrium investors engage in costly evaluation of projects, so that banks with lower-return projects fail. There also exist the classic "full-run" and "no-run" equilibria in which there is no project evaluation. Investors' coordination on a specific equilibrium is triggered by a self-fulfilling prophecy. So, financial crises are seen as both fundamentals-based and self-fulfilling prophecies-based phenomena.
Nikolaou, K. (2008). "The behaviour of the real exchange rate: Evidence from regression quantiles." Journal of Banking & Finance 32(5): 664-679.
We test for mean reversion in real exchange rates using a recently developed unit root test for non-normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of different magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. It, therefore provides a detailed mapping of the real exchange rate behaviour, while being a robust alternative to previous unit root tests. The latter is confirmed by a simulation analysis comparing the power of the alternative tests. As concerns the real exchange rate, our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER.
Nilsson, R. (2008). "The value of shorting." Journal of Banking & Finance 32(5): 880-891.
This paper assesses the effects of short-sale constraints on asset prices. The analysis focuses on a particular period in Sweden during which shorting stocks was impossible but stock options were traded. Firstly, the effect on both stock options and the underlying stock was investigated jointly by considering deviations from put-call-parity. Secondly, the effects on only the derivatives were investigated by considering their implied volatilites. The main findings are: (i) the impact on pricing are consistent with a short-sale constraint, (ii) these effects are much more pronounced when shorting is not possible, (iii) these effects are not solely attributable to the mispricing of the stock, as previous research indicates, and (iv) access to international shorting markets can alleviate local short-sale constraints.
Niu, J. (2008). "Can subordinated debt constrain banks' risk taking?" Journal of Banking & Finance 32(6): 1110-1119.
This paper presents a model in which requiring banks to issue a proper amount of subordinated debt can constrain their risk taking both before and after debt issuance. The main idea is that the prospect of issuing debt motivates banks to invest in safe assets before debt issuance; holding such assets then constrains their risk taking after debt issuance. The model helps understand the existing empirical findings, and offers a new testable prediction. It also suggests that: (1) regulators should set the amount of subordinated debt within a range; and (2) subordinated debt cannot entirely substitute for equity capital.
Norden, L. and W. Wagner (2008). "Credit derivatives and loan pricing." Journal of Banking & Finance 32(12): 2560-2569.
This paper examines the relation between the new markets for credit default swaps (CDS) and banks' pricing of syndicated loans to US corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain about 25% of subsequent monthly changes in aggregate loan spreads during 2000-2005. Moreover, when compared to traditional explanatory factors, they turn out to be the dominant determinant of loan spreads. In particular, they explain loan rates much better than same rated bonds. This suggests that CDS prices contain, beyond general credit risk, to a substantial extent information relevant for bank lending. We also find that, over time, new information from CDS markets is faster incorporated into loans, but information from other markets is not. Overall, our results indicate that the markets for CDS have gained an important role for banks.
Normandin, M. and P. St-Amour (2008). "An empirical analysis of aggregate household portfolios." Journal of Banking & Finance 32(8): 1583-1597.
This paper analyzes the important time variation in US aggregate household portfolios. To do so, we first use flexible descriptions of preferences and investment opportunities to derive household optimal decision rules that nest static, myopic, and non-myopic portfolio allocations. We then compare these rules to the data through formal statistical analysis. Our main results reveal that: (i) static and myopic investment behaviors are rejected, (ii) non-myopic portfolio allocations are supported, and (iii) the Fama-French factors best explain empirical portfolio shares.
Novak, S. Y. and J. Beirlant (2006). "The magnitude of a market crash can be predicted." Journal of Banking & Finance 30(2): 453-462.
Could the magnitude of the stock market crash of 19.10.1987 be predicted on the base of the data available on the eve of "the black Monday"? How far can the financial market fall, say, once in 40 years? We demonstrate that modern methods of Extreme Value Theory can help in answering these questions.
Nyström, K. and J. Skoglund (2006). "A credit risk model for large dimensional portfolios with application to economic capital." Journal of Banking & Finance30(8): 2163-2197.
In this paper we develop a multi-period and multi-state portfolio credit risk model which is applicable to large dimensional portfolios like for example retail and mortgage portfolios. The model includes a methodology for estimation and simulation of systematic transition risk through a model for stochastic migration, a methodology for the modelling of recoveries in the case of stochastic collaterals as well as an approach to dimension reduction of the portfolio. One important application of our model is economic capital (EC) and a concept of EC based on the analogy with classical risk theory is introduced and the questions of allocation as well as risk-adjusted pricing based on the allocation of EC are structured and described. The model is illustrated by an extensive numerical example giving a concretization of the model as well as of several of the concepts introduced.
Ødegaard, B. A. (2007). "Price differences between equity classes. Corporate control, foreign ownership or liquidity?" Journal of Banking & Finance 31(12): 3621-3645.
This paper is the first comprehensive study of price differences for dual class equity at the Oslo Stock Exchange. It analyzes the relative importance of corporate control, foreign ownership restrictions and stock market liquidity for the price differences. The Norwegian market has the peculiar feature that in part of the sample period non-voting shares were trading at a premium to voting shares, i.e., what is usually termed the "voting premium" was negative. This result can be rationalized by restrictions on foreign ownership. In the later part of the period, with no regulatory restrictions on foreign ownership, the voting premium is positive, and related to corporate governance and liquidity.
Ohta, W. (2006). "An analysis of intraday patterns in price clustering on the Tokyo Stock Exchange." Journal of Banking & Finance 30(3): 1023-1039.
Stock prices tend to cluster at round numbers, a phenomenon observed in many markets. Using tick-by-tick transaction data, this article studies price clustering on the Tokyo Stock Exchange, which is a computerized limit order market. As for the intraday pattern, the degree of price clustering is greatest at the market opening. Then, it decreases during the first half hour and reaches a stable level. It does not increase again near the market closing. There is no clear difference in clustering between call auctions and continuous auctions.
Oikarinen, E. (2009). "Interaction between housing prices and household borrowing: The Finnish case." Journal of Banking & Finance 33(4): 747-756.
Employing time series econometrics this study shows that there has been a significant two-way interaction between housing prices and housing loan stock in Finland since the financial liberalization in the late 1980s. Before the financial deregulation the interaction was substantially weaker. Furthermore, housing appreciation has a notable positive impact on the outstanding consumption loan stock. It appears that there is no similar relationship between stock prices and credit. Understanding the two-way interaction between housing prices and credit is of importance, since the interdependence is likely to augment boom-bust cycles in the economy and increase the fragility of the financial sector.
Orlowski, L. T. (2005). "Monetary convergence of the EU accession countries to the eurozone: A theoretical framework and policy implications." Journal of Banking & Finance 29(1): 203-225.
A flexible approach to direct inflation targeting offers the European Union accession countries a viable monetary policy choice that is believed to facilitate both the economic transition and the monetary convergence to the eurozone. Following this assumption, a model investigating the nexus between inflation and selected monetary variables in three EU accession countries: the Czech Republic, Poland and Hungary is advanced. The empirical analysis is aimed at explaining the sensitivity of the CPI-based inflation path in these countries to backward- as well as forward-looking expectations, nominal exchange rate fluctuations, the eurozone inflation impulses, and output changes. The analysis implies that the monetary convergence begins with flexible inflation targeting and concludes with a full-fledged euroization.
Oswald, D. and S. Young (2008). "Share reacquisitions, surplus cash, and agency problems." Journal of Banking & Finance 32(5): 795-806.
Share repurchases help alleviate agency costs of surplus cash by restricting management's scope to waste corporate resources. But why do self-interested managers agree to disgorge surplus cash in the first place? This study examines the intervening effect of managerial monitoring and incentive alignment mechanisms on the decision to distribute excess cash through a share repurchase. Findings indicate that repurchases substitute for cash retention decisions that would otherwise prove costly for shareholders, and that better managerial incentive alignment and closer monitoring by external shareholders are important factors stimulating such payouts.
Otchere, I. (2005). "Do privatized banks in middle- and low-income countries perform better than rival banks? An intra-industry analysis of bank privatization."Journal of Banking & Finance 29(8-9): 2067-2093.
This paper presents a comprehensive analysis of the pre- and post-privatization operating performance and stock market performance of privatized banks and their rivals in middle- and low-income countries. First, we find that privatization announcements elicit negative abnormal returns for rival banks. The effects are more pronounced for subsequent tranche sales where the proportion of government ownership in the privatized bank is reduced. Second, we observe that the privatized banks underperformed the benchmark index in the long run. Investors who bought shares of the privatized banks on the first day of trading and held them for 5 years (instead of investing in the market index) lost 24% of their wealth. The underperformance is consistent with the negative long run returns that have been documented for initial public offerings. Third, we document marginal improvements in the post-privatization operating performance of the privatized banks. Though the privatized banks in middle- and low-income countries are better capitalized than rival banks, they carry higher problem loans and are overstaffed relative to other private banks in the post-privatization period. Since most of the sample firms are partially privatized, we submit that perhaps the continued government ownership of the privatized banks might have hindered managers' ability to restructure the firms.
Otchere, I. and K. Abou-Zied (2008). "Stock exchange demutualization, self-listing and performance: The case of the Australian Stock Exchange." Journal of Banking & Finance 32(4): 512-525.
This paper examines the effects of the recent spate of financial exchange mutual-to-stock conversion phenomenon on the performance of listed exchanges and the quality of the stock market using the Australian Stock Exchange (ASX) as a case study. We find that the ASX stock significantly outperformed the stock index and the control group on a market-adjusted return basis. The stock market performance is driven by strong operating performance. The profitability ratios of the ASX have significantly improved in the five years following the demutualization and self-listing. The performance improvements remain significant even after controlling for growth in the Australian economy. From a market quality perspective, we document evidence of increased trading activity by foreign investors after ASX's demutualization and self-listing. Interestingly, we also find that bid-ask spreads of the stock market have narrowed in the post-conversion period. In particular, small-cap firms have become more liquid. The results show that stock exchange conversion from mutual to publicly traded exchange is not only value enhancing for the exchange and its shareholders, but it is also beneficial for the stock market as a whole.
Palmon, O., S. Bar-Yosef, et al. (2008). "Optimal strike prices of stock options for effort-averse executives." Journal of Banking & Finance 32(2): 229-239.
This paper evaluates the common practice of setting the strike prices of executive option plans at-the-money. Hall and Murphy [Hall, Brian, Murphy, Kevin J., 2000. Optimal exercise prices for executive stock options. American Economic Review 90 (2), 209-214] claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance. However, they do not incorporate effort and the possibility that managers are effort-averse into their model. We revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages, options, and stock grants. We simulate the manager's effort choice and compensation as well as the value of shareholders' equity under alternative compensation schemes, and identify schemes that are optimal. Our simulations indicate that, when abstracting from tax considerations, it is optimal to award managers with options that will most likely be highly valuable (i.e., substantially in-the-money) on their expiration date. Prior to 2006, the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations. Recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006.
Panchenko, V. and E. Wu (2009). "Time-varying market integration and stock and bond return concordance in emerging markets." Journal of Banking & Finance33(6): 1014-1021.
We investigate the extent to which emerging stock market integration affects the joint behavior of stock and bond returns using a two-stage semi-parametric approach. Using a sample of 18 emerging markets, we find an unambiguous and robust link between emerging stock market integration and stock-bond return decoupling. We explain this with a decline in the segmentation risk premia in equities modeled by De Jong and De Roon [De Jong, F., De Roon, F.A., 2005. Time-varying market integration and expected returns in emerging markets. Journal of Financial Economics 78, 583-613] that leads to increased demand for stocks and reduced or unchanged demand for bonds. Our findings deliver new insights into the financial liberalization and stock-bond comovement literatures.
Pang, J. and H. Wu (2009). "Financial markets, financial dependence, and the allocation of capital." Journal of Banking & Finance 33(5): 810-818.
We explore one specific channel through which finance promotes growth: the allocation of capital. Using international industrial data, we find that countries with developed financial markets invest more in growing industries, and pull out more funds of declining ones. Most interestingly, this pattern is more eminent for those industries more dependent on external financing. Various robustness checks show that the results are not driven by reverse causality, omitted variables, specific countries or industries.
Pantzalis, C. and J. C. Park (2009). "Equity market valuation of human capital and stock returns." Journal of Banking & Finance 33(9): 1610-1623.
We investigate whether and how well firms' stock market valuations reflect their employees' collective skills and effectiveness relative to that of their industry peers and competitors. We devise a relative stock market valuation measure of human capital intangibles (EVHC) and find that portfolios of low EVHC firms systematically outperform portfolios of high EVHC firms by an average 1.34% per month. However, this is primarily a small firms effect, because for large firms the excess returns of the arbitrage portfolio that is long on the low EVHC stocks and short on the high EVHC stocks is zero. Our results suggest that reliance on human capital intangibles may proxy for risk not fully accounted for by conventional asset pricing models, or alternatively, that the market cannot correctly price human capital intangibles for small size firms.
Paolella, M. S. and L. Taschini (2008). "An econometric analysis of emission allowance prices." Journal of Banking & Finance 32(10): 2022-2032.
Knowledge of the statistical distribution of the prices of emission allowances, and their forecastability, are crucial in constructing, among other things, purchasing and risk management strategies in the emissions-constrained markets. This paper analyzes the two emission permits markets, CO2 in Europe, and SO2 in the US, and investigates a model for dealing with the unique stylized facts of this type of data. Its effectiveness in terms of model fit and out-of-sample value-at-risk-forecasting, as compared to models commonly used in risk-forecasting contexts, is demonstrated.
Parigi, B. M. and L. Pelizzon (2008). "Diversification and ownership concentration." Journal of Banking & Finance 32(9): 1743-1753.
If controlling shareholders can divert profits, equity ownership is more concentrated the higher the stock returns correlation. A higher returns correlation reduces the benefits of diversification, giving rise to both a higher investment by the controlling shareholder in the asset that he controls and a lower investment by the non-controlling shareholders. The empirical analysis supports the predictions of the model: equity ownership is more concentrated in countries where the stock returns correlation is higher; moreover the intensity of the relationship between the stock returns correlation and ownership concentration is amplified by poor investor protection.
Park, K. H. and W. L. Weber (2006). "A note on efficiency and productivity growth in the Korean Banking Industry, 1992-2002." Journal of Banking & Finance30(8): 2371-2386.
In this paper we present estimates of Korean bank inefficiency and productivity change for the period 1992-2002 that are derived from the directional technology distance function. Our method controls for loan losses that are an undesirable by-product arising from the production of loans and allows the aggregation of individual bank inefficiency and productivity growth to the industry level. Our findings indicate that technical progress during the period was more than enough to offset efficiency declines so that the banking industry experienced productivity growth.
Park, S. and S. Peristiani (2007). "Are bank shareholders enemies of regulators or a potential source of market discipline?" Journal of Banking & Finance 31(8): 2493-2515.
In moral hazard models, bank shareholders have incentives to transfer wealth from the deposit insurer - that is, maximize put option value - by pursuing riskier strategies. For safe banks with large charter value, however, the risk-taking incentive is outweighed by the possibility of losing charter value. Focusing on the relationship between Tobin's q and an ex ante measure of the failure probability, this paper develops a semi-parametric model for estimating the critical level of bank risk at which put option value starts outweighing charter value. From these estimates, we infer the prevalence of moral hazard. Examining publicly held bank holding companies (BHC) during the tumultuous 1986-1992 period, we find that shareholders' risk-taking incentives were confined to a small fraction of highly risky institutions. Furthermore, our analysis shows that the inflection point at which banks begin to tilt in favor of moral hazard increased substantially in 1993-2005. These findings are encouraging to bank regulators and legislators because they indicate that tighter capital rules and more rigorous supervision introduced by several legislative initiatives in the 1990s have helped squeeze a lot of the moral hazard incentives out of the banking system.
Pathan, S. (2009). "Strong boards, CEO power and bank risk-taking." Journal of Banking & Finance 33(7): 1340-1350.
This study examines the relevance of bank board structure on bank risk-taking. Using a sample of 212 large US bank holding companies over 1997-2004 (1534 observations), this study finds that strong bank boards (boards reflecting more of bank shareholders interest) particularly small and less restrictive boards positively affect bank risk-taking. In contrast, CEO power (CEO's ability to control board decision) negatively affects bank risk-taking. These results are consistent with the bank contracting environment and robust to several proxies for bank risk-takings and different estimation techniques.
Patro, D. K. and J. K. Wald (2005). "Firm characteristics and the impact of emerging market liberalizations." Journal of Banking & Finance 29(7): 1671-1695.
We provide a firm level analysis of the impact of capital market liberalization in 18 emerging markets. Consistent with models of international asset pricing, we find that firms' stock returns increase during liberalization and that a majority of firms have lower mean returns and lower dividend yields after liberalization. We also find that emerging market firms have increased exposure to the world market and decreased exposure to the home market following liberalization. These changes in returns and exposures support the predictions of theoretical international asset pricing models. We also test and find support for the importance of size, local risk, foreign exchange risk, and cross-listing status in explaining the cross-section of changes in returns.
Pederzoli, C. and C. Torricelli (2005). "Capital requirements and business cycle regimes: Forward-looking modelling of default probabilities." Journal of Banking & Finance 29(12): 3121-3140.
This paper proposes a forward-looking model for time-varying capital requirements, which finds application within Basel II. The model rests on the relationship between default rates and the business cycle: by positing two regimes, expansion and recession, and by forecasting the associated probabilities, the default probability for each rating class is defined as the expected value of a default rate whose distribution is a mixture of an expansion and a recession distribution. The application to US data over the forecasting period 1971-2002 provides evidence that the model makes it possible to preserve the risk sensitivity of the capital requirement and at the same time to dampen procyclicality.
Pelizzon, L. and G. Weber "Efficient portfolios when housing needs change over the life-cycle." Journal of Banking & Finance In Press, Accepted Manuscript.
We address the issue of the efficiency of household portfolios in the presence of housing risk. We treat housing stock as an asset and rents as a stochastic liability stream: over the life-cycle, households can be short or long in their net housing position. Efficient financial portfolios are the sum of a standard Markowitz portfolio and a housing risk hedge term that multiplies net housing wealth. Our empirical results show that net housing plays a key role in determining which household portfolios are inefficient. The largest proportion of inefficient portfolios obtains among those with positive net housing, who should invest more in stocks.
Pemy, M., Q. Zhang, et al. (2007). "Liquidation of a large block of stock." Journal of Banking & Finance 31(5): 1295-1305.
In the financial engineering literature, stock-selling rules are mainly concerned with liquidation of the security within a short period of time. This is practically feasible only when a relative smaller number of shares of a stock is involved. Selling a large position in a market place normally depresses the market if sold in a short period of time, which would result in poor filling prices. In this paper, we consider the liquidation strategy for selling a large block of stock by selling much smaller number of shares over a longer period of time. In particular, we treat the selling rule problem by using a fluid model in the sense that the number of shares are treated as fluid (continuous) and the corresponding liquidation is dictated by the rate of selling over time. The objective is to maximize the expected overall return. The underlying problem may be formulated as a stochastic control problem with state constraints. Method of constrained viscosity solution is used to characterize the dynamics governing the optimal reward function and the associated boundary conditions. Numerical examples are reported to illustrate the results.
Pérignon, C., Z. Y. Deng, et al. (2008). "Do banks overstate their Value-at-Risk?" Journal of Banking & Finance 32(5): 783-794.
This paper is the first empirical study of banks' risk management systems based on non-anonymous daily Value-at-Risk (VaR) and profit-and-loss data. Using actual data from the six largest Canadian commercial banks, we uncover evidence that banks exhibit a systematic excess of conservatism in their VaR estimates. The data used in this paper have been extracted from the banks' annual reports using an innovative Matlab-based data extraction method. Out of the 7354 trading days analyzed in this study, there are only two exceptions, i.e. days when the actual loss exceeds the disclosed VaR, whereas the expected number of exceptions with a 99% VaR is 74. For each sample bank, we extract from historical VaRs a risk-overstatement coefficient, ranging between 19 and 79%. We attribute VaR overstatement to several factors, including extreme cautiousness and underestimation of diversification effects when aggregating VaRs across business lines and/or risk categories. We also discuss the economic and social cost of reporting inflated VaRs.
Pérignon, C. and D. R. Smith (2007). "Yield-factor volatility models." Journal of Banking & Finance 31(10): 3125-3144.
The term structure of interest rates is often summarized using a handful of yield factors that capture shifts in the shape of the yield curve. In this paper, we develop a comprehensive model for volatility dynamics in the level, slope, and curvature of the yield curve that simultaneously includes level and GARCH effects along with regime shifts. We show that the level of the short rate is useful in modeling the volatility of the three yield factors and that there are significant GARCH effects present even after including a level effect. Further, we find that allowing for regime shifts in the factor volatilities dramatically improves the model's fit and strengthens the level effect. We also show that a regime-switching model with level and GARCH effects provides the best out-of-sample forecasting performance of yield volatility. We argue that the auxiliary models often used to estimate term structure models with simulation-based estimation techniques should be consistent with the main features of the yield curve that are identified by our model.
Pflug, G. C. (2006). "A value-of-information approach to measuring risk in multi-period economic activity." Journal of Banking & Finance 30(2): 695-715.
In this paper, we discuss measures of risk for uncertain outcomes of economic activity, which are based on the notion of the value of full information in stochastic programs. Information is measured in terms of [sigma]-algebras. For multi-period income streams information is represented by filtrations, i.e. sequences of [sigma]-algebras. The basic properties of our risk measures are multi-period coherence ("diversification decreases risk"), compound concavity ("random alternatives increase risk") and convex monotonicity ("insurance decreases risk").
Pirrong, C. and M. Jermakyan (2008). "The price of power: The valuation of power and weather derivatives." Journal of Banking & Finance 32(12): 2520-2529.
Pricing contingent claims on power presents numerous challenges due to (1) the unique behavior of power prices, and (2) time-dependent variations in prices. We propose and implement a model in which the spot price of power is a function of two state variables: demand (load) and fuel price. In this model, any power derivative price must satisfy a PDE with boundary conditions that reflect capacity limits and the non-linear relation between load and the spot price of power. Moreover, since power is non-storable and demand is not a traded asset, the power derivative price embeds a market price of risk. Using inverse problem techniques and power forward prices from the PJM market, we solve for this market price of risk function. During 1999-2001, the upward bias in the forward price was as large as $50/MWh for some days in July. By 2005, the largest estimated upward bias had fallen to $19/MWh. These large biases are plausibly due to the extreme right skewness of power prices; this induces left skewness in the payoff to short forward positions, and a large risk premium is required to induce traders to sell power forwards. This risk premium suggests that the power market is not fully integrated with the broader financial markets.
Pliska, S. R. and J. Ye (2007). "Optimal life insurance purchase and consumption/investment under uncertain lifetime." Journal of Banking & Finance 31(5): 1307-1319.
In this paper, we consider optimal insurance and consumption rules for a wage earner whose lifetime is random. The wage earner is endowed with an initial wealth, and he also receives an income continuously, but this may be terminated by the wage earner's premature death. We use dynamic programming to analyze this problem and derive the optimal insurance and consumption rules. Explicit solutions are found for the family of CRRA utilities, and the demand for life insurance is studied by examining our solutions and doing numerical experiments.
Poloz, S. S. (2006). "Financial stability: A worthy goal, but how feasible?" Journal of Banking & Finance 30(12): 3423-3427.
Financial stability has proved elusive. Despite the success of central banks in controlling inflation, economies continue to experience periods of exchange rate overvaluation, stock market volatility and housing price bubbles that affect individuals very deeply. This note speculates that such financial volatility may be the product of three factors, (a) successful inflation targeting, (b) the existence of nonlinearities and differential economic dynamics, and (c) the recent evolution of key structural parameters in the economy. If so, then central banks might better focus on making financial systems more resilient than on trying to develop more sophisticated policies aimed at reducing financial volatility.
Polwitoon, S. and O. Tawatnuntachai (2006). "Diversification benefits and persistence of US-based global bond funds." Journal of Banking & Finance 30(10): 2767-2786.
This paper examines diversification benefits and performance persistence of 188 US-based global bond funds that survived and were defunct during the period of 1993-2004. Consistent with managed fund literature, global funds underperform broad-based benchmark indexes; however, the underperformance is less than the funds' expense ratio. The results using both simple and time-varying frameworks suggest that global funds provide higher total return and comparable risk-adjusted return to domestic bond funds. For US investors specializing in domestic bond funds, global funds can enhance return by 0.5-1% per year without increasing risk. Global funds also provide incremental diversification benefits to equity fund investors. The funds exhibit short-run performance persistence, but this is difficult for investors to exploit, especially in long-run. Global funds show no return seasonality during the sample period. On a risk-adjusted basis, larger and newer funds and funds with long maturity and low expense ratio perform well.
Post, T. (2007). "Nonparametric efficiency estimation in stochastic environments: Noise-to-signal estimation, finite sample performance and hypothesis testing."Journal of Banking & Finance 31(7): 2065-2080.
This study considers the issues of noise-to-signal estimation, finite sample performance and hypothesis testing for a new nonparametric and stochastic efficiency estimation technique. We apply the technique for analyzing the efficiency of European banks from various regions and with various specializations. The technique seems well suited for this application area because banking inputs and outputs generally are measured with error, the banking production technology is not well-defined and large banking data sets such as BankScope allow for a nonparametric approach.
Post, T. and P. van Vliet (2006). "Downside risk and asset pricing." Journal of Banking & Finance 30(3): 823-849.
We analyze if the value-weighted stock market portfolio is stochastic dominance (SD) efficient relative to benchmark portfolios formed on size, value, and momentum. In the process, we also develop several methodological improvements to the existing tests for SD efficiency. Interestingly, the market portfolio seems third-order SD (TSD) efficient relative to all benchmark sets. By contrast, the market portfolio is inefficient if we replace the TSD criterion with the traditional mean-variance criterion. Combined these results suggest that the mean-variance inefficiency of the market portfolio is caused by the omission of return moments other than variance. Especially downside risk seems to be important for explaining the high average returns of small/value/winner stocks.
Post, T., P. van Vliet, et al. (2008). "Risk aversion and skewness preference." Journal of Banking & Finance 32(7): 1178-1187.
Empirically, co-skewness of asset returns seems to explain a substantial part of the cross-sectional variation of mean return not explained by beta. This finding is typically interpreted in terms of a risk averse representative investor with a cubic utility function. This paper questions this interpretation. We show that the empirical tests fail to impose risk aversion and the implied utility function takes an inverse S-shape. Unfortunately, the first-order conditions are not sufficient to guarantee that the market portfolio is the global maximum for this utility function, and our results suggest that the market portfolio is more likely to represent the global minimum. In addition, if we do impose risk aversion, then co-skewness has minimal explanatory power.
Powell, J. G., J. Shi, et al. (2009). "Political regimes, business cycles, seasonalities, and returns." Journal of Banking & Finance 33(6): 1112-1128.
This paper provides a method for testing for regime differences when regimes are long-lasting. Standard testing procedures are generally inappropriate because regime persistence causes a spurious regression problem - a problem that has led to incorrect inference in a broad range of studies involving regimes representing political, business, and seasonal cycles. The paper outlines analytically how standard estimators can be adjusted for regime dummy variable persistence. While the adjustments are helpful asymptotically, spurious regression remains a problem in small samples and must be addressed using simulation or bootstrap procedures. We provide a simulation procedure for testing hypotheses in situations where an independent variable in a time-series regression is a persistent regime dummy variable. We also develop a procedure for testing hypotheses in situations where the dependent variable has similar properties.
Powell, R. and A. Yawson (2005). "Industry aspects of takeovers and divestitures: Evidence from the UK." Journal of Banking & Finance 29(12): 3015-3040.
This paper examines takeover and divestiture activity at the industry level for the population of UK firms over the period 1986-2000. Consistent with US research, takeovers in the UK cluster both across industries and over time. The evidence for divestitures indicates clustering across industries only. The paper further investigates whether broad and specific industry shocks (e.g., growth, free cash flow, concentration, deregulation, foreign competition, technology, stock market performance) explain takeover and divestiture clustering at the industry level. The results suggest that broad shocks increase (decrease) the likelihood of takeovers (divestitures), although not significantly for takeovers. Specific industry shocks that increase the likelihood of takeover activity include low growth, the threat of foreign competition and high stock market performance. For divestitures, high industry concentration and deregulation increase activity. Little evidence is found for deregulation as a significant factor in explaining takeover activity.
Primbs, J. A. and Y. Yamada (2006). "A moment computation algorithm for the error in discrete dynamic hedging." Journal of Banking & Finance 30(2): 519-540.
This paper develops a computational approach to determining the moments of the distribution of the error in a dynamic hedging or payoff replication strategy under discrete trading. In particular, an algorithm is developed for portfolio affine trading strategies, which lead to portfolio dynamics that are affine in the portfolio variable. This structure can be exploited in the computation of moments of the hedging error of such a strategy, leading to a lattice based backward recursion similar in nature to lattice based pricing techniques, but not requiring the portfolio variable. We use this algorithm to analyze the performance of portfolio affine hedging strategies under discrete trading through the moments of the hedging error.
Pritsker, M. (2006). "The hidden dangers of historical simulation." Journal of Banking & Finance 30(2): 561-582.
Many large financial institutions compute the Value-at-Risk (VaR) of their trading portfolios using historical simulation based methods, but the methods' properties are not well understood. This paper theoretically and empirically examines the historical simulation method, a variant of historical simulation introduced by Boudoukh et al. [Boudoukh, J., Richardson, M., Whitelaw, R., 1998. The best of both worlds, Risk 11(May) 64-67] (BRW), and the filtered historical simulation method (FHS) of Barone-Adesi et al. [Barone-Adesi, G., Bourgoin F., Giannopoulos, K., 1998. Don't look back. Risk 11(August) 100-104; Barone-Adesi, G., Giannopoulos K., Vosper L., 1999. VaR without correlations for nonlinear portfolios. Journal of Futures Markets 19(April) 583-602]. The historical simulation and BRW methods are both under-responsive to changes in conditional risk; and respond to changes in risk in an asymmetric fashion: measured risk increases when the portfolio experiences large losses, but not when it earns large gains. The FHS method is promising, but its risk estimates are variable in small samples, and its assumption that correlations are constant is violated in large samples. Additional refinements are needed to account for time-varying correlations; and to choose the appropriate length of the historical sample period.
Qi, M. and X. Yang (2009). "Loss given default of high loan-to-value residential mortgages." Journal of Banking & Finance 33(5): 788-799.
This paper studies loss given default using a large set of historical loan-level default and recovery data of high loan-to-value residential mortgages from several private mortgage insurance companies. We show that loss given default can largely be explained by various characteristics associated with the loan, the underlying property, and the default, foreclosure, and settlement process. We find that the current loan-to-value ratio is the single most important determinant. More importantly, mortgage loss severity in distressed housing markets is significantly higher than under normal housing market conditions. These findings have important policy implications for several key issues in Basel II implementation.
Qin, D. and T. Tan "How much intraregional exchange rate variability could a currency union remove? The case of ASEAN+3." Journal of Banking & Finance In Press, Accepted Manuscript.
A multilateral currency union removes intraregional exchange rates but not the union rate. The pre-union intraregional exchange rate variability is thus latent; a two-step procedure is developed to measure this. The measured variables are used to model inflation and intraregional trade growth of individual union members. Counterfactual simulations of the union impact are carried out using the resulting models. Application to ASEAN+3 shows that the intraregional variability mainly consists of short-run exchange rate shocks, that the variability significantly affects inflation and intraregional trade of major ASEAN+3 members, and that a union would reduce inflation and promote trade regionwide.
Quaranta, A. G. and A. Zaffaroni (2008). "Robust optimization of conditional value at risk and portfolio selection." Journal of Banking & Finance 32(10): 2046-2056.
This paper deals with a portfolio selection model in which the methodologies of robust optimization are used for the minimization of the conditional value at risk of a portfolio of shares. Conditional value at risk, being in essence the mean shortfall at a specified confidence level, is a coherent risk measure which can hold account of the so called "tail risk" and is therefore an efficient and synthetic risk measure, which can overcome the drawbacks of the most famous and largely used VaR. An important feature of our approach consists in the use of techniques of robust optimization to deal with uncertainty, in place of stochastic programming as proposed by Rockafellar and Uryasev. Moreover we succeeded in obtaining a linear robust copy of the bi-criteria minimization model proposed by Rockafellar and Uryasev. We suggest different approaches for the generation of input data, with special attention to the estimation of expected returns. The relevance of our methodology is illustrated by a portfolio selection experiment on the Italian market.
Rachev, S., T. Jasic, et al. (2007). "Momentum strategies based on reward-risk stock selection criteria." Journal of Banking & Finance 31(8): 2325-2346.
In this paper, we analyze momentum strategies that are based on reward-risk stock selection criteria in contrast to ordinary momentum strategies based on a cumulative return criterion. Reward-risk stock selection criteria include the standard Sharpe ratio with variance as a risk measure, and alternative reward-risk ratios with the expected shortfall as a risk measure. We investigate momentum strategies using 517 stocks in the S&P 500 universe in the period 1996-2003. Although the cumulative return criterion provides the highest average monthly momentum profits of 1.3% compared to the monthly profit of 0.86% for the best alternative criterion, the alternative ratios provide better risk-adjusted returns measured on an independent risk-adjusted performance measure. We also provide evidence on unique distributional properties of extreme momentum portfolios analyzed within the framework of general non-normal stable Paretian distributions. Specifically, for every stock selection criterion, loser portfolios have the lowest tail index and tail index of winner portfolios is lower than that of middle deciles. The lower tail index is associated with a lower mean strategy. The lowest tail index is obtained for the cumulative return strategy. Given our data-set, these findings indicate that the cumulative return strategy obtains higher profits with the acceptance of higher tail risk, while strategies based on reward-risk criteria obtain better risk-adjusted performance with the acceptance of the lower tail risk.
Rakowski, D. and X. Wang Beardsley (2008). "Decomposing liquidity along the limit order book." Journal of Banking & Finance 32(8): 1687-1698.
In this paper, we estimate the asymmetric information and order processing components of liquidity at extended depths along the limit order book. Using data from the INET ECN, we find that the asymmetric information component decreases as depth increases. Inactive stocks have more information asymmetry at the inside quotes, but it decreases more rapidly along the book than for active stocks. The order processing component of liquidity has fixed and variable constituents, consistent with a fixed cost per order as well as a variable portion based on the size of the order.
Rakowski, D. and X. Wang "The dynamics of short-term mutual fund flows and returns: A time-series and cross-sectional investigation." Journal of Banking & Finance In Press, Corrected Proof.
This study analyzes the dynamics of daily mutual fund flows. A Vector Auto Regression (VAR) of flows and returns shows that the behavior of fund investors is more consistent with contrarian rather than momentum characteristics. Past fund flows have a positive impact on future fund returns, with the long-term information effect dominating the transient price-pressure effect. Seasonality in daily flows, such as day-of-week and day-of-month patterns are present, and daily flows are generally mean-reverting. Probit regressions indicate that fund investment objective, marketing policy and level of active management explain cross-sectional variation in the behavioral patterns displayed in daily flows. Our results are robust to the different methods of calculating daily flows based on whether or not the day-end TNA figures include the current-day's flow. Throughout the analysis, we contrast the dynamics of daily flows with established results for monthly fund flows and find important differences between the two.
Ramírez, C. D. "Bank fragility, "money under the mattress," and long-run growth: U.S. evidence from the "perfect" Panic of 1893." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper examines how the U.S. financial crisis of 1893 affected state output growth between 1900 and 1930. The results indicate that a 1 percent increase in bank instability reduced output growth by 2 to 5 percent. A comparison of Nebraska, which had one of the highest bank failure rates, with West Virginia, which did not experience a single bank failure, reveals that disintermediation affected growth through a portfolio change among savers: people simply stopped trusting banks. Time series evidence from newspapers indicates that articles containing the words "money hidden" significantly increase after banking crises, then slowly die out.
Ranaldo, A. "Segmentation and time-of-day patterns in foreign exchange markets." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper sheds light on a puzzling pattern in spot foreign exchange markets: domestic currencies appreciate (depreciate) systematically during foreign (domestic) working hours. This phenomenon spans many years and several exchange rates, and overrides calendar effects. We argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors: domestic agents tend to be net buyers of foreign currency and to trade mostly in their country's working hours. The prevalence of domestic (foreign) traders demanding the counterpart currency during domestic (foreign) working hours implies sell-price (buy-price) pressure on the domestic currency during domestic (foreign) working hours.
Ranciere, R., A. Tornell, et al. (2006). "Decomposing the effects of financial liberalization: Crises vs. growth." Journal of Banking & Finance 30(12): 3331-3348.
We present a new empirical decomposition of the effects of financial liberalization on economic growth and on the incidence of crises. Our empirical estimates show that the direct effect of financial liberalization on growth by far outweighs the indirect effect via a higher propensity to crisis. We also discuss several models of financial liberalization and growth whose predictions are consistent with our empirical findings.
Ratti, R. A., S. Lee, et al. (2008). "Bank concentration and financial constraints on firm-level investment in Europe." Journal of Banking & Finance 32(12): 2684-2694.
This study examines the effect of bank concentration on financing constraints of non-financial firms in 14 European countries between 1992 and 2005. Using firm-level data we analyze financial constraints with the Euler equation derived from the dynamic investment model. We find that with a highly concentrated banking sector firms are less financially constrained. This result is robust to consideration of firm opacity, firm size, and business cycle. Relaxation of financial constraint while greater for firms in less opaque industries also accrues for firms in more opaque industries. Greater bank concentration is associated with less tight financial constraint during both expansions and recessions. Results overall are consistent with an information-based hypothesis that more market power increases banks' incentives to produce information on potential borrowers. Findings are robust to consideration of country specific institutional factors.
Renneboog, L., J. Ter Horst, et al. (2008). "Socially responsible investments: Institutional aspects, performance, and investor behavior." Journal of Banking & Finance 32(9): 1723-1742.
This paper provides a critical review of the literature on socially responsible investments (SRI). Particular to SRI is that both financial goals and social objectives are pursued. Over the past decade, SRI has experienced an explosive growth around the world reflecting the increasing awareness of investors to social, environmental, ethical and corporate governance issues. We argue that there are significant opportunities for future research on the increasingly important area of SRI. A number of questions are reviewed in this paper on the causes and the shareholder-value impact of corporate social responsibility (CSR), the risk exposure and performance of SRI funds and firms, as well as fund subscription and redemption behavior of SRI investors. We conclude that the existing studies hint but do not unequivocally demonstrate that SRI investors are willing to accept suboptimal financial performance to pursue social or ethical objectives. Furthermore, the emergence of SRI raises interesting questions for research on corporate finance, asset pricing, and financial intermediation.
Rhee, S. G. and J. Wang (2009). "Foreign institutional ownership and stock market liquidity: Evidence from Indonesia." Journal of Banking & Finance 33(7): 1312-1324.
From January 2002 to August 2007, foreign institutions held almost 70% of the free-float value of the Indonesian equity market, or 41% of the total market capitalization. Over the same period, liquidity on the Jakarta Stock Exchange improved substantially with the average bid-ask spread more than halved and the average depth more than doubled. In this study we examine the Granger causality between foreign institutional ownership and liquidity, while controlling for persistence in foreign ownership and liquidity measures. We find that foreign holdings have a negative impact on future liquidity: a 10% increase in foreign institutional ownership in the current month is associated with approximately 2% increase in the bid-ask spread, 3% decrease in depth, and 4% rise in price sensitivity in the next month, challenging the view that foreign institutions enhance liquidity in small emerging markets. Our findings are consistent with the negative liquidity impact of institutional investor ownership in developed markets.
Rigobon, R. and B. Sack (2005). "The effects of war risk on US financial markets." Journal of Banking & Finance 29(7): 1769-1789.
This paper measures the effects of the risks associated with the war in Iraq on various US financial variables using a heteroskedasticity-based estimation technique. The results indicate that increases in war risk caused declines in Treasury yields and equity prices, a widening of lower-grade corporate spreads, a fall in the dollar, and a rise in oil prices. This "war risk" factor accounted for a considerable portion of the variances of these financial variables over the three months leading up to the arrival of coalition forces in central Baghdad.
Riyanto, Y. E. and A. Schwienbacher (2006). "The strategic use of corporate venture financing for securing demand." Journal of Banking & Finance 30(10): 2809-2833.
This paper focuses on the strategic role of corporate venture financing carried out by a corporation (a headquarter). When the headquarter finances a venture through its corporate venture-financing arm, it can increase the complementarity between products of the venture and the headquarter. The effect of having an increase in complementarity is a softening of ex post product market competition with rival products. Hence, in deciding whether to finance the venture, the headquarter faces a trade-off between, on the one hand, being more aggressive ex post in the product market, and, on the other hand, using venture financing to soften ex post competition with substitute products.
Riyanto, Y. E. and L. A. Toolsema (2008). "Tunneling and propping: A justification for pyramidal ownership." Journal of Banking & Finance 32(10): 2178-2187.
This paper links existence of the pyramidal ownership structure to tunneling and propping. Tunneling refers to a transfer of resources from a lower-level firm to a higher-level firm in the pyramidal chain, whereas propping concerns a transfer in the opposite direction intended to bail out the receiving firm from bankruptcy. We show that tunneling alone cannot justify the pyramidal structure unless outside investors are myopic, since rational outside investors anticipate tunneling and adjust their willingness-to-pay for the firm's shares accordingly. With propping, however, they may be willing to be expropriated in exchange for implicit insurance against bankruptcy.
Rockafellar, R. T., S. Uryasev, et al. (2006). "Master funds in portfolio analysis with general deviation measures." Journal of Banking & Finance 30(2): 743-778.
Generalized measures of deviation are considered as substitutes for standard deviation in a framework like that of classical portfolio theory for coping with the uncertainty inherent in achieving rates of return beyond the risk-free rate. Such measures, derived for example from conditional value-at-risk and its variants, can reflect the different attitudes of different classes of investors. They lead nonetheless to generalized one-fund theorems in which a more customized version of portfolio optimization is the aim, rather than the idea that a single "master fund" might arise from market equilibrium and serve the interests of all investors. The results that are obtained cover discrete distributions along with continuous distributions. They are applicable therefore to portfolios involving derivatives, which create jumps in distribution functions at specific gain or loss values, well as to financial models involving finitely many scenarios. Furthermore, they deal rigorously with issues that come up at that level of generality, but have not received adequate attention, including possible lack of differentiability of the deviation expression with respect to the portfolio weights, and the potential nonuniqueness of optimal weights. The results also address in detail the phenomenon that if the risk-free rate lies above a certain threshold, the usually envisioned master fund must be replaced by one of alternative type, representing a "net short position" instead of a "net long position" in the risky instruments. For nonsymmetric deviation measures, the second type need not just be the reverse of the first type, and there can sometimes even be an interval for the risk-free rate in which no master fund of either type exists. A notion of basic fund, in place of master fund, is brought in to get around this difficulty and serve as a single guide to optimality regardless of such circumstances.
Rockafellar, R. T., S. Uryasev, et al. (2007). "Equilibrium with investors using a diversity of deviation measures." Journal of Banking & Finance 31(11): 3251-3268.
It has been argued that investors who optimize their portfolios with attention paid only to mean and standard deviation will all end up choosing some multiple of a certain master fund portfolio. Justification for the capital asset pricing model of classical portfolio theory, which relates individual assets to such a master fund, has come from this direction in particular. Attempts have been made to provide solid mathematical support by showing that the imputed behavior of investors is a consequence of price equilibrium in a market in which assets are traded subject to budget constraints, and optimization is carried out with respect to utility functions that depend only on mean and standard deviation. In recent years, reliance on standard deviation has come under increasing criticism because of inconsistencies in its effect on portfolio preferences. One response has been to introduce generalized measures of deviation which lead to alternative master funds. The market implications of such extensions of theory have hitherto been unclear, but in this paper the existence of equilibrium is established in circumstances where nonstandard deviations are admitted. Equilibrium is guaranteed even when different investors use different measures of deviation and thereby end up with portfolios scaled from different master funds. Whether they employ the same measure or not, they may impose caps on deviation, which likewise may be different.
Romero-Ávila, D. (2007). "Finance and growth in the EU: New evidence from the harmonisation of the banking industry." Journal of Banking & Finance 31(7): 1937-1954.
This paper presents an investigation of the finance-growth nexus by analysing the growth effect of the harmonisation of banking laws in the EU-15 over the period 1960-2001. The main findings point to the existence of a positive growth impact from banking harmonisation. These results are robust to controlling for other growth determinants, unobserved heterogeneity, potential simultaneity bias and business-cycle effects. The analysis of the transmission channels indicates that the harmonisation process influences economic growth mainly through the increase in the efficiency of financial intermediation.
Roosenboom, P. and M. A. van Dijk "The market reaction to cross-listings: Does the destination market matter?" Journal of Banking & Finance In Press, Corrected Proof.
This paper examines (i) whether market reactions to cross-listings differ across destination markets and (ii) to what extent the following explanations for value creation around cross-listings can account for differences in market reactions across cross-listings on various destination markets: overcoming market segmentation, increased market liquidity, improved information disclosure, and better investor protection ("bonding"). We analyze 526 cross-listings from 44 different countries on eight major stock exchanges and document significant announcement returns of 1.3% on average for cross-listings on US exchanges, 1.1% on London Stock Exchange, 0.6% on exchanges in continental Europe, and 0.5% (not significant) on Tokyo Stock Exchange. We find evidence consistent with improved disclosure and bonding creating value for cross-listings on US exchanges, while overcoming segmentation and bonding are associated with higher announcement returns on the London Stock Exchange. The evidence is mixed for continental European exchanges and for Tokyo. Our results highlight the role of the destination market in value creation around cross-listings.
Rosati, S. and S. Secola (2006). "Explaining cross-border large-value payment flows: Evidence from TARGET and EURO1 data." Journal of Banking & Finance30(6): 1753-1782.
We analysed the distribution of the TARGET cross-border interbank payment flows from both a cross-section and a time-series point of view using average daily data for the period 1999-2002. Our findings were, first, that "location matters" in the sense that bilateral payment flows seem to reflect an organisation of interbank trading between countries in which the size of the banking sector, geographic proximity and cultural similarities play a significant role. This result was also confirmed by a model developed drawing on the gravity models literature. Second, we found that the payment traffic in TARGET is strongly affected by technical market deadlines. In addition, such traffic is positively related mainly to the liquidity conditions and to the turnover of the euro area money market (particularly the unsecured overnight segment). Our model also provides a good explanation of the determinants of the interbank payments settled in the EURO 1 system.
Rosen, R. J. (2007). "Banking market conditions and deposit interest rates." Journal of Banking & Finance 31(12): 3862-3884.
This paper shows that the impact of market structure on bank deposit interest rates is complex. Both market size structure and multimarket bank presence have independent effects on rates. There is evidence that mid-size banks were more aggressive competitors than other banks, but that the effect of market structure on deposit rates has evolved over time, with mega-banks recently becoming more aggressive competitors. This may be related to the growth of mega-banks in many markets. These findings have implications for existing theories of deposit pricing and, by extension, antitrust policy in banking.
Rossetto, S. and J. v. Bommel (2009). "Endless leverage certificates." Journal of Banking & Finance 33(8): 1543-1553.
An endless leverage certificate (ELC) is a novel retail structured product that gives its holder the right to claim the difference between the value of an underlying security and an interest accruing financing level. An ELC ceases to exist if the underlying breaches a contractual knockout level, if the holder exercises, or if she/he sells it back to the issuer. We use Monte Carlo analysis to value ELCs and find that due to limited liability, a typical ELC written on a typical DAX stock can be worth 0.3% more than its intrinsic value (the difference between the value of the underlying and the financing level). Empirically, we find that in January 2007, the 5129 ELCs issued on the thirty DAX stocks traded at an average premium of 0.67% over the intrinsic value, and that the median bid-ask spread, expressed as a percentage of the underlying, was 0.18%. For covered warrants and options this spread measure was almost twice as high. Finally, we find that upon knockout, investors received on average 3.2% less than the theoretical knockout value, which is consistent with discontinuous trading of the underlying. Overall, our findings suggest that ELCs complete the market for leverage seeking retail investors.
Rossi, S. P. S., M. S. Schwaiger, et al. "How loan portfolio diversification affects risk, efficiency and capitalization: A managerial behavior model for Austrian banks."Journal of Banking & Finance In Press, Accepted Manuscript.
The aim of this paper is to analyze how diversification of banks across size and industry can affect risk, cost and profit efficiency, and bank capitalization for large Austrian commercial banks over the years 1997 to 2003. Employing a unique dataset, provided by the Austrian Central Bank, we test for several different types of managerial hypotheses, formalized according to a modified version of the Berger and DeYoung model (1997). Overall, we find that, although diversification negatively affects cost efficiency, it increases profit efficiency and reduces banks' realized risk. Finally, diversification seems to have a positive impact on banks' capitalization.
Roth, V. and K. Richter (2006). "How to fend off shoulder surfing." Journal of Banking & Finance 30(6): 1727-1751.
Magnetic stripe cards are in common use for electronic payments and cash withdrawal. Reported incidents document that criminals easily pickpocket cards or skim them by swiping them through additional card readers. Personal identification numbers (PINs) are obtained by shoulder surfing, through the use of mirrors or concealed miniature cameras. Both elements, the PIN and the card, are generally sufficient to give the criminal full access to the victim's account. In this paper, we present alternative PIN entry methods to which we refer as cognitive trapdoor games. These methods make it significantly harder for a criminal to obtain PINs even if he fully observes the entire input and output of a PIN entry procedure. We also introduce the idea of probabilistic cognitive trapdoor games, which offer resilience to shoulder surfing even if the criminal records a PIN entry procedure with a camera. We studied the security as well as the usability of our methods. The result support the hypothesis that our primary mechanism strikes a balance between security and usability that is of practical value. In this article, we give a detailed account of our mechanisms and their evaluation.
Rousseau, P. L. and J. H. Kim (2008). "A flight to Q? Firm investment and financing in Korea before and after the 1997 financial crisis." Journal of Banking & Finance 32(7): 1416-1429.
We examine investment behavior among exchange-listed Korean manufacturing firms before and after the 1997 financial crisis using firm-level panel data. Starting with the standard Q-theory of investment, we augment it by allowing for a sales accelerator and the possibility of cash constraints, categorizing firms based on their age, size and affiliation to an industrial conglomerate (i.e., chaebol). We find that Tobin's Q is a robust determinant of investment in a pooled sample for 1992-2001, but that it became more important for small firms and less important for chaebol-affiliated firms after the crisis. Investment by chaebol firms also became more sensitive to the availability of internal cash balances after the crisis. We interpret this as reflecting a shift in the Korean economy to a stronger market orientation after the crisis and to a business climate in which the quality of potential projects became more important relative to capital market imperfections in determining the destination of investment funds.
Rubin, A. and D. R. Smith (2009). "Institutional ownership, volatility and dividends." Journal of Banking & Finance 33(4): 627-639.
We find that the sign of the correlation between institutional ownership and volatility depends on the firm's dividend policy: institutional ownership is negatively (positively) related to volatility among non-dividend (dividend) paying stocks. The empirical results are consistent with an interaction between institutional preference for low volatility and the tendency of higher levels of institutional ownership to increase volatility through their trading behavior. This result is robust to many control variables and possible endogeneity concerns. Supporting our conjecture that institutions herd on dividend signals we find that the correlation between turnover and institutional ownership is higher for dividend paying stocks, and that the positive correlation between turnover and institutional ownership is higher on dividend declaration days. Finally, we also find that the level of institutional ownership drops following an increase in volatility for both dividend payers and non-payers, and that volatility rises following increased institutional ownership for dividend paying stocks.
Ruthenberg, D. and Y. Landskroner (2008). "Loan pricing under Basel II in an imperfectly competitive banking market." Journal of Banking & Finance 32(12): 2725-2733.
The new Basel II Accord (2006), established new and revised capital requirements for banks. In this paper we analyze and estimate the possible effects of the new rules on the pricing of bank loans. We relate to the two approaches for capital requirements (internal and standardized) and distinguish between retail and corporate customers. Our loan-equation is based on a model of a banking firm facing uncertainty operating in an imperfectly competitive loan market. We use Israeli economic data and data of a leading Israeli bank. The main results indicate that high quality corporate and retail customers will enjoy a reduction in loan interest rates in (big) banks which, most probably, will adopt the IRB approach. On the other hand high risk customers will benefit by shifting to (small) banks that adopt the standardized approach.
Sandow, S., C. Friedman, et al. (2006). "Economy-wide bond default rates: A maximum expected utility approach." Journal of Banking & Finance 30(2): 679-693.
We consider the 12-month moving average aggregate default rate of S&P-rated US-bonds. We estimate the conditional probability distribution of this default rate as a function of a weighted average bond rating, a lagged default rate and a preliminary predictor that is based on lagged new issuance. Our modeling approach is asymptotically optimal for an expected utility maximizing investor. The resulting conditional probability density is consistent with our intuition. We measure the model's performance by the out-of-sample expected utility. According to this measure, our model clearly outperforms a simple regression model, a regression model with ARMA error terms and a Poisson model.
Santos, J. A. C. (2006). "Why firm access to the bond market differs over the business cycle: A theory and some evidence." Journal of Banking & Finance 30(10): 2715-2736.
This paper presents a theory of firm access to the bond market in which information gathering agencies are valuable but alter the relative cost of bond financing across firms and over the business cycle. The theory builds on the assumption that information frictions prevent these agencies from rating firms correctly all of the time. As a result, the cost of bond financing becomes dependent on the state of the economy and the "quality" of the signal provided by these agencies' ratings. In addition, when the mix of bond issuers becomes riskier, as happens in recessions, bond financing becomes more expensive for mid-quality firms. Bond financing may even become more expensive to all firms, in which case mid-quality firms will be affected the most. The analysis of the bonds issued in the last two decades by American firms shows that split ratings, our proxy for the "quality" of the rating agencies' signal, do not affect the relative cost of bond financing across firms in expansions, but they do increase the relative cost of this funding source for mid-credit quality issuers in recessions.
Sarantis, N. (2006). "On the short-term predictability of exchange rates: A BVAR time-varying parameters approach." Journal of Banking & Finance 30(8): 2257-2279.
In this paper we propose a Bayesian vector autoregressive model with time-varying parameters (BVAR-TVP) to examine the short-term predictability of exchange rates. An important contribution of the paper is the application of the BVAR-TVP model, for the first time, to daily data using information from financial markets. Another contribution is the production of forecasts in real time at the very short horizon of one-trading day-ahead typically used by traders and investors in financial markets. We employ financial criteria and recently developed statistical tests to assess the exchange rate predictability. We find that the BVAR-TVP model outperforms the random walk for all exchange rates. These forecast gains are due primarily to the time-variation of coefficients, and secondly to information from other financial markets. It is shown that international investors could have made statistically significant excess profits if they had followed an inter-day trading strategy based on the buy/sell signals generated by the model's one-day-ahead exchange rate forecasts, even after allowing for transaction costs and risk factors.
Sarkar, S. (2008). "Can tax convexity be ignored in corporate financing decisions?" Journal of Banking & Finance 32(7): 1310-1321.
The standard modeling practice in corporate finance has been to assume a linear tax schedule. This paper extends the structural contingent-claim model of corporate finance to incorporate a more realistic convex tax schedule. It is shown that tax convexity raises the optimal default boundary and thus increases the likelihood of default, and also reduces the optimal leverage ratio. While the former effect seems insignificant in general, the effect of tax convexity on the optimal leverage ratio can be quantitatively significant. We conclude that tax convexity should not be ignored in corporate financing decisions, and theoretical models should use a convex tax schedule instead of a linear one. Thus, the short answer to the question in the title is "No".
Sarno, L. and G. Valente (2006). "Deviations from purchasing power parity under different exchange rate regimes: Do they revert and, if so, how?" Journal of Banking & Finance 30(11): 3147-3169.
We propose an empirical model for deviations from long-run purchasing power parity (PPP) that simultaneously accounts for three key features: (i) adjustment toward PPP may occur via nominal exchange rates and relative prices at different speeds; (ii) different exchange rate regimes may generate regime shifts in the structural dynamics of PPP deviations; (iii) nonlinear reversion toward PPP in response to shocks. This empirical framework encompasses and synthesizes much previous empirical research. Using over a century of data for the G5 countries, we provide evidence that long-run PPP holds, the relative importance of nominal exchange rates and prices in restoring PPP varies over time and across different exchange rate regimes, and reversion to PPP occurs nonlinearly, at a speed that is fairly consistent with the nominal rigidities suggested by conventional open economy models.
Saunders, A. (2005). "An appreciation of Lawrence G. Goldberg." Journal of Banking & Finance 29(10): 2407-2408.
Saunders, A. and B. Scholnick (2006). "Frontiers in payment and settlement systems: Introduction." Journal of Banking & Finance 30(6): 1605-1612.
Schmiedel, H., M. Malkamäki, et al. (2006). "Economies of scale and technological development in securities depository and settlement systems." Journal of Banking & Finance 30(6): 1783-1806.
This paper investigates the existence and extent of economies of scale in depository and settlement systems. Evidence from 16 settlement institutions across different regions for the years 1993-2000 indicates the existence of significant economies of scale. The degree of such economies, however, differs by size of settlement institution and region. While smaller settlement service providers reveal a high potential of economies for scale, larger institutions show an increasing trend toward cost effectiveness. Clearing and settlement systems in countries in Europe and Asia report substantially larger economies of scale than those of the US system. European cross-border settlement seems to be more cost intensive than that on a domestic level, reflecting chiefly complexities of EU international securities settlement systems and differences in the scope of international settlement service providers. The evidence also reveals that investments in implementing new systems and upgrades of settlement technology continuously improved cost effectiveness over the sample period.
Scholnick, B., N. Massoud, et al. (2008). "The economics of credit cards, debit cards and ATMs: A survey and some new evidence." Journal of Banking & Finance32(8): 1468-1483.
This paper provides a critical survey of the large and diffuse literature on credit cards, debit cards and ATMs. We argue that because there are still many outstanding issues and questions about the pricing, use and substitutability of these payment mechanisms, that there are significant further opportunities for research in these areas. A large number of questions are examined in this survey, including the pricing of credit cards, the impact of networks on the provision and pricing of ATMs, as well as the tradeoffs that consumers make between different types of payment mechanism, including debit cards, credit cards and ATMs. Importantly, this paper is also amongst the first to provide new evidence on this latter question from bank level data (from Spain). We conclude that point of sale (debit card) and ATM transactions are substitutes, and that ATM surcharges impacts point of sale volume significantly.
Sercu, P. and T. Vinaimont (2006). "The forward bias in the ECU: Peso risks vs. fads and fashions." Journal of Banking & Finance 30(8): 2409-2432.
Forward rates of European currencies against the private and official ECU exhibit a bias similar to the one found in other data: the Cumby-Obstfeld-Fama (COF) regression coefficients are systematically below unity, and two thirds of them are negative. We use the discount of the private ECU relative to the official ECU as a measure of market scepticism or mistrust. In one view, this sentiment is based on peso risk: fears of realignments, and possibly also the risk of a meltdown of the private ECU relative to the official one. Alternatively, the discount just reflects fads and fashions. Dichotomizing the data on the basis of the size of the discount in the private ECU, we find that the COF beta strongly depends on the degree of mistrust and that the negative COF coefficients are generated by typically less than 20% of the data. But the pattern fits the fads and fashion view better than the peso theory. If the sentiment factor contains a conventional risk premium at all, then this risk premium is definitely not the one predicted by Bansal [Bansal, R., 1997. An exploration of the forward premium puzzle in currency markets. Review of Financial Studies 10, 369-403]. Nor is the sentiment factor proxying for Huisman et al.'s [Huisman, R., Koedijk, K., Kool, C., Nissen, F., 1998. Extreme support for uncovered interest parity. Journal of International Money and Finance 17, 211-228] transaction-cost effects.
Serifsoy, B. (2007). "Stock exchange business models and their operative performance." Journal of Banking & Finance 31(10): 2978-3012.
In recent years stock exchanges have been increasingly diversifying their operations into related business areas such as derivatives trading, post-trading services and software sales. This trend can be observed most notably among profit-oriented trading venues. While the pursuit for diversification is likely to be driven by the attractiveness of these investment opportunities, it is yet an open question whether certain integration activities are also efficient, both from a social welfare and from the exchanges' perspective. Academic contributions so far analyzed different business models primarily from the former perspective, whereas there is only little literature considering their impact on the exchange itself. By employing a panel data set of 28 stock exchanges for the years 1999-2003, we seek to shed light on this topic by comparing the technical efficiency and factor productivity of exchanges with different business models. Our findings suggest that exchanges that diversify into related activities are mostly less efficient than exchanges that remain focused on the cash market. In particular, we find no evidence that vertically integrated exchanges are more efficient. However, they seem to possess a substantially stronger factor productivity growth than other business models. We presume that integration activity comes at the cost of increased operational complexity which outweigh potential synergies between related activities and therefore leads to technical inefficiencies. Our findings contribute to the ongoing discussion about the drawbacks and merits of vertical integration.
Serifsoy, B. and M. Weiß (2007). "Settling for efficiency - A framework for the European securities transaction industry." Journal of Banking & Finance 31(10): 3034-3057.
Despite a lot of restructuring and many innovations in recent years, the securities transaction industry in the European Union is still a highly inefficient and inconsistently configured system for cross-border transactions. This paper analyzes the functions performed, the institutions involved and the parameters concerned that shape market and ownership structure in the industry. Of particular interest are microeconomic incentives of the main players that can be in contradiction to social welfare. We develop a framework and analyze three consistent systems for the securities transaction industry in the EU that offer superior efficiency than the current, inefficient arrangement. Some policy advice is given to select the [`]best' system for the Single European Financial Market.
Shanker, L. and N. Balakrishnan (2005). "Optimal clearing margin, capital and price limits for futures clearinghouses." Journal of Banking & Finance 29(7): 1611-1630.
We provide a model for a futures clearinghouse to use for setting optimal levels of clearing margin, capital and price limits, which minimizes the costs to clearing firms and simultaneously protects the clearinghouse from default by clearing firms. We show how to estimate the capital requirement, which supports the clearinghouse's residual default risk that is not covered by the clearing margin. We apply our model to the Winnipeg Commodity Exchange and demonstrate that price limits reduce the sum of optimal clearing margin and capital to a level that is substantially lower than that required in the absence of price limits.
Shen, C.-H. and H.-L. Chih (2005). "Investor protection, prospect theory, and earnings management: An international comparison of the banking industry." Journal of Banking & Finance 29(10): 2675-2697.
This paper raises three issues related to the earnings management (EM) of banks across 48 countries. First, does earnings management of banks exist in all 48 countries? Second, what is the incentive of banks to manage earnings? Third, why does EM vary across countries? To answer these three questions, two thresholds (viz., a threshold of zero earnings and a threshold of zero earnings change) are employed. The answer to the first question above is that banks in more than two-thirds of the 48 countries sampled are found to have managed their earnings. With respect to the second question, prospect theory is used to provide an answer. The relationship between return and risk is positive for high earnings groups, but is negative for low earnings banks. Finally, as to the last question, stronger protection of investors and greater transparency in accounting disclosure can reduce banks' incentives to manage earnings. Also, higher real GDP per capita decreases the degree of earnings management. It is seen that stronger enforcement of laws can counter intuitively result in stronger earnings management. However, this effect appears in low-income countries only, and not in high-income countries.
Shum, P. and M. Faig (2006). "What explains household stock holdings?" Journal of Banking & Finance 30(9): 2579-2597.
This is an empirical study of the determinants of stock holdings using data from the US Survey of Consumer Finances from 1992 to 2001. There is a great heterogeneity in the way households form their portfolios. Stock ownership is positively correlated with various measures of wealth, age, retirement savings, and having sought financial advice. It is negatively correlated with holdings of alternative risky investments, such as investments in private businesses, and with the willingness to undertake non-financial investments in the future. While we can predict reasonably well who holds stocks, we have less predictive power about the share of stocks owned by those who hold positive amounts.
Silva, A. C. and G. A. Chávez (2008). "Cross-listing and liquidity in emerging market stocks." Journal of Banking & Finance 32(3): 420-433.
In this study, we analyze liquidity costs for stocks and ADRs from the four main Latin American markets. The results indicate that international investors are exposed to different trading costs in Latin America, with market location and firm size as important determinants. In the local market, stocks that cross-list internationally do not always present a liquidity cost advantage relative to non-cross-listed stocks. When the ADR and the local stock markets are compared, large firms present lower trading costs in the home market. The opposite occurs for small firms.
Slovin, M. B., M. E. Sushka, et al. (2007). "Analyzing joint ventures as corporate control activity." Journal of Banking & Finance 31(8): 2365-2382.
We analyze joint ventures initiated by two publicly traded firms, and compare the results to asset sales and mergers. Combined returns are significantly greater for joint ventures than asset sales, and smaller than mergers. Gains are shared between joint venture parties, unlike asset sales and mergers where all gains accrue to sellers/targets. Ownership structure has no effect on joint venture returns. Combined gains from quasi-asset-sale joint ventures are significantly greater than for asset sales, and similar to mergers. Horizontal joint ventures generate greater gains than vertical or cross-industry ventures, and there is evidence that horizontal ventures capitalize expected monopoly rents.
Spaliara, M.-E. "Do financial factors affect the capital-labour ratio? Evidence from UK firm-level data." Journal of Banking & Finance In Press, Accepted Manuscript.
This paper analyses how firms' capital-labour ratio is affected by cash flow, leverage, and collateral, and how this effect differs at firms more and less likely to face financing constraints using a rich UK firm-level data set. It is common in the literature to examine the impact of financial constraints on hiring and firing decisions separately from their impact on decisions related to investment in physical capital. We argue that as long as firms use both inputs in production and there is some substitutability between them, the two decisions need to be jointly analysed. When we differentiate across firms that are more or less financially constrained, we find that the former group exhibits higher sensitivities of the capital-labour ratio to firm-specific characteristics compared to the latter.
Spiegel, M. M. and N. Yamori (2007). "Market price accounting and depositor discipline: The case of Japanese regional banks." Journal of Banking & Finance31(3): 769-786.
We examine the determinants of Japanese regional bank pricing-to-market decisions and their impact on the intensity of depositor discipline, in the form of the sensitivity of deposit growth to bank financial conditions. To obtain consistent estimates, we first model and estimate the bank pricing-to-market decision and then estimate the intensity of depositor discipline after conditioning for that decision. We find that banks were less likely to adopt market price accounting the larger were their unrealized securities losses. We also find statistically significant evidence of depositor discipline among banks that elected to price to market. Our results indicate that depositor discipline was more intense for the subset of banks that adopted market price accounting.
Stanhouse, B. and M. Ingram (2007). "A computational approach to the optimal structure of bank input prices." Journal of Banking & Finance 31(2): 439-453.
Most bank deposits contain an embedded option which permits the depositor to withdraw funds at will. Demand deposits generally allow costless withdrawal, while time deposits often require payment of an early withdrawal penalty. Managing the risk that depositors will exercise their withdrawal option is an important aspect of input pricing. This paper acknowledges the threat of deposit withdrawal and then solves for the optimal structure of bank deposit rates.
Stein, J. L. (2007). "United States current account deficits: A stochastic optimal control analysis." Journal of Banking & Finance 31(5): 1321-1350.
The "Pessimists" and the "Optimists" disagree whether the US external deficits and the associated buildup of US net foreign liabilities are problems that require urgent attention. A warning signal should be that the debt ratio deviates significantly from the optimal ratio. The optimal debt ratio or debt burden should take into account the vulnerability of consumption to shocks from the productivity of capital, the interest rate and exchange rate. The optimal debt ratio is derived from inter-temporal optimization using Dynamic Programming, because the shocks are unpredictable, and it is essential to have a feedback control mechanism. The optimal ratio depends upon the risk adjusted net return and risk aversion both at home and abroad. On the basis of alternative estimates, we conclude that the Pessimists' fears are justified on the basis of trends. The trend of the actual debt ratio is higher than that of the optimal ratio. The Optimists are correct that the current debt ratio is not a menace, because the current level of the debt ratio is not above the corresponding level of the optimum ratio.
Stein, J. L. and Z. Zheng (2007). "Inter-temporal optimization in a stochastic environment: Introduction." Journal of Banking & Finance 31(5): 1287-1293.
Stein, R. M. (2005). "The relationship between default prediction and lending profits: Integrating ROC analysis and loan pricing." Journal of Banking & Finance29(5): 1213-1236.
In evaluating credit risk models, it is common to use metrics such as power curves and their associated statistics. However, power curves are not necessarily easily linked intuitively to common lending practices. Bankers often request a specific rule for defining a cut-off above which credit will be granted and below which it will be denied. In this paper we provide some quantitative insight into how such cut-offs can be developed. This framework accommodates real-world complications (e.g., "relationship" clients). We show that the simple cut-off approach can be extended to a more complete pricing approach that is more flexible and more profitable. We demonstrate that in general more powerful models are more profitable than weaker ones and we provide a simulation example. We also report results of another study that conservatively concludes a mid-sized bank might generate additional profits on the order of about $4.8 million per year after adopting a moderately more powerful model.
Stiroh, K. J. and A. Rumble (2006). "The dark side of diversification: The case of US financial holding companies." Journal of Banking & Finance 30(8): 2131-2161.
Potential diversification benefits are one reason why US financial holding companies are offering a growing range of financial services. This paper examines whether the observed shift toward activities that generate fees, trading revenue, and other non-interest income has improved the performance of US financial holding companies (FHCs) from 1997 to 2002. We find evidence that diversification benefits exist between FHCs, but these gains are offset by the increased exposure to non-interest activities, which are much more volatile but not necessarily more profitable than interest-generating activities. Within FHCs, however, marginal increases in revenue diversification are not associated with better performance, while marginal increases in non-interest income are still associated with lower risk-adjusted profits. The key finding that diversification gains are more than offset by the costs of increased exposure to volatile activities represents the dark side of the search for diversification benefits and has implications for supervisors, managers, investors, and borrowers.
Stoimenov, P. A. and S. Wilkens (2005). "Are structured products [`]fairly' priced? An analysis of the German market for equity-linked instruments." Journal of Banking & Finance 29(12): 2971-2993.
Based on a unique data set, this paper examines the pricing of equity-linked structured products in the German market. The daily closing prices of a large variety of structured products are compared to theoretical values derived from the prices of options traded on the Eurex (European Exchange). For the majority of products, the study reveals large implicit premiums charged by the issuing banks in the primary market. A set of driving factors behind the issuers' pricing policies is identified, for example, underlying and type of implicit derivative(s). For the secondary market, the product life cycle is found to be an important pricing parameter.
Stojanovic, D., M. D. Vaughan, et al. (2008). "Do Federal Home Loan Bank membership and advances increase bank risk-taking?" Journal of Banking & Finance32(5): 680-698.
Since the early 1990s, commercial banks have turned to Federal Home Loan Bank (FHLBank) advances to plug the gap between loan and deposit growth. Is this trend worrisome? On the one hand, advances implicitly encourage risk by insulating borrowers from market discipline. On the other, advances give borrowers greater flexibility to managing interest rate and liquidity risk. And access to FHLBank funding encourages members to reshape their balance sheets in ways that could lower credit risk. Using quarterly financial and supervisory data for banks from 1992 to 2005, we assess the effect of FHLBank membership and advances on risk. The evidence suggests liquidity and leverage risks rose modestly, but interest-rate risk declined somewhat. Credit risk and overall failure risk were largely unaffected. Although the evidence suggest FHLBank membership and advances have had, at best, only a modest impact on bank risk, we caution that our sample period constitutes one observation and that moral hazard could be pronounced if leverage ratios revert to historical norms.
Stolper, A. (2009). "Regulation of credit rating agencies." Journal of Banking & Finance 33(7): 1266-1273.
Financial regulators recognize certain credit rating agencies for regulatory purposes. However, it is often argued that credit rating agencies have an incentive to assign inflated ratings. This paper studies a repeated principal-agent problem in which a regulator approves credit rating agencies. Credit rating agencies may collude to assign inflated ratings. Yet we show that there exists an approval scheme which induces credit rating agencies to assign correct ratings.
Stoyanov, S. V., S. T. Rachev, et al. (2008). "Relative deviation metrics and the problem of strategy replication." Journal of Banking & Finance 32(2): 199-206.
In the paper, we generalize the classical benchmark tracking problem by introducing the class of relative deviation metrics. We introduce an axiomatic description of the benchmark tracking problem and a classification inspired by the theory of probability metrics. Two examples of such metrics are provided and their in-sample behaviour is compared to the classical tracking error in a numerical example.
Sturm, J.-E. and B. Williams (2008). "Characteristics determining the efficiency of foreign banks in Australia." Journal of Banking & Finance 32(11): 2346-2360.
The factors determining foreign bank efficiency are investigated using a three stage research method. It is found that host market incumbency reduces efficiency of foreign banks in Australia, resulting in over use of inputs. Factors underlying the limited global advantage hypothesis of Berger et al. [Berger, Allen N., DeYoung, Robert, Genay, Hesna, Udell, Gregory F., 2000. Globalisation of financial institutions: Evidence from cross-border banking performance. Brookings-Wharton Papers on Financial Service 3, 23-120] are identified, in that nationality specific factors represented by dummy variables are not significant once other relevant effects are controlled for. Parent profitability is not found to result in increased host nation efficiency, while parent credit rating effects are mixed. Some evidence is presented that banks from more financially sophisticated nations are more efficient. The implications of these results are explored from the perspectives of bank management and bank regulators.
Suchard, J.-A. (2005). "The use of stand alone warrants as unique capital raising instruments." Journal of Banking & Finance 29(5): 1095-1112.
This study documents a significant positive announcement effect for a unique capital raising tool, stand alone warrants, in the Australian market. The result is consistent with the models of Schultz [J. Financ. Econom. 34 (1993) 109] and Mayers [J. Financ. Econom. 47 (1998) 83] where a warrant is viewed positively by the market. The results of the model developed to analyse the determinants of the announcement effect, support variants of the information asymmetry hypothesis (proxied by major shareholder pre-commitment and issue size).
Suchard, J.-A. (2009). "The impact of venture capital backing on the corporate governance of Australian initial public offerings." Journal of Banking & Finance33(4): 765-774.
This study explores the role of venture capitalists on investee boards at the time of listing for 552 initial public offerings. Australian board structures and mechanisms are more similar to those in the US and the United Kingdom, but market activity characteristics are more similar to Japanese and German systems. Further, the Australian private equity market is relatively young compared to US and European markets. IPOs backed by venture capital have more independent boards, similar to US IPOs. Venture capitalists improve governance by using their networks to recruit specialist independent directors with industry experience.
Sun, J., S. F. Cahan, et al. (2009). "Compensation committee governance quality, chief executive officer stock option grants, and future firm performance." Journal of Banking & Finance 33(8): 1507-1519.
This paper examines whether the relationship between future firm performance and chief executive officer (CEO) stock option grants is affected by the quality of the compensation committee. Compensation committee quality is measured using six committee characteristics - the proportion of directors appointed during the tenure of the incumbent CEO, the proportion of directors with at least ten years' board service, the proportion of directors who are CEOs at other companies, the aggregate shareholding of directors on the compensation committee, the proportion of directors with three or more additional board seats, and compensation committee size. We find that future firm performance is more positively associated with stock option grants as compensation committee quality increases.
Szakmary, A. C., C. M. Conover, et al. (2008). "An examination of Value Line's long-term projections." Journal of Banking & Finance 32(5): 820-833.
Unlike previous papers, which have focused on the timeliness ranks, we examine Value Line's 3-5 year projections for stock returns, earnings, sales and related measures. We find that Value Line's stock return and earnings forecasts exhibit large positive bias, although their sales predictions do not. For stock returns, Value Line's projections lack predictive power; for other variables predictive power may exist to some degree. Our findings suggest the spectacular past performance of the timeliness indicator reflects either close alignment with other known anomalies or data mining, and that investors and researchers should use Value Line's long-term projections with caution.
Szego, G. (2008). "Francesco Paris, the power of the will." Journal of Banking & Finance 32(7): 1177-1177.
Szegö, G. (2006). "Editorial." Journal of Banking & Finance 30(1): v-ix.
Szegö, G. (2006). "A pioneer in Finance: Marshal Samat, 1929-2006." Journal of Banking & Finance 30(12): iii-iv.
Takaoka, S. and C. R. McKenzie (2006). "The impact of bank entry in the Japanese corporate bond underwriting market." Journal of Banking & Finance 30(1): 59-83.
The 1993 Japanese financial system reform allowed banks to enter the underwriting market for corporate bonds through bank-owned security subsidiaries. This paper examines empirically whether underwriting commissions and yield spreads on corporate straight bonds issued domestically fell as a result of this bank entry. The empirical results show that bank entry significantly lowers both underwriting commissions and yield spreads. Commissions charged by banks are significantly lower than those charged by investment houses. Lending and shareholding relationships between the issuer and underwriter are not important in determining commissions or yield spreads.
Tang, D. Y. and H. Yan "Market conditions, default risk and credit spreads." Journal of Banking & Finance In Press, Accepted Manuscript.
This study empirically examines the impact of the interaction between market and default risk on corporate credit spreads. Using credit default swap (CDS) spreads, we find that average credit spreads decrease in GDP growth rate, but increase in GDP growth volatility and jump risk in the equity market. At the market level, investor sentiment is the most important determinant of credit spreads. At the firm level, credit spreads generally rise with cash flow volatility and beta, with the effect of cash flow beta varying with market conditions. We identify implied volatility as the most significant determinant of default risk among firm-level characteristics. Overall, a major portion of individual credit spreads is accounted for by firm-level determinants of default risk, while macroeconomic variables are directly responsible for a lesser portion.
Taylor, N. (2007). "A note on the importance of overnight information in risk management models." Journal of Banking & Finance 31(1): 161-180.
This paper examines the economic value of overnight information to users of risk management models. In addition to the information revealed by overseas markets that trade during the (domestic) overnight period, this paper exploits information generated via recent innovations in the structure of financial markets. In particular, certain securities (and associated derivative products) can now be traded at any time over a 24-h period. As such, it is now possible to make use of information generated by trading, in (almost) identical securities, during the overnight period. Of the securities that are available over such time periods, S&P 500 related products are by far the most actively traded and are, therefore, the subject of this paper. Using a variety of conditional volatility models that allow time-dependent information flow within (and across) three different S&P 500 markets, the results show that overnight information flow has a significant impact on the conditional volatility of daytime traded S&P 500 securities. Moreover (time-consistent) forecasts from models that incorporate overnight information are shown to have economic value to risk managers. In particular, Value-at-Risk (VaR) models based on these conditional volatility models are shown to be more accurate than VaR models that ignore overnight information.
Thompson, T. H. and V. Apilado (2006). "Investment banker reputation and two-stage combination carve-outs and spin-offs." Journal of Banking & Finance 30(1): 85-110.
This study examines whether investment banker reputation impacts the initial period returns of two stage combinations (carve-outs followed by spin-offs). All prior literature regarding investment banker reputation is based on single-stage events (IPOs). An analysis is conducted of all completed two-stage carve-outs/spin-offs from 1981 to 2002. Findings indicate that underwriters for two-stage combinations retain their reputation in contrast with the single-stage findings of Carter et al. [Carter, R.B., Dark, F.H., Piwowar, M.S., 2002. IPOs and underwriter reputation: Redeeming the value of reputation. Working Paper, Iowa State University] that investment bankers redeemed (cashed-in) their reputation. Also, this study finds that the Carter et al. reputation factors dominate the Loughran and Ritter [Loughran, T., Ritter, J.R., 2002. Why don't issuers get upset about leaving money on the table in IPOs? The Review of Financial Studies 15 (2), 413-443] reputation factors.
Thornton, D. L. (2005). "Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate." Journal of Banking & Finance 29(10): 2541-2556.
The expectations hypothesis (EH) of the term structure plays an important role in the analysis of monetary policy, where shorter-term rates are assumed to be determined by the market's expectation for the overnight federal funds rate. With two exceptions, tests using the effective federal funds rate as the short-term rate easily reject the EH. These exceptions are when the EH is tested over the nonborrowed reserve targeting period and when the test is performed only using data for settlement Wednesdays - the last day of bank reserve maintenance period. This paper argues that these exceptions are anomalous: in the former case, the failure to reject the EH occurs when economic analysis suggests that the market should be less able to forecast the federal funds rate. In the latter case, it occurs when there are sharp spikes in the funds rate that cannot improve materially the market's ability to forecast the funds rate. Additional analysis shows that these anomalous results are a consequence of the procedure used to test the EH.
Tompkins, R. G. and R. L. D'Ecclesia (2006). "Unconditional return disturbances: A non-parametric simulation approach." Journal of Banking & Finance 30(1): 287-314.
Simulation methods are extensively used in Asset Pricing and Risk Management. The most popular of these simulation approaches, the Monte Carlo, requires model selection and parameter estimation. In addition, these approaches can be extremely computer intensive. Historical simulation has been proposed as a non-parametric alternative to Monte Carlo. This approach is limited to the historical data available. In this paper, we propose an alternative historical simulation approach. Given a historical set of data, we define a set of standardized disturbances and we generate alternative price paths by perturbing the first two moments of the original path or by reshuffling the disturbances. This approach is either totally non-parametric when constant volatility is assumed; or semi-parametric in presence of GARCH(1, 1) volatility. Without a loss in accuracy, it is shown to be much more powerful in terms of computer efficiency than the Monte Carlo approach. It is also extremely simple to implement and can be an effective tool for the valuation of financial assets. We apply this approach to simulate pay off values of options on the S&P 500 stock index for the period 1982-2003. To verify that this technique works, the common back-testing approach was used. The estimated values are insignificantly different from the actual S&P 500 options payoff values for the observed period.
Tong, Z. (2008). "Deviations from optimal CEO ownership and firm value." Journal of Banking & Finance 32(11): 2462-2470.
The transaction cost theory of managerial ownership and firm value predicts that deviations from optimal managerial ownership reduce firm value. This paper empirically tests the transaction cost theory by studying the relation between deviations on either side of optimal CEO ownership and firm value. We find that both above-optimal and below-optimal deviations reduce firm value. We find that a change in CEO ownership is associated with a higher (lower) abnormal return if it moves the ownership towards (away from) the optimal level. These findings are consistent with the transaction cost theory of managerial ownership and firm value.
Topaloglou, N., H. Vladimirou, et al. (2008). "Pricing options on scenario trees." Journal of Banking & Finance 32(2): 283-298.
We examine valuation procedures that can be applied to incorporate options in scenario-based portfolio optimization models. Stochastic programming models use discrete scenarios to represent the stochastic evolution of asset prices. At issue is the adoption of suitable procedures to price options on the basis of the postulated discrete distributions of asset prices so as to ensure internally consistent portfolio optimization models. We adapt and implement two methods to price European options in accordance with discrete distributions represented by scenario trees and assess their performance with numerical tests. We consider features of option prices that are observed in practice. We find that asymmetries and/or leptokurtic features in the distribution of the underlying materially affect option prices; we quantify the impact of higher moments (skewness and excess kurtosis) on option prices. We demonstrate through empirical tests using market prices of the S&P500 stock index and options on the index that the proposed procedures consistently approximate the observed prices of options under different market regimes, especially for deep out-of-the-money options.
Trindade, A. A., S. Uryasev, et al. (2007). "Financial prediction with constrained tail risk." Journal of Banking & Finance 31(11): 3524-3538.
A new class of asymmetric loss functions derived from the least absolute deviations or least squares loss with a constraint on the mean of one tail of the residual error distribution, is introduced for analyzing financial data. Motivated by risk management principles, the primary intent is to provide "cautious" forecasts under uncertainty. The net effect on fitted models is to shape the residuals so that on average only a prespecified proportion of predictions tend to fall above or below a desired threshold. The loss functions are reformulated as objective functions in the context of parameter estimation for linear regression models, and it is demonstrated how optimization can be implemented via linear programming. The method is a competitor of quantile regression, but is more flexible and broader in scope. An application is illustrated on prediction of NDX and SPX index returns data, while controlling the magnitude of a fraction of worst losses.
Tsiakas, I. (2008). "Overnight information and stochastic volatility: A study of European and US stock exchanges." Journal of Banking & Finance 32(2): 251-268.
This paper provides a comprehensive evaluation of the predictive ability of information accumulated during nontrading hours for a set of European and US stock indexes. We introduce a stochastic volatility model, which conditions on lagged overnight information, distinguishes between the nontrading periods of weeknights, weekends, holidays and long weekends, and allows for an asymmetric leverage effect on the impact of overnight news. We implement Bayesian methods for estimation and ranking of the empirical models, and find two key results: (i) there is substantial predictive ability in financial information accumulated during nontrading hours; and (ii) the performance of stochastic volatility models improves considerably by separating the asymmetric impact of positive and negative news made available over weeknights, weekends, holidays and long weekends.
Uchida, H. and Y. Tsutsui (2005). "Has competition in the Japanese banking sector improved?" Journal of Banking & Finance 29(2): 419-439.
This paper investigates whether competition in the Japanese banking sector has improved in the last quarter of the 20th century. By estimating the first order condition of profit maximization, together with the cost function and the inverse demand function, we found that competition had improved, especially in the 1970s and in the first half of the 1980s. The results fail to reject a Cournot oligopoly for city banks for most of the period, while they do reject it for regional banks for the overall period. This suggests that competition among city banks was stronger than that among regional banks.
Uhde, A. and U. Heimeshoff (2009). "Consolidation in banking and financial stability in Europe: Empirical evidence." Journal of Banking & Finance 33(7): 1299-1311.
Using aggregate balance sheet data from banks across the EU-25 over the period from 1997 to 2005 we provide empirical evidence that national banking market concentration has a negative impact on European banks' financial soundness as measured by the Z-score technique while controlling for macroeconomic, bank-specific, regulatory, and institutional factors. Furthermore, our analysis reveals that Eastern European banking markets exhibiting a lower level of competitive pressure, fewer diversification opportunities and a higher fraction of government-owned banks are more prone to financial fragility whereas capital regulations have supported financial stability across the entire European Union.
Uhrig-Homburg, M. (2005). "Cash-flow shortage as an endogenous bankruptcy reason." Journal of Banking & Finance 29(6): 1509-1534.
This paper develops a simple model for a leveraged firm and endogenizes the firm's bankruptcy point by assuming that equity issuance is costly. Equity-issuance costs reflect the difficulties in issuing new equity for firms that are close to financial distress. The resulting model captures cash-flow shortage as a reason to go bankrupt, though the equity value is positive. I analyze the optimal bankruptcy point as well as corporate bond prices and yield spreads for various levels of equity-issuance costs in order to study the impact of different liquidity constraints. Finally, I discuss the consequences on optimal capital structure.
Van Cayseele, P. and C. Wuyts (2007). "Cost efficiency in the European securities settlement and depository industry." Journal of Banking & Finance 31(10): 3058-3079.
We examine whether the European settlement and custody institutions operate in an efficient way. To do this, we start from an analytically founded discussion regarding the activities performed by the operators in this sector. Based on the insights obtained, we estimate both a translog cost function and a constant elasticity of substitution - quadratic cost function. From the results obtained, there clearly are economies of scale in this industry. Moreover, also economies of scope between the activities performed are present. These findings imply that probably further consolidation is ahead, and that separating certain activities from others can only be done at a cost in terms of efficiency.
Van Tassel, E. and S. Vishwasrao (2007). "Asymmetric information and the mode of entry in foreign credit markets." Journal of Banking & Finance 31(12): 3742-3760.
In a newly liberalized credit market, foreign banks with cost advantages are likely to be less informed than domestic banks that hold information on credit risks. These relative advantages may generate incentives for a foreign bank to negotiate acquisition of a domestic bank in order to capture information endowments. However, if it is difficult to assess the value of information held by banks, the foreign bank will face important choices about the optimal mode of entry and what acquisition price to pay. These choices have implications for the survival of domestic banks and how capital is allocated after liberalization.
VanHoose, D. (2007). "Theories of bank behavior under capital regulation." Journal of Banking & Finance 31(12): 3680-3697.
This paper reviews academic studies of bank capital regulation in an effort to evaluate the intellectual foundation for the imposition of the Basel I and Basel II systems of risk-based capital requirements. The theoretical literature yields general agreement about the immediate effects of capital requirements on bank lending and loan rates and the longer-term impacts on bank ratios of equity to total or risk-adjusted assets. This literature produces highly mixed predictions, however, regarding the effects of capital regulation on asset risk and overall safety and soundness for the banking system as a whole. Thus, the intellectual foundation for the present capital-regulation regime is not particularly strong. The mixed conclusions in the academic literature on banking certainly do not provide unqualified support for moving to an even more stringent and costly system of capital requirements. These widely ambiguous results do suggest, however, that assessing the implications of capital regulation for balance-sheet risk and monitoring effort in diverse banking systems is an important agenda for future theoretical research in the banking area.
Venezia, I. and Z. Shapira (2007). "On the behavioral differences between professional and amateur investors after the weekend." Journal of Banking & Finance31(5): 1417-1426.
This paper compares the trading patterns of amateur and professional investors during the days following the weekend. The comparison is based on all the daily transactions of a large sample of both amateurs and professionally managed investors in a major brokerage house in Israel from 1994 to 1998. We find that weekends influence both amateurs and professional investors; however they affect them in opposite directions. Individuals increase both their buy and sell activities, and their propensity to sell rises more than their propensity to buy. Professionals on the other hand tend to perform fewer buy as well as sell trades after the weekend, but unlike individuals, the drop in their activity is almost the same for buy trades and for sell trades. The results agree with previous hypotheses raised in the literature, which were not directly tested, about the effects of the weekend on the predisposition to trade of individuals and institutions in other markets. We also find that returns on the Israeli Stock Market Index are correlated in general with the behavioral patterns exhibited by the investors in our sample. In particular the returns on the days following the weekend are lower than those in other weekdays in a manner consistent with the behavioral patterns we found.
Ventura Bravo, J. M. and C. M. Pereira da Silva (2006). "Immunization using a stochastic-process independent multi-factor model: The Portuguese experience."Journal of Banking & Finance 30(1): 133-156.
In this paper, we evaluate the relative immunization performance of the M-vector proposed by Nawalkha and Chambers (1997) [Nawalkha, S.K., Chambers, D.R., 1997. The M-vector model: derivation and testing of extensions to M-squared. The Journal of Portfolio Management 23, 92-98], using data for the Portuguese government debt market. Empirical results show that: (i) immunization models (single- and multi-factor) remove most of the interest rate risk underlying a more naïve maturity strategy; (ii) duration-matching portfolios constrained to include the maturity bond and formed using a single-factor model provide the best immunization performance overall, particularly in highly volatile term structure environments and shorter holding periods; (iii) varying the rebalancing frequency and the investment horizon shows that these results are less robust for Portugal than for other countries.
Vermilyea, T. A., E. R. Webb, et al. (2008). "Implicit recourse and credit card securitizations: What do fraud losses reveal?" Journal of Banking & Finance 32(7): 1198-1208.
In this paper, we develop and test a model of implicit recourse in asset-backed securitizations. Fraud losses on securitized assets are generally incurred by the bank and do not affect the performance of securitization trusts, while credit losses do affect the trust's performance and are potentially borne by the owner of the securitized assets. Thus, the classification of losses as either fraud or credit losses provides a potential avenue of implicit recourse to manipulate the performance of securitization trusts. Using annual data from 2001 to 2006, we find that the performance of the credit card securitization portfolio is negatively related to fraud losses reported by the bank. We examine these results in light of the proposed Basel II capital rules and argue that a bank's incentive to provide implicit recourse will increase under the anticipated regime.
Vesala, T. (2007). "Switching costs and relationship profits in bank lending." Journal of Banking & Finance 31(2): 477-493.
This paper studies how the cost of switching banks affects the profits available from relationship based lending when the relationship produces inside information. Lower switching cost compounds the adverse selection problem, discouraging outsider banks to depress loan rates. The adverse selection effect eases off along with higher switching cost, leading to more aggressive bidding and thereby reduction in insider profits. Above a certain threshold, however, the adverse selection effect vanishes completely and the insider profits turn increasing in the switching cost. The model predicts that the availability of relationship credit is non-monotonously related to the magnitude of the switching cost.
Viale, A. M., J. W. Kolari, et al. (2009). "Common risk factors in bank stocks." Journal of Banking & Finance 33(3): 464-472.
This paper provides evidence on the risk factors that are priced in bank equities. Alternative empirical models with precedent in the nonfinancial asset pricing literature are tested, including the single-factor CAPM, three-factor Fama-French model, and ICAPM. Our empirical results indicate that an unconditional two-factor ICAPM model that includes the stock market excess return and shocks to the slope of the yield curve is useful in explaining the cross-section of bank stock returns. However, we find no evidence that firm specific factors such as size and book-to-market ratios are priced in bank stock returns. These results have a number of important implications for the estimation of the banks' cost of capital as well as regulatory initiatives to utilize market discipline to evaluate bank risk under Basel II.
Villatoro, F. "The delegated portfolio management problem: Reputation and herding." Journal of Banking & Finance In Press, Corrected Proof.
We study the relationship between financial intermediaries' reputation and herding in a delegated portfolio management problem context. We identify conditions under which equilibria exist such that intermediaries with good reputation invest in private information, whereas those with poor reputation herd. The model's empirical predictions are discussed and found to be consistent with previous evidence. From a normative stand, our work points out the possible existence of a policy trade-off between protecting investors by demanding more transparency from intermediaries and encouraging herding by free-riders for whom imitating portfolio decisions would be easier under tighter regulation, such as more frequent portfolio disclosure.
von Hagen, J. and G. B. Wolff (2006). "What do deficits tell us about debt? Empirical evidence on creative accounting with fiscal rules in the EU." Journal of Banking & Finance 30(12): 3259-3279.
Fiscal rules, such as the excessive deficit procedure and the stability and growth pact (SGP), aim at constraining government behavior. [Milesi-Ferretti, G., 2003. Good, bad or ugly? On the effects of fiscal rules with creative accounting, Journal of Public Economics, 88, 377-394] develops a model in which governments circumvent such rules by reverting to creative accounting. The amount of this depends on the reputation cost for the government and the economic cost of sticking to the rule. We provide empirical evidence of creative accounting in the European Union. We find that the SGP rules have induced governments to use stock-flow adjustments, a form of creative accounting, to hide deficits. The tendency to substitute stock-flow adjustments for budget deficits is especially strong for the cyclical component of the deficit, as in times of recession the cost of reducing the deficit is particularly large.
von Hagen, J. and J. Zhou (2005). "The determination of capital controls: Which role do exchange rate regimes play?" Journal of Banking & Finance 29(1): 227-248.
This paper investigates the role of exchange rate regime choices in the determination of capital controls in transition economies. We first use a simultaneous equations model to allow direct interactions between decisions on capital controls and on exchange rate regimes. We find that exchange rate regime choices strongly influence the imposition or removal of capital controls, but the feed-back effect is weak. We further estimate a single equation model for capital controls with exchange rate regime choices as independent variables, and we find that there is a hump-shaped relationship between exchange rate regime flexibility and capital control intensity.
Voordeckers, W. and T. Steijvers (2006). "Business collateral and personal commitments in SME lending." Journal of Banking & Finance 30(11): 3067-3086.
Using a database of SME credit approvals from a large Belgian bank, this paper extends the empirical evidence on the determinants of collateral by examining the determinants of business collateral simultaneously with the determinants of personal collateral/commitments. Our results suggest that firm and relationship characteristics seem to be more important determinants of collateral/commitment protection than loan and lender characteristics. Family firms are more likely to offer a higher degree of collateral/commitment protection while introducing competition between banks decreases this likelihood. The collateral requirement decreases in the length of the bank-borrower relationship. Furthermore, trade credit seems to have a signalling effect. The [`]lazy banks hypothesis' was not supported. Our results suggest that beside risk arguments, also commercial arguments help explain the pledging of collateral. Using a continuation-ratio logit model, we discover several differences in the determinants of the collateralisation decision and the determinants of the type of collateral/commitments.
Vos, E., A. J.-Y. Yeh, et al. (2007). "The happy story of small business financing." Journal of Banking & Finance 31(9): 2648-2672.
We examine two data sets, one from the UK (n = 15,750) and one from the US (n = 3239), to show that SME financial behaviour demonstrates substantial financial contentment, or [`]happiness'. We find fewer than 10% of the UK firms seek significant growth and only 1.32% of US firms list a shortage of capital other than working capital as a problem. Financial performance indicators (growth, return on assets, profit margin) were not found to be determinants of SME financing activities, as might be expected in a [`]rational' risk-return environment. Younger and less educated SME owners more actively use external financing - even though more education reduces the fear of loan denial - while older and more educated ([`]wiser') SME owners are found to be being less likely to seek or use external financing. The contentment hypothesis for SME financing also extends to high-growth firms in that we show that they participate more in the loan markets than low-growth firms. By way of contrast to the finance gap hypothesis, the contentment hypothesis observes the importance of social networks (connections) [for finance] and confirms the [`]connections - happiness' linkage in the literature on happiness while doubting the theoretical suitability of Jensen and Meckling [Jensen, M., Meckling, W., 1976. Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics 3, 305-360.] base-case analysis for SMEs.
Vrontos, S. D., I. D. Vrontos, et al. (2008). "Hedge fund pricing and model uncertainty." Journal of Banking & Finance 32(5): 741-753.
This article uses Bayesian model averaging to study model uncertainty in hedge fund pricing. We show how to incorporate heteroscedasticity, thus, we develop a framework that jointly accounts for model uncertainty and heteroscedasticity. Relevant risk factors are identified and compared with those selected through standard model selection techniques. The analysis reveals that a model selection strategy that accounts for model uncertainty in hedge fund pricing regressions can be superior in estimation/inference. We explore potential impacts of our approach by analysing individual funds and show that they can be economically important.
Wachtel, P. (2005). "Introduction to the Symposium Issue." Journal of Banking & Finance 29(1): 1-4.
Wachtel, P. (2006). "Policy issues relevant to transition and emerging market economies: Papers from the 10th Dubrovnik Economic Conference." Journal of Banking & Finance 30(5): 1333-1334.
Wachtel, P. and B. Vujcic (2006). "Introduction: Crises, financial stability and macroeconomic policy. Papers from the 11th Dubrovnik Economic Conference."Journal of Banking & Finance 30(12): 3257-3258.
Wagner, W. (2007). "The liquidity of bank assets and banking stability." Journal of Banking & Finance 31(1): 121-139.
This paper shows that an increased liquidity of bank assets, paradoxically, increases banking instability and the externalities associated with banking failures. This is because even though higher asset liquidity directly benefits stability by encouraging banks to reduce the risks on their balance sheets and by facilitating the liquidation of assets in a crisis, it also makes crises less costly for banks. As a result, banks have an incentive to take on an amount of new risk that more than offsets the positive direct impact on stability.
Wang, C. (2005). "Ownership and operating performance of Chinese IPOs." Journal of Banking & Finance 29(7): 1835-1856.
We examine changes in operating performance of Chinese listed companies around their initial public offerings, and focus on the effect of ownership and ownership concentration on IPO performance changes. We document a sharp decline in post-issue operating performance of IPO firms. We also find that neither state ownership nor concentration of ownership is associated with performance changes, but there is a curvilinear relation between legal-entity ownership and performance changes and between concentration of non-state ownership and performance changes. Our results are robust to different performance measures and industry adjustments. These findings suggest that agency conflicts, management entrenchment, and large shareholders' expropriation co-exist to influence Chinese IPO performance, and the beneficial and detrimental effects of state shareholdings tend to offset each other.
Wang, J., G. Meric, et al. (2009). "Stock market crashes, firm characteristics, and stock returns." Journal of Banking & Finance 33(9): 1563-1574.
A number of studies have investigated the causes and effects of stock market crashes. These studies mainly focus on the factors leading to a crash and on the volatility and co-movements of stock market indexes during and after the crash. However, how a stock market crash affects individual stocks and if stocks with different financial characteristics are affected differently in a stock market crash is an issue that has not received sufficient attention. In this paper, we study this issue by using data for eight major stock market crashes that have taken place during the December 31, 1962-December 31, 2007 period with a large sample of US firms. We use the event-study methodology and multivariate regression analysis to study the determinants of stock returns in stock market crashes.
Wang, J., C. Wu, et al. (2008). "Liquidity, default, taxes, and yields on municipal bonds." Journal of Banking & Finance 32(6): 1133-1149.
We examine the effects of liquidity, default and personal taxes on the relative yields of Treasuries and municipals using a generalized model with liquidity risk. The municipal yield model includes liquidity as a state factor. Using a unique transaction dataset, we estimate the liquidity risk of municipals and its effect on bond yields. Empirical evidence shows that municipal bond yields are strongly affected by all three factors. The effects of default and liquidity risk on municipal yields increase with maturity and credit risk. Liquidity premium accounts for about 9-13% of municipal yields for AAA bonds, 9-15% for AA/A bonds and 8-19% for BBB bonds. A substantial portion of the maturity spread between long- and short-maturity municipal bonds is attributed to the liquidity premium. Ignoring the liquidity risk effect thus results in a severe underestimation of municipal bond yields. Conditional on the effects of default and liquidity risk, we obtain implicit tax rates very close to the statutory tax rates of high-income individuals and institutional investors. Furthermore, these implicit income tax rates are quite stable across bonds of different maturities. Results show that including liquidity risk in the municipal bond pricing model helps explain the muni puzzle.
Wang, Y., L. Wu, et al. (2009). "Does the stock market affect firm investment in China? A price informativeness perspective." Journal of Banking & Finance 33(1): 53-62.
This paper investigates the empirical relationship between firm-level investment and the stock market in China from a price informativeness perspective. We find that firm investment does not significantly respond to the stock market valuation, because stock prices contain very little extra information about the future operating performance of firms. This finding is further supported by the relative investment response test and the relative price information content test based on the informativeness proxy of price non-synchronicity combined with firm information transparency.
Wei, S. X. and C. Zhang (2005). "Idiosyncratic risk does not matter: A re-examination of the relationship between average returns and average volatilities." Journal of Banking & Finance 29(3): 603-621.
A recent study by Goyal and Santa-Clara [J. Finance 58 (2003) 975] finds a significantly positive relationship between average stock returns and pre-determined average return volatility measures, while finding no relationship between the average return and its own volatility. The result is interpreted as evidence that idiosyncratic risk matters in asset pricing. We re-examine the issue in extended sample periods and find the proclaimed positive relationship is not substantiated. Our analysis indicates that the above-mentioned positive relationship is mainly driven by the data in the 1990s. The trading strategy suggested by Goyal and Santa-Clara to exploit the return predictability by pre-determined volatility does not yield sustained economic gains.
Weiss, M. A. and B. P. Choi (2008). "State regulation and the structure, conduct, efficiency and performance of US auto insurers." Journal of Banking & Finance32(1): 134-156.
This research investigates the impact of regulation on state automobile insurance markets while controlling for other state insurance market characteristics that may be related to performance. Data for a large sample of insurers are analyzed. The results suggest that insurers in competitive and non-stringently regulated states may benefit from market power by charging higher unit prices, however insurers in these states are on average more cost X-efficient and cost X-efficient insurers charge lower prices and earn smaller profits. The empirical results also suggest that insurers in some rate regulated states are less revenue and cost-scale efficient than in competitive states.
Wilkens, S. and P. A. Stoimenov (2007). "The pricing of leverage products: An empirical investigation of the German market for [`]long' and [`]short' stock index certificates." Journal of Banking & Finance 31(3): 735-750.