Category Archives: Finance

Savings selectivity bias, subjective expectations and stock market participation

Yosef Bonaparte and Frank Fabozzi
Applied Financial Economics, Volume 21, Issue 3, pp. 119-130.

Studies of household stock market participation report low participation rates. The explanations cited are that the fixed costs associated with participation and high risk aversion discourage households from buying stocks. However, the low participation rate findings are unchallenged. We argue that because prior studies fail to recognize that not all households save, there exists a selection bias when estimating the household participation rate. After correcting for this selection bias, as well as accounting for the influence of subjective expectations on market participation, we show that the unconditional probability of participating in the stock market would increase twofold.

The effects of bank relations on stock repurchases: Evidence from Japan

Jun-Koo Kanga, Kenneth A. Kim, P. Kitsabunnarat-Chatjuthamard, and Takeshi Nishikawa
Journal of Financial Intermediation, Vol. 20, Issue 1, Pages 94–116

This paper examines the effects that bank relations have on stock repurchases in Japan. Similar to US evidence, we find that stock repurchase announcements in Japan have positive announcement period returns. Announcement returns are positively related to equity ownership by main banks, but are negatively related to nonbank debt ratios. In contrast, bank debt ratios do not have such a negative relation. Announcement returns are also negatively related to future growth opportunities, suggesting that repurchase announcements are greeted more positively by investors when repurchasing firms have lower growth opportunities. We also find that firms with high leverage are less likely to repurchase stocks, whereas firms with high equity ownership by main banks are more likely to do so. Overall, these results are consistent with the views that banks, particularly main banks, are effective monitors of agency costs and financial distress risk, and that their presence as dual stakeholders are value-enhancing.

Conditional coskewness in stock and bond markets: time-series evidence

Jian Yang, Yinggang Zhou, Zijun Wang
Management Science,Vol. 56, Issue 11, Pages: 2031-2049.

In the context of a three-moment intertemporal capital asset pricing model specification, we characterize conditional coskewness between stock and bond excess returns using a bivariate regime-switching model. We find that both conditional US stock coskewness (the relation between stock return and bond volatility) and bond coskewness (the relation between bond return and stock volatility) command statistically and economically significant negative ex ante risk premiums. The impacts of stock and bond coskewness on the …
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Environmental Risk and Shareholder Returns: Evidence from the Announcement of the Toxic 100 Index

Kenneth Bettenhausen, John Byrd, and Elizabeth S. Cooperman
International Review of Accounting, Banking and Finance, Volume 2, Issue 3, pp. 28~45

This paper examines the stock price response to the announcement that a U.S. company has been named to the Toxic 100 list of the largest air polluters, where rankings are based on data from the Environmental Protection Agency’s (EPA) Risk Screening Environmental Indicator (RSEI) project. We find a significant negative average abnormal return (AR) of – 1.20% in 2006 and – 1.60 % in 2008 over the two – day announcement periods for the Toxic 100 announcements, representing an average drop in market value for the average firm in the index of – $235,944,909 in 2006 and – $237,595,885 in 2008.  Firms in the top 10 ranking of the index had a significantly, larger negative abnormal return than in the bottom 10 ranking. Firms that were not on the 2006 index, but were added to the 2008 index experienced an average abnormal return of -3.5%. The results are interesting for two reasons. One, they show that investors impound environmental risk into their company valuations, implying that environmental disclosure and reporting is important. Two, the results suggest that although analysts had the RSEI data prior to the release of the Toxic 100 lists, they view the Toxic 100 as a significant event. This suggests limits to the semi-strong form of market efficiency, suggesting that the anticipated payoff from computing their own environmental risk assessment may not justify their time and effort required to do so.

Financial Policies and the Agency Costs of Free Cash Flow: Evidence from the Oil Industry

John W. Byrd
International Review of Accounting, Banking and Finance, Volume 2, pp. 23-50

Jensen (1986) posits that costly conflicts of interest between managers and shareholders are especially pronounced in companies with substantial amounts of free cash flow. Jensen argues that, all else equal, firms that finance assets with debt will be less prone to this agency problem of overinvestment than other firms. Picchi (1985) and McConnell and Muscarella (1986) provide evidence that investment opportunities in exploration and development were quite limited during the early 1980s. During the same period, cash flows to petroleum producers were large because of high crude oil prices. This research uses data from 1979-1985 for a sample of U.S. oil and gas production and exploration companies to test Jensen’s free cash flow theory. Our evidence indicates that estimated agency costs are inversely related to financial leverage, consistent with the control effects of debt. These results persist across a variety of model specifications and data aggregation methods.

Explaining Production Inefficiency in China’s Agriculture using Data Envelopment Analysis and Semi-Parametric Bootstrapping

Daniel C. Monchuk, Zhuo Chen and Yosef Bonaparte
China Economic Review,
Vol. 21, Issue 2, June 2010, Pages 346-354,

In this paper we examine more closely the factors associated with production inefficiency in China’s agriculture. The approach we take involves a two-stage process where output efficiency scores are first estimated using data envelopment analysis, and then in the second stage, variation in the resulting efficiency scores is explained using a truncated regression model with inference based on a semi-parametric bootstrap routine. Among the results we find that a heavy industrial presence is associated with reduced agricultural production efficiency and may be an indication that externalities from the industrial process, such as air and ground water pollution, affect agricultural production. We also find evidence that counties with a large percentage of the rural labor force engaged in agriculture tend to be less efficient, and suggests that nurturing and promoting growth of non-primary agriculture may lead to more efficient use of labor resources in agriculture

Explaining production inefficiency in China’s agriculture using data envelopment analysis and semi-parametric bootstrapping

Daniel C Monchuk, Zhuo Chen, Yosef Bonaparte
China Economic Review,Vol. 21, Issue 2, Pages: 346-354.

In this paper we examine more closely the factors associated with production inefficiency in China’s agriculture. The approach we take involves a two-stage process where output efficiency scores are first estimated using data envelopment analysis, and then in the second stage, variation in the resulting efficiency scores is explained using a truncated regression model with inference based on a semi-parametric bootstrap routine. Among the results we find that a heavy industrial presence is associated with reduced agricultural …
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Financial distress and idiosyncratic volatility: An empirical investigation

Jing Chen, Lorn Chollete, Rina Ray
Journal of Financial Markets,Vol. 13, Issue 2, Pages: 249-267.

We investigate the link between distress and idiosyncratic volatility. Specifically, we examine the twin puzzles of anomalously low returns for high idiosyncratic volatility stocks and high distress risk stocks, documented by Ang et al.(2006) and Campbell et al.(2008), respectively. We document that these puzzles are empirically connected, and can be explained by a simple, theoretical, single-beta CAPM model.
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Rationalizing Trading Frequency and Returns

Yosef Bonaparte, Russell Cooper
National Bureau of Economic Research,Issue w16022,

Barber and Odean (2000) study the relationship between trading frequency andreturns. They find that households who trade more frequently have a lower net return than other households. But all households have about the same gross return. They argue that these results cannot emerge from a model with rational traders and instead attribute these findings to overconfidence. Using a dynamic optimization approach, we find that neither a model with rational agents facing adjustment costs nor various models of …
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Broad-based employee stock ownership incentives and contracting efficient

John P. Daley
International Journal of Accounting, Banking and Finance, Volume 2, Issue 1, Pp. 45-69

Neoclassical price theory implies that the incentive effects produced by broad-based employee stock ownership compensation plans will be overwhelmed by the problem of free riding. Yet the use of such plans is relatively common. This paper seeks to explain this apparent dichotomy. Using the theories of the firm of Alchian and Demsetz (1972) and Demsetz (1983) and the analytical structure of Jensen and Meckling (1976), I develop a microeconomic rationale for the use of broad-based stock incentives in the presence of a central monitor. I show that the ability of stock to align owner and employee interests is a function of marginal monitoring costs. At the margin, when monitoring costs are large relative to their benefits, the value of shirking to employees is minute. Hence, the small gain promised by stock ownership is sufficient to motivate reduced shirking. The theory rigorously unifies much of the common litany of explanations for the efficacy of such plans: monitoring and information costs, employee self-selection, the small cost of changing behavior, and alignment of employee with employer interests. Two pairs of refutable implications are derived. First, the optimal level of individual employee ownership is negatively related to firm size and positively related to marginal monitoring costs. Second, the change in firm value attributable to employee stock ownership is positively related to both the level of individual employee ownership and marginal monitoring costs.

Nonlinearity and intraday efficiency tests on energy futures markets

Tao Wang and Jian Yang
Energy Economics, Vol. 32, Issue 2, pp. 496-503

Using high frequency data, this paper first time comprehensively examines the intraday efficiency of four major energy (crude oil, heating oil, gasoline, natural gas) futures markets. In contrast to earlier studies which focus on in-sample evidence and assume linearity, the paper employs various nonlinear models and several model evaluation criteria to examine market efficiency in an out-of-sample forecasting context. Overall, there is evidence for intraday market inefficiency of two of the four energy future markets (heating oil and natural gas), which exists particularly during the bull market condition but not during the bear market condition. The evidence is also robust against the data-snooping bias and the model overfitting problem, and its economic significance can be very substantial.

Director tenure and the compensation of bank CEOs

John Byrd, Elizabeth S. Cooperman, Glenn A. Wolfe|
Managerial Finance, Vol. 36 Issue 2, pp. 86 – 102

Purpose – The purpose of this paper is to examine how board tenure affects the compensation of CEOs using a sample of 93 publicly traded US banks.

Design/methodology/approach – The paper proposes a CEO allegiance hypothesis whereby long-term relationships with executives and other directors will shift allegiance from shareholders to executives vs a more traditional expertise hypothesis that predicts superior monitoring of executives by directors with longer tenure. A generalized least squares regression methodology is used to examine the relationship between CEO compensation and outside director tenure.

Findings – For the full sample, board tenure variables were found to be insignificant. However, when examining a subsample of firms with CEO tenure of greater than six years or more, the relationship between CEO pay and the median tenure of outside directors becomes positive, supporting a CEO allegiance hypothesis.

Research limitations/implications – On a caveat, since this study relies on data for large bank holding companies over a short period of time, further research is needed to determine if the results carry over to a broader sample of firms and across time.

Practical implications – The results suggest that the independence of outside directors may be compromised when they serve for longer tenure periods together with the same CEO; an important consideration for better corporate governance.

Originality/value – The study provides a unique examination of outside director independence from the perspective of board tenure and the long-term relationships with executives and other directors that may result in allegiance shifts away from shareholders and towards managers.

On the Economic Value of Return Predictability

Yufeng Han
ANNALS OF ECONOMICS AND FINANCE Vol. 11 Issue 1, Pages: 1–33

Recent studies provide strong statistical evidence challenging the existence of out-of-sample return predictability. The economic significance of return
predictability is also controversial. In this paper, we find significant economic gains for dynamic trading strategies based on return predictability when ap-
propriate portfolio constraints are imposed. We findthat imposingappropriate portfolio constraints is critical for obtaining economic profits, which seems to
explain the contradictory findings about economic significance in the literature. We also compare the performance of several predictive models including
the VAR, the VAR-GARCH, and the (semi)nonparametric models and find that the simple VAR model performs similarly to other more complex models.

The Shareholder Wealth Effects of an Executive Joining Another Company’s Board

John Byrd, L. Ann Martin, and Subhrendu Rath
International Journal of Managerial Finance, Volume 6 Issue 1, pp. 48-57

Purpose – The purpose of this paper is to examine the impact of high‐level‐executives joining the Board of another US company on the shareholder wealth of the firms in which these executives work.
Design/methodology/approach – The “event‐study” methodology is used first to estimate the shareholder effects and then, through multivariate regression analysis, establish a relationship of these effects with executive characteristics.
Findings – The paper documents that the abnormal return becomes more positive the closer the executive is to retirement and more negative as the number of other corporate Boards the executive already sits on increases. Unlike previous research, it is not found that prior performance of the employing company helps explain the cross‐sectional variation in the announcement day abnormal returns.
Research limitations/implications – The result supports the concerns of shareholder activists that key executives joining the Boards of other companies do their home shareholders a disservice by being spread too thin. It supports the hypothesis that investors interpret a CEO joining the Board of another firm as value decreasing.
Originality/value -The paper provides a link between managerial labor and shareholder wealth. Important and high‐level‐executives, while attempting to enhance their own personal benefits by joining other Boards, can destroy shareholder value of the company for which they work.

Nonlinearity, data-snooping, and stock index ETF return predictability

Jian Yang, Juan Cabrerab and Tao Wang
European Journal of Operational Research, Vol. 200 Issue 2,  pp. 498-507

This paper examines daily return predictability for eighteen international stock index ETFs. The out-of-sample tests are conducted, based on linear and various popular nonlinear models and both statistical and economic criteria for model comparison. The main results show evidence of predictability for six of eighteen ETFs. A simple linear autoregression model, and a nonlinear-in-variance GARCH model, but not several popular nonlinear-in-mean models help outperform the martingale model. The allowance of data-snooping bias using White’s Reality Check also substantially weakens otherwise apparently strong predictability.

Out-of-Sample Predictability in International Equity Markets: A Model Selection Approach

Xiaojing Su, Tao Wang and Jian Yang
Financial Review, Vol. 44 Issue 4, p559-582

For 13 major international stock markets, there is much evidence of out-of-sample predictability for growth stocks especially when evaluated with economic criteria, and to a noticeably lesser extent for general stock markets and value stocks. Our results shed light on the recent debate about stock return predictability, using different assets (growth-style indexes), forecasting variables (past returns), forecasting models (nonlinear models), and alternative forecasting evaluation criteria (economic criteria). Our analysis suggests that (growth) stock returns might be predictable.

The stock-bond correlation and macroeconomic conditions: One and a half centuries of evidence

Yang, Jian, Zhou, Yinggang, and Wang, Zijun
Journal of Banking & Finance Vol. 33, Issue 4, p. 670-680

Using monthly stock and bond return data in the past 150 years (1855–2001) for both the US and the UK, this study documents time-varying stock-bond correlation over macroeconomic conditions (the business cycle, the inflation environment and monetary policy stance). There are different patterns of time variation in stock-bond correlations over the business cycle between US and UK, which implies that bonds may be a better hedge against stock market risk and offer more diversification benefits to stock investors in the US than in the UK. Further, there is a general pattern across both the US and the UK during the post-1923 subperiod and during the whole sample period: higher stock–bond correlations tend to follow higher short rates and (to a lesser extent) higher inflation rates.

Introduction to Financial Models for Management and Planning

James R. Morris and John P. Daley
London: Chapman and Hall. 2009

A properly structured financial model can provide decision makers with a powerful planning tool that helps them identify the consequences of their decisions before they are put into practice. Introduction to Financial Models for Management and Planning enables professionals and students to learn how to develop and use computer-based models for financial planning. Providing critical tools for the financial toolbox, this volume shows how to use these tools to build successful models.

Placing a strong emphasis on the structure of models, the book focuses on developing models that are consistent with the theory of finance and, at the same time, are practical and usable. The authors introduce powerful tools that are imperative to the financial management of the operating business. These include interactive cash budgets and pro forma financial statements that balance even under the most extreme assumptions, valuation techniques, forecasting techniques that range from simple averages to time series methods, Monte Carlo simulation, linear programming, and optimization.

The tools of financial modeling can be used to solve the problems of planning the firm’s investment and financing decisions. These include evaluating capital projects, planning the financing mix for new investments, capital budgeting under capital constraints, optimal capital structure, cash budgeting, working capital management, mergers and acquisitions, and constructing efficient security portfolios.

While the primary emphasis is on models related to corporate financial management, the book also introduces readers to a variety of models related to security markets, stock and bond investments, portfolio management, and options.

This authoritative book supplies broad-based coverage and free access to @Risk software for Monte Carlo simulation, making it an indispensible text for professionals and students in financial management.