Category Archives: Finance

Life and Death of Businesses: A Review of Research on Firm Mortality

Morris, James R.
Journal of Business Valuation and Economic Loss Analysis Vol 4, Issue 1, Article 3

Neither the literature of finance nor the literature of valuation practitioners has taken account of the relatively short life expectancy of firms. Fewer than fifty percent of new firms live longer than ten years; yet, it is common practice to estimate firm value with a very long term horizon model such as the constant growth model. The purpose of this paper is to increase awareness of the life expectancy of firms and show how to take account of the likelihood of firm death in valuation. Data on firm death rates and life expectancy that is available in the field of industrial organization is reviewed and summarized so that valuation practitioners can take it into account in their valuations.

Do futures lead price discovery in electronic foreign exchange markets?

Cabrera, Juan, Wang, Tao and Yang, Jian
Journal of Futures Markets Vol. 29, Issue 2, p. 137-156

Using intraday data, this study investigates the contribution to the price discovery of Euro and Japanese Yen exchange rates in three foreign exchange markets based on electronic trading systems: the CME GLOBEX regular futures, E-mini futures, and the EBS interdealer spot market. Contrary to evidence in equity markets and more recent evidence in foreign exchange markets, the spot market is found to consistently lead the price discovery process for both currencies during the sample period. Furthermore, E-mini futures do not contribute more to the price discovery than the electronically traded regular futures.

Is Value Premium a Proxy for Time-Varying Investment Opportunities: Some Time Series Evidence

Guo, Hui, Robert Savickas, Zijun Wang, and Jian Yang
Journal of Financial and Quantitative Analysis, Vol 44, Issue 1 , pp. 133-154

Recent authors argue that the value premium constructed from the cross-section of stocks is a proxy for investment opportunities. We show that this conjecture sheds light on the puzzling empirical risk-return tradeoff in the stock market across time. That is, in contrast with many early authors, we find that the stock market return is positively and significantly related to its conditional variance after controlling for its covariance with the value premium. The covariance, which is negatively correlated with stock variance, is positively and significantly priced as well.

Therefore, by ignoring the effect of time-varying investment opportunities on the stock market return, the early specification might suffer from an omitted variables problem, which generates a downward bias in the estimate of the risk-return relation. Also, consistent with recent investment-based equilibrium models, we document a positive and significant relation between the value premium and its conditional variance over the post-1963 period. Overall, our empirical evidence suggests that the value premium might be a proxy for investment opportunities.

U.S. Monetary Policy Surprises and Currency Futures Markets: A New Look

Tao Wang, Jian Yang and Simpson, Marc W.
Financial Review Vol. 43, Issue 4, p. 509-541

Intraday currency futures prices react to both surprises in the federal funds target rate (the target factor) and surprises in the anticipated future direction of Federal Reserve monetary policy (the path factor) in similar magnitude, and the reaction is short-lived. Dollar-denominated currency futures prices drop significantly in response to positive surprises (i.e., unexpected increases) in the target and path factors, but have generally little response to negative surprises. A monetary policy tightening during expansionary periods leads to an appreciation of the domestic currency, while a monetary policy loosening during recessionary periods tends to have no significant impact.

Fiscal policy and asset markets: A semiparametric analysis

Dennis W. Jansen, Qi Li, Zijun Wang, and Jian Yang
Journal of Econometrics Vol. 147, Issue 1, p. 141-150

This paper contributes to the literature in two important aspects. We first examine the role of fiscal policy on the U.S. stock and bond markets, and we document the conditioning information role of fiscal policy via interactions with monetary policy, a feature that has been forcefully emphasized in the recent theoretical literature but not yet thoroughly investigated empirically. The few existing empirical works only consider the role of fiscal policy as a direct information variable separate from monetary policy. Second, we employ a flexible varying coefficient specification in our econometric analysis, which has not been commonly used in this line of research. We find that a semiparametric varying coefficient model and its variants (Cai, Fan, Yao, 2000) appear to be particularly suitable for capturing the potentially complex interactions between fiscal and monetary policies.

Realized volatility and correlation in energy futures markets.

Wang, Tao, Wu, Jingtao, and Yang, Jian
Journal of Futures Markets, Vol. 28 Issue 10, p. 993-1011

Using high-frequency returns, realized volatility and correlation of the NYMEX light, sweet crude oil, and Henry-Hub natural gas futures contracts are examined. The unconditional distributions of daily returns and daily realized variances are non-Gaussian, whereas the distributions of the standardized returns (normalized by the realized standard deviation) and the (logarithms of) realized standard deviations appear approximately Gaussian. The (logarithms of) standard deviations exhibit long-memory, but the realized correlation between the two futures does not, implying rather weak inter-market linkage in the long run. There is evidence of asymmetric volatility for natural gas but not for crude oil futures. Finally, realized crude oil futures volatility responds with an increase in the weeks immediately before the OPEC events recommending price increases.

Do Euro exchange rates follow a martingale? Some out-of-sample evidence

Yang, Jian, Su, Xiaojing, and Kolari, James
Journal of Banking & Finance; Vol. 32 Issue 5, p. 729-740

Traditional autocorrelation and variance ratio tests are based on serial uncorrelatedness rather than martingale difference. As such, they do not capture potential nonlinearity-in-mean, which could lead to misleading inferences in favor of the martingale hypothesis. This paper employs various parametric and nonparametric nonlinear models as well as several model comparison criteria to examine the potential martingale behavior of Euro exchange rates in the context of out-of-sample forecasts. The overall evidence indicates that, while martingale behavior cannot be rejected for Euro exchange rates with major currencies such as the Japanese yen, British pound, and US dollar, there is nonlinear predictability in terms of economic criteria with respect to several smaller currencies.

Regulatory Regime Changes and Acquisition Attributes: The Case of Commercial Bank and Thrift Acquisitions of Thrifts

Fatma Cebenoyan,A. Sinan Cebenoyan, and Elizabeth S. Cooperman
Quarterly Journal of Finance and Accounting Vol. 47, Issue. 1, pp. 27-52

Significant changes in regulations affecting bank/thrift activities during the 1990s provide us with an opportunity to examine shifts in acquisition characteristics as deregulation leads to changes in behavior. Consistent with a regime change hypothesis, we find a structural change in acquisition attributes for pre-and post-deregulation periods. We also report significant differences in target attributes depending on acquirer identity. Our results demonstrate a higher likelihood in the deregulated period after 1994 for banks to acquire …

Contagion around October 1987 International Stock Market Crash

Yang, Jian, and David A. Bessler
European Journal of Operation Research, Vol 184, Issue 1, Pages 291-310

This study investigates financial contagion among seven international stock markets around the October 19, 1987 crash. Building on a recent advance in vector autoregression analysis by [Swanson, N., Granger, C.W.J., 1997. Impulse response functions based on a causal approach to residual orthogonalization in vector autoregression. Journal of the American Statistical Association 92, 357–367], data-determined historical decompositions are conducted to provide a day-by-day picture of price fluctuation transmission, which is crucial to explore the financial contagion pattern characterized by rich dynamics. The results clearly show that the crash originated in the US market and that an upward movement in the Japanese market after the crash helped the recovery in the US market, which has not yet been empirically documented in the literature.

Tax Treatment of Compensation Received as a Nonprofessional Representative

Conner, Elizabeth C. and Schaefer, Michael V.
Tax Adviser
Vol. 38, Issue 11, p. 653-654

The article focuses on tax treatment of compensation received as a nonprofessional representative. According the U.S. Internal Revenue Service, self-employment tax only applies for a nonprofessional executor or administrator if a trade or business is included in the assets of the estate, the executor actively participates in the business and the fees are related to operation of the business.

I Bonds versus TIPS: Should Individual Investors Prefer One to the Other?

Arak, Marcelle and Rosenstein, Stuart

CFA Digest Vol. 37, Issue 3, p. 77-78

The article compares the features of the Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds, two alternatives for investors hoping to avoid the negative effects of inflation on their portfolios without incurring credit risk, to determine the better after-tax alternative for the individual investor. Results reveal that TIPS enjoyed an 80 bps real return advantage over I Bonds.

I Bonds versus TIPS: should individual investors prefer one to the other?

Arak, Marcelle and Rosenstein, Stuart
Financial Services Review Vol. 15 Issue 4, p. 265-280

Both TIPS and Series I Bonds are adjusted for inflation, offering a real rate and an inflation adjustment. The inflation adjustment is the same on both securities, but the real portion of the interest rate on TIPS is generally much higher. Despite I Bonds’ less attractive real rate, they have several features that add to their value. They may be redeemed before maturity, at par value plus accrued interest, eliminating price risk. In addition, taxes may be deferred until redemption. We estimate the value of these two features, and find that they are substantial and could potentially offset the lower real rate of I Bonds.

Convertible Bonds: How Much Equity, How Much Debt?

Arak, Marcelle, and Martin, L. Ann
Financial Analysts Journal Vol. 61, Issue 2, p. 44-50

Financial analysts need accurate estimates of debt, equity, leverage, and EPS. The method proposed here, based on the probability of conversion, yields new estimates of the debt and equity in a convertible bond issue. When this method is used, the value of the equity component in a hypothetical issue is found to be substantial–larger than the value of the options and clearly larger than zero, which is assigned under current accounting rules. The estimate of the debt component is smaller than recorded under current accounting rules. Thus, the leverage of convertible bond issuers is substantially lower when this method is used.

S&L Performance Persistence: Moral Hazard and Market Discipline

Cooperman, Elizabeth S. with Sinan Cebenoyan and Charles A. Register
Managerial Finance Special Issue on Performance of Financial Service Institutions Vol. 30, Issue 9, p. 56-69

This research examines for performance persistence for the U.S. thrift industry during 1989 to 1994. Results indicate significant performance persistence, with firms in the sample 16 times more likely ot remain in an initial position as a winner or loser than to switch. Consistent with a moral hazard hypothesis, persistent losers exhibit low charter values and greater risk-taking behaviour with the opposite relations for persistent winners. We also find persistent losers to have a significantly higher probability of subsequent takeover, suggesting an effective takeover market for disciplining poor performers.

Stock Exposures in Portfolios with Options

Arak, Marcelle
Journal of Wealth Management Vol. 6 Issue 3, p. 19-25

Describes a procedure for combining options with outright stock holdings to get an accurate view of overall exposure to each company’s equity price. Examination of long call options in a portfolio of stocks and bonds; Measurement of an investor’s exposure to a stock; Procedures for calculating effective shares.

Ownership Structure, Operating Inefficiency and Regulatory Reform: An Analysis of U.S. Thrifts

Cooperman, Elizabeth S. (with Fatma and Sinan Cebenoyan
and Charles A. Register)
Financial Management, Pages. 43-60

This paper examines the effect of ownership structure on operating inefficiency, as a proxy for operational risk, along with other risk and performance measurs for U.S. thrifts operating in 1989-1994. We find a very significant effect of ownership structure on thrift operating inefficiency and other performance and risk measures, suggesting that ownership structure should be an important regulatory concern.