European Financial Management 2015 Archive

January 2016, VOL 22:1 March 2016, VOL 22:2 June 2016, VOL 22:3 September 2016, VOL 22:4 November 2016, VOL 22:5

European Financial Management, VOL 22:1, January 2016

Mandatory Gender Balance and Board Independence

Oyvind Bohren and Siv Staubo

We find that forcing radical gender balance on corporate boards is associated with increased board independence and reduced firm value. A mandatory 40% gender quota shifts the average fraction of independent directors from 46% to 67% because female directors are much more often independent directors than males are. This shock to board independence via gender quotas is strongest in small, young, profitable, non-listed firms with powerful stockholders and few female directors. Such firms also lose the most value, presumably because they need advice from dependent directors the most and monitoring by independent directors the least.

Keywords: corporate governance;regulation;board independence;female directors, gender quota, Norway

JEL Classification: G30, G38

Equity Issues and Stock Repurchases of Initial Public Offerings

Wolfgang Bessler, Wolfgang Drobetz, Martin Seim and Jan Zimmermann

We investigate the financing strategies and valuation effects of 247 IPO firms at the 'Neuer Markt' in Germany that either issued additional equity (SEO) or repurchased shares (SRP) within five years after going public. IPOs issuing additional equity exhibit a temporary outperformance before the event, but negative announcement returns and a long-run underperformance. In contrast, repurchasing IPOs experience positive announcement returns and no long-run underperformance. Free cash flow problem resulting from mandatory equity issuance at the IPO explain the SRP decision. Our findings for SEOs are consistent with a staged financing strategy, while we find no evidence for market timing.

Keywords: Initial public offerings;share repurchases;seasoned equity offerings;valuation effects

JEL Classification: G32, G35

Envy-Motivated Merger Waves

John A. Doukas and Wenjia Zhang

This study examines whether top managerial executive envy plays an important role in merger waves. Since managerial benefits, especially compensation, always increase with firm size, the envy hypothesis conjectures that top executive officers rush into acquisitions due to their envious psychology once other executives initiate them. Six empirical predictions of the envy hypothesis concerning - bidder (target) size, transaction size, value creation for bidders, compensation increases for top managers, likelihood of bidding, as well as total gains (synergies) from mergers - are tested in the context of the banking industry and find that merger waves are motivated by envy-pay.

Keywords: CEO envy;top management envy;bank merger waves

JEL Classification: G21, G34 J33

High-Frequency Exchange Rate Forecasting

Charlie X. Cai and Qi Zhang

Predictability of exchange rate movement is of great interest to both practitioners and regulators. We examine the predictability of exchange rate movement in the high-frequency domain. To this end, we apply a model designed for modelling high-frequency and irregularly spaced data, the autoregressive conditional multinomial-autoregressive conditional duration (ACM-ACD) model. Studying three pairs of currencies, we find strong predictability in the high-frequency quote change data, with the rate of correct predictions varying from 54 to 70%. We demonstrate that filtering the data, by increasing the threshold of mid-quote price change, in combination with dynamic learning, can improve forecasting performance.

Keywords:foreign exchange;high-frequency data;forecasting;duration model

JEL Classification: F31, F37, G17

The Impact of Sovereign Rating News on European Banks

Stefano Caselli, Gino Gandolfi and Maria Gaia Soana

This paper examines the spillover effect of Eurozone sovereign rating changes announced by Standard and Poor's, Moody's, and Fitch on domestic bank share prices in the period 2002-2012. This spillover effect appears negative in the case of downgrades, but insignificant for upgrades. Surprisingly, announcement of sovereign negative credit watches results in increased bank stock returns. Bank share price losses following sovereign downgrades increase as bank leverage, efficiency, and equity performance increase, and they decrease as bank systematic risk and payout ratio increase. On the contrary, bank share prices rise following sovereign negative credit watches, as leverage and bank size decrease and as bank systematic risk increases.

Keywords:sovereign rating change, European banks, event study, spillovers

JEL Classification: G14, G15, G21, G24

European Financial Management, VOL 22:2, March 2016

Can Internet Search Queries Help To Predict Stock Market Volatility?

Thomas Dimpfl and Stephan Jank

We study the dynamics of stock market volatility and retail investors' attention to the stock market. The latter is measured by internet search queries related to the leading stock market index. We find a strong co-movement of the Dow Jones' realized volatility and the volume of search queries for its name. Furthermore, search queries Granger-cause volatility: a heightened number of searches today is followed by an increase in volatility tomorrow. Including search queries in autoregressive models of realized volatility improves volatility forecasts in-sample, out-of-sample, for different forecasting horizons and in particular in high-volatility phases.

Keywords:realized volatility, forecasting, investor behavior, limited attention, noise trader, search engine data

JEL Classification: G10, G14, G17

Investing in Systematic Factor Premiums

Kees Koedijk, Alfred Slager and Philip Stork

In this paper we investigate and evaluate factor investing in the United States and Europe for equities and bonds. We show that factor-based portfolios generally produce comparable or better portfolios than market indices. We expand the analysis to other asset classes and factors, work with other optimization methods and add a basic liability structure. The results do not depend on adding other asset classes or on the removal of a specific factor. Finally, we study the results for a worldwide investor who invests beyond the US and Europe. Over the longer term and with consistently applied factor diversification, factor investing appears to be advantageous.

Keywords:Portfolio Management, Factor Investing, Diversification, Optimization

JEL Classification: G11, G12, G23

Diversification, Size and Risk: The Case of Bank Acquisitions of Nonbank Financial Firms

Barbara Casu, Panagiotis Dontis-Charitos, Sotiris Staikouras and Jonathan Williams.

We investigate the risk effects of bank acquisitions of insurance companies and securities firms between 1991 and 2012 using a newly constructed dataset of M&A deals. We examine risk changes before and after deal announcements by decomposing risk into systematic and idiosyncratic components. Subsequently, we investigate the relationship between risk and diversification by modelling the determinants of risks. We find that bank combinations with securities firms yield higher risks than combinations with insurance companies. Bank size is an important and consistent determinant of risk whereas diversification is not. Our results inform the continuing debate on diversification versus functional separation of bank activities.

Keywords: Banks, nonbank financial firms, financial conglomerates, diversification,risk decomposition, determinants of risk

JEL Classification: G21, G22, G32, G34

Collateral Regulation and IPO-Specific Liberalization:
The Case of Price Limits in the Athens Stock Exchange

Stavros Thomadakis, Dimitrios Gounopoulos, Christos Nounis and Andreas Merikas

This paper uses a unique testing ground on the effect of price limits upon IPO pricing and initial returns. The Athens Stock Exchange offers the opportunity for this new experiment, as three substantial changes in limit regulations were implemented in a short period of eight years. The results indicate significant differences in initial returns. Effective price limits reduce underpricing in all market segments, without visible diminution of IPO activity. The introduction of mandatory book-building after price limits were phased out in Athens also led to reduced underpricing in the main market segment. Nevertheless, the existence of an independent effect of price limits explains why some regulators continue to use them to the present day.

Keywords: Price Limits, IPO Underpricing, IPO Regulation, Government Intervention, Hot/Cold Market Conditions.

JEL Classification: G14, G32, G24

Securities Transaction Tax and Market Quality: The Case of France

Peter Gomber, Martin Haferkorn and Kai Zimmermann

We study the French Securities Transaction Tax implementation of August 1st, 2012. Although a similar tax is planned to be introduced across 11 European countries, consequences for market quality are yet to be thoroughly assessed. We show that liquidity demand and supply significantly drop. Even though the French proposal exempts professional liquidity provision, we find increased spreads and a declined order book depth resulting in additional transaction costs for market participants besides the tax. As all venues trading French stocks are affected, we further find that STT threatens inter-market information transmission by impairing price coordination among fragmented markets in Europe.

Keywords:Financial Transaction Tax, Liquidity, Market Efficiency, Volatility

JEL Classification: G12, G14, G18, G28

European Financial Management, VOL 22:3, June 2016

The Ex-Dividend Day Behavior of REITS: Tax or Market Microstructure Effects

Kose John, Ravi Mateti, Duong Nguyen and Gopala Vasudevan

We examine the importance of the tax and microstructure theories in explaining the ex-dividend day behavior of US REIT stock prices in three tick size regimes—the 1/8th, 1/16th, and decimal eras. We present a new theory that shows how the tax and microstructure effects interact to produce the observed ex-dividend day behavior. Our theory also shows why in an era of a large tick size, as in the 1/8th era, the tax effects fail to get detected and the observed ex-dividend day behavior could be misinterpreted as resulting solely from the microstructure effects.

Keywords:Ex-dividend day behavior, tax effects, market microstructure effects, tick size era, REITs

JEL Classification: G10, G12

Portfolio Overlapping Bias in Tests of the Fama and French Three-Factor Model

Kathrin Tauscher and Martin Wallmeier

In the standard approach of the three-factor model of Fama and French (1993), both the test portfolios and the SMB and HMLfactor portfolios are formed on the basis of size and the book-to-market ratio. Thus, a potential overlapping bias in time-series regressions arises. Based on a resampling method and a split-sample approach, we provide an in-depth analysis of the effect of overlapping for a broad sample of European stocks. We find that the overlapping bias is non-negligible, contrary to what seems to be the general opinion.

Keywords: asset pricing, three-factor model, portfolio overlapping, size effect, value premium

JEL Classification: G12, G14

Media Endorsements of New Product Announcements: A New Marketing Strategy

Angelos J. Doukas, Jie (Michael) Guo, Herbert Y. T. Lam and Sarah (Hong) Xiao

This paper examines whether investors’ decisions are influenced by the word content of newspaper reports of new product announcements. Using textual analysis we find that announcements of new products covered by financial newspapers with positive word content earn significant abnormal returns. These returns are 270 basis points higher than new products without positive word coverage, and such announcements bring negative impact to their rival firms’ value. We also find that there is an abnormally high Google Search Volume (SVI) for firms in the aftermath of positive announcements, suggesting that news with positive word content attracts stronger investor attention. Our results suggest that the market reacts to the linguistic content of the new product announcement rather than to the announcement itself.

Keywords: product launch, event study, media sentiment, textual analysis, industry rivals

JEL Classification: G10, G12, G14

In Search of Concepts: The Effects of Speculative Demand on Stock Returns

Owain Ap Gwilym, Iftekhar Hasan, Qingwei Wang and Ru Xie

Using a novel proxy of investors’ speculative demand constructed from online search interest in investment concepts, we examine how speculative demand affects the returns of Chinese stocks. We find that speculative demand increases following high market returns and predicts subsequent return reversals. Moreover, the speculative demand explains more variation in subsequent returns of A shares (more populated by retail investors) than B shares (less populated by retail investors). Our findings support the attention theory of Barber and Odean (2008).

Keywords: Investment Concepts, Speculative Demand, Investor Attention, Market Returns, Trading Volume

JEL Classification: G02, G12, G14

Which Beta is Best? On the Information Content of Option-Implied Betas

Rainer Baulez, Olaf Korn and Sven Sassnin

Option-implied betas are a promising alternative to historical beta estimators, because they are inherently forward-looking and can incorporate new information immediately and fully. Recently, different implied beta estimators have been developed, but very little is known about their properties and information content. This paper presents a first systematic comparison between six different implied beta estimators, providing guidance for applications and identifying directions for further improvement. The analysis identifies explanatory factors for the predictive performance of implied estimators both in the cross section of stocks and over time. Furthermore, the analysis reveals patterns in the term structure of implied betas.

Keywords: beta, option-implied information

JEL Classification: G11, G12, G13, G14, G17

Do Investors Trade Around Social Rating Announcements?

Alexis Cellier, Pierre Chollet and Jean-françois Gajewski

This paper investigates trading around Corporate Social Responsibility (CSR) rating announcements. Focusing on CSR rating announcements made by Vigeo on European markets, we use Euronext intraday data to prove that trading volume drops sharply before announcements and increases afterwards. Willingness to trade depends mainly on prior private information and the content of the announcement. Our results show effects from disaggregated scores, but not from overall scores. More specifically, we find that some topics like business behavior, human resources and human rights significantly influence investor trades. Environmental risk does not have an impact on trading behavior.

Keywords: Corporate Social Responsibility, Rating, Trading Volume, Event Study

JEL Classification: G11, G12, G14, L25, M14

European Financial Management, VOL 22:4, September 2016

Target Risk Funds

Edwin J. Elton, Martin Gruber, and Andre de Souza

There is a vast literature which shows that investors don’t make rational decisions in allocating resources among different types of investments. Target risk funds and target date funds are two types of mutual funds primarily organized as fund of funds that make the asset allocation decision for an investor. Both are used as options in 401K plans and IRAs. However they control for risk in very different ways. Target risk funds have not been studied. This article is the first comprehensive study of their characteristics and performance and how they compare to target date funds as an investment.

Keywords:Target Risk Funds, Characteristics, Performance

JEL Classification: G11 G23

The Bright Side of Discretionary Accruals: Evidence from Finance and Innovation

Qing (Grace) Hao and Keming Li

We find cross-sectional evidence that a financially constrained firm with patentable innovation opportunities can use discretionary accruals to reveal information about the firm’s prospects and facilitate its financing activities. Specifically, using firms with patents in the National Bureau of Economic Research (NBER) patent database, we find that among financially constrained firms, higher discretionary accruals are associated with more capital being raised, greater research and development (R&D) expenditures, more patents, more patent citations, and better operating performance in the future. These positive relationships are driven by firms that raise equity capital, especially those that raise equity capital from employees.

Keywords:discretionary accruals, innovation, research and development (R&D), patent, financial constraint, equity financing

JEL Classification: G30, G32, M41

Non-cancellable Operating Leases and Operating Leverage

Figen Gunes Dogan

I explore the link between a firm’s non-cancellable operating lease commitments and stock returns. Firms with more operating lease commitments earn a significant premium over firms with fewer commitments, and this premium is countercyclical. Non-cancellable operating lease payments represent a major claim on a firm’s cash flows. Firms with high levels of operating leases have higher cash flow sensitivity to aggregate shocks and hence higher operating leverage. The relation between operating leases and stock returns is stronger in small firms than in big firms.

Keywords:operating lease, operating leverage, cross section of expected returns

JEL Classification: E22, G12

Persistent doubt: An examination of the Performance of Hedge Funds

María de la O. González,Nicolas A. Papageorgiou and Frank Skinner

We examine whether performance persistence is suspicious. Top quintile portfolios formed on the Sharpe ratio, alpha, and information ratio persistently outperform similarly constructed mediocre third quintile portfolios throughout our sample period, but performance is more modest and less persistent when portfolios are formed on the excess manipulation-proof performance measure (EMPPM). By selecting funds formed on ranking by Sharpe and information ratios, investors also select funds that have persistently doubtful performance according to the doubt ratio. In contrast, portfolios formed on alphas and especially the EMPPM have much less excess and persistent doubt.

Keywords:Hedge funds, performance measures, manipulation-proof performance measure, doubt ratio

JEL Classification: G11; G1; G23; G24

Unbundling the Expense Ratio: Hidden Distribution Costs in European Mutual Fund Markets

Marco Navone and Giacomo Nocera

Using data on more than 5,000 mutual funds domiciled in four European countries in 2006, we investigate whether distribution costs embedded into the expense ratio can be held responsible for the differences of expense ratios of mutual funds in different countries. We confirm the existence of relevant country effects in the pricing of mutual fund management services. Comparing load and no-load funds and using survey data on fee retrocession to the distribution channel, we provide evidence that these effects are heavily influenced by the cost of the distribution embedded in the expense ratio

Keywords:Mutual funds, expense ratios, distribution costs

JEL Classification: G11, G23

Market and Style Timing: German Equity and Bond Funds

Keith Cuthbertson, Simon Hayley, and Dirk Nitzsche

We apply parametric and non-parametric estimates to test market and style timing ability of individual German equity and bond mutual funds using a sample of over 500 equity and 350 bond funds, over the period 1990-2009. For equity funds, both approaches indicate no successful market timers in the 1990-1999 or 2000-2009 periods, but in 2000-2009 the non-parametric approach gives fewer unsuccessful market timers than the parametric approach. There is evidence of successful style timing using the parametric approach, and unsuccessful style timing, particularly in the 2000-2009 period. There is evidence of positive and negative bond timing in the 2000-09 period.

Keywords: Mutual funds performance, market timing

JEL Classification: C14, G11

Multiple Large Shareholders and Corporate Risk-taking: Evidence from French Family Firms

Sabri Boubaker, Pascal Nguyen and Wael Rouatbi

We investigate the role of multiple large shareholders (MLS) in corporate risk-taking. Using a sample of publicly listed French family firms over the period 2003–2012, we show that the presence, number, and voting power of MLS are associated with higher risk-taking. Our results suggest that MLS help restrain the propensity of family owners to undertake low-risk investments. This effect is much stronger in firms that are more susceptible to agency conflicts. The results highlight the important governance role played by MLS in family firms and may explain why MLS are associated with higher firm performance.

Keywords: Risk-taking, Ownership structure, Family firms, Private benefit of control, Contestability, Corporate governance

JEL Classification: G30, G32, G34

European Financial Management, VOL 22:5, November 2016

Empirical Analysis Of The Intertemporal Relation Between Downside Risk And Expected Returns: Evidence From Time-varying Transition Probability Models

Cathy Yi-Hsuan Chen and Thomas C. Chiang

We examine the intertemporal relation between downside risk and expected stock returns for five advanced markets. Using Value-at-Risk as a measure of downside risk, we find a positive and significant relation between VaR and the expected return before the world financial crisis (September 2008). However, when we estimate the model using sample after this date, the results show a negative riskreturn relation. Evidence from a two-state Markov regime-switching model indicates that as uncertainty rises, the sign of the risk-return relation turns negative. This paper finds that the Markov regimeswitching model helps to resolve the conflicting signs in the risk-return relation.

Keywords:Downside risk, Value-at-Risk, Tail risk, Time-varying transition probability model, Risk-return relation

JEL Classification: G11, G12, G15, C24, F30

Style Migration in Europe

John Paul Broussard,Jussi Mikkonen and Vesa Puttonen

This paper complements the literature on style migration by examining value and size premiums throughout Europe. Information from more than 25 European markets indicates an average value premium of 9.58% per year. The primary determinants of the persistent value outperformance are: 1) value firms migrating to a neutral or growth portfolio, and 2) growth stocks migrating to neutral or value portfolios. The financial health metric F_SCORE helps uncover outperforming stocks ex ante, and provides preliminary evidence on the probability of migration, but only for small stocks.

Keywords: Migration; Value; Growth; F_SCORE

JEL Classification: G11; G15

Cross Economic Determinants of Implied Volatility Smile Dynamics: Three Major European Currency Options

Qian Han, Jufang Liang, and Accs Boqiang Wu

We examine the contemporaneous and lead-lag relations between economic variables and implied volatility smiles for three major European currency options. We find that cross economic determinants are at least as important as own economic variables in explaining the dynamics of implied volatility smiles. Out-of-sample tests also suggest that cross economic variables are important in predicting an economy’s currency option smile. These findings suggest that the price impact from cross economic determinants may help fill the gap between the theoretical and the practical implied volatility skews.

Keywords: Implied Volatility Smile, Economic Determinants, Currency Options

JEL Classification: G13

Affine-structure models and the pricing of energy commodity derivatives

Ioannis Kyriakou,Nikos K. Nomikos,Panos K. Pouliasis and Nikos C. Papapostolou

We consider a seasonal mean-reverting model for energy commodity prices with jumps and Heston-type stochastic volatility, and three nested models for comparison. By exploiting the affine form of the log-spot models, we develop a general valuation framework for futures and discrete arithmetic Asian options. We investigate five major petroleum commodities from Europe (Brent crude oil, gasoil) and US (light sweet crude oil, gasoline, heating oil) and analyze the effects of the competing fitted spot models in futures pricing, Asian options pricing and hedging. We find evidence that price jumps and stochastic volatility are important features of the petroleum price dynamics.

Keywords:energy prices, affine models, futures, arithmetic Asian options, control vari- ate Monte Carlo

JEL Classification: G15, G13, C63, C13

The Evolution of Informed Liquidity Provision and Consumption: Evidence from an Order-driven Market

Joey Wenling Yang and Marvin Wee

The liquidity provision strategies by institutional traders on the ASX have changed over the period 2006 to 2012. Besides using smaller-sized orders more frequently than their retail counterparts, they have increased the use of passive limit orders. Institutional traders are found more sensitive and responsive to changes in market conditions. Analyses on order placement and price impact suggest that institutional traders are better informed. However, their limit orders are found to have a lower price impact at the intra-day level in the 2012 subsample period. We show evidence this is associated with the proliferation of algorithmic and high frequency trading.

Keywords: Liquidity provision, informed trading, limit orders, information asymmetry

JEL Classification: G10, G12, G13

Corporate Governance and Firm-Specific Stock Price Crashes

Panayiotis Andreou, Constantinos Antoniou Joanne Horton, and Christodoulos Louca

We investigate whether ownership structure, accounting opacity, board structure & processes and managerial incentives attributes relate to future stock price crash risk. Principal component analysis on the 21 attributes that comprise these four corporate governance dimensions reveals that they can explain between 13.1% and 23.0% of a one standard deviation in crash risk. Transient institutional ownership, CEO stock option incentives and the proportion of directors that hold equity increase crashes, whilst insiders’ ownership, accounting conservatism, board size and the presence of a corporate governance policy mitigate crash risk. Overall these relations are more pronounced in environments that accentuate agency risk.

Keywords: Crash risk, corporate governance, agency risk, information environment.

JEL Classification: G38, G34, M48

Why Are Successive Cohorts of Listed Firms Persistently Riskier?

Anup Srivastava and Senyo Y. Tse

Prior studies show that the risk level of each new cohort of listed firms is higher than its predecessor’s. We find that these risk differences are persistent and investigate two potential explanations: (1) each cohort adopts and retains operating innovations that are associated with higher risks and (2) increasing numbers of younger and less-experienced firms are represented in each new cohort. Our results support the first explanation. Each new cohort uses riskier production technologies and operates in more competitive product markets than its predecessor.

Keywords: idiosyncratic risk, earnings volatility, intangible investments, product-market uncertainty

JEL Classification:M41, G11, G32

The Impact of the 2011 Short-sale Ban on Financial Stability: Evidence From the Spanish Stock Market

Óscar Arce, Sergio Mayordomo

We examine the effect of the 2011 short-selling ban on Spanish stocks on the financial sector’s risk level. Before the ban, short positions were positive and significantly related to several indicators of bank default risk. Subsequently, the ban moderated the risk of banking institutions, especially those more exposed to short-seller activity, which, on average, showed higher levels of maturity mismatch, uncertainty about their fundamentals, and exposure to sovereign risk. The ban also caused a side effect on non-financial firms, since it led to an increase in their exposure to short sales, reflecting the existence of a common aggregate risk factor.

Keywords: short-sales constraints, financial stability, financial institutions, credit default swap, contagion.

JEL Classification: G01, G12, G14, G18