European Financial Management 2012 Archive

January 2012, VOL 18:1 March 2012, VOL 18:2 June 2012, VOL 18:3 September 2012, VOL 18:4 November 2012, VOL 18:5

European Financial Management, VOL 18:1 January 2012

Agency and Institutional Investment

Michael J. Brennan, Xiaolong Cheng and Feifei Li

In this paper we summarize and extend the agency-based model of asset pricing of Brennan (1993) to show that the implied agency effects on asset pricing are too small to be empirically detectable: empirical tests confirm this and we show that the positive findings of Gomez and Zapatero are due to their choice of sample. We also derive new empirical implications for the composition of institutional investment portfolios and empirically confirm the major result, that institutional portfolios will be short the minimum variance portfolio.


JEL Classification:

Bank Relationships and Firms' Financial Performance: The Italian Experience

Analisa Castelli, Gerald Dwyer and Iftekhar Hasan

Abstract: We examine the relationship between the number of bank relationships and firmsҍ performance, evaluating possible differential effects related to firmsҠsize. Using an unique data set of Italian small firms for which bank debt is a major source of financing, we find that return on equity and return on assets decrease as the number of bank relationship increases, with a stronger relationship for small firms than for large firms. We also find that interest expense over assets increases as the number of relationships increases. Particularly for small firms, our results are consistent with analyses indicating that fewer bank relationships reduce information asymmetries and agency problems which outweigh negative effects connected to hold-up problems.

Keywords:bank relationships, small business lending, firmsҠperformance

JEL Classification: D21, G21, G32

Did the Market Signal Impending Problems at Northern Rock? An Analysis of four Financial Instruments

Paul Hamalainen, Adrian Pop, Max Hall and Barry Howcroft

The academic literature has regularly argued that market discipline can support regulatory authority mechanisms in ensuring banking sector stability. This includes, amongst other things, using forward-looking market prices to identify those credit institutions that are most at risk of failure. The paperӳ key aim is to analyse whether market investors signalled potential problems at Northern Rock in advance of the bank announcing that it had negotiated emergency lending facilities at the Bank of England in September 2007. A further aim of the paper is to examine the signalling qualities of four financial market instruments (credit default swap spreads, subordinated debt spreads, implied volatility from options prices and equity measures of bank risk) so as to explore both the relative and individual qualities of each. Therefore, the paperӳ findings contribute to the market discipline literature on using market data to identify bank risk-taking and enhancing supervisory monitoring. Our analysis suggests that private market participants did signal impending financial problems at Northern Rock. These findings lend some empirical support to proposals for the supervisory authorities to use market information more extensively to improve the identification of troubled banks. The paper identifies equities as providing the timeliest and clearest signals of bank condition, whilst structural factors appear to hamper the signalling qualities of subordinated debt spreads and credit default swap spreads. The paper also introduces idiosyncratic implied volatility as a potentially useful early warning metric for supervisory authorities to observe.

Keywords:Banking regulation, bank failures, market discipline, early warning signals

JEL Classification: G14, G21, G28

Exchange Rate Changes and the 'Operating' Performance of Multinationals

Jungwon Suh and Bong-Soo Lee

Abstract: Using a sample of 261 U.S. multinationals over the period 1984 to 2002, we examine the relation between exchange rate changes and the profitability of foreign operations. We find that the impact of exchange rate changes on foreign operationsҠprofitability is not statistically significant in the majority of industries. Furthermore, according to our variance components analysis, exchange rate changes explain less than two percent of the variation in foreign operationsҠprofitability for most industries. We also find that the impact of exchange rate changes on foreign operationsҠprofitability is generally weak for non-U.S. multinationals from Australia, Canada, Japan and the U.K. Our evidence is consistent with the finding of prior studies that the impact of exchange rate changes on firm value is not significant for most multinationals.

Keywords:exchange rate exposure; operating performance; multinational companies

JEL Classification: : F23, F31, G32

Long Term Performance of Greek IPOs

Stavros Thomadakis, Christos Nounis and Dimitrios Gounopoulos

Abstract We analyze the long-run performance of 254 Greek IPOs that were listed during the period 1994ֲ002, computing buy-and-hold abnormal returns (BHAR) and cumulative abnormal returns (CAR) over 36 months of secondary market performance. The empirical results differ from international evidence and reveal long-term overperformance that continues for a substantial interval after listing. Measuring these returns in calendar time, we find statistical significance with several of the benchmarks employed. We also find that long-term overperformance is a feature of the mass of IPOs conducted during a pronounced IPO wave. Cross-sectional regressions of long-run performance disclose several significant factors. The study demonstrates that although Greek IPOs overperform the market for a longer period, underperformance eventually emerges, in line with much international evidence. Our interpretation is that the persistence of overperformance over a significant interval is due to excessive supply of issues during the Ԩot IPO periodԮ Results associated with pricing during the Ԩot IPO periodԠindicate positive short- (1-year), medium- (2-year) and negative long-term (3-year) performance

Keywords:: Initial Public Offerings, Long-term Performance, Market Efficiency

JEL Classification: G14, G32, G24

In Defence of Capitalization Weights: Evidence from the FTSE 100 and S&P 500 Indices

Isaac T. Tabner

A simple method for decomposing the variance covariance matrix of portfolio returns at the level of individual stocks is applied to the FTSE 100 Index. During extreme negative shocks, the largest index constituents exhibit lower than average covariance, thereby reducing the volatility of the capitalization-weighted index. The risk-adjusted returns of the capitalization-weighted FTSE 100 Index exceed those of an equally-weighted version of the same index and the outperformance is robust to the method of risk adjustment applied. The equally-weighted index also exhibits greater systematic (market) risk than the capitalization-weighted version.

Keywords:FTSE 100 Index, S&P 500 Index, benchmark portfolios, capitalization weights, stock indices, portfolio diversification, performance measurement.

JEL Classification: G10, G11, G12, G14, G15, C63, L11

European Financial Management, VOL 18:2 March 2012

Two Paradigms and Nobel Prizes in Economics: A Contradiction or Coexistence?

Haim Levy, Enrico De Giorgi and Thorsten Hens

Markowitz and Sharpe won the Nobel Prize in Economics for the development of Mean-Variance (M-V) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximization in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximize the expectation of an S-shaped value function, which contains a risk-seeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPMӳ underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.

Keywords:asset pricing, cumulative prospect theory, capital asset pricing model, equilibrium

JEL Classification: C62, D51, D52, G11, G12

Option-adjusted Delta Credit Spreads: A Cross-country Analysis

Leonardo Becchetti, Andrea Carpentieri and Iftekhar Hasan

Abstract: This study analyzes the determinants of the variation in option-adjusted credit spreads (OASs) using a unique database and enlarges the traditional analysis to include disaggregated indexes, new variables, and a complete set of markets (U.S., UK, and the Eurozone). An extended set of regressors explains almost half the variability of OASs in the three markets. We find that institutional trading activity significantly affects corporate bond spreads, signaling either variation in perceptions of risk or the existence of an indirect measure of liquidity. We also find that U.S. business cycle indicators significantly affect the variability of OASs in the UK and the Eurozone. Finally, we find evidence that stock returns have more influence on high-yield bonds in the Eurozone than in the U.S.

Keywords:option adjusted credit spread, corporate bonds.

JEL Classification: G11, G12.

What Governance Mechanisms Promote Efficiency in Reaching Poor Clients? Evidence from Rated Microfinance Institutions

Valentina Hartarska and Roy Mersland

This paper evaluates the effectiveness of several governance mechanisms on microfinance institutionsҠ (MFI) performance. We first define performance as efficiency in reaching many poor clients. Following the literature on efficiency in banks, we estimate a stochastic cost frontier and measure output by the number of clients. Therefore, we capture the cost minimization goal and the goal of serving many poor clients, both of which are pursued by MFIs. We next explore the impact of measurable governance mechanisms on the individual efficiency coefficients. The results show that efficiency increases with a board size of up to nine members and decreases after that. MFIs in which the CEO chairs the board and those with a larger proportion of insiders are less efficient. The evidence also suggests that donorsҠpresence on the board is not beneficial. We do not find consistent evidence for the effect of competition, and we find weak evidence that MFIs in countries with mature regulatory environments reach fewer clients, while MFIs regulated by an independent banking authority are more efficient.

Keywords:microfinance institutions, board, governance, performance, efficiency

JEL Classification: G21, G30

The Agency Effect of Repurchases on Closed-End Funds

Jingfeng An, Gordon Gemmill and Dylan C Thomas

Share prices rise after companies announce repurchases, but there are differing views as to why this happens. Repurchases are announced by closed-end funds when their discounts are widening (market-to-book is falling). The immediate post-announcement effect is a small jump in a fundӳ share price, but the main effect occurs over the next four years during which time there is significant outperformance both of the fundӳ price and of its investment portfolio. Liquidity of the shares does not change. Repurchases, if executed, reduce the size of a fund and therefore the managerӳ fees. Our findings are consistent with directors using the threat of repurchases to discipline managers whose investment performance has been poor, leading to a closer alignment of pay and performance

Keywords:repurchases; agency problem; closed-end funds

JEL Classification: G30, G23, G14

Modeling the Blind Principal Bid Basket Trading Cost

Christos Giannikos, Hany Guirguis and Tin Shan Suen

A blind principal bid (BPB) is one of the mechanisms for simultaneously trading a basket of stocks at a pre-determined execution price. In a BPB, asset managers auction a basket of stocks directly to liquidity providers who do not know the identities of the individual stocks in the basket. Unlike other methods of trading, the cost and composition of the BPB basket are not reported in a standard and timely manner. Complete basket data are available only to the asset manager and the broker who won the auction. The current literature contains very little information on the BPB phenomenon, largely due to a lack of public data for research. This paper analyzes a unique dataset of 140 executed baskets, building on the seminal papers of Kavajecz and Keim (2005) and Stoll (1978a, 1978b) to develop empirical and structural models of BPB trading costs. Our research provides novel insights into the dynamics of pricing BPB trading costs, a topic that has rarely been examined in the literature. The research reported here also has significant practical applications. Asset managers obtain a benchmark for evaluating the lowest bid, and brokers obtain qualitative insights that can aid them in formulating their bids.

Keywords: Blind principal Bids, Basket Trading, Asset Pricing

JEL Classification: G1, G10, G11 and G12

How Does Cross-Border Activity Affect the EU Banking Markets?

Ana Lozano-Vivas and Laurent Weill

Cross-border activity in the EU is widely viewed as a necessary condition for the implementation of a single banking market and therefore as a positive factor for the enhancement of competition and cost performance in the region. In this paper, we analyze the relevance of this view by investigating whether cross-border activity really promotes competition and cost efficiency in EU banking markets. We also consider the potential role of a bankӳ mode of entry by comparing existing domestic banks that foreign banks take over (mergers and acquisitions) with new branches created by foreign banks, often through subsidiaries (greenfield operations). We consider the impact of cross-border banks on cost efficiency (measured by the stochastic frontier approach), profitability (assessed through return on assets) and competition (measured by the Lerner index). We find that greenfield banks enhance cost efficiency and competition, while mergers and acquisitions hamper competition and cost efficiency. Therefore, our results suggest that EU authorities should promote only greenfield banks rather than all cross-border entries.

Keywords:: banks, competition, cross-border entry, efficiency, European integration

JEL Classification: G21

European Financial Management, VOL 18:3 June 2012

Post-Retirement Financial Strategies: Forecasts and Valuation

William F. Sharpe

This paper uses a discrete-time, discrete-state Monte Carlo simulation model to evaluate representative strategies for investing and spending a fixed sum designed to fund consumption during the period after retirement. Two assets are considered ֠one providing a riskless real return, the other a market portfolio of bonds and stocks. A stochastic process for the returns from the market portfolio is proposed. Then a set of Arrow-Debreu state prices is obtained on the assumption that the market portfolio is an efficient investment strategy. The model is used to forecast ranges of consumption and ranges of the ratios of year-to-year consumption, and also to estimate the values of components of future consumption.

Keywords:retirement, strategy, simulation, pricing, valuation

JEL Classification: D14, G11, G17, G21

Europeӳ Second Markets for Small Companies

Silvio Vismara, Stefano Paleari and Jay R. Ritter

European stock exchanges have repeatedly opened second markets to list small companies. We explain the motivation for the creation of these second markets, and why many of them have failed. We find that the probability of being a takeover target is higher for second-market firms, and that the average long-run performance of initial public offerings (IPOs) on second markets is dramatically worse than for main market IPOs. However, the second markets have been successful in providing firms with the opportunity to raise funds at the IPO and in follow-on offerings. The relative success of Londonӳ AIM, which is an exchange-regulated market with minimal regulations, has led other European stock exchanges to establish similar non-EU regulated second markets. Most of the IPOs on these exchange-regulated markets are offered exclusively to institutional investors, and are equivalent to private placements. These IPOs, which frequently raise only a few million euros, rarely develop liquid trading.

Keywords:stock exchanges, second markets, financial regulation, IPOs, AIM, London Stock Exchange

JEL Classification: G15, G30

Benchmark Bonds Interactions Under Regime Shifts

Dimitris A. Georgoutsos, Petros M. Migiakis

Abstract: In the present paper we examine the interactions among five benchmark ten year government bonds, namely those of the US, Germany, France, Italy and the Netherlands. Our aim is to illustrate empirically a net of interactions existing among the major bond markets of Europe and the US market taking into account shifts in the underlying stochastic processes. For this purpose, differing from the rest of the relevant empirical literature, after specifying the long run equilibrium relations we estimate the linkages between the bond markets as subject to hidden Markov chains, by applying the Markov Switching Vector Error Correction framework (MS-VECM). This formulation is found to efficiently reflect the shifts brought about by significant economic events, such as the European monetary unification. As a result we illustrate different short-run relations referring to the periods before and after the monetary union. Overall, our empirical results indicate that stronger interactions among the markets of the system exist in the period after the EMU. Also, by means of a variance decomposition analysis we assess leader-follower relations which indicate that the benchmark status of bonds has changed since the introduction of the common monetary policy framework in Europe.

Keywords:Financial integration; bond markets; benchmarks; Markov Switching

JEL Classification: F21, F37, G12, G15

The Stochastic Seasonal Behavior of Natural Gas Prices

Andres Garcia Mirantes, Javier Poblacion and Gregorio Serna

Previous studies have explored the seasonal behavior of commodity prices as a deterministic factor. This paper goes further by proposing a general (n+2m)-factor model for the stochastic behavior of commodity prices, which nests the deterministic seasonal model by Sorensen (2002). We consider seasonality as a stochastic factor, with n non-seasonal and m seasonal factors. The non-seasonal factors are as defined in Schwartz (1997), Schwartz and Smith (2000) and Cortazar and Schwartz (2003). The seasonal factors are trigonometric components generated by stochastic processes. The model has been applied to the Henry Hub natural gas futures contracts listed by NYMEX. We find that models allowing for stochastic seasonality outperform standard models with deterministic seasonality. We obtain similar results with other energy commodities. Moreover, we find that stochastic seasonality implies that the volatility of futures returns follows a seasonal pattern. This result has important implications in terms of option pricing.

Keywords:Stochastic calculus, seasonality, commodity prices, Kalman filter, natural gas

JEL Classification: C32, C51, C60, G13.

False Discoveries in UK Mutual Fund Performance

Keith Cuthbertson, Dirk Nitzsche and Niall O'Sullivan

We use a multiple hypothesis testing framework to estimate the false discovery rate (FDR) amongst UK equity mutual funds. Using all funds, we find a relatively high FDR for the best funds of 32.8% (at a 5% significance level), which implies that only around 3.7% of all funds truly outperform their benchmarks. For the worst funds the FDR is relatively small at 7.6% which results in 22% of funds which truly underperform their benchmarks. For different investment styles, this pattern of very few genuine winner funds is repeated for all companies, small companies and equity income funds. Forming portfolios of funds recursively for which the FDR is controlled at a ԡcceptableԠvalue, produces no performance persistence for positive alpha funds and weak evidence of persistence for negative alpha funds.

Keywords:Mutual fund performance, false discovery rate

JEL Classification: C15, G11, C14

Asset Bubbles: An Application to Residential Real Estate

Anna Scherbina and Bernd Schlusche

Behavioral models offer new insights into why bubbles are ubiquitous in residential real estate markets. These markets are dominated by unsophisticated households who often develop optimistic views by extrapolating from past returns. Rational investors cannot easily trade against an overvaluation of housing assets because of high transaction costs and a binding short sale constraint. Circumventing the effect of the latter, the supply of housing frequently increases in response to rising prices. This helps to mitigate bubbles but often leads to overbuilding, which slows down the recovery after a bubble bursts. Models that incorporate the effects of perverse incentives and limits to arbitrage are especially helpful in explaining the bubble that developed in mortgage-backed securities and helped fuel the recent real estate bubble by relaxing home buyersҠborrowing constraints. The literature is ambiguous about whether governments should intervene to burst bubbles, as a better response may lie in improving incentives of key market players.

Keywords:Bubbles, Residential Real Estate, Limits to Arbitrage, Financial Crisis

JEL Classification: G00, G01, G02, G10, R31

European Financial Management, VOL 18:4 September 2012

Looking Beyond Credit Ratings: Factors Investors Consider in Pricing European Asset-Backed Securities

Frank Fabozzi and Dennis Vink

In this paper, we empirically investigate what credit factors investors rely upon when pricing the spread at issue for European asset-backed securities. More specifically, we investigate how credit factors affect new issuance spreads after taking into account credit rating. We do so by investigating primary market spreads for tranches of non-mortgage-related assetbacked securities issued from 1999 to the year prior to the subprime mortgage crisis, 2007. We find that although credit ratings play a major role in determining spreads, investors appear to not rely exclusively on these ratings. Our findings strongly suggest that investors do not ignore other credit factors beyond the assigned credit rating.

Keywords:asset-backed securities (ABS), credit ratings, collateral, default risk, securitization, over-reliance

JEL Classification: G21, G24, G32

Evaluating Natural Resource Investments Under Different Model Dynamics: Managerial Insights

Andrianos E. Tsekrekos Mark B. Shackleton and Rafal Wojakowski

We focus on factors that drive the dynamics of commodity prices. We highlight the capital budgeting implications of three highlyףited, nested, multiצactor models for commodity prices that have been successful in empirical investigations. Competing assumptions regarding commodity prices and their convenience yields can account for differences close to 40% on average, and in excess of 60% in cases, in the valuation of typical natural resource investments. These value differences are found to increase with the maturity and the intrinsic value of the investment, and also with the level and the volatility of the resourceӳ convenience yield. Resources such as oil or copper, that are used for production purposes, usually exhibit high and volatile convenience yields; thus our findings should be more relevant for decision׭akers in such sectors.

Keywords:Natural resource investment, Real options, Factor models, Commodity prices, least׳quares Monte Carlo simulation

JEL Classification: C15, D81, G13, G31, Q30

Risk-adjusted Measures of Value Creation in Financial Institutions

Alistair Milne and Mario Onorato

Measuring value creation by comparing the RAROC of an exposure (the return on risk capital) with a single institution-wide hurdle rate is inconsistent with the standard theory of financial valuation. We use asset pricing theory to determine the appropriate hurdle rate for such a RAROC performance measure. We find that this hurdle rate varies with the skewness of asset returns. Thus the RAROC hurdle rate should differ substantially between equity which has a right skew and debt which has a pronounced left skew and also between different qualities of debt exposure. We discuss implications for both financial institution risk management and supervision.

Keywords:G22, G31

JEL Classification: asset pricing, banking, capital allocation, capital budgeting, capital management, corporate finance, downside risk, economic capital, economic value added, performance measurement, RAROC, risk management, hurdle rate, value at risk

The Dependency of the Banks' Assets and Liabilities: Evidence from Germany

Christoph Memmel and Andreas Schertler

Two decades of developments in risk-transfer instruments may have fundamentally changed the extent to which banks practice on-balance sheet term and liquidity transformation. These changes should be deliberated in on-balance sheet asset-liability dependencies. By using correlation analyses, we investigate asset-liability dependency for all three sectors of German universal banks from 1994 to 2007 and find that it declined over our sample period. We also investigate whether asset-liability dependency varies systematically with a bankӳ affinity for using risk-transfer instruments, regulatory capital, and profitability and document several differences between the three sectors of German universal banks.

Keywords:Asset-liability dependency, correlation analysis

JEL Classification: G21, G32

European Corporate Governance: A Thematic Analysis of National Codes of Governance

James Cicon, Stephen Ferris, Armin Kammel and Greg Noronha

Using Latent Semantic Analysis techniques to analyze the corporate governance codes of twenty-three EU nations, we obtain a number of new findings regarding their thematic content, variability, and convergence. We determine that these codes can be decomposed into five common themes, with substantial cross-sectional variability in their relative importance. We also find that the themes contained in these codes cluster in ways that are not fully consistent with the legal regime classifications of La Porta et al. (1997), leading us to construct two new country clusters. We further discover that the identity of the code issuer (e.g., government versus stock exchange) is important in explaining a codeӳ primary theme as well as changes in theme prominence over time. Finally, we fail to find evidence of an unchecked thematic convergence towards an Anglo-Saxon model of corporate governance, with some code themes converging to U.K. practices while others diverge

Keywords:governance; convergence; legal regimes

JEL Classification: G30, G34

On the Performance of European Index Funds and ETFs

David Blitz, Joop Huij and Laurens Swinkels

European index funds and exchange-traded funds underperform their benchmarks by 50 to 150 basis points per annum. The explanatory power of dividend withholding taxes as a determinant of this underperformance is at least on par with fund expenses. Dividend taxes also explain performance differences between funds that track different benchmarks and time variation in fund performance. Our results imply that not only fund expenses, but also dividend taxes can result in a substantial drag on mutual fund performance.

Keywords:Passive investing; index funds; exchange-traded funds; dividend withholding taxes

JEL Classification: G11, G12, G14

Product Market Competition and Shareholder Rights: International Evidence

Anzhela Knyazeva and Diana Knyazeva

This paper examines the interaction between product markets and shareholder rights in relation to firm performance and corporate policies. In contrast to existing literature, we provide evidence of complementarities between product market competition and country shareholder rights protections. The benefits of shareholder rights protections for firm performance are conditional on the presence of a competitive industry environment. We find that stronger shareholder rights protections are associated with better firm performance in competitive industries. However, this relation is not significant in concentrated industries. Consistent results are obtained from the analysis of key corporate policies.

Keywords:competition, shareholder rights, performance, law and finance, complementarity

JEL Classification: G30, G34, G38

Ownership and the Value of Political Connections: Evidence from China

Wenfeng Wu, Chongfeng Wu and Oliver M. Rui

Research has found that political connectedness can have both positive and negative effects on firm value. To resolve these mixed findings, we investigate the impact of political ties conditional on ownership for a sample of Chinese firms over the period 1999 to 2006. We find that private firms with politically connected managers have a higher value and obtain more government subsidies than those without connected managers, whereas local state-owned enterprises with connected managers have a lower value and employ more surplus labour than those without connected managers. Our results indicate that the effect of political ties is subject to firm ownership

Keywords:political connection, ownership, firm value, corporate governance, China

JEL Classification: G32; G34; G38

European Financial Management, VOL 18:5 November 2012

Investability and Firm Value

Todd Mitton and Thomas OӃonnor

We study how investability, or openness to foreign equity investors, affects firm value in a sample of over 1,400 firms from 26 emerging markets. We find that, on average, investability is associated with a 9% valuation premium (as measured by Tobinӳ q). This significant valuation premium persists in firm-fixed effects regressions, although the magnitude and robustness of the premium is somewhat lower. Analysis of the components of Tobinӳ q shows that firms that become investable experience significant increases in both market values and physical investment. These effects are strongest for firms that face country-level or firm-level financial constraints prior to becoming investable.

Keywords:Financial liberalization, Investability, Foreign investors, Tobinӳ q

JEL Classification: G15, F36

A Pricing Framework for Real Estate Derivatives

Frank J. Fabozzi, Radu Tunaru and Robert Shiller

New methods are developed here for pricing the main real estate derivatives - futures and forward contracts, total return swaps, and options. Accounting for the incompleteness of this market, a suitable modelling framework is outlined that can produce exact formulae, assuming that the market price of risk is known. This framework can accommodate econometric properties of real-estate indices such as predictability due to autocorrelations. The term structure of the market price of risk is calibrated from futures market prices on the Investment Property Databank index. The evolution of the market price of risk associated with all five futures curves during 2009 is discussed.

Keywords:derivatives pricing; real-estate indices; incomplete markets; market price of risk; serial correlation

JEL Classification: G13, G15, G20

External Financing, Growth and Stock Returns

Gikas Hardouvelis, Georgios Papanastasopoulos, Dimitrios Thomakos and Tao Wang

We investigate the relation of the value/growth anomaly with the anomaly on corporate financing activities. We confirm and expand earlier results that value/growth and external financing indicators are, to some degree, related predictors of stock returns in the cross section. We show that external financing indicators are incrementally informative since they pick up stock returns associated with earnings quality. Portfolios that combine information from both these indicators generate significantly higher returns than portfolios containing each individual indicator. More importantly, our analysis strongly suggests that the external financing anomaly is, to some extent, distinct from the value/growth anomaly, in that it may also reflect investorsҠmisunderstanding of the effects of opportunistic earnings management.

Keywords:Corporate financing activities, value/growth, earnings quality, stock returns

JEL Classification: G10, M4

Dividend Policies of Privately Held Companies: Stand-Alone and Group Companies in Belgium

An Rommens, Ludo Cuyvers and Marc Deloof

This study examines the dividend policies of privately held Belgian companies, differentiating between stand-alone companies and those affiliated with a business group. We find that privately held companies typically do not pay dividends. Compared to public companies, they are less likely to pay dividends and they have lower dividend payouts. Our results also suggest that group companies pay more dividends than stand-alone companies, consistent with the hypothesis that tax-exempt group firms redistribute dividend payments on the groupӳ internal capital market. Group companies pay higher dividends if they have minority shareholders.

Keywords:Dividend policy, privately held companies, business groups, internal capital markets, minority shareholders, Belgium

JEL Classification: G32, G35

Banking Competition and Capital Ratios

Klaus Schaeck and Martin Cihak

Empirical studies provide evidence that bank capital ratios exceed regulatory requirements. But why do banks maintain capital levels above regulatory requirements? We use data for more than 2,600 banks from 10 European countries to test recent theories suggesting that competition incentivizes banks to maintain higher capital ratios. These theories also predict that banks that engage in armӳ length lending have lower capital ratios, and that shareholder rights and deposit insurance characteristics affect capital ratios. Consistent with these theories, our evidence robustly indicates that competition increases capital holdings. Banks that lend at armӳ length exhibit lower capital ratios, whereas banks in countries with strong shareholder rights operate with higher capital ratios. We also show some evidence that generous deposit protection schemes that exclude non-deposit creditors are associated with higher capital ratios. Our results have important policy implications. First, while the traditional view suggests imposing restrictions on bank activities in order to restrain competition, our analysis indicates the opposite, even after adjusting the regressions for risk-taking. Second, weak shareholder rights undermine market forces that would otherwise encourage banks to hold higher capital ratios.

Keywords:bank capital, regulation, competition, deposit insurance, shareholder rights

JEL Classification: G21, G28, L11

Equity Markets Do not Fit all: An Analysis of Public-to-Private Deals in Continental Europe

Manuela Geranio and Giovanna Zanotti

Concentration of family-based ownership and recent development of private equity companies in Continental Europe suggest that the motivations and results of public-to-private (PTP) deals may differ from well-studied cases in the United States and United Kingdom. We overview the PTP market and measure the cumulative abnormal returns (CARs) of 106 PTP deals concluded in Continental Europe from 2000 to 2005, introducing a model to explain the abnormal returns. Our results partially confirm findings of previous studies, namely, that undervalued and smaller firms register higher CARs. We additionally find that deals promoted by family owners register higher abnormal returns, whereas financial investors and private operating firms show no impact.

Keywords:: Public-to-private deals, Going private, Abnormal returns, Equity markets, Continental Europe, CAR

JEL Classification: G32, G34

Consumption and Hedging in Oil-Importing Developing Countries

Felipe Aldunate and Jaime Casassus

We study the consumption and hedging strategy of an oil-importing developing country that faces multiple crude oil shocks. In our model, developing countries have two particular characteristics: their economies are mainly driven by natural resources and their technologies are less efficient in energy usage. The natural resource exports can be correlated with the crude oil shocks. The country can hedge against the crude oil uncertainty by taking long/short positions in existing crude oil futures contracts. We find that both, infficiencies in energy usage and shocks to the crude oil price, lower the productivity of capital. This generates a negative income effect and a positive substitution effect, because today's consumption is relatively cheaper than tomorrow's consumption. Optimal consumption of the country depends on the magnitudes of these effects and on its risk-aversion degree. Shocks to other crude oil factors, such as the convenience yield, are also studied. We fnd that the persistence of the shocks magnifes the income and substitution effects on consumption, thus affecting also the hedging strategy of the country. The demand for futures contracts is decomposed in a myopic demand, a pure hedging term and productive hedging demands. These hedging demands arise to hedge against changes in the productivity of capital due to changes in crude oil spot prices. We calibrate the model for Chile and study up to what extent the country's copper exports can be used to hedge the crude oil risk.

Keywords:Crude oil prices, convenience yields, risk management, emerging markets, government policy, two-sector economies

JEL Classification: G11, Q43, Q48, D92, O41, C60

Mean Reversion in Profitability for Non-listed Firms

Nordal Kjell Bjorn and Randi Naes

The presence of mean reversion in profitability at the firm level is important for valuation and prediction of growth and earnings. We investigate the mean reversion in accounting profitability for Norwegian non-listed firms for the period 1988-2006. We find a mean rever- sion rate of about 0.44 per year. This is higher than found in other studies. We also find that small firms have a higher mean reversion rate than large firms. Our results should have important practical implications for the difficult task of valuing non-listed firms. Previously, price-to-book ratios have been used to investigate changes in profitability over time for listed firms. We examine bankruptcy risk as an alternative variable for unlisted firms. We find that bankruptcy risk may help explain changes in profitability, but the results are not as strong as found in previous work.

Keywords:Non-listed firms, profitability, mean reversion

JEL Classification: G10, G30

Project Finance Collaterlized Debt Obligations: An Empirical Analysis of Spreads Determinants

Valerio Buscaino, Stefano Caselli, Francesco Corielli and Stefano Gatti

Credit rating is the most important variable in determining tranche spread at issue on collateralized debt obligations (CDOs) issues backed by project finance (PF) loans. Factors that are important for pricing in the case of corporate bonds, such as market liquidity and weighted average maturity, are also relevant for determining spreads for these securities. Furthermore, the nature of the underlying assets has a substantial impact on CDO pricing: Primary market spread is significantly higher when the underlying PF loans bear a higher level of market risk and when the proportion of projects still under construction in the securitized portfolio is larger.

Keywords:Collateralized debt obligations, project finance

JEL Classification: G12, G15