European Financial Management 2015 Archive

January 2015, VOL 21:1 March 2015, VOL 21:2 June 2015, VOL 21:3 September 2015, VOL 21:4 November 2015, VOL 21:5

European Financial Management, VOL 21:1, January 2015

Investor Inattention: A Hidden Cost of Choice in Pension Plans?

Magnus Dahlquist and Jose Vicente Martinez

We investigate inattention on the part of pension plan participants using a dataset covering savings in Sweden's Premium Pension System. These data permit direct comparison of the investment behaviors of pension and retail mutual fund investors. Unlike retail mutual fund investors, pension investors do not seem to react to past fund performance. This behavior means that pension investors face a greater risk of being caught in poorly performing funds. Our evidence suggests that inertia and inattention to past performance may translate into poorer investment results for pension investors. We discuss a potential change in the design of dened contribution pension schemes that may mitigate costs for inattentive investors while maintaining exibility for attentive investors.

Keywords: ows, inertia, pension plan design, performance, redemptions.

JEL Classification: G11, G23, H55.

Sell-side Analyst Research in the Presence of Conflicts of Interest

Daniel Arand and Alexander G. Kerl

Using a unique dataset of conflicts of interest reported by a large investment bank, we examine the relationship between conflicts of interests and sell-side analysts?behavior in setting target prices and stock recommendations. We demonstrate that the aggregate number of simultaneous business ties with a subject company is positively associated with optimism in target prices and recommendations. Furthermore, the results provide some indication that stocks for which conflicts of interests exist earn lower risk-adjusted returns than unconflicted stocks. However, we find no evidence that investors discount the value of sell-side analysts? research with respect to the prevailing level of conflicts.

Keywords: Target Prices, Stock Recommendations, Conflicts of Interest, Bias, Regulation

JEL Classification: G14; G15

Liquidity Dynamics in an Electronic Open Limit Order Book: An Event Study Approach

Peter Gomber, Uwe Schweickert and Erik Theissen

We analyze the dynamics of liquidity in an electronic limit order book using the Exchange Liquidity Measure (XLM), a measure of the cost of a roundtrip trade of given size V. We use intraday event study methodology to analyze how liquidity shocks - large transactions and Bloomberg ticker news - affect the XLM. We find that resiliency after large transactions is high, i.e., liquidity quickly reverts to normal levels. Large trades are 'timed'; they take place at times when liquidity is unusually high. Bloomberg ticker news items do not have a discernible effect on liquidity.

Keywords: Liquidity, limit order book, resiliency

JEL Classification: G 10.

Does State Ownership Drive M&A Performance? Evidence from China

Bilei Zhou,Jie(Michael) Guo, Jun Hua and Angelos J. Doukas

This paper examines the role of state ownership in mergers and acquisitions by analyzing the short- and long-term performance of Chinese state-owned enterprise (SOE) acquirers relative to privately owned enterprise (POE) peers from 1994 to 2008. The empirical results show that SOE acquirers outperform POE acquirers in terms of long-run stock performance and operating performance. In addition, consistent with previous literature, our results suggest that the gains from government intervention outweigh the inefficiency of state ownership in Chinese mergers and acquisitions.

Keywords:State ownership, mergers and acquisitions, market valuations, Chinese

JEL Classification: G14; G34

The Returns to Hedge Fund Activism in Germany

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 out-performance before the event, but negative announcement returns and a long-run underper-formance. In contrast, repurchasing IPOs experience positive announcement returns and no long-run underperformance. Free cash flow problems, resulting from mandatory equity issu-ance 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 Offer-ings, Valuation Effects

JEL Classification: G32, G35

Informed Trading and Market Structure

Charlie X. Cai, Jeffrey H. Harris, Robert S. Hudson and Kevin Keasey

We examine London Stock Exchange trading around information releases and link market quality dimensions with market structure during periods with heightened interaction between informed and uninformed traders. We find support for both the hypothesis that automated electronic markets minimize trading costs for liquid stocks and the hypothesis that adverse selection costs are minimized with intermediated trading. We examine how news affects both dealer and electronic systems and find that electronic markets are prone to greater stealth trading and post-trade volatility, both consistent with the proliferation of algorithmic trading and short-term volatility events such as the May 6, 2010 "flash crash."

Keywords:Market Structure; Informed Trading; Trading Systems; London Stock Exchange.

JEL Classification: G10, G15.

Directors' Dealing and Post-IPO Performance

Hafiz Hoque and Meziane Lasfer

We use a unique mainly hand-collected dataset to assess the impact of directors' trades on IPOs' long-term returns. We find that IPOs where directors are net sellers are more likely to generate positive long-run returns which occur mostly before the sell trades, suggesting that directors sell when their IPOs reach their optimal values. Conversely, IPOs where directors are net buyers underperform significantly. Our results are not consistent with insider trading in seasoned firms, partly because the valuation uncertainty of IPOs and the specific motivations to trade weaken the precision of the trades' informativeness.

Keywords:Long run IPO performance, insider trades, London Stock Exchange, market timing.

JEL Classification: G12, G14, G24.

European Financial Management, VOL 21:2, March 2015

Investors' Judgments, Asset Pricing Factors, and Sentiment

Hersh Shefrin

This paper presents results based on new data showing that the relationships involving investors' judgments of risk and variables such as beta, size, and book-to-market equity (B/M) have the same directional effects as those involving realized returns. Moreover, the relationships involving risk are mediated by Baker-Wurgler sentiment, with directional effects similar to those that have already been documented for realized returns. In this regard, Baker-Wurgler sentiment mediates the time series of investors' judgments of expected return and the cross-section of their judgments about risk. The results are consistent with the position that investors' judgments of risk and return, both mediated by sentiment, influence market prices.

Keywords: risk, sentiment, size, book-to-market, beta, representativeness, affect

JEL Classification: D03, G10, G12

Unique Option Pricing Measure with Neither Dynamic Hedging nor Complete Markets

Nassim Nicholas Taleb

Proof that under simple assumptions, such as constraints of Put-Call Parity, the probability measure for the valuation of a European option has the mean derived from the forward price which can, but does not have to be the risk-neutral one, under any general probability distribution, bypassing the Black-Scholes-Merton dynamic hedging argument, and without the requirement of complete markets and other strong assumptions. We confirm that the heuristics used by traders for centuries are both more robust, more consistent, and more rigorous than held in the economics literature. We also show that options can be priced using infinite variance (finite mean) distributions.

Keywords:option theory, derivatives, risk management, hedging

JEL Classification: G13, D81, A14

Higher-moment risk exposures in hedge funds

Georges Hubner, Marie Lambert and Nicolas Papageorgiou

This paper singles out the key roles of US equity skewness and kurtosis in the hedge fund return generating process. We propose a conditional higher-moment model with location, trading, and higher-moment factors to describe the dynamics of the equity hedge, event-driven, relative value, and fund of funds styles. If the volatility, skewness, and kurtosis implied in US options are used by fund managers as instruments to anticipate market movements, managers should adjust their market exposure in response to variations in these moments. We indeed show that higher-moment premia improve the conditional asset pricing model across all hedge fund styles.

Keywords: Hedge funds; implied higher-moments; conditioning factors

JEL Classification: G10; G12

Common Factors in the Performance of European Corporate Bonds: Evidence before and after the Financial Crisis

Wolfgang Aussenegg, Lukas Goetz, and Ranko Jelic

We examine monthly excess returns for 23 Euro-denominated corporate bond indices and propose a new specification for bond asset pricing models. Specifically, we separate level and slope components of term and default risk factors and examine liquidity risk. Our results suggest that level and slope risk factors, derived from complete interest rate and default spread term structures, significantly improve the explanatory power of the Fama and French (1993) 2-factor model. We also demonstrate different sensitivities of risk factors before and after recent financial crisis. The results are robust to calendar seasonality and the consideration of equity market returns.

Keywords:asset pricing, Euro corporate bonds, factor models, financial crisis, anomalies

JEL Classification: G12, G14, G15, G30

Does Centralization of FX Derivative Usage Impact Firm Value? Some Empirical Evidence

Hakan Jankensgard

Previous research has shown that firms identified as derivative users tend to be valued at a premium relative to non-users. In this paper I develop the hypothesis that the 'derivative premium' is higher in firms with centralized FX exposure management, compared to a decentralized approach in which subsidiaries retain bank contacts and/or decision-making authority. This study benefits from unique survey data on the FX management practices and derivative usage of Swedish listed firms. The data supports the centralization-hypothesis. Firms with a centralized approach have a statistically significant derivative premium of around 15%, whereas there is no premium for decentralized firms.

Keywords: Centralization, risk management, currency risk, derivative, hedging

JEL Classification: G30, G32.

Inferring Default Correlation from Equity Return Correlation

Sheen Liu, Howard Qi, Jian Shi and Yan Alice Xie

This paper presents a new approach for estimating default correlation by linking default correlation to equity return correlation while preserving the fundamental relation between default and asset correlations in the structural framework. Our hybrid model thus overcomes a long-standing empirical difficulty that default correlation estimation relies on the unobservable asset process. The empirical analysis shows that our hybrid model demonstrates a considerable improvement over the existing structural model of Zhou (2001) for the sample periods of 1970-1993 and 1990-2010. We also illustrate the difference between the two models in predicting default correlations over the period of the 2008 financial crisis.

Keywords: Default correlation; equity (return) correlation; defaultable bonds; structural model

JEL Classification: G1, G2.

The Role of Pre-existing Liquidity in Determining Price Efficiency and Liquidity Gains Following the Introduction of SETSmm

Patricia L. Chelley-Steeley

In this paper we examine the impact that the new trading system SETSmm had on market quality measures such as firm value, liquidity and pricing efficiency. This system was introduced for mid-cap securities on the London Stock Exchange in 2003. We show that there is a small SETSmm return premium associated with the announcement that securities are to migrate to the new trading system. We find that migration to SETSmm also improves liquidity and pricing efficiency and these changes are related to the return premium. We also find that these gains are stronger for firms with high pre SETSmm liquidity and weaker for firms with low SETSmm liquidity.

Keywords: microstructure, pricing efficiency, trading system, liquidity

JEL Classification: G15

Leasing Decisions and Credit Constraints: An Empirical Analysis on a Sample of Italian Firms

Stefania Cosci, Roberto Guida and Valentina Meliciani

Although lease financing provides a significant source of funds enabling many companies to invest, few studies examine the determinants of leasing in Continental Europe and we are aware of no study on the Italian case. This paper investigates the relationship between financial constraints and leasing decisions for a sample of I3.talian firms. In particular, it investigates the determinants of firm leasing decisions, the degree of substitutability between leasing and debt, and the impact of leasing on the probability of firms feeling "credit rationed". Our results support the hypothesis that leasing preserves capital, thus helping to relieve credit constraints.

Keywords: Leasing, debt finance, credit rationing, capital structure

JEL Classification: G32

European Financial Management, VOL 21:3, June 2015

Cash Flow Multipliers and Optimal Investment Decisions

Holger Kraft and Eduardo S.Schwartz

Valuation multipliers are frequently used in practice. By postulating a simple stochastic process for the firm's cash flows in which the drift and the variance of the process depend on the investment policy, we develop a stylized model that links the cash flow multiplier to the optimal investment policy. Our model implies that the multiplier increases with investment at a decreasing rate. On the other hand, the multiplier is inversely related to discount rates. Using an extensive data set we examine the implications of our model. We find strong support for the variables postulated by the model.

Keywords:Firm valuation, Valuation multiples, Real options

JEL Classification: C61, G12, G13, M40

Time-Varying Credit Risk Discovery in the Stock and CDS Markets: Evidence from Quiet and Crisis Times

Santiago Forte and Lidija Lovreta

We analyze the dynamic relationship between the stock and the CDS market during the period 2002-2008. We document that the stock market's informational dominance reported in previous studies holds only in times of financial crisis. During tranquil times, the CDS market's contribution to price discovery is equal or higher than that of the stock market. Moreover, the credit risk level of the company has a positive effect on the information share of its stocks beyond the effect of the overall state of the economy. We show that these conclusions do not contradict the argument of insider trading in credit derivatives.

Keywords: Credit risk, credit default swap market, stock market, price discovery

JEL Classification: G12, G14

The Safety and Soundness Effects of Bank M&A in the EU: Does Prudential Regulation Have any Impact?

Jens Hagendorff and Maria J. Nieto

This paper studies the impact of European bank mergers on changes in key safety and soundness measures of both acquirers and targets. We find that acquirers in cross-border deals tend to perform better when their home country prudential supervisors and deposit insurance funding systems are stricter than that of the target. For target banks, we find that stronger supervision and tougher deposit insurance funding regimes result in positive post merger changes in liquidity and performance. Overall, while bank mergers have undermined bank safety and soundness in some cases, our evidence indicates that strong regulation and supervision can partly ameliorate this.

Keywords: banks, mergers, Europe

JEL Classification: G21, G34, G28

Are Cooperative Banks a Lever for Promoting Bank Stability? Evidence from the Recent Financial Crisis in OECD Countries

Laura Chiaramonte, Federica Poli and Marco Ercole Oriani

Based on a sample of cooperative, savings, and commercial banks from OECD countries, this paper examines whether and to what extent cooperative banks affected average bank soundness during 2001-2010. To account for the impact of the recent financial crisis, we analyse separately the pre-crisis period (2001-2006) and crisis years (2007-2010). Unlike published claims that blame the fragility of banking systems on the presence of non-profit-maximizing entities, our main finding is that cooperative banks have explanatory power for stabilization during the crisis years, but only above a certain market share threshold.

Keywords: financial stability, z-score, cooperative bank, financial crisis

JEL Classification: G01, G21

When Do Sell-side Analyst Reports Really Matter? Shareholder Protection, Institutional Investors and the Imformativeness of Equity Research

Daniel Arand, Alexander Kerl and Andreas Walter

We examine whether the informativeness of sell-side analyst reports depends on the strength of the regulatory environment of a country and the regulatory background of the institutional investors of a company. Based on both measures that we use to proxy the informativeness of analyst research (i.e., short-term market reaction and forecast errors with respect to corporate earnings), our results show that the information value of research increases as the level of investor protection increases. This result is robust to different specifications of investor protection. We further demonstrate that analyst forecasts are more (less) valuable when the majority of institutional investors are from strong (weak) investor protection countries.

Keywords: shareholder protection, institutional investors, analyst reports, regulation

JEL Classification: G14; G15; G18; G24; G32

The Empirical Determinants of Credit Default Swap Spreads: A Quantile Regression Approach

Pedro Pires, Joao Pedro Pereira and Luis Filipe Martins

We study the empirical determinants of Credit Default Swap (CDS) spreads through quantile regressions. In addition to traditional variables, such as implied volatility, put skew, historical stock return, leverage, profitability, and ratings, the results indicate that CDS premiums are strongly determined by CDS illiquidity costs, measured by absolute bid-ask spreads. The quantile regression approach reveals that high-risk firms are more sensitive to changes in the explanatory variables that low-risk firms. Furthermore, the goodness-of-fit of the model increases with CDS premiums, which is consistent with the credit spread puzzle

Keywords: Credit Default Swap, Credit Risk, Liquidity, Quantile Regression

JEL Classification: G12, G13, C21

Foreign Debt Usage in Non-Financial Firms: A Horse Race between Operating and Accounting Exposure Hedging

Tom Aabo, Marianna Andryeyeva Hansen and Yaz Gulnur Muradoglu

Previous studies show that foreign exchange exposure from international sales can be hedged by foreign debt. We go beyond the foreign sales measure by using a unique database with detailed exposure information on Danish non-financial firms with international operations. Our results indicate that foreign debt is used to hedge foreign assets and subsidiaries (accounting exposure) as opposed to foreign sales (operating exposure). The paper adds to the literature on corporate hedging by highlighting the importance of accounting exposure in the hedging behavior of corporate managers and the perceived need to reduce risks due to currency mismatches between assets and liabilities.

Keywords:exchange rate exposure management; foreign debt; foreign assets; foreign subsidiaries; accounting exposure

JEL Classification: F23, G32

European Financial Management, VOL 21:4, September 2015

Idiosyncratic Volatility, Institutional Ownership, and Investment Horizon

Doina C. Chichernea, Alex Petkevich and Blerina Bela Zykaj

This paper reevaluates the cross-sectional effect of institutional ownership on idiosyncratic volatility by conditioning on institutions investment horizon. Prior literature establishes a positive link between growing institutional ownership and idiosyncratic volatility. However, this effect may vary depending on the type of institutional ownership. We document that short-term (long-term) institutional ownership is positively (negatively) linked to idiosyncratic volatility in the cross section. These opposite effects persist after controlling for institutional preferences and information-based trading and remain qualitatively unchanged after controlling for endogeneity. This suggests that short-term (long-term) institutions exhibit higher (lower) trading activity, which increases (decreases) idiosyncratic volatility.

Keywords:institutional investors; idiosyncratic volatility; investment horizon; trading preferences.

JEL Classification: G12; G23

Change Analysis of Dependence Structure and Dynamic Pricing of Basket Default Swaps

Li Ping Li and Ze-Zheng Li

In this paper we use a type of dynamic copula method to characterise the dependence structure between financial assets and price basket default swaps (BDSs). We first employ a goodness-of-fit test and a binary segmentation procedure to analyse the change of dependence structure between the obligations underlying a BDS, then present a numerical example to demonstrate the change analysis and BDS pricing process. We find that in different time periods, the best copula fitting the data is not the same; therefore the tranche spreads of the BDS are also different. We also compare our results with those obtained from static copulas and dynamic Gaussian copula. The results show that the static copula and dynamic Gaussian copula methods underestimate the spreads for riskier tranches and overestimate those for less risky tranches.

Keywords: change analysis; basket default swap; dynamic copula; dependence structure

JEL Classification: G12, G13, G17

Liquidity and asset prices: An empirical investigation of the Nordic stock markets

Hilal Anwar Butt and Nader Shahzad Virk

This paper presents a simplified single period asset-pricing model adjusted for liquidity and tests it for the Nordic markets. The detailed empirical evidence is presented from Finnish test case. Empirical testing of small yet developed markets is motivated by the increased relevance of the illiquidity effect for illiquid assets/markets. The main evidence reports liquidity risk makes sufficiently larger part of predicted factor risk premium than the market risk, contrary to comparable U.S. evidence. This highlights the ability of liquidity related model betas in capturing the time variation in expected returns across illiquid (Nordic) markets than market beta.

Keywords: Asset-pricing model, illiquidity effect, predicted factor risk premium, model betas

JEL Classification: G10, G12, G15.

On the Role of Cultural Distance in the Decision to Cross-List

Olga Dodd, Bart Frijns and Aaron Gilbert

This paper examines the role of culture in the choice of the destination market for cross-listing firms. We argue that firms cross-list in markets with greater cultural similarities, because 1) investors are more willing to invest in culturally familiar firms and 2) managers seek to avoid potential conflicts with culturally disparate investors and managers. Employing Hofstede's cultural dimensions, we find that firms from developed countries display greater cross-listing propensity towards culturally similar countries. These results are robust to various alternative cultural measures. We further find that it is mainly the difference in uncertainty avoidance and individualism that affect cross-listing decisions.

Keywords:National culture, cultural distance, international cross-listing.

JEL Classification: C24; G10.

Equally-Weighted vs. Long Run Optimal Portfolios

Carolina Fugazza, Massimo Guidolin and Giovanna Nicodano

Out-of-sample experiments cast doubt on the ability of portfolio optimizing strategies to outperform equally weighted portfolios, when investors have a 1-month time horizon. This paper examines whether this finding holds for longer investment horizons over which the optimizing strategy exploits linear predictability in returns. Our experiments indicate that investors with longer horizons on average would have benefited, ex post, from an optimizing strategy over the period 1995-2009. We analyze performance sensitivity to investor risk aversion, to the number of predictors included in the forecasting model and to the deduction of transaction costs from portfolio performance.

Keywords:Equally weighted portfolios; strategic asset allocation; Real Estate Investment Trusts (REITs); ex post performance; return predictability; parameter uncertainty.

JEL Classification: G11, L85.

European Financial Management Association (EFMA) Annual Meetings: A Retrospective Evaluation

John A. Doukas and Andreas Walter

We provide a retrospective evaluation of the European Financial Management Association (EFMA) annual meetings from 2001 to 2010. In the 10-year investigation period, 2,986 papers have been presented at the annual EFMA meetings. Presented research has, in accordance with the objective of the EFMA, a strong focus on European financial topics, and most accepted papers were written by European authors. Our analysis reveals that empirical papers analyzing European datasets have a positive impact on the likelihood of being published in the European Financial Management (EFM), the journal of the EFMA, compared to other peer-reviewed journals. This evidence appears to be consistent with the EFM objectives to foster more research on European finance issues.

Keywords: finance conference, publication analysis, retrospective evaluation

JEL Classification: G0

How to Pay Envious Managers: A Theoretical Analysis

Marc Crummenerl, Tilmann Doll and Christian Koziol

This paper analyzes how envy affects the decisions of competing managers and their optimal stock-based compensation from the perspective of shareholder value. We consider a typical framework in which managers can induce effort to reduce production costs and make decisions regarding production volume. At first glance, envy between managers from competing firms appears to be an unfavorable characteristic because it does not align the interests of managers with those of shareholders. However, our model finds that envy is a powerful incentive mechanism. The model yields three key findings: (i) envious managers outperform self-interested managers, (ii) firms optimally hire envious managers, and (iii) shareholders do not grant any stock-based compensation to envious managers.

Keywords:Executive compensation, Inequity aversion, Cournot competition

JEL Classification: D21, D63, J31, M52

European Financial Management, VOL 21:5, November 2015

Measuring Systemic Risk: Common Factor Exposures and Tail Dependence Effects

Wan-Chien Chiu, Juan Ignacio Peña, and Chih-Wei Wang

We model systemic risk using a common factor that accounts for market-wide shocks and a tail dependence factor that accounts for linkages among extreme stock returns. Specifically, our theoretical model allows for firm-specific impacts of infrequent and extreme events. Using data on the four sectors of the U.S. financial industry from 1996 to 2011, we uncover two key empirical findings. First, disregarding the effect of the tail dependence factor leads to a downward bias in the measurement of systemic risk, especially during weak economic times. Second, when these measures serve as leading indicators of the St. Louis Fed Financial Stress Index, measures that include a tail dependence factor offer better forecasting ability than measures based on a common factor only.

Keywords:Systemic risk, Tail dependence effects, Correlated jumps, Predictability

JEL Classification: G01, G10, G18, G20, G28.

The Lure of the Brand: Evidence from the European Mutual Fund Industry

Jan Jaap Hazenberg, Fabian Irek, Willem van der Scheer and Mariela Stefanova

We investigate the effect of the fund family’s brand on mutual fund ‡flows by using a unique data set that represents a direct assessment of the brand image of European fund providers. A superior brand image increases the sensitivity of ‡flows to good past performance, while it protects against outfl‡ows when there is underperformance. Flows of funds of independent providers have a higher sensitivity to past performance and brand image than ‡flows of funds of providers owned by banks or insurers. These fi…ndings highlight the importance of marketing and brand in generating growth for the fund families.

Keywords:Mutual funds, fund ‡flows, fund performance, marketing, brand image.

JEL Classification: G11, G23, M31

Gains to Chinese Bidder Firms: Domestic vs. Foreign Acquisitions

Emma L. Black, Angelos J. Doukas, Xiaofei Xing and Jie (Michael) Guo

This paper examines whether foreign acquisition of Chinese firms improves share price performance relative to domestic acquisitions. The results show that foreign acquisitions are not associated with positive abnormal returns in the short-run, but that they are so associated for domestic acquisitions. Foreign acquisitions also realize significant long-run gains, especially when the acquiring firm is large. Specifically, we find that there is a significant, positive long-run outperformance of 29.81% for large foreign acquisitions benchmarked against domestic ones, while large foreign acquisitions earn 22.39% in aggregate. Our evidence suggests that large Chinese acquirers gain when they expand their operations abroad, consistent with the literature on reverse internalisation.

Keywords: Mergers and Acquisitions, China, Financial Performance, Scarcity, Cross-Border, Foreign Direct Investment, Multinational, Diversification

JEL Classification: G14; G34.

Heterogeneity in the Speed of Capital Structure Adjustment across Countries and over the Business Cycle

Wolfgang Drobetz, Dirk C. Schilling and Henning Schroder

This study analyzes the heterogeneity in the speed of capital structure adjustment. Using a doubly-censored Tobit estimator that accounts for mechanical mean reversion in leverage ratios, the speed of adjustment is 25% per year in a large international sample, supporting the economic relevance of the trade-off theory. Differences in the adjustment speed across distinct financial systems are attributable to differences in the costs of adjustment. Macroeconomic and micro-level supply-side constraints also affect the dynamics of leverage. Firms adjust more slowly during recessions, and the effect on adjustment speed is most pronounced for financially constrained firms in market-based countries.

Keywords:Capital structure, speed of adjustment, institutional arrangements, business cycle, dynamic panel methods

JEL Classification: G30, G32

Is there a Positive Risk-Return Tradeoff? A Forward-Looking Approach to Measuring the Equity Premium

Dimitrios Koutmos

This article revisits the puzzling time-series relation between risk and return on the stock market portfolio. It replaces the standard ex post mean returns with forward-looking calculations of the equity risk premium derived from the classic Gordon stock valuation model. The article estimates the equity premium for several industrialized markets and finds that conditional market risk is significantly priced in the context of asset pricing theory both in the short- and long-run using various specifications for volatility. Findings herein lend credible support for the presence of a positive intertemporal risk-return relation and suggest that perhaps ex post realized returns are unjustifiably used to make ex ante inferences regarding expected returns and to motivate asset pricing tests.

Keywords:asset pricing, intertemporal risk return tradeoff, GARCH, realized volatility, fed model, earnings-yield, dividend-yield

JEL Classification: C50, G10, G11, G12, G15, G17

Multifactor Models and their Consistency with the ICAPM: Evidence from the European Stock Market

Fabian Lutzenberger

This paper conducts a European investigation of eight multifactor models that have been previously tested using US data. Many results confirm the US evidence: Most of the eight multifactor models investigated do a good job explaining the cross-section of our testing portfolios, but most models are not justifiable by the Intertemporal CAPM (ICAPM). Carhart’s four-factor model shows the best empirical performance and consistency with the ICAPM. Nevertheless, some results counter the US evidence: Fama and French’s three-factor model is inconsistent with the ICAPM and the models of Hahn and Lee (2006) and Koijen et al. (2010) show low explanatory power.

Keywords: Asset pricing; Europe; ICAPM; multifactor models; risk factors

JEL Classification: G12