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The European Financial Management was founded in 1994 by Dr. John Doukas to serve as a high quality refereed publication outlet that publishes significant new research as it relates to European corporations, financial institutions and capital markets. The EFM journal is published in five issues per year [January, March, June, September and November ] and its acceptance rate is about 3%. The June issue is based on the Keynote Address and a small set of articles selected from the papers presented at the Annual Meetings of the European Financial Management Association. The articles published in the EFM journal are indexed and abstracted in the Social Science Citation Index.
Newly Accepted Papers
Bank Risk Dynamics Where Assets are Risky Debt Claims
Sharon Peleg and Alon Raviv
The structural approach views firm’s equity as a call option on the value of its assets, which motivates stockholders to increase risk. However, since bank assets are risky debt claims, bank equity resembles a subordinated debt. Using this assumption, and considering the strategic interaction between a bank and its debtor, we argue that risk shifting is limited to states in which the debtor is in financial distress. Furthermore,risk shifting increases with bankruptcy costs and decreases with bank capital. Thus, increasing a bank’s capital affects stability, not only through the additional capital buffer, but also by affecting the risk shifting incentive.
Keywords:Risk taking, Asset risk, Financial institutions, Stress test, Leverage
JEL Classification: G21, G28, G32, G38
The Market Liquidity Timing Skills of Debt-Oriented Hedge Funds
Baibing Li, Ji Luo and Kai-Hong Tee
We investigate the liquidity timing skills of debt-oriented hedge funds following the 2008 credit crisis, which demonstrated the importance of understanding liquidity conditions to manage the market exposure of investments. We base the analysis on the estimated co-movements of fixed income and equity market liquidity. Our findings, which are statistically robust, show evidence of liquidity timing ability in the fixed income market for all debt-oriented hedge fund strategy categories. Joint market liquidity timing skill, however, is only found in some categories. Our findings suggest that debt-oriented hedge fund managers use a sophisticated set of timing strategies in their investment managements.
Keywords:Fixed income market; hedge funds; liquidity timing skill; market exposure
JEL Classification: G1; G11; G23
Endogenous Credit Spreads and Optimal Debt Financing Structure in the Presence of Liquidity Risk
Eva Luetkebohmert, Daniel Oeltz and Yajun Xiao
We present a structural model that allows a ﬁrm to eﬀectively manage its exposure to both insolvency and illiquidity risk inherent in its ﬁnancing structure. Besides insolvency risk, the ﬁrm is exposed to rollover risk through possible runs by short-term creditors. Moreover, asset price volatilities are subject to macro-economic shocks and inﬂuence creditors' risk attitudes and margin requirements. Credit spreads are derived endogenously depending on the ﬁrm's total default risk. Equity holders have to bear the rollover losses. An optimal debt structure that maximizes the ﬁrm's equity value is determined by trading off lower ﬁnancing costs and higher rollover risk.
Keywords:funding liquidity, optimal capital structure, rollover risk, structural credit risk models
JEL Classification: G01, G32, G33
Financial Flexibility and Investment Ability Across the Euro Area and the UK
Annalisa Ferrando, Maria-Teresa Marchica, and Roberto Mura
We use a very large sample of European private and public firms to show that financial flexibility attained through a conservative leverage policy is more important for private, small-medium-sized, and young firms and for firms in countries with less access to credit and weaker investor protection. Further, using the 2007 financial crisis as a natural experiment, we show that a higher degree of financial flexibility allows firms to reduce the negative impact of liquidity shocks on investment. Our findings support the hypothesis that financial flexibility improves companies’ ability to undertake future investment, despite market frictions hampering possible growth opportunities.
Keywords: low leverage, financial flexibility, investment, cross-country analysis
JEL Classification:G31, G32, D92
Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry
Manuel Ammann, Kristian Blickle and Christian Ehmann
This paper investigates the announcement effects of CoCo bonds issued by global banks between January 2009 and June 2014. Using a sample of 34 financial institutions, we examine abnormal stock price reactions and CDS spread changes before and after the announcement dates. We find that the announcement of CoCos correlates with positive abnormal stock returns and negative CDS spread changes in the immediate post-announcement period. We explain these effects with a set of theories including the lowered probability of costly bankruptcy proceedings, a signaling framework based on pecking order theory and the cost advantage of CoCos over equity (tax shield).
Keywords: contingent convertible securities, CoCo bonds, announcement effects, event study
JEL Classification: G01, G14, G21
Risk control: Who cares?
The performance of recently introduced risk-control indices is evaluated and tested with respect to a set of competing indices. Applying a method of moments methodology to these data reveals that the performance of strategies that track risk-control indices have economic and statistical significance to investors with realistic risk aversion parameter values. How- ever, this performance varies over time and appears to be determined by macroeconomic and liquidity conditions.
Keywords: Risk control, volatility, certainty equivalent return, method of moments
JEL Classification: G53, G11, G17
A Theoretical Model for the Term Structure of Corporate Credit based on Competitive Advantage
Myuran Rajaratnam, Bala Rajaratnam and Kanshukan Rajaratnam
We derive the term structure of Corporate Credit based on the Competitive Advantage of a firm and the tax deductibility of its interest payments. We consider the competitive advantage enjoyed by the firm as the central tenet of our model and capture its eventual demise in a probabilistic manner. We compensate the bond holder for expected losses and then provide an additional spread based on the tax deductibility of interest payments. Our simple intuitive model appears to overcome some of the well-known shortcomings of structural credit risk models.
Keywords: Term Structure, Corporate Credit, Competitive Advantage, Value-Investing, Credit Spread Puzzle
JEL Classification: EFM 340 Fixed Income; JEL G12 Bond Interest Rates
The Role of the Conditional Skewness and Kurtosis in VIX Index Valuation
Simon Lalancette and Jean-Guy Simonato
The CBOE VIX index is a widely recognised benchmark measure of expected stock market volatility. As shown in the literature, probability distributions other than Gaussian are key features required to describe the dynamics of the S&P 500, the variable that ultimately determines the VIX index level. As such, it is important to assess if deviations from the Gaussian distribution have important impacts on the VIX index level. We examine herein how a model articulated over a time-varying non-Gaussian distribution with conditional skewness and kurtosis can contribute to the overall explanation of the VIX dynamics.
Keywords:VIX, GARCH, skewness, kurtosis, risk-neutral valuation
JEL Classification: C58, G1
Dynamic Asset Allocation with Liabilities
Daniel Giamouridis, Athanasios Sakkas, Nikolaos Tessaromatis
We develop an analytical solution to the dynamic multi-period portfolio choice problem of an investor with risky liabilities and time varying investment opportunities. We use the model to compare the asset allocation of investors who take liabilities into account, assuming time varying returns and a multi-period setting with the asset allocation of myopic ALM investors. In the absence of regulatory constraints on asset allocation weights, there are significant gains to investors who have access to a dynamic asset allocation model with liabilities. The gains are smaller under the typical funding ratio constraints faced by pension funds.
Keywords:Strategic Asset Allocation,Dynamic Asset Allocation, Asset-Liability Management, Return Predictability, Myopic Investors
JEL Classification: G11, G12, G23
Bankers on the Board and CEO Incentives
Min Jung Kang and Young (Andy) Kim
Governance improvement measures often demand more financial experts on corporate boards. Directors from the lending bank require particular attention because the conflicts of interest between shareholders and debtholders would be severe. Hence, we examine whether commercial banker directors work in the best interests of shareholders in providing incentives to the CEO. We find that the CEO’s compensation VEGA is lower if an affiliated banker director is on the board, especially when the director is the chair of the compensation committee. Further, commercial banker directors increase debt-like compensation and make it more sensitive to performance and less sensitive to risk.
Keywords:bankers on board, financial expertise, conflicts of interest, governance, board of directors, CEO compensation
JEL Classification: G14
Due Diligence and Investee Performance
Douglas Cumming and Simona Zambelli
We estimate the economic value of due diligence (DD) in the context of private equity by investigating the relationship between DD and investee performance, while controlling for endogeneity. With the adoption of a novel dataset, we find evidence highly consistent with the view that a thorough DD is associated with improved investee performance. We also distinguish the role of different types of DD and show that the DD performed by fund managers has a more pronounced impact on performance. Instead, the DD mainly performed by external agents, i.e., consultants, lawyers and accountants, gives rise to puzzling results and imperfect matching.
Keywords:Due Diligence, Governance, Performance, Private Equity
JEL Classification: G23, G24, G28
Where will the “Silver Money” Go?
Na Young Park
Using international country-level data, this paper shows that demographic ageing is likely to significantly expand the insurance industry. This expansion is driven by the increased need to secure earnings for post-retirement consumption, the desire to hedge against risks associated with increasing age, and the older generation’s risk aversion to increasing the demand for safer assets such as insurance and pension products. Moreover, such an expansion of the insurance industry is particularly apparent in financially liberalized countries. This is because risk and asset management associated with insurance and pension products could be facilitated and more effective in liberalized financial markets.
Keywords:demographic ageing, demographic change, financial liberalization, insurance industry, insurance markets
JEL Classification: G21, G28, G30
Financial Hedging and Firm Performance: Evidence from Cross-Border Mergers and Acquisitions
Zhong Chen, Bo Han and Yeqin Zeng
Using a sample of 1,369 cross-border acquisitions announced by Standard & Poor's 1500 firms between 2000 and 2014, we find strong evidence that derivatives users experience higher announcement returns than nonusers, which translates into a $193.7 million shareholder gain for an average-sized acquirer. In addition, we find that acquirers with hedging programmes have higher deal completion probabilities, longer deal completion times, and better long-term post-deal performance. We confirm our findings after employing an extensive array of models to address potential endogeneity. Overall, our results provide new insights into a link between corporate financial hedging and firm performance.
Keywords:Cross-border M&As; risk management; financial derivatives
JEL Classification: F31; G13; G32; G34
Relationship Lending and Firms Leverage: Empirical Evidence in Europe
Roberto Guida and Valentina Sabato
Using a novel measure of relationship lending based on the kind of information banks use to assess borrowers, we investigate the role of relationship lending in firms’ capital structure. Using a unique dataset of European manufacturing firms, we measure relationship lending based on three dimensions (closeness, soft information, exclusivity) and relate them to firms’ leverage. Overall our results support the hypothesis that supply factors matter. We find that the actual use of soft information increases leverage and only firms without soft information-intensive relationships increase their leverage through multiple relationships. However, the effect of relationship lending on leverage varies across countries.
Keywords:relationship lending; soft information; capital structure; leverage; financial systems
JEL Classification: D45, G15, G21, G32
Innovation-Related Diversification and Firm Value
Zhao Rong and Sheng Xiao
We examine a novel determinant of corporate diversification and its valuation effect: corporate innovations. We find consistent evidence that corporate innovations increase the extent of diversification. To establish causality, we estimate the firm fixed effect, 2SLS and GMM models. The 2SLS model uses the U.S. state-level R&D tax credits as an instrumental variable for corporate innovations. We also find that a firm is more likely to diversify into an industry where it has more applicable innovations. Further, such innovation-related diversification is associated with significantly higher firm value. Our results are robust to various measures of corporate innovations.
Keywords:innovation; diversification; firm value
JEL Classification: G34; O32
Tax Havens, Tax Evasion and Tax Information Exchange Agreements in the OECD
David M. Kemme, Bhavik Parikh, and Tanja Steigner
Using data on Foreign Portfolio Investment (FPI), we find a positive relationship between higher tax burden and OECD residents’ tax evasion, especially via tax havens. Contrary to established investor preference for certain country characteristics, we find they are less important to tax evaders who value privacy and want to remain undetected by their home tax authorities. We find very limited evidence that OECD Tax Information Exchange Agreements (TIEAS) reduce tax evasion, controlling for other determinants of overall OECD FPI. Without the US in the OECD sample, tax havens play a lesser role and OECD policies appear to make marginal impact.
Keywords:Tax Haven, Tax Evasion, Foreign Portfolio Investment, Tax Information Exchange Agreements, OECD
JEL Classification: F38, G38, H26
How to Manage Long-term Financial Self-sufficiency of National Catastrophe Insurance Fund? The Feasibility of Three Bailout Programs
Jo-Yu Wang, Yang-Che Wu, Wen-Lin Wu, and Ming Jing Yang
This paper shows the feasibility that a natural catastrophe insurance fund (NCIF) may achieve financial self-sufficiency via three bailout programs, including pre-funding, loan-financing and equity-financing, to support the insurer during bad years. Under such programs, different accounting procedures of insurer and NCIF are developed to simulate their 30-year cash flows based on best-fitting loss model calibrated by global insured loss data. The numerical analysis indicates proposed programs can balance the financial revenue and expenditure of NCIF in the long term, and this conclusion implies the authority can develop similar scheme as NCIF to smooth the peak risk of natural catastrophes.
Keywords:natural catastrophe insurance fund, pre-funding bailout program, loan-financing bailout program, equity-financing bailout program
JEL Classification: G32; G11; C15
An Examination of European Firms Derivatives Usage: The Importance of Model Selection
Anthony Carroll, Fergal O'Brien, and James Ryan
This paper investigates the determinants of foreign currency (FX) and interest rate (IR) derivatives usage for European non-financial firms. We employ a Tobit model and a two-part model which allows the determinants of the usage decision to differ from the extent of usage decision. We find FX derivatives usage is motivated by economies of scale and FX exposure, while IR derivatives usage is motivated by the magnitude and nature of firms’ debt. We also find that for IR derivatives the determinants of the usage decision differ from the determinants of the extent of usage decision.
Keywords:foreign exchange exposure, interest rate exposure, hedging policies
JEL Classification: G32
Retail Investor Attention and IPO Valuation
Hugh M. J. Colaco, Amedeo De Cesari, and Shantaram P. Hegde
Given restrictions placed on communication with prospective investors, retail investor attention can help firms/underwriters with the task of initially valuing an IPO. Using Google search volume to proxy for retail investor attention, we find that the presence of and an increase in retail attention following initial filing but prior to initial pricing are positively related to initial valuations. Our results are robust to alternative matching methods to identify our matched sample of non-IPO firms and to including several controls for institutional demand. We conclude that retail investor attention plays a critical role in the early stages of IPO valuation.
Keywords: initial public offering; equity valuation; retail investor; investor attention
JEL Classification: G30; G32
Conservative Accounting, IFRS Convergence and Cash Dividend Payments: Evidence from China
William Bradford, Chao Chen, and Song Zhu
We investigate the governance role of conservative accounting in mitigating the creditor-stockholder conflict by affecting firms’ dividend policies, and how the convergence to International Financial Reporting Standards (IFRS) affects the governance role of conservative accounting as it relates to dividend policy. We analyze data on Chinese listed firms from 2000 through 2011. The use of conservative accounting reduced cash dividend payouts, thereby playing a governance role by mitigating the firm’s creditor-stockholder agency conflict. However, China’s convergence to IFRS reduced the governance role of conservative accounting on dividend policy by reducing the accounting conservatism of listed firms in China.
Keywords:Accounting Conservatism; Mandatory IFRS adoption; Cash Dividend Policy
Extreme Returns in the European Financial Crisis
Andreas Chouliaras and Theoharry Grammatikos
We examine the transmission of financial shocks among the euro-periphery (Portugal, Ireland, Italy, Greece, Spain), the euro-core (Germany, France, the Netherlands, Finland, Belgium), and the major European Union (but not euro) countries (Sweden, the United Kingdom, Poland, the Czech Republic, Denmark). Using extreme returns on daily stock market data from 2004 until 2013, we find transmission effects for the tails of the returns distributions for the pre-crisis, US crisis and euro crisis periods from the euro-periphery to the non-euro and euro-core groups. During the crises, the shocks transmitted were more substantial, indicating significantly higher losses on extreme return days.
Keywords:Financial crisis, financial contagion, spillover, euro crisis, stock markets
JEL Classification: G01, G15
Determinants of Management Earnings Forecasts: The Case of Global Shipping IPOs
Wolfgang Drobetz, Dimitrios Gounopoulos, Andreas Merikas and Anna Merika
Firms that go public on global stock markets are not obliged to disclose earnings forecasts in their prospectuses. We use this fact to examine the shipping industry, where most firms issue earnings forecasts during the IPO process, and thus provide unique, international-level evidence. We find overall pessimistic forecasts of ship owners, primarily because of the industry’s uncer-tain and volatile environment. High ship owner participation after going public is associated with less accurate earnings forecasts. Our results further indicate that financial leverage, a listing in an emerging stock market, and global market conditions are other main factors responsible for in-accurate earnings forecasts.
Keywords:Earnings management, voluntary disclosure environment, forecast accuracy, IPOs
JEL Classification: D82, G14, G32, M41
Does Ownership Structure Matter?
Capital Assets are held in a variety of ownership structures that can be characterized by how they are taxed, whether or not their equity is publicly traded, and by the relationship between the ownership of the assets and the management of the assets. When taxes and regulations change, the popularity of the different ownership structures change. These changes in ownership structure can affect how the assets are managed, which can in turn influence innovation.
Keywords: Corporations, Master Limited Partnerships, Real Estate Investment Trusts, Private Equity, Family businesses
JEL Classification: G31 and G38
CEO Personal Investment Decisions and Firm Risk
Wei Cen and John A. Doukas
We develop a novel approach of measuring CEO risk preferences, based on the personal allocation of their deferred compensation funds, and find CEOs holding more volatile deferred compensation portfolios lead riskier firms. We also use the 2008 financial crisis as a natural experiment to check the robustness of this new approach and find consistent evidence in support of a positive association between CEO risk-taking and firm risk. Moreover, the evidence shows that risk-taking CEOs pursue risky financial and investment policies. Our results, in accord with the behavioral consistency theory, demonstrate that CEOs act consistently across personal and professional choices.
Keywords: CEO Risk preferences; Firm risk; CEO Deferred compensation; Inside debt; Financial Crisis
JEL Classification: G30; G32; G34; M52
Cold Case File? Inventory Risk and Information Sharing during the pre-1997 Nasdaq Preopening
This paper shows that dealers in OTC markets might choose to share information about transient price pressures. Using data from the pre-1997 NASDAQ preopening, I find that the frequency and magnitude of non-positive spreads (the information-sharing vehicle) initiated by wholesalers (specialized marketmakers with a high exposure to inventory risk) are strongly related to opening price reversals and daily rading imbalances. This activity is more likely to occur on days of large liquidity shocks, and it is not observed for other dealers. Overall, the obligation to absorb price pressure at a yet unknown opening price might induce dealers to communicate the direction in which the opening price should move. The findings contain lessons for the design of today's OTC markets.
Keywords: OTC markets, Preopen, NASDAQ, Information Sharing, Price Reversals
JEL Classification: G12, G14, D82
How Useful is Basel III"s Liquidity Coverage Ratio? Evidence from U.S. Bank Holding Companies?
This paper approximates a construction of Basel III’s Liquidity Coverage Ratio (LCR) for U.S. bank holding companies. This study examines (i) the LCR’s marginal contribution to a firm’s systemic risk and (ii) whether the LCR can predict ex ante which banks are most exposed to systemic losses in a true systemic event. Panel regressions from 2002 to 2015 show that the LCR is associated with lower relative systemic risk, measured by ΔCoVaR, as proposed by Adrian and Brunnermeier (2016). The LCR may be used conjunctively with marginal expected shortfall to predict a firm’s systemic losses during the crisis of 2007-2008.
Keywords: Financial crisis; Banking; Systemic risk; Liquidity coverage ratio
JEL Classification: G01; G10; G18; G21
Maximum Diversication Strategies Along Commodity Risk Factors
Simone Bernardiy, Markus Leippoldz and Harald Lohrex
Pursuing risk-based allocation across a universe of commodity assets, we nd diversi ed risk parity (DRP) strategies to provide convincing results. DRP strives for maximum diversi cation along uncorrelated risk sources. A straightforward way to derive uncorrelated risk sources relies on principal components analysis (PCA). While the ensuing statistical factors can be associated with commodity sector bets, the corresponding DRP strategy entails excessive turnover because of the instability of the PCA factors. We suggest an alternative design of the DRP strategy relative to common commodity risk factors that implicitly allows for a uniform exposure to commodity risk premia.
Keywords: Commodity Strategies, Risk-Based Portfolio Construction, Risk Parity, Diversi - cation
JEL Classification: G11; D81
Do Managerial Practices Matter in Innovation and Firm Performance Relation? New Evidence from the UK
Ilayda Nemlioglu and Sushanta Mallick
Keywords: firm performance, firm profitability, financial crisis, leverage, intangible assets, R&D intensity, innovation, managerial practices, panel data models
JEL Classification: JEL-codes: G01 (financial crisis), G1 (general financial markets), G3 (corporate finance), O3 (innovation, R&D and technological change, intellectual property rights), O32 (management of technological innovation and R&D), O34 (intellectual property& intellectual capital), C33 (panel data models)
Market-based Estimates of Implicit Government Guarantees in European Financial Institutions
I exploit the price differential of credit default swap (CDS) contracts written on debts with different levels of seniority to measure the implicit government guarantees enjoyed by European financial institutions from 2005 to 2013. I determine that the aggregate guarantee increases substantially during the recent financial crises and peaks at an average of 89 bps in 2011. My analysis suggests that the extent of implicit support depends on the type of financial institutions and there exists a Eurozone effect. Further investigation of feedback relationship shows that the guarantee implicitly offered by a government positively “Granger causes” the sovereign’s default risk.
Keywords:Credit default swap, financial crisis, financial institutions, implicit government guarantees, too-big-to-fail
JEL Classification: G01, G21, G28
The Contagion versus Interdependence Controversy between Hedge Funds and Equity Markets
Tae Yoon Kim and Hee Soo Lee
This study considers the ‘contagion versus interdependence’ controversy between hedge funds and equity markets. We find that contagion effects break down the established interdependence between them and conditional return smoothing could play a key role in the contagion process by increasing or decreasing the contagion likelihood during crisis and prosperity. It is noted that the return smoothing tends to produce a biased pattern of returns during crisis and a decreased amount of return during prosperity. These findings are obtained by linking single equation error correction model to factor model and carrying out quantile regression, Z-test and Wald–Wolfowitz runs test.
Keywords:hedge funds; contagion; interdependence; conditional return smoothing, single equation error correction model; factor model
JEL Classification: G01, C22, C58
The Manipulation Potential of Libor and Euribor
Alexander Eisl, Rainer Jankowitsch, and Marti G. Subrahmanyam
The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate (Euribor) are two key benchmark interest rates used in a plethora of financial contracts. The integrity of the rate-setting processes has been under intense scrutiny since 2007. We analyze Libor and Euribor submissions by the individual banks and shed light on the underlying manipulation potential for the actual and several alternative rate-setting procedures. We find that such alternative fixings could significantly reduce the effect of manipulation. We also explore related issues such as the sample size and the particular questions asked of the banks in the rate-setting process.
Keywords:Money markets, Libor, Euribor, manipulation, collusion
JEL Classification: G01, G14, G18
Asset Pricing Puzzles in an OLG Economy with Generalized Preferences
Amadeu DaSilva and Mira Farka
Liquidity Risk and Volatility Risk in Credit Spread Models: a Unified Approach
Stylianos Perrakis and Rui Zhong
We present an integrated framework incorporating both exogenous liquidity risk in the secondary corporate bond market and volatility risk in the dynamics of asset value in debt rollover models. Using an innovative theoretical approach we derive general expressions for the debt and equity values in all cases.Taking advantage of the analytical expressions for the asset value with the constant elasticity of variance (CEV) process, we show numerically using realistic parameter values from empirical studies that volatility risk, together with deteriorating bond market liquidity, decrease both debt and equity values and increase significantly the credit spreads.
Keywords: liquidity risk, volatility risk, credit risk, structural model
JEL Classification: G12, G13, G32, G3
The Revealed Preference of Sophisticated Investors
Jesse Blocher and Marat Molyboga
Berk and van Binsbergen (2016) have shown that the Capital Asset Pricing Model (CAPM) best represents the revealed preferences of any investor who can invest in mutual funds (i.e., all investors). This claim seems overly broad, as it applies to all asset classes. However, we show that hedge fund investors’ revealed preferences are also best modeled by the CAPM. Because hedge fund investors are sophisticated and can access all assets classes, our finding supports this broad claim. Using the CAPM is rational, as we show that CAPM alpha correlates with managerial skill and predicts performance better than other multi-factor models.
Keywords: Investor Preferences, Benchmarks, Capital Asset Pricing Model, Return Predictability
JEL Classification: G12, G14, G23