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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 9%. 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.


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EFM in the NEWS


European Financial Management, VOL 7:1, March 2001
European Financial Management, VOL 7:2, June 2001
European Financial Management, VOL 7:3, September 2001
European Financial Management, VOL 7:4, December 2001
European Financial Management, VOL 8:1, March 2002
European Financial Management, VOL 8:2, June 2002
European Financial Management, VOL 8:3, September 2002
European Financial Management, VOL 8:4, December 2002
European Financial Management, VOL 9:1, March 2003
European Financial Management, VOL 9:2, June 2003
European Financial Management, VOL 9:3, September 2003
European Financial Management, VOL 9:4, December 2003
European Financial Management, VOL 10:1, March 2004
European Financial Management, VOL 10:2, June 2004
European Financial Management, VOL 10:3, September 2004
European Financial Management, VOL 10:4, December 2004
European Financial Management, VOL 11:1, January 2005
European Financial Management, VOL 11:2, March 2005
European Financial Management, VOL 11:3, June 2005
European Financial Management, VOL 11:4, September 2005
European Financial Management, VOL 11:5, November 2005
European Financial Management, VOL 12:1, January 2006
European Financial Management, VOL 12:2, March 2006
European Financial Management, VOL 12:3, June 2006
European Financial Management, VOL 12:4, September 2006
European Financial Management, VOL 12:5, November 2006
European Financial Management, VOL 13:1, January 2007
European Financial Management, VOL 13:2, March 2007
European Financial Management, VOL 13:3, June 2007
European Financial Management, VOL 13:4, September 2007
European Financial Management, VOL 13:5, November 2007
European Financial Management, VOL 14:1, January 2008
European Financial Management, VOL 14:2, March 2008
European Financial Management, VOL 14:3, June 2008
European Financial Management, VOL 14:4, September 2008
European Financial Management, Newly Accepted Papers



European Financial Management, VOL 7:1 March 2001

Efficiency in the pricing of the FTSE 100 futures contract
Joelle Miffre
ISMA Centre, The University of Reading, Reading, Berks. UK

Abstract
This paper studies the pricing efficiency in the FTSE 100 futures contract by linking the predictable movements in futures returns to the time-varying risk and risk premia associated with prespecified factors. The results indicate that the predictability of the FTSE 100 futures returns is consistent with a conditional multifactor model with time-varying moments. The dynamics of the factor risk premia, combined with the variation in the betas, capture most of the predictable variance of returns, leaving little variation to be explained in terms of market inefficiency. Hence the predictive power of the instruments does not justify a rejection of market efficiency.

Keywords:FTSE 100 Futures Contract, Efficiency, Time-varying Risk, Risk Premia.

JEL: G12, G13, G14


European Financial Management, VOL 7:1 March 2001

The Pricing of French Unit Seasoned Equity Offerings
Pierre Chollet and Edith Ginglinger
IAE, Université de Tours, Tours cedex 3, France
ESA, IRG, Université Paris XII, Créteil, France

Abstract.
Units are bundles of common stock and warrants. By issuing units, firms precommit to a future and uncertain seasoned offering at the exercise price of the warrants. This study shows that the issuance of units seasoned offerings in France is accompanied by significant abnormal returns of on average 9 to 12%, depending on the computing methods. Underpricing increases with the risk of the issuer and the relative size of the future seasoned equity issue linked to warrant exercises. Our results are consistent with our signaling hypothesis.

Keywords:Units, Warrants, Seasoned Equity Offerings, Underpricing, Signaling

JEL: G14, G32


European Financial Management, VOL 7:1 March 2001

Competition and Integration Among Stock Exchanges in Europe: Network Effects, Implicit Mergers and Regulatory Considerations
Carmine Di Noia
Divisione Mercati, Commissione Nazionale per le Societa e la Borsa (CONSOB) Roma, Italy

Abstract
The economic theory of network externalities and a simple-game theoretical framework are used to explore the issue of competition among stock exchanges and the possibility of consolidation in the European stock-exchange industry, among the different exchanges. The main features of this paper are the following: the treatment of exchanges as firms; the application of network externalities to study competition among exchanges; the extension of network externalities, through implementing ``cross-network'' effects; and the existence of equilibria where exchanges may decide, even unilaterally, to achieve full compatibility through implicit mergers and remote access, specializing only in trading or listing services. One implication is that consolidation of European exchanges into one may occur with a welfare-efficient outcome or with a lock-in to a Pareto-inferior equilibrium. This is due to the network externalities and the different starting points of the various exchanges. ``Implicit mergers'' among exchanges together with remote access are always weakly (in half of the cases, strictly) more efficient than the actual competition. This finding also sheds light on the existence and efficacy, especially in the U.S., of automated trading systems, which are exchanges specializing in trading services.

Keywords:Securities Exchanges, Competition, Implicit Merger, Network Effect, Remote Access

JEL: C71, D43, F36, G15


European Financial Management, VOL 7:1 March 2001

Improving Portfolio Performance with Option Strategies: Evidence from Switzerland
Dusan Isakov and Bernard Morard
HEC, University of Geneva, Switzerland
HEC, University of Geneva, Switzerland

Abstract
This paper investigates the performance of a global investment strategy that combines diversification and option strategies, in particular the covered call strategy, on the Swiss Exchange over the epriod 1989-1996. As the return distributions of portfolios including options are possibly non-normal, the mean-variance framework may not be appropriate to assess the relative performance of such portfolios. Stochastic dominance and modified betas are the alternative approaches, robust to departure from normality, used in this paper to compare the performance of portfolios. The results show that the use of option strategies consistently improves the performance of stock portfolios, even in the presence of transaction costs.

Keywords:Covered Call Options, Portfolio Management, Stochastic Dominance

JEL: G11, G13


European Financial Management, VOL 7:1 March 2001

Stock Exchange Reforms and Market Efficiency: The Italian Evidence
Giovanni Majnoni and Massimo Massa
Banca d'Italia, Research Department, Italy
INSEAD, France

Abstract
This paper examines whether the reforms introduced by the Italian Stock Exchange from 1991 to 1994 (creation of specialised intermediaries, obligation to trade on the official markets, screen-based trading and cash settlement) did increase market efficiency. The issue is addressed using both the traditional information efficiency model, which tests market efficiency by verifying the predictability of prices conditional on some information subset and a microstructure approach that measures efficiency as the distance of the price movements from their efficient components, represented by a random walk process. The joint analysis of daily and intraday data on prices and volumes validates the hypothesis that most of the reforms have increased market efficiency over the sample period, except for cash settlement, which appears to have substantially reduced it.

Keywords:Stock Market, Informational Efficiency, Trading Systems

JEL: G14


European Financial Management, VOL 7:1 March 2001

PROFESSIONAL FORUM

Efficiency Barriers to the Consolidation of the European Financial Services Industry
Allen N. Berger, Robert DeYoung, Gregory F. Udell
Board of Governors of the Federal Reserve System and Wharton Financial Institutions Center
Federal Reserve Bank of Chicago
Kelley School of Business, Indiana University

Abstract
Cross-border consolidation of financial institutions within Europe has been relatively limited, possibly reflecting efficiency barriers to operating across borders, including distance; differences in language, culture, currency and regulatory/supervisory structures; and explicit or implicit rules against foreign competitors. EU policies such as the Single Market Programme and European Monetary Union attenuate some but not all of these barriers. The evidence is consistent with the hypothesis that these barriers offset most of any potential efficiency gains from cross-border consolidation. Banks headquartered in other EU nations have slightly lower average measured efficiency than domestic banks and non-EU-based foreign banks.

Keywords: Banks, Mergers, Efficiency, Europe, Financial institutions.

JEL: G21, G22, G24, G28, G34, F23





European Financial Management, VOL 7:2 June 2001

Identifying The Risk Structure of Mutual Fund Returns
Martin J. Gruber
Stern School of Business, NYU

Keynote Address at the European Financial Management Association 2000 Annual Meetings, Athens, Greece, June 2000.

Keywords: Mutual Fund Returns; Risk; Benchmarks and Indexes; Asset Management; Performance Measures

JELClassification : G11, G12



European Financial Management,VOL 7:2 June 2001

The Structure of Banking Systems in Developed and Transition Economies
DwightJaffee and Mark Levonian
Haas School of Business, University of California, Berkeley, USA
Visiting Scholar, Federal Reserve Bank of San Francisco, USA

Abstract
The paper empirically analyzes the determinants of banking system structure (as measured by bank assets, number, branches and employees) for 26 developed OECD countries.  The estimated regressions are then applied to 23 transition economies, to obtain benchmarks for the efficient structure of their banking systems.  The actual and benchmark measures of banking structure are compared to evaluate the state of banking system development, including the computation of a measure of "banking system convergence". The results are objective and replicable multidimensional measures of banking system development for the transition economies.

Keywords: Banks, Banking systems, Banking structure, Transition economies, Developing Economies

JEL Classification: G21, O16, P34



European Financial Management,VOL 7:2 June 2001

Paying for Minimum Interest Rate Guarantees: Who Should Compensate Who?
Bjarne A. Jensen and Carsten Sorensen

Abstract
Defined contribution pension schemes and life insurance contracts often have a mandatory minimum interest rate guarantee as an integrated part of the contract. This guarantee is an embedded put option issued by the institution to the individual, who is forced to hold the option in the portfolio. However, taking the inability to short this saving and other institutional restrictions into account the individual may actually face a restriction on the feasible set of portfolio choices, hence be better off without such guarantees. We measure the effect of the minimum interest guarantee constraint through the wealth equivalent and show that guarantees may induce a significant utility loss for relatively risk tolerant investors. We also consider the case with heterogenous investors sharing a common portfolio. Investors with different risk attitudes will experience a loss of utility by being forced to share a common portfolio. However, the relatively risk averse investors are partly compensated by the minimum interest rate guarantee, whereas the relatively risk tolerant investors are suffering a further utility loss.

Keywords:Minimum interest rate guarantee, asset allocation restrictions, utility loss, wealth equivalent, heterogenous investors.

JEL Classification: G11,G13



European Financial Management,VOL 7:2 June 2001

European Managerial Perceptions of the Net Benefits of Foreign Stock Listings
Franck Bancel and Usha R. Mittoo
ESCP-EAP, France
University of Manitoba, Canada

Abstract
This study surveys the European managers on the costs, benefits and net benefits of foreign listing. Increase in prestige and visibility and growth in shareholders are perceived as the major benefits and the costs of public relations and legal fees are cited as the major costs by the managers. While a majority of managers (60 percent) perceive that benefits outweigh the costs of foreign listing, about 30 percent also view the net benefits to be negative. Perceived net benefits are positively related to the increase in the total trading volume after foreign listing, the financial disclosure levels of the firm and the dual listing on both the U.S. and European foreign exchanges. Without the influence of these factors, the perceived net benefits are negative.

Keywords: Foreign listing, European Managers, survey, costs and benefits

JEL Classification: G15, G30, G39



European Financial Management,VOL 7:2 June 2001

Shareholder Wealth Effects of Corporate Selloffs: Impact of Growth Opportunities,Economic Cycle and Bargaining Power
George Alexandrou and Sudi Sudarsanam
University of Essex, UK
Cranfield University School of Management, UK

Abstract
Most of the existing empirical evidence on corporate selloffs documents significant wealth gains for the seller’s shareholders. We investigate the sources of these wealth gains by examining the impact of business and financial strategy, the economic environment during selloff, the bargaining advantages of the seller including information asymmetry. We find evidence that sellers with growth opportunities and financially strong sellers enjoy higher returns. Selloffs during recessions generate larger wealth gains than those during economic boom. Information asymmetry due to the buyer’s location being different from the purchased division’s gives the seller a bargaining advantage leading to larger wealth gains. Relatively large divestments are more beneficial to seller shareholders than small ones. The study highlights the importance of both firm specific and environmental factors in explaining the wealth gains associated with corporate selloffs.

Keywords: Selloffs, business strategy, financial distress, economic environment and information asymmetry

JEL Classification:



European Financial Management,VOL 7:2 June 2001

The Effects of Liberalization on Market and Currency Risk In The European Union
Francesca Carrieri
Faculty of Management, McGill University, Canada

Abstract
This paper investigates the effects of liberalization on the pricing of market and currency risk for a number of financial markets in the European Union(EU). An International Asset Pricing Model with a multivariate GARCH-in-Mean specification and time-varying prices of risk is used for the four markets with the largest capitalization in the EU. Only one price of market risk exists and international investors are rewarded for their exposure to currency risk. The evidence shows that all prices of risk are time-varying and have been decreasing during the process of liberalization. There is also evidence that markets react to period of uncertainty in the process toward the completion of liberalization. In addition, the operation of the European Monetary System has generated lower covariances. As a consequence, total risk premia have declined in the last decade.

Keywords: International Asset Pricing, Currency Risk, Liberalization, European Union

JEL Classification: G12, G15





European Financial Management, VOL 7:3 September 2001

Value Maximization, Stakeholder Theory and the Corporate Objective Function
Michael Jensen (Mjensen@hbs.edu)
Harvard Business School,

Abstract.
This paper examines the role of the corporate objective function  productivity and efficiency,social welfare ,and the accountability of managers and directors.I argue that since it is logically impossible to maximize in more than one dimension,purposeful behavior requires a single valued objective function.Two hundred years of work in economics and finance implies that in the abscence of externalities and monopoly(and when all goods are priced),social welfare is maximized when each firm in an economy maximizes its total market value.Total value is not just the value of the equity but also includes the market values of all other financial claims including debt,preferred stock  and warrants.
           Stakeholders theory argues that managers should make decisions so as to take account of all the stakeholders in a firm(including not only financial claimants but also employees,customers,communities,government officials and under some interpratations the environment,terrorists,blackmailers and thieves).Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing intereststhay leave managers with a theory that makes it impossible for them to make purposeful decisions.With no way to keep score,stakeholder theory makes managers unaccountable for their actions.It seems clear that such a theory can be attractive to the selfinterest of managers and directors.
         It takes more than the acceptance of value maximization as the organizational objective to create value.As a statement of corporate purpose or vision,value maximization is not likely to tap into the energy and enthusiasm of employees and managers to create value.Seen in this light,changes in longterm market value becomes the scoreborad that managers,directors  and others use to assess the success or failure of the organization.It must be complemented by the corporate
vision,strategy and tactics that unite participants in the organization in its struggle for survival and dominance in its competitive arena.
     Since a firm cannot maximize value if it ignores the interests of its stakeholders,enlightened value maximization can utilize much of the structure of stakeholder theory by accepting longterm maximization of the value of the firm as the criterion for making the requisite tradeoffs among its stakeholders,managers, directors,strategists and management scientisits can benefit from enlightened stakeholder theory as well.enlightened stakeholder specifies value maximization or value seeking as the firm's objective and therefore resolves the logical problems that cause traditional stakeholder theory to fail as a guide to corporate action.

Keywords: Value Maximization; Stakeholder Theory; Balanced Scorecard; Multiple Objectives; Social Welfare; Social Responsibility; Corporate Objective Function; Corporate Purpose; Tradeoffs; Corporate Governance; Strategy; Special Interest Groups

JEL Classification: G3, G30, G32



European Financial Management,VOL 7:3 September 2001

Agency Costs and Strategic Considerations behind Sell-offs: The UK Evidence
Kevin M.J. Kaiser and Aris Stouraitis
McKinsey & Co, Paris, France
Department of Economics and Finance, City University of Hong Kong,Hong Kong

Abstract.
We analyse the impact of the motivation behind the sell-off and the use of the proceeds from the sale on the value of UK firms divesting assets during 1984-1994. Our findings suggest that managers do not create value when they divest assets in order to raise cash, in order to reshuffle assets without increasing corporate focus and when they do not announce the motivation behind the transaction. In contrast, we find value increases for firms refocusing during the 1990s and for firms divesting loss-making assets for operational reasons. Returning the proceeds from the sale yo shareholders or reducing leverage were also associated with value increases, whereas reinvesting the proceeds for growth had a negative impact during the 1980s, which disappeared after 1990, as a result of disciplinary role of the economic turndown on the investment behaviour of firms.

Keywords:Corporate Structuring, Sell-offs, Agency Costs, Refocusing

JEL Classification: G34, G14



European Financial Management,VOL 7:3 September 2001

Smiles, Bid-Ask Spread and Option Pricing
Ignacio Pena, Gonzalo Rubio and Gregorio Serna
Universidad Carlos III de Madrid, Spain
Universidad del Pais Vasco, Spain
Universidad Carlos III de Madrid, Spain

Abstract.
Given the evidence provided by Longstaff (1995) and Pena, Rubio and Serna (1999) a serious candidate to explain the pronounced pattern of volatility estimates across exercise prices might be related to liquidity costs. Using all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-35 index futures from January 1994 to October 1998 we extend previous papers to study the influence of liquidity costs, as proxied by the relative bid-ask spread, on the pricing of options. Surprisingly, alternative parametric option pricing models incorporating the bid-ask spread seem to perform poorly relative to Black-Scholes.

Keywords:Smiles, Bid-Ask Spread, Implied Volatility Function, Option Pricing

JEL Classification: G12, G13



European Financial Management,VOL 7:3 September 2001

Belgian Intragroup Relations and the Determinants of Corporate Liquid Reserves
Marc Deloof
Faculty of Applied Economics, University of Antwerp - UFSIA, Belgium

Abstract.
The determinants of liquid reserves are investigated for a sample of 1038 large Belgian non-financial firms in the 1992-1994 period. The results confirm the hypothesis that the terms of payment of intragroup claims can be adjusted to the firm’s liquidity needs, thereby reducing the need for liquid reserves. Furthermore, the results confirm the transaction motive for holding liquid reserves, but only partially confirm the precautionary motive Finally, the results indicate that liquid reserves play a significant role in the financing of new investments, as predicted by the pecking order model of Myers and Majluf (1984).

Keywords:Liquid Reserves, Corporate Groups, Pecking Order

JEL Classification: G31, G32



European Financial Management,VOL 7:3 September 2001

Decomposing and Testing Long-Run Returns With An Application to Initial Public Offerings in Denmark
Jan Jakobsen and Ole Sorensen
Department of Finance, Copenhagen Business School, Denmark
Department of Accounting and Auditing, Copenhagen Business School, Denmark

Abstract.
An improved method for measuring and testing long-run returns is proposed. The method adjusts for the right-skewed distribution of long-run buy-and-hold returns by decomposing average cross-sectional buy-and-hold returns into mean components and volatility components. The method is applied to initial public offerings in Denmark. The mean component under performance of initial public offering stocks compared to the market is 30 percent and significant after five years. Comparing to matching firms, the underperformance of IPO stocks is 13 percent after five years but insignificant.

Keywords: Initial Public Offerings; Long-Run Returns; Right Skewed Distributions

JEL Classification: G14, G32



European Financial Management,VOL 7:3 September 2001

PROFESSIONAL FORUM

The Impact of the Introduction of the Euro on Foreign Exchange Risk Management in UK Multinational Companies

Eilidh Christie and Andrew Marshall
Arthur Anderson, Glasgow and the Department of Accounting and Finance, University of Strathclyde,UK
Department of Accounting and Finance, Curran Building, Glasgow ,Scotland,UK

Abstract
One of the arguments in favour of the euro is that it will eliminate foreign exchange risk for companies in the euro-zone. There could also be benefits for companies outside this zone, although their currency risk with the euro remains. This paper considers this, by examining the effect of the euro on the currency risk management of UK multinational companies (MNCs). Using the responses from a questionnaire and interviews we found that the euro, which is being widely used in UK MNCs, is generally favoured due to reductions in exchange uncertainty and costs of managing currency risk. Nonetheless, contrary to what would theoretically be expected, there was no exact relationship in the reduction in hedging activity accompanied by this reduction in risk. The majority of MNCs stated that their hedging activities would remain unchanged. The capacity of MNCs to benefit from reductions in risk and hedging depend on the proportion of non-UK European trade, the industry sector and the ability to transfer risk down the supply chain. Finally, despite the reductions in currency exposure experienced by the majority of companies the euro will not encourage UK MNCs to expand international trade.

Keywords: Euro, foreign exchange risk management.

JEL Classification : F23; F31





European Financial Management, VOL 7:4 December 2001

The Emerging Role of the European Commission
in Merger and Acquisition Monitoring:The Boeing / Mc Donnell Douglas Case

Nihat Aktas,Eric de Bodt,Michel Levasseur and André Schmitt
Institut d’Administration et de Gestion, Université Catholique de Louvain,Belgium
Institut d’Administration et de Gestion, Université Catholique de Louvain,Belgium  and Ecole Supérieure des Affaires, Université de Lille , France
Institut d’Administration et de Gestion, Université Catholique de Louvain,Belgium  and Ecole Supérieure des Affaires, Université de Lille , France
Ecole Supérieure des Affaires, Université de Lille , France

Abstract.
The object of this study is to evaluate the consequences of the application of the EEC regulation n°4064/89  to non-European companies. We focus on the Boeing – Mc Donnell Douglas merger case, one of the first non-European mergers considered by the Commission. The analysis of abnormal returns on the two securities shows that the threat of a ban of the merger by the Commission were not perceived as credible at first. But when Boeing decided to ask the support of the American government, just after the decision of the European Commission to extend its investigations to the long term exclusivity contracts, the role of the Commission emerged.

Key words: mergers and acquisitions, regulation costs, concentration control, event studies

JEL Classification : G14; G18; G34



European Financial Management, VOL 7:4 December 2001

Why do firms raise foreign currency denominated debt?Evidence from Finland

Matti Keloharju and Mervi Niskanen
Helsinki School of Economics and Business Administration, Helsinki,Finland
Häme Polytechnic University, Finland

Abstract
This study examines the determinants of the decision to raise currency debt.  The  results  suggest  that  hedging  figures  importantly  in  the currency-of- denomination  decision:  firms  in  which  exports constitute a significant  fraction  of net sales are more likely to raise currency debt.However,  firms  also  tend  to borrow in periods when the nominal interest rate  for  the  loan  currency, relative to other currencies, is lower than usual.   This  is  consistent  with  the currency debt issue decision being affected  by  speculative motives.  Large firms, with a wider access to the international  capital  markets,  are  more  likely  to  borrow  in
foreign currencies than small firms.

Keywords: Currency of denomination, hedging, speculation

JEL classification: F23, G32



European Financial Management, VOL 7:4 December 2001

Simulating the Evolution of the Implied Distribution

George Skiadopoulos and Stewart Hodges
Associate Research Fellow at the Financial Options Research Centre,University of Warwick,UK
Director of the Financial Options Research Centre, Warwick Business School,University of Warwick.UK.

Abstract:
Motivated by the implied stochastic volatility literature (Britten-Jones and Neuberger (1998), Derman and Kani (1997), Ledoit and Santa-Clara (1998)),this paper proposes a new and general method for constructing smile-consistent stochastic volatility models. The method is developed by recognizing that option pricing and hedging can be accomplished via the simulation of the implied risk neutral distribution. We devise an algorithm for the simulation of the implied distribution, when the first two moments change over time. The algorithm can be implemented easily and it is based on an economic interpretation of the concept of mixture of distributions. It
can also be generalized to cases where more complicated forms for the mixture are assumed.

Keywords: Smile-Consistent stochastic volatility models, Implied Distribution, Mixture of Distributions, Simulation.

JEL Classification: G 13



European Financial Management, VOL 7:4 December 2001

What Determines IPO Gross Spreads in Europe?

Sami Torstila
Helsinki School of Economics and Business Administration, Finland

Abstract
This paper examines the behavior of underwriting gross spreads in European IPO markets using a data set of 565 IPOs by European issuers in the period 1986 - 1999. Privatizations have lower gross spreads than other IPOs, other things remaining equal. Gross spreads on European listings by European issuers are significantly lower than on U.S. listings by European issuers, except on the technology stock - oriented EASDAQ and Frankfurt Neuer Markt exchanges. IPOs involving a U.S. bulge bracket underwriter (for joint U.S./Europe listings) or bookbuilding are characterized by relatively higher spreads.

Keywords: initial public offerings, gross spreads, European equity markets

JEL classification: G24, G32



European Financial Management, VOL 7:4 December 2001

Binomial Option Pricing Biases and Inconsistent Implied Volatilities

Brent J. Lekvin and Ashish Tiwari
School of Business and Economics, Michigan Technological University, Houghton, MI,USA
Department of Finance, Henry B. Tippie College of Business Administration, University of Iowa, Iowa City, IA ,USA

Abstract
We evaluate the binomial option pricing methodology (OPM) by examining simulated portfolio strategies. A key aspect of our study involves sampling from the empirical distribution of observed equity returns.  Using a Monte Carlo simulation, we generate equity prices under known volatility and return parameters.  We price American-style put options on the equity and evaluate the risk-adjusted performance of various strategies that require writing put options with different maturities and moneyness characteristics.  The performance of these strategies is compared to an alternative strategy of investing in the underlying equity.  The relative performance of the strategies allows us to identify biases in the binomial OPM leading to the well-known volatility smile.  By adjusting option prices so as to rule out dominated option strategies in a mean-variance context, we are able to reduce the pricing errors of the OPM with respect to option prices obtained from the LIFFE.  Our results suggest that a simple recalibration of inputs may improve binomial OPM performance.

Keywords: option pricing; binomial model; implied volatility; volatility smile

JEL classification: G13





European Financial Management, VOL 8:1 March 2002

Short-Run Returns Arond the Trades of Corporate Insiders on the London Stock Exchange

Sylvain Friederich, Alan Gregory, John Matatko and Ian Tonks
Financial Markets Group, London School of Economics and Universite de Paris - I.
School of Business and Management, University Of Exeter.
Department of Economics, University of Bristol.

Abstract
Previous work examined the long-run profitability of strategies mimicking the trades of company directors in the shares of their own company, as a way of testing for market efficiency. The current paper examines patterns in abnormal returns in the days around these on the London Stock exchange.
We find movements in returns that are consistent with the directors engaging in short-term market timing. We also report that some types of trades have superior predictive content over future returns. In particular, medium-sized trades are more informative for short-term returns than large ones, consistently with Barclay and Warner's(1993) "stealth trading" hypothesis whereby informed traders avoid trading in blocks.
Another contribution of this study is to properly adjust the abnormal return estimates for microstructure (spread) transactions costs using daily bid-ask spread data. On a net basis, we find that abnormal returns all but disappear.

Keywords: market efficiency, corporate insiders, insider trading, informed trading, London Stock Exchange

JEL Classification: G14



European Financial Management, VOL 8:1 March 2002

Backtesting Derivative Portfolios with Filtered Historial Simulation(FHS)

Giovanni Barone-Adesi, Kostas Giannopoulos and Les Vosper
Usi, via Buffi 13, Lugano 6900 Switzerland.
University of Westminster, London, UK
The London Clearing House, Aldgate High Street, London, UK

Abstract
Filtered historical simulation provides the general framework to our backtests of portfolios of derivative securities held by a large sample of financial institutions. We allow for stochastic volatility and exchange rates. Correlations are preserved implicitly by our simulation procedure. Options are repriced at each node. Overall results support the adequacy of our framework, but our VaR numbers are too high for swap portfolios at long horizons and too low for options and futures portfolios at short horizons.

Keywords: Value-at-risk; historical simulation; GARCH.

JEL Classification: G19



European Financial Management, VOL 8:1 March 2002

Estimating Systematic Risk Using Time Varying Distributions

Gregory Koutmos and Johan Knif
Charles F. Dolan School of Business, Fairfield University, Fairfield, CT,06430, USA
Hansen, Swedish School of Business and Economic Administration, P.O.Box#287, FIN-65101, Vasa Finland

Abstract
This article proposes a dynamic vector GARCH model for the estimation of time-varying betas. The model allows the conditional variances and the conditional covariance between individual portfolio returns and market portfolio returns to respond asymmetrically to past innovations depending on their sign. Co variances tend to be higher during market declines. There is substantial time variation in betas but the evidence on beta Asymmetry is mixed. Specifically, in fifty percent of the cases betas are Higher during market declines and for the remaining fifty percent the opposite is true. A time series analysis of estimated time varying betas reveals that they follow stationary mean-reverting processes. The average degree of persistence is approximately four days. It is also found that the static market model overstates non-market or, unsystematic risk by more than ten percent. On the basis of an array of diagnostics it is confirmed that the vector GARCH model provides a richer framework for the analysis of the dynamics of systematic risk.

Keywords: dynamic betas; mean-reversion in betas; asymmetric covariance; time-varying distributions; vector GARCH;

JEL classification: G12, G15



European Financial Management, VOL 8:1 March 2002

European Mutual Fund Performance

Roger Otten and Dennis Bams
Maastricht University and FundPartners, PO BOX 616 6200 MD Maastricht, The Netherlands
Maastricht University and ING Group, PO BOX 616 6200 MD Maastricht, The Netherlands

Abstract
This paper presents an overview of the European mutual fund industry and investigates mutual fund performance using a survivorship bias controlled sample of 506 funds from the 5 most important mutual fund countries. The latter is done using the Carhart (1997) 4-factor asset-pricing model. In addition we investigate whether European fund managers exhibit hot hands, persistence in performance. Finally the influence of fund characteristics on risk-adjusted performance is considered. Our overall results suggest that European mutual funds and especially small cap funds are able to add value, as indicated by their positive after cost alphas. If we add back management fees, 4 out of 5 countries exhibit significant out-performance at an aggregate level. Finally, we detect strong persistence in mean returns for funds investing in the United Kingdom. Our results deviate from most US studies that argue mutual funds under-perform the market by the amount of expenses they charge.

Key words: Mutual Funds, Performance Evaluation, Portfolio Management, Style Analysis

JEL Classification: G12, G20, G23



European Financial Management, VOL 8:1 March 2002

PROFESSIONAL FORUM

The New Basel Capital Accord: Making it Effective with Stronger Market Discipline

Harald Benink and Clas Wihlborg
Rotterdam School of Management, Erasmus University Rotterdam,P.O. Box 1738, 3000 DR Rotterdam, The Netherlands
Department of Finance, Copenhagen Business School, Solbjerg Plads 3, DK-2000 Frederiksberg, Denmark & School of Economics and Commercial Law, Gothenburg University, Sweden

Abstract
In January 2001 the Basel Committee on Banking Supervision proposed a new capital adequacy framework to respond to deficiencies in the 1988 Capital Accord on credit risk. The main elements or “pillars” of the proposal are capital requirements based on the internal risk-ratings of individual banks, expanded and active supervision and information disclosure requirements to enhance market discipline. We discuss the incentive effects of the proposed regulation. In particular, we argue that it provides incentives for banks to develop new ways to evade the intended consequences of the proposed regulation. Supervision alone cannot prevent banks from “gaming and manipulation” of risk-weights based on internal ratings. Furthermore, the proposed third pillar to enhance market discipline of banks’ risk-taking is too weak to achieve its objective. Market discipline can be strengthened by a requirement that banks issue subordinated debt. We propose a first phase for introducing a requirement for large banks to issue subordinated debt as part of the capital requirement.

Key words: asset pricing, general equilibrium, value-at-risk, risk management.

JEL classification: G11, G12






European Financial Management, VOL 8:2, June 2002

Neoclassical Finance, Alternative Financeand the Closed End Fund Puzlle

Stephen A. Ross

Keynote Address at the European Financial Management Association 2001 Annual Meetings, Lugano Switzerland, June 2001.



European Financial Management, VOL 8:2 June 2002

The Effect of VaR Based Risk Management on asset and the Volatility Smile

Arjan Berkelaar, Phornchanok Cumperayot and Roy Kouwenberg

Abstract
Value-at-Risk (VaR) has become the standard criterion for accessing risk in the financial industry. Given the widespread usage of VaR, it becomes increasingly important to study the effects of VaR based risk management on the prices of stocks and options. We solve a continuous-time asset pricing model, based on Lucas (1978) and Basak and shapiro ( 2001), to investigate these effects. We find that the presence of risk manegements tends to reduce market volatility, as intended. Howeverl, in some cases VaR risk management undesirably raises the probablity of extreme losses. Finally, we demonstrate that option prices in an economy with VaR risk managers display a volatility smile.

Key words: Mutual Funds, Performance Evaluation, Portfolio Management, Style Analysis

JEL classification: G11, G12



European Financial Management, VOL 8:2 June 2002

Board Overlap, Seat Accumulation and Share Prices

Claudio Loderer and Urs Peyer

Abstract
We examine the board overlap among firms listed in Switzerland. Collusion, managerial entrenchment and financial participation cannot explain it. The overlap appears to be induced by banks and by the accumulation of seats by the most popular directors. We also document that seat accumulation is negatively related to firm value, possibly because of the conflicts of interest that multiple directorships induce and the time constraints directors face. Contrary to popular beliefs, however, the directors of traded firms do not generally hold more than one mandate in other traded firms. They do hold multiple seats in nontraded firms.

Key words: Board of Director, Board Overlap, Board Composition, Firm Value

JEL classification: G34



European Financial Management, VOL 8:2 June 2002

Planning Your Own Debt

Soren Nielson and Rolf Poulsen

Abstract
We model the Danish market for mortgage backed securities with a two-factor interest re=ate model and use a stochastic programming approach to analyse now an individual home-owner should initially compose and subsequently readjust his mortgage in an optimal way. Results show that the "rules of thumb" used by financial institutions are reasonable, although best suited formore aggressive mortgagors, for whom the delivery option of some value. More risl-averse investors should also re-adjust frequently, but use more diversified portfilios. Results are insensitive to whether one or two factor model is used, provided the former is suitably calibrated.

Key words: Term structure of interest, mortgage-backed securities, portfolio choice, stochastic programming.

JEL classification: C61, D81, E43, G11, G21



European Financial Management, VOL 8:2 June 2002

Dispersion in Analyst Forecasts and the Profitability of Earnings Momentum Strategies

Andreas Dische

Abstract
This paper shows that the dispersion in analysts' consensus forecasts contains incremental information to predict future stock returns. Consistent with prior research, stock prices in the German market underreact to news about future earnings and drift in the direction suggested by analysts' forecasts revisions. Even higher abnormal returns can be achieved by applying such an earnings momentum strategy to stocks with a low dispersion in analyst forecasts. These results support one of the recent behavioral models in which investors underweight new evidence and conservatively update their beliefs in the right direction, but by too little in magnitude with respect to more objective information.

Keywords: analyst forecasts, dispersion, momentum, underreaction, investor behavior.

JEL classification: G12, G14






European Financial Management, VOL 8:3 September 2002

Performance and Policy of Foundation-Owned Firms in Germany

Markus Herrmann and Gunter Franke

Abstract
This paper compares performance and policy of foundation owned firms and of listed corporations in Germany. Foundations have no owners so that there exist no natural persons with financial ownership claims on firms which are wholly owned by foundations. This suggests weaker outside control of foundation owned firms implying lower profitability. The empirical findings show a slightly better performance of foundation owned firms compared to corporations. Foundation owned firms display higher labor intensity, lower labor productivity and lower salary levels. This policy promotes job security without endangering the viability of foundation owned firms.

Keywords: corporate governance, foundation owned firms, performance, business policy, ownership structure.

JEL Classification: G30 - G33



European Financial Management, VOL 8:3 September 2002

Diversification, Ownership and Control of Swedish Corporations

John A. Doukas, Martin Holmen and Nickolaos G. Travlos*

Abstract
We study the short- and long-term valuation effects of Swedish takeovers. Using a sample of 93 bidding firms that acquired 101 targets between 1980 and 1995, we find that diversifying acquisitions lead to a negative market reaction and deterioration of the operating performance of the bidder. Announcement and performance gains in each of the three years following the acquisition occur only when bidders expand their core than their peripheral lines of business. Our findings suggest that focused acquisitions lead to greater synergies and operating efficiencies than diversifying acquisitions. Intra-group acquisitions, however, show that bidders do not realize significant gains whether they adopt diversifying or focusing investment strategies by purchasing firms controlled by the Wallenberg and SHB conglomerate groups. Intra-group targets realize significant gains regardless bidder’s investment strategy. Finally, the evidence does not support the view that intra-conglomerate acquisitions are associated with expropriation of minority shareholders. However, they appear to enhance the control rights of large shareholders of the bidding firm.

Keywords: Conglomerate and Non-conglomerate Acquisitions; Corporate Focus; Diversification

JEL classification: G34



European Financial Management, VOL 8:3 September 2002

External Financing Costs and Economies of Scale in Investment Banking: The Case of Seasoned Equity Offerings in Germany

Thomas Buhner and Christoph Kaserer

Abstract
This paper is focused on the cost of raising equity capital in Germany. In the spirit of Altinkiliç and Hansen (2000) it challenges the conventional wisdom that flotation costs are characterized by economies of scale.
For a sample of 120 SEOs on the German capital market over the years 1993-1998 it is found that average total flotation costs amount to 1.61 percent of gross proceeds, while average underwriting fees are about 1.32 percent. Moreover, it turns out that flotation costs rise the larger the free float of the company is and the larger the share of stocks offered within a firm commitment cash offering is. As far as the economies of scale view is concerned, we do not find clear evidence in favour of decreasing marginal flotation costs. Moreover, fixed costs seem not to be very high in that they account on average for not more than 14 to 24 percent of total flotation costs or total underwriting fees, respectively.

Keywords: raising capital, seasoned equity offerings, underwriting fees, economies of scale, German stock market

JEL Classification: G24



European Financial Management, VOL 8:3 September 2002

Stock Index-Linked Debt and Shareholder Value: Evidence from the Paris Bourse

Gordon S. Roberts, Vasumathi Vijayraghavan and Sebouh Aintablian

Abstract
French banks and nonfinancial companies issue index-linked debt whose value at maturity is indexed to the CAC 40 or to a basket of European indices. This paper examines stock announcement effects associated with these bonds on three dates: the date the issuer’s General Assembly decides future capital needs, the publication in the journal of the COB (the stock market board) and the issue date. We find the issuance of index-linked debt has significant positive announcement effects on the issue date, which we attribute to its market-completion property. In order to examine further whether market completion is at play, we decompose the value of the bond at issue into its straight bond and option values. We determine that the bonds are overvalued again supporting market completion.

Keywords: announcement effect, index-linked debt, market completion

JEL Classification: G14, G32



European Financial Management, VOL 8:3 September 2002

The Distribution of Information Among Institutional and Retail Investors in IPOs

Matti Keloharju and Sami Torstila

Abstract
This study examines investor performance in IPOs using a unique database comprising 85,384 investors and 29 offerings from Finland. The evidence indicates that on average institutional investors do not obtain larger initial returns than retail investors, as the incentive to acquire information is limited by allocation rules which favour small orders. This result is in contrast to findings by Aggarwal et al. (2001), who show that institutional investors perform better in a bookbuilding environment. Within each investor category, however, large orders are associated with the best performance, suggesting that information differences figure more importantly within rather than between categories.

Key words: IPOs, investment performance, institutional investors, retail investors

JEL classification: G32, G14



European Financial Management, VOL 8:3 September 2002

PROFESSIONAL FORUM

Anatomy of the Eurobond Market 1980-2000

Anouk Claes, Marc J.K. De Ceuster, Ruud Polfliet
University of Antwerp UFSIA, Prinsstraat 13, 2000 Antwerp, Belgium

Abstract
In this paper, we provide descriptive evidence of primary market activity in the Eurobond market for the period 1980-2000. This study explores the Bondware Database that contains 33 024 publicly issued Eurobonds. We analyse some characteristics of the issuers (nationality, industry and credit quality), the intermediary parties (bookrunners, lead managers) and the structures used for the bonds (currencies, size, years to maturity, interest and repayment structure, embedded options).

Keywords: Eurobond market, primary market, Bondware

JEL Classification: G15, G100




European Financial Management, VOL 8:4 December 2002

Competition on the London Stock Exchange

Nicholas Taylor

Abstract
This paper investigates the determinants of the level of competition on the order-driven market organised by the London Stock Exchange. In contrast to previous empirical market microstructure studies, we treat the level of competition as an endogenous variable. The statistical nature of the measures of competitive activity used in this paper necessitate use of a count regression model. Using a sample of 50 stocks, we find that users of the system tend to follow the lead of other users (termed the 'herding effect') and that competition is greater during the period when the US exchanges are open (termed as 'US effect'). In addition, the level of competition is positively related to the bid-ask spread pertaining to a particular stock (termed the 'spread effect'). The latter result is most likely due to traders following a strategy where trade immediacy is traded off against price advantage. Finally, we find that the magnitude of the herding effect, the spread effect and the fit of the count regression models (termed the 'fit effect') vary in a predictable manner across the liquidity of stocks.

Keywords: Count models, competition, limit-orders, liquidity.

JEL Classification: G14; C32



European Financial Management, VOL 8:4 December 2002

The Impact of Macroeconomic and Financial Variables on Market Risk: Evidence from International Equity Returns

Dilip K. Patro, John K. Wald and Yangru Wu*

Abstract
Using a GARCH approach, we estimate a time-varying two-factor international asset pricing model for the weekly equity index returns of 16 OECD countries. We find significant time-variation in the exposure (beta) of country equity index returns to the world market index and in the risk-adjusted excess returns (alpha). We then explain these world market betas and alphas using a number of country-specific macroeconomic and financial variables with a panel approach. We find that several variables including imports, exports, inflation, market capitalization, dividend yields and price-to-book ratios significantly affect a country’s exposure to world market risk. Similar conclusions are obtained by using lagged explanatory variables and thus these variables may be useful as predictors of world market risks. Several variables also significantly impact the risk-adjusted excess returns over this time period. Our results are robust to a number of alternative specifications. We further discuss some economic hypotheses that may explain these relationships.

Keywords: World market risk; Determinants of country risk exposure; Panel estimation

JEL classification: F30, G12



European Financial Management, VOL 8:4 December 2002

Yield Spread and Term to Maturity: Default vs. Liquidity

Antonio Diaz and Eliseo Navarro

Abstract
The aim of this paper is the analysis of the yield spreads between Treasury and non-Treasury Spanish fixed income assets and its relationship with the term to maturity. We find a downward sloping term structure of yield spreads for investment-grade bonds that seems to be contrary to the crisis at maturity theory. However, we claim that this outcome is caused mainly by the effect of liquidity on yield spreads. Once the effect of liquidity and other factors are removed we find that there is a positive relationship between default premiums and term to maturity. That result is now consistent with the existing literature.

Keywords: Corporate bonds; Yield spread; Default risk; Liquidity; Term to maturity market

JEL Classification: G10, E43



European Financial Management, VOL 8:4 December 2002

Valuation Effects of Listing on a More Prominent Segment of the Stock Market

J. F. Bacmann, M. Dubois and C. Ertur

Abstract
We examine the behaviour of stock prices during the period around the transfer to the Marché à Règlement Mensuel. First, we discuss the financial reasons, which can justify abnormal returns around the transfer. Second, an event study based on a sample of 71 firms is set up to test the existence of the exchange listing effect on the French market. Third, we explore three hypotheses in order to explain the impact on stock returns: the informative content of the transfer, the increase in the relative size of the firm’s investor base and the reduction of trading costs (immediacy and adverse selection). Cross-sectional regressions show that the increase in the relative size of the firm’s investor base is the only variable, which helps to explain the valuation effect.

Keywords: Exchange listing, event study, analyst following, liquidity, trading activity, systematic risk, firm’s investor base.

JEL Classification: G12, G14



European Financial Management, VOL 8:4 December 2002

Extracting Information from Options Markets: Smiles, State-Price Densities and Risk-Aversion

Christophe Perignon and Christophe Villa

Abstract
In this paper, recent techniques of estimating implied information from derivatives markets are presented and applied empirically to the French derivatives market. We determine nonparametric implied volatility functions, state-price densities and historical densities from a high-frequency CAC 40 stock index option dataset. Moreover, we construct an estimator of the risk-aversion function implied by the joint observation of the cross-section of option prices and time-series of underlying asset value. We report a decreasing implied volatility curve with the moneyness of the option. The estimated relative risk-aversion functions are positive and globally consistent with the decreasing relative risk-aversion assumption.

Key words: Risk-aversion; state-price density; non-parametric methods

JEL classification: G12, G13, C13



European Financial Management, VOL 8:4 December 2002

PROFESSIONAL FORUM

A Note on the Three-Portfolio Matching Problem

Fabio Trojani, Paolo Vanini and Luigi Vignola

Abstract
A typical problem arising in the financial planning for private investors consists in the fact that the initial investor’s portfolio, the one determined by the consulting process of the financial institution and the universe of instruments made available to the investor have to be matched/optimized when determining the relevant portfolio choice. We call this problem the three-portfolios matching problem. Clearly, the resulting portfolio selection should be as close as possible to the optimal asset allocation determined by the consulting process of the financial institution. However, the transition from the investor’s initial portfolio to the final one is complicated by the presence of transaction costs and some further more specific constraints. Indeed, usually the portfolios under consideration are structured at different aggregation levels, making portfolios comparison and matching more difficult. Further, several investment restrictions have to be satisfied by the final portfolio choice. Finally, the arising portfolio selection process should be sufficiently transparent in order to incorporate the subjective investor’s trade-off between the objectives ’optimal portfolio matching’ and ’minimal portfolio transitbute to its market-completion property. In order to examine further whether market completion is at play, we decompose the value of the bond at issue into its straight bond and option values. We determine that the bonds are overvalued again supporting market completion.

Keywords: announcement effect, index-linked debt, market completion

JEL Classification: G14, G32





European Financial Management, VOL 9:1 March 2003

Passive Investment Strategies and Efficient Markets

Burton Malkiel

Abstract
This paper presents the case for and the evidence in favor of passive investment strategies and examines the major criticisms of the technique. I conclude that the evidence strongly supports passive investment management in all markets? Small-capitalization stocks as well as large-capitalization equities, U.S. markets as well as international markets and bonds as well as stocks. Recent attacks on the efficient market hypothesis do not weaken the case for indexing.

Key words: passive investment strategies; efficient markets

JEL classification: G11, G14


European Financial Management, VOL 9:1 March 2003

What is an Asset Price Bubble? An Operational Definition

Jeremy J. Siegel

Abstract
This paper reviews and analyzes the current definitions of bubbles in asset prices. It makes the case that one cannot identify a bubble immediately, but one has to wait a sufficient amount of time to determine whether the previous prices can be justified by subsequent cash flows. The paper proposes an operational definition of a bubble as any time the realized asset return over given future period is more than two standard deviations from its expected return. Using this framework, the paper shows how the great crash of 1929 and 1987-both periods generally characterized as bubbles-prove not to be bubbles but the low point in stock prices in 1932 is a "negative bubble." The paper then extends this analysis to the internet stocks and concludes that it is virtually certain that it is a bubble.

Key words: asset prices; asset returns; bubbles; internet bubble; irrational exuberance

JEL classification: G12, G14



European Financial Management, VOL 9:1 March 2003

Herd Behavior and Cascading in Capital Markets: A Review and Synthesis

David Hirshleifer and Siew Hong Teoh

Abstract
We review theory and evidence relating to herd behavior, payoff and reputational interactions, social learning and informational cascades in capital markets. We offer a simple taxonomy of effects and evaluate how alternative theories may help explain evidence on the behavior of investors, firms and analysts. We consider both incentives for parties to engage in herding or cascading and the incentives for parties to protect against or take advantage of herding or cascading by others.

Key Words: herd behavior, informational cascades, social learning, analyst herding, capital markets, financial reporting, behavioral finance, investor psychology, market efficiency


European Financial Management, VOL 9:1 March 2003

Contrarian and Momemtum Strategies in the Spanish Stock Market

Carlos Forner and Joaquin Marhuenda

Abstract
There is extensive international evidence that the momentum strategy yields positive abnormal returns when short-term periods are considered, while for long-term periods the contrarian strategy is the effective one. However, this topic has received scarce attention in the Spanish Stock Market. In this paper we show that these two phenomena seem to be present in this marketand concretely, that the 12-month momentum strategy and the 60-month contrarian strategy yield positive abnormal returns, although the effectiveness of the contrarian strategy is under suspicion when non-overlapping test-periods are used. So, this work adds additional evidence that the results obtained for the literature on this topic are not from data snooping.

Keywords: Efficiency, Contrarian Strategy, Momentum Strategy, Risk

JEL classification: G14, G11, G12



European Financial Management, VOL 9:1 March 2003

Post-earnings-announcement Drift in the UK

Weimin Liu, Norman Strong and Xinzhong Xu

Abstract
This paper fills a void in the market efficiency literature by testing for the presence of post-earnings announcement drift in a non-US market. We test for drift using alternative earnings surprise measures based on: (i) the time-series of earnings; (ii) market prices; and (iii) analyst forecasts. Using each of the measures we find evidence of significant post-earnings-announcement drift, robust to alternative controls for risk and market microstructure effects. Using a one-dimensional analysis, the price-based measure of earnings surprise gives the strongest drift and using a two-dimensional analysis the drift associated with the price-based measure almost subsumes drift associated with the other two measures. Our conclusion is that the UK stock market is inefficient with respect to publicly available corporate earnings information. This evidence provides out-of-sample confirmation of the post-earnings-announcement drift documented in the US.

Keywords: Post-earnings-announcement drift; market efficiency, earnings surprises

JEL classification: G14; M41



European Financial Management, VOL 9:1 March 2003

Spanish Stock Returns: Where is the Weather Effect?

Angel Pardo and Enric Valor

Abstract
Psychological studies support the existence of an influence of weather on mood. It could affect the behaviour of market traders, as suggested by some authors, and this should be reflected by the stock returns. This paper investigates the possible relation between weather and market index returns in the context of the Spanish market, in order to test the above hypothesis. In 1989, this market changed its open outcry trading system into a computerised and decentralised trading system. Therefore, it is possible to check the influence of weather variables (sunshine hours and humidity levels) on index returns in an open outcry trading system, and to compare it with a screen traded environment. The empirical evidence indicates that, independently of the trading system, there is no influence of weather on stock prices. Thus, these findings do not contest the notion of efficient market.





European Financial Management, VOL 9:2 June 2003

Keynote Address

Michael Jenson


European Financial Management, VOL 9:2 June 2003

Secured Creditor Recovery rates from Management Buy-outs in Distress

David Citron, Mike Wright, Rod Ball and Fred Rippington

Abstract
Buy-out literature suggests that secured creditors will recoup substantial proportions of the funds they extend to finance the initial buy-out. This paper uses a unique dataset of 42 failed MBOs to examine the extent of credit recovery by secured lenders under UK insolvency proceduresand the factors that influence the extent of this recovery. On average, secured creditors recover 62 per cent of the amount owed. The percentage of secured credit recovered is increased where the distressed buy-outs is sold as a going concern and where the principal reason for failure concerns managerial factors. The presence of a going concern qualification in the audit report and the size of the buy-out reduce the recovery rate by secured creditors.

Keywords: bankruptcy; secured debt; financial distress resolution

JEL Classification: G33; G32


European Financial Management, VOL 9:2 June 2003

The Underinvestment and Overinvestment Hypothesis: An Analysis using Panel Data

Arthur Morgado and Julio Pindado

Abstract
We study the relationship between firm value and investment to test the underinvestment and overinvestment hypotheses. The results obtained, using panel data methodology as the estimation method, indicate that the abovementioned relation is quadratic, whichimplies that thereexists an optimal level of investment. As a consequence, firms that invest less than the optimal level suffer from an underinvestment problem, while those investing more than the optimum suffer from overinvestment. The quadratic relation is maintained when firms are classified depending on their investment opportunities, the optimum being in accordance with the quality of investment opportunities.

Keywords: Firm investment, firm value, underinvestment, overinvestment, investment opportunities.

JEL Classification: G31


European Financial Management, VOL 9:2 June 2003

Dynamic Portfolio Selection: The Relevance of Switching Regimes and Investment Horizon

Andreas Graflund and Birger Nilsson

Abstract
This paper investigates the questions of dynamic portfolio selection and intertemporal hedging within a Markovian regime-switching framework. The investment opportunity set is spanned by a well-diversified home-market portfolio and the risk-free asset. Our results highlight the economic importance of regimes, as optimal portfolio weights are clearly dependent on the prevailing regime. We present evidence that the question of intertemporal hedging is a more complex issue than is hinted in the previous literature, since demand for intertemporal hedging is present in some regimes, but not in others. Finally, our main findings are qualitatively unchanged across the four largest stock markets in the world.

Keywords: intertemporal hedging, dynamic portfolio selection, regime switching

JEL Classification: G11, G15, C15, C32


European Financial Management, VOL 9:2 June 2003

Conditioning Information and European Bond Fund Performance

Maria Ceu Cortez, Florida Silva and Manuel Rocha Armada

Abstract
In this paper we evaluate the performance of European bond funds using unconditional and conditional models. As conditioning information we use variables that we find to be useful in predicting bond returns in the European Market. The results show that, in general, bond funds are not able to outperform passive strategies. These findings are robust to whatever model (unconditional versus conditional and single versus multi-index) we use. The multi-index model seems to add some explanatory power in relation to the single-index model. Furthermore, when we incorporate the predetermined information variables, we can observe a slight tendency towards better performance. This evidence is consistent with previous studies on stock funds and comes in support of the argument that conditional models might allow for a better assessment of performance. However, our results suggest that the impact of additional risk factors seems to be greater than the impact of incorporating predetermined information variables.

Keywords: Performance Evaluation, Conditional Models, Bond Funds

JEL Classification: G11, G12, G14


European Financial Management, VOL 9:2 June 2003

Managerial Equity Ownership and the Demand for Outside Directors

Kenneth V. Peasnell, Peter F. Pope and Steve Young

Abstract
This paper examines the linkage between the use of outside directors and managerial ownership. We conjecture there are two linkages: the standard incentive-alignment demand for monitoring when managers own little stock and an entrenchment-amelioration demand when managerial stock ownership is high. As a consequence, we predict the association between managerial ownership and board composition will be nonlinear (U-shaped if the entrenchment effect is sufficiently pronounced). Using U.K. data, we find that both quadratic and logarithmic models outperform the simple linear relationship assumed in prior research and that the substitution between managerial ownership and board composition is stronger than hitherto supposed.

Keywords: managerial ownership; board of directors; Cadbury Report

JEL Classification: G32; G3


European Financial Management, VOL 9:2 June 2003

PROFESSIONAL FORUM

Simple Construction of the Efficient Frontier

David Feldman and Haim Reisman

Abstract
We provide simple methods of constructing known results. At the core of our methods is the identification of a simple concise basis that spans the Capital Market Line (CML). We show that a portfolio whose risky assets weights are the product of the inverse variance-covariance matrix of (nonredundant) security rates of return times the vector of the excess expected rates of return over the risk-free rate is a CML portfolio. This portfolio and the risk-free security span the CML. In addition, with this basis, there is immediate construction of the efficient frontier of risky assets (the "hyperbola"), "tangency" portfolios, "reflection" portfolios, and a CAPM relationship. Our method is quick and simple. It is easy to derive, teach, implement, interpret, and remember.

Keywords: portfolio frontier, efficient frontier, capital market line, asset pricing

JEL Classification: G10, G11, G12




European Financial Management, VOL 9:3 September 2003

The Impact of Institutional Differences on Derivatives Usage: A Comparative Study of US and Dutch Firms

Gordon M Bobnar, Abe de Jong and Victor Marcae

Abstract
This paper examines the influence of institutional differences on corporate risk management practices in the US and the Netherlands. We compare results to surveys in each country using a strategy that corrects for differences over industry and size classes across the Dutch and US samples. We document several differences in the firms’ uses and attitudes towards derivatives and attempt to attribute them to the differences in the institutional environments between the US and the Netherlands. We find that institutional differences appear to have an important impact on risk management practices and derivatives use across US and Dutch firms.

Keywords: risk management; derivatives; hedging; international finance

JEL classification: F30; G15; G32


European Financial Management, VOL 9:3 September 2003

Incorporating Collateral Value Uncertainty in Loss-Given-Default Estimates and Loan-to-Value Ratios

Esa Jokivuolle and Samu Peura

Abstract
We present a model of risky debt in which collateral value is correlated with the possibility of default. The model is then used to study the expected loss given default, primarily as a function of collateral. The results obtained could prove useful for estimating losses given default in many popular models of credit risk which assume them constant. We also examine the problem of determining sufficient collateral to secure a loan to a desired extent. In addition to bank practitioners, regulators might find our analysis useful in reviewing banks' lending standards relative to current collateral values. In particular, the current proposals for The New (Basel) Capital Accord involve options for the use of banks' own loss given default estimates which might benefit from the analysis in this paper.

Keywords: credit risk, collateral, loss given default, loan-to-value, Basel II

JEL Classification: G13, G21


European Financial Management, VOL 9:3 September 2003

Price Differentials Between Classes of Dual-Class Stocks: Voting Premium or Liquidity Discount?

Robert Neumann

Abstract
A series of papers suggest that private benefits can explain the price differentials between stock classes carrying different voting rights. However, in Denmark the premium is negative for several firms over long periods. This indicates that in the absence of takeover contests, where the voting right becomes crucial in a transfer of corporate control, the price differential in stock classes with identical dividend rights is more likely to reflect investors' liquidity risks. Whereas the existing literature tends to focus primarily on corporate control-related explanations, this paper documents the impact of liquidity on price spreads between dual-class shares.

Keywords: Dual-class shares; voting rights; Liquidity risk; Ownership structure

JEL Classification: G32, G34


European Financial Management, VOL 9:3 September 2003

Strategic Management of Cost efficiencies in Networks: Cross-country Evidence on European Branch Banking

Nayantara D. Hensel

Abstract
This paper examines the role of cost efficiencies on efficient management of branch networks in the contemporary European commercial banking industry. The analysis, which could be generalized to other industries, indicates that larger banks are more likely to have heavily utilized branch networks than smaller banks and to exhibit fewer cost efficiencies from building more branches. The finding of this result within each country suggests the role of internal firm size regardless of competitive conditions. The similar cross-country finding suggests the impact of factors such as market structure/ concentration levels and type of non-price competition. Larger banks often generate less income per unit asset deployed. Cross-border efficiency might be improved by greater use of banks with under-used networks by banks with over-used networks.

Keywords: European banking; cost efficiencies; market structure

JEL Classification: L10, L89, L21, G21, F23, F36


European Financial Management, VOL 9:3 September 2003

Firm Defaults and the Correlation Effect

Hans Gersbach and Alexander Lipponer

Abstract
We examine how the correlations of bank loan defaults depend on the correlations of asset returns and how correlations and diversification are affected by macroeconomic risks. We highlight the main properties of the relationship between asset re-turns and default correlations, illustrating how adverse macroeconomic shocks raise not only the likelihood of defaults, but also the correlation of defaults. The latter effect, called correlation effect, may account for more than 50% of the increase in the credit risk.

Keywords: Credit Portfolio Management, Default Correlations, Macroeconomic Shocks, Correlation Effect, Monte-Carlo Simulation

JEL Classification: F47, G11, G33


European Financial Management, VOL 9:3 September 2003

PROFESSIONAL FORUM

Paying People to Lie: The Truth About the Budgeting Process

Michael C. Jensen

Abstract
This paper analyzes the counterproductive effects associated with using budgets or targets in an organization's performance measurement and compensation systems. Paying people on the basis of how their performance relates to a budget or target causes people to game the system and in doing so to destroy value in two main ways: 1. both superiors and subordinates lie in the formulation of budgets and therefore gut the budgeting process of the critical unbiased information that is required to coordinate the activities of disparate parts of an organization, and 2. they game the realization of the budgets or targets and in doing so destroy value for their organizations. Although most managers and analysts understand that budget gaming is widespread, few understand the huge costs it imposes on organizations and how to lower them.
My purpose in this paper is to explain exactly how this happens and how managers and firms can stop this counterproductive cycle. The key lies not in destroying the budgeting systems, but in changing the way organizations pay people. In particular to stop this highly counterproductive behavior we must stop using budgets or targets in the compensation formulas and promotion systems for employees and managers. This means taking all kinks, discontinuities and non-linearities out of the pay-for-performance profile of each employee and manager. Such purely linear compensation formulas provide no incentives to lie, or to withhold and distort information, or to game the system.
While the evidence on the costs of these systems is not extensive, I believe that solving the problems could easily result in large productivity and value increases?sometimes as much as 50 to 100% improvements in productivity. I believe the less intensive reliance on such budget/target systems is an important cause of the increased productivity of entrepreneurial and LBO firms. Moreover, eliminating budget/target-induced gaming from the management system will eliminate one of the major forces leading to the general loss of integrity in organizations. People are taught to lie in these pervasive budgeting systems because if they tell the truth they often get punished and if they lie they get rewarded. Once taught to lie in this system people generally cannot help but extend that behavior to all sorts of other relationships in the organization.

Keywords: Budgeting, Budgets, Compensation, Performance Measurement, Gaming, Lying, Loss of Integrity, Truthfulness, Sandbagging, Motivation, Productivity, Incentives, Control Systems, Accounting Irregularities, Fraud, Goldbricking, Channel Stuffing, Cooking the Books, Managing Earnings, Managing the Numbers




European Financial Management, VOL 9:4 December 2003

Differences between European and American IPO Markets

Jay R. Ritter

Abstract
This brief survey discusses recent developments in the European initial public offering (IPO) market. The spectacular rise and fall of the Euro NM markets and the growth of bookbuilding as a procedure for pricing and allocating IPOs are two important patterns. Gross spreads are lower and less clustered than in the U.S. Unlike the U.S., some European IPOs, especially those in Germany, have when-issued trading prior to the final setting of the offer price. Current research includes empirical studies on the valuation of IPOs and both theoretical and empirical work on the determinants of short-run underpricing.



European Financial Management, VOL 9:4 December 2003

Choice of Selling Mechanism at the IPO: The Case of the French Second Market

Sigrid Vandemaele

Abstract
This study examines the choice of flotation mechanism within the framework of the French Second Market. Between 1983 and 1996, a firm that opted for a quotation on the Second Market, had the choice between (i) an auction-like procedure (there were two variants) and (ii) a fixed-price introduction procedure. Several interesting results are presented. First, the choice for an auction-like procedure appears to be positively related to firm valuation uncertainty at the IPO. Second, the likelihood of opting for an auction-like procedure decreases as the reputation of the investment bank guiding the flotation increases. Third, the likelihood of opting for an auction is increasing in the number of secondary shares sold by venture capitalists and investment banks.

Keywords: IPO; Contract Choice

JEL Classification: G32



European Financial Management, VOL 9:4 December 2003

Privatization Initial Public Offerings: The Polish Experience

Ranko Jelic and Richard Briston
University of Birmingham, Birmingham Business School, Birmingham, UK

Abstract
The Polish government has preferred gradual direct sales to privatisation initial public offerings (PIPOs) by a 2.8 to 1 margin. Evidence suggests that the government has attempted to manage the timing of PIPOs. We, however, find no evidence of underpricing of PIPOs to a greater degree than that found for issues in the private sector. Both domestic and international investors in PIPOs earned predominantly positive returns up to 36 months after listing. The difference between PIPOs and private sector IPOs average returns is statistically significant only for international investors.

Keywords: Privatisation, IPOs, Economies in Transition

JEL Classification: G18, G32, P31



European Financial Management, VOL 9:4 December 2003

Takeover Defenses and IPO Firm Value In the Netherlands

Peter Roosenboom and Tjalling van der Goot
Tilburg University and Center, University of Amsterdam

Abstract
The central question of this study involves the relation between the use of takeover defenses and IPO firm value. We report that management frequently uses takeover defenses before taking the firm public. The use of takeover defenses is primarily motivated by managerial entrenchment. IPO investors anticipate potential conflict of interests with mangement and reduce the price they pay for the IPO shares if takeover defenses are adopted. Although managers internalize this cost of takeover defenses to the degree they own pre-IPO stock, they are likely to gain through private control benefits. Non-management pre-IPO owners lose. Their shares are worth less, but different from managers, they do not get offsetting private control benefits. We infer that managers use takeover defenses to protect private control benefits at non-management pre-IPO owners’ expense.

Keywords: initial public offering, takeover defense, firm valuation

JEL Classification: G32, G34



European Financial Management, VOL 9:4 December 2003

Should Firms Going Public Enjoy Tax Benefits? An Analysis of the Italian Experience in the '90s

Arioso Giudici and Stefano Paleari

Abstract
In Italy tax benefits are granted to firms going public. However, dDoes such tax relief really reduce the corporate tax burden ? In this workburden? In this study we tackle the issue, by considering 21 industrial firms that were listed on the Italian Exchange from 1995 to 1997, enjoying1997 and enjoyed a temporary tax rate cut-off. We find that the increase in the taxable income reported by these firms largely counterbalances the effect of the tax relief. We conclude that a tax rate cut-off may not necessarily provoke a reduction in the tax burden for newly listed firms, since in the short runterm they report larger earnings compared towith privately-owned companies. We claim that this ‘induced’ effect is mainly due to: the significant improvement ofthe operating performance in the year of the listing, tolisting; the reduction of the debt tax shield, to the increase in investments as well as to more transparency in accounting.shield; an increase in investment and more accounting transparency. Our findings suggest that tax relievesrelief for IPO firms does not necessarily provoke a loss of revenues for the Government.mean a loss of revenue for the government.

Keywords: Initial public offerings; Italian stock exchange; Tax relief; Corporate income tax

JEL Classification: G10, H20




European Financial Management, VOL 10:1 March 2004

Shareholder Wealth Effects of European Domestic and Cross-border Takeover Bids

Marc Goergen and Luc Renneboog

Abstract
This paper analyses the short-term wealth effects of large intra-European takeover bids. We find announcement effects of 9% for the target firms compared to a statistically significant announcement effect of only 0.7% for the bidders. The type of takeover bid has a large impact on the short-term wealth effects with hostile takeovers triggering substantially larger price reactions than friendly operations. When a UK firm is involved, the abnormal returns are higher than those of bids involving both a Continental European target and bidder. There is strong evidence that the means of payment in an offer has an impact on the share price. A high market-to-book ratio of the target leads to a higher bid premium, but triggers a negative price reaction for the bidding firm. We also investigate whether the predominant reason for takeovers is synergies, agency problems or managerial hubris. Our results suggest that synergies are the prime motivation for bids and that targets and bidders share the wealth gains.

Keywords: Mergers and acquisitions, domestic and cross-border takeover bids, hostile takeovers, the market for corporate control, short-term wealth effects.

JEL Classification: G32, G34


European Financial Management, VOL 10:1 March 2004

Shareholder value Creation in European M&As

José Manuel Campa and Ignacio Hernando

Abstract
This paper looks at the value generated to shareholders by the announcement of mergers and acquisitions involving firms in the European Union over the period 1998-2000. Cumulative abnormal shareholder returns due to the announcement of a merger reflect a revision of the expected value resulting from future synergies or wealth redistribution among stakeholders. Target firm shareholders receive on average a statistically significant cumulative abnormal return of 9% in a one-month window centred on the announcement date. Acquirers’ cumulative abnormal returns are null on average. When distinguishing in terms of the geographical and sectoral dimensions of the merger deals, our main finding is that mergers in industries that had previously been under government control or that are still heavily regulated generate lower value than M&A announcements in unregulated industries. This low value creation in regulated industries becomes significantly negative when the merger involves two firms from different countries and is primarily due to the lower positive return that shareholders of the target firm enjoy upon the announcement of the merger. This evidence is consistent with the existence of obstacles (such as cultural, legal, or transaction barriers) to the successful conclusion of this type of transaction, which lessen the probability of the merger actually being completed as announced and, therefore, reduce its expected value.

Keywords: mergers and acquisitions, Europe, event study.

JEL Classification: G34, G38, L44


European Financial Management, VOL 10:1 March 2004

Target Company Cross-Border Effects in Acquisitions into the UK

Jo Danbolt

Abstract
We analyze the abnormal returns to target shareholders in cross-border and domestic acquisitions of UK companies. The cross-border effect during the bid month is small (0.84 percentage points), although cross-border targets gain significantly more than domestic targets during the months surrounding the bid. We find no evidence for the level of abnormal returns in cross-border acquisitions to be associated with market access or exchange rate effects, and only limited support for an international diversification effect. However, the cross-border effect appears to be associated with significant payment effects, and there is no significant residual cross-border effect once various bid characteristics are controlled for.

Keywords: Mergers and acquisitions; shareholder returns; cross-border; differential wealth effects

JEL Classification: G34, G14, G15


European Financial Management, VOL 10:1 March 2004

Explaining the M&A-success in European Bank mergers and acquisitions

Patrick Beitel, Dirk Schiereck and Mark Wahrenburg

Abstract
We study 98 large M&As of European bidding banks from 1985 to 2000 in order to investigate drivers of excess returns to the shareholders of the targets, the bidders, and to the combined entity of the bidder and the target. Our findings show that many of 13 drivers identified mostly from prior, US-focused research have significant explanatory power, indicating that the stock market reaction to M&A-announcements of European bidding banks can be at least partly forecasted. Our results are largely consistent with the US-experience and confirm the preference of stock markets for focused transactions and against diversification. Moreover, we find that less active bidders create more value than more active/experienced bidders. This stands in contrast to some US research and may indicate that managers of frequent European bidding banks may be motivated by other objectives than creating shareholder value.

JEL Classification: G14, G21, G34

Keywords: European banks; bank mergers; mergers and acquisitions; shareholder value


European Financial Management, VOL 10:1 March 2004

An examination of takeovers, job loss and the wage decline within UK industry

Til Beckmann and William Forbes

Abstract
This paper investigates the effects of takeovers on workers’ employment prospects and wages in the United Kingdom for the years 1987-1995. We address directly the idea that takeovers involve a "breach of trust" with employees. Our results provide no support for the breach of trust hypothesis and rather suggest shareholders and workers in the post-acquisition joint entity are locked in a form of ``equal misery`` following the execution of the takeover.
There already an exist a wide range of event studies documenting the effect of takeovers on shareholders and a smaller number of studies discussing the impact of takeovers on employees. The contribution of the present study is to relate the separate effects of acquisition on these two groups to each other. By doing so we seek to test directly the proposition that takeovers reallocate rents from workers to target shareholders, via the bid-premia paid on acquisition.

Keywords: Restructuring, job loss, trust, wealth transfers

JEL Classification: G3, G18, L14


European Financial Management, VOL 10:1 March 2004

Dynamics in ownership and firm survival: Evidence from corporate Germany

Florian Heiss and Jens Koke

Abstract
This study investigates the determinants of changes in corporate ownership and firm failure for German firms. We find that many of the determinants of failure also affect ownership changes in this bank-based economy. They include poor performance, weak corporate governance, high leverage, and small firm size. The ownership structure also plays a role for both events. Separate analyses of one of these events are therefore likely to miss important effects. The implications for the German corporate governance system are that the differences to countries with more market-based systems are not as pronounced as previously speculated.

Keywords: Bankruptcy, corporate governance, ownership structure

JEL Classification: G32, G33, G34




European Financial Management, VOL 10:2 June 2004

Why Study Large Projects? An Introduction to Research on Project Finance

Benjamin Esty

Abstract
Despite the fact that more than $200 billion of capital investment was financed through project companies in 2001, an amount that grew at a compound annual rate of almost 20% during the 1990s, there has been very little academic research on project finance. The purpose of this article is to explain why project finance in general and why large projects in particular merit separate academic research and instruction. In short, there are significant opportunities to study the relationship among structural attributes (i.e., high leverage, contractual details, and concentrated equity ownership), managerial incentives, and asset values, as well as improve current practice in this rapidly growing field of finance.


European Financial Management, VOL 10:2 June 2004

Keeping Up with the Joneses and the Home Bias

Beni Lauterbach and Haim Reisman

Abstract
We argue that when individuals care about their consumption relative to that of their neighbors, a home bias emerges, that is investors overweight domestic stocks in their portfolios. Domestic stocks are preferred because they also serve the objective of mimicking the economic fortunes and welfare of the investor’s neighbors, countrymen, and social reference group. We also demonstrate that globalization mitigates the home bias, and derive a modified International CAPM.

Keywords: International diversification; Home bias; Relative preferences; International CAPM.

JEL Classification: F30, G11, G12, G15


European Financial Management, VOL 10:2 June 2004

Investor Sentiment and the Closed-end Fund Puzzle: Out-of-Sample Evidence

John A. Doukas and Nikolaos T. Milonas

Abstract
In this paper we examine the proposition that small investor sentiment, measured by the change in the discount/premium on closed-end funds, is an important factor in stock returns. We conduct an out-of-sample test of the investor sentiment hypothesis in a market environment that is more likely to be prone to investor sentiment than the U.S.. We fail to provide supporting evidence of the claim of Lee, Shleifer, and Thaler (1991) that investor sentiment affects the risk of common stocks. Consistent with Elton, Gruber, and Busse (1998), who show that investor sentiment does not enter the return generating process, our tests do not detect investor sentiment in a capital market that is more susceptible to small investor sentiment. Our results provide additional support against the claim that investor sentiment represents an independent and systematic asset pricing risk.

Keywords: Closed-end-funds; discounts/premiums; investor sentiment; stock returns.

JEL Classification: G12, G14


European Financial Management, VOL 10:2 June 2004

Corporate Governance and Expected Stock Returns: Evidence from Germany

W. Drobetz, A. Schillhofer, and H. Zimmermann

Abstract
Recent empirical work shows evidence of higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm-level corporate governance also help to explain firm performance in a cross-section of companies within a single jurisdiction. Constructing a broad cor-porate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evi-dence that expected stock returns are negatively correlated with firm-level corpo-rate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high-CGR firms and shorted low-CGR firms earned abnormal returns of around 12 percent on an annual basis during the sample period.

JEL Classification: G12, G34, G38


European Financial Management, VOL 10:2 June 2004

Why Do Firms Hold Cash? Evidence from EMU Countries

Miguel A. Ferreira and Antonio S. Vilela

Abstract
This paper investigates the determinants of corporate cash holdings in EMU countries. Our results suggest that cash holdings are positively affected by the investment opportunity set and cash flows and negatively affected by asset’s liquidity, leverage and size. Bank debt and cash holdings are negatively related, which supports that a close relationship with banks allows the firm to hold less cash for precautionary reasons. Firms in countries with superior investor protection and concentrated ownership hold less cash, supporting the role of managerial discretion agency costs in explaining cash levels. Capital markets development has a negative impact on cash levels, contrary to the agency view.

Keywords: Cash holdings; Liquidity; Agency costs; Corporate Governance.

JEL Classification: G3, G32, G39


European Financial Management, VOL 10:2 June 2004

Implied Foreign Exchange Risk Premia

Nikolaos Panigirtzoglou

Abstract
This paper uses implied volatilities from foreign exchange option prices and the results of no-arbitrage theory to estimate foreign exchange risk premia. In particular, under the assumption of no-arbitrage, the foreign exchange risk premium is driven by the difference between investors’ market prices of risk in the two currencies. In an international economy with three currencies, sterling, US dollar and Deutschemark, we can use the information on implied volatilities of the three cross rates to derive estimates of implied or ex ante market prices of risk and of foreign exchange risk premia. The foreign exchange risk premia estimates are then compared to survey-based risk premia.

Keywords: foreign exchange; risk premia; pricing kernel.

JEL Classification: G12, G15, F31


European Financial Management, VOL 10:2 June 2004

Why European Firms issue Convertible Debt?

Franck Bancel and Usha R. Mittoo

Abstract
We survey European managers to gain some insights into motivations of convertible issuance. Our analysis shows that a majority of firms issue convertibles as “delayed equity” and as “debt sweetener”. Managers also use convertibles to avoid short-term equity dilution and to signal firm’s future growth opportunities. We document a large cross-sectional variation across firms in rationales for issuing convertibles and find mixed support for most theoretical models. Our evidence suggests that the popularity of convertibles is driven primarily by their versatility in adjusting their design to fit the financing needs of individual firms, and by their increased demand among institutional investors.

Keywords: Convertible Debt, European Managers, Survey, Delayed Equity, Debt Sweetener

JEL Classification: G32, G15, F23




European Financial Management, VOL 10:3 September 2004

Divergence of US and Local Returns in the After-Market for Equity Issuing ADRs

Padma Kadiyala and Avanidhar Subrahmanyam

Abstract
We study one-year post-listing prices and returns to equity issuing ADRs that listed in the US between January 1991 and October 2000. ADRs from countries that impose restrictions on capital flows are priced at a premium to their home market ordinaries. While the mean premium for the full sample is statistically indistinguishable from zero, after an adjustment for asynchronous trading, the magnitude of the premium to ADRs from restricted markets is 11.33% at the 300-day post listing interval, which is statistically significant. In the short run (30 days) following listing, the magnitude of the premium is larger for ADRs with larger excess demand from US investors. At the longer 300-day horizon, Nasdaq listed ADRs earn a larger premium than their NYSE/AMEX listed counterparts. Time-series regressions and two-stage cross-sectional regressions establish that the premium to foreign equity issuers is greater if the US listing attracts liquidity and if US returns have a lower correlation with the local country index.

Keywords: ADRs, Market Efficiency, International Finance

JEL Classification: F30, G12, G14


European Financial Management, VOL 10:3 September 2004

An empirical analysis of Finnish mutual fund expenses and returns

Timo Korkeamaki and Thomas Smythe, Jr.

Abstract
A tremendous amount of research examines U.S. mutual funds, but fund markets also thrive in other countries. However, research about these fast growing markets is lacking. This study addresses Finnish funds. Fast growth of the Finnish fund industry, strong bank dominance in the industry, and recent EU membership make it an interesting market to examine. The Finnish fund market is also of particular interest since it had the fastest growth among the EU countries during 1996-2000. We find evidence that bank-managed and older funds charge higher expenses but investors are not compensated for paying higher expenses with higher risk-adjusted returns, suggesting a potential agency problem. Overall, Finnish fund expenses have decreased over time, consistent with EU membership reducing market segmentation and generating competition.

Keywords: Mutual funds, fees, returns, international.

JEL Classification: G15, G18, G20


European Financial Management, VOL 10:3 September 2004

Multinational Diversification and Corporate Performance: Evidence From European Firms

Ike Mathur, Manohar Singh and Kimberly C. Gleason

Abstract
We investigate the empirical relationship between accounting based measures of performance and the degree of multinational diversification for a set of European chemical industry firms. We find that for these firms, the degree of multinational diversification is strongly related to superior financial performance. The results hold for each of the three sample years. The findings suggest that multinational firms outperform purely domestic and exporting firms. The results provide strong support for gains from multinational diversification. The results indicate that while greater European unification may have eroded potential benefits of exploiting international capital and product market imperfections, the benefits of firm specific economies of scope and scale as well as managerial and financial synergies are still realized through exports.

Keywords: Multinational diversification; corporate performance; European unification

JEL Classification: F23, F21, F31


European Financial Management, VOL 10:3 September 2004

The Cost of Capital of Cross-listed Firms

Koedijk Kees and Van Dijk

Abstract
This paper analyzes the cost of capital of firms with foreign equity listings. Our purpose is to shed light on the question whether international and domestic asset pricing models yield a different estimate of the cost of capital for cross-listed stocks. We distinguish between (i) the multifactor ICAPM of Solnik (1983) and Sercu (1980) including both the global market portfolio and exchange rate risk premia, and (ii) the single factor domestic CAPM. We test for the significance of the cost of capital differential in a sample of 336 cross-listed stocks from nine countries in the period 1980-1999. Our hypothesis is that the cost of capital differential is substantial for firms with international listings, as these are often large multinationals with a strong international orientation. We find that the asset pricing models yield a significantly different estimate of the cost of capital for only 12 percent of the cross-listed companies. The size of the cost of capital differential is around 50 basis points for the U.S., 80 basis points for the U.K., and 100 basis points for France.

Keywords: Cross-listings, cost of equity capital, foreign exchange exposure

JEL Classification: G15, G31, F31


European Financial Management, VOL 10:3 September 2004

The Effects of Monetary Unification on German Bond Markets

Hans Dewachter, Marco Lyrio and Konstantijn Maes

Abstract
We develop a benchmark against which the effects of ECB monetary policy on the German bond market can be evaluated. We first estimate an affine term structure model for the pre-EMU period linking the German yield curve with the Bundesbank monetary policy. The German monetary policy and its implied yield curve are then reprojected onto the EMU period. The reprojected yield curve differs significantly from the observed one. Short-term interest rates during the EMU period are significantly lower than they would have been in case the Bundesbank were still in charge of monetary policy. Furthermore, yield spreads increased substantially during the EMU period.

Keywords: EMU, ECB, Bundesbank, central bank monetary policy rule, essentially affine term structure model

JEL Classification: E43, E44, E52, E58


European Financial Management, VOL 10:3 September 2004

Exchange Rates and Capital Flows

Robin Brooks, Hali Edison, Manmohan S. Kumar, Torsten Sloka

Abstract
This paper explores the ability of portfolio and foreign direct investment flows to track movements in the euro and the yen against the dollar. Net portfolio flows from the euro area into U.S. stocks possibly reflecting differences in expected productivity growth track movements in the euro against the dollar closely. Net FDI flows, which capture the recent burst in cross-border M&A activity, appear less important in tracking movements in the euro-dollar rate, possibly because many M&A transactions consist of share swaps. Movements in the yen versus the dollar remain more closely tied to conventional variables such as the current account and interest differential.

Keywords: Exchange rate models, euro/dollar and yen/dollar exchange rates, capital flows

JEL Classification: F31, F32




European Financial Management, VOL 10:4 December 2004

The Agency Costs of Overvalued Equity and the Current State of Corporate Finance

Michael C. Jensen

Keywords: Overpriced E