Research in Finance: Volume 21

We use stochastic dominance to test whether investors should prefer riskier securities as the investment horizon lengthens. Simulated return distributions for stocks, bonds, and U.S. Treasury bills are generated for holding periods of one to 20 years and stochastic dominance tests are run to establish preferences among the alternative portfolios. With independent returns, we find no evidence that high-risk securities (stocks) dominate low-risk securities (bonds) as the investment horizon lengthens. Under the assumption that security returns are correlated across time, we find that common stocks dominate corporate bonds and U.S. Treasury bills for sufficiently long investment horizons.

We examine the benefits for firms participating in collaborations funded via minority equity placements. Selling firms, on average, realize significant increases in share value – strongly correlated with the size of the equity stake, its beta, and the relatedness of the two firms (by industry). Shares of purchasing firms, though, show neutral responses on average (but positive response for R&D intensive alliances). Further, purchasing firms have better financial performance than their industry peers in the years surrounding the announcement (suggesting, unlike joint ventures, that poor performance is not their motivation). Selling firms, however, may be motivated by poor operating performance.

This paper explores the relationship between size, book-to-market, beta, and expected stock returns in the U.S. Information Technology sector over the July 1990–June 2001 period. Two models, the multivariate model and the three-factor model, are employed to test these relationships. The risk-return tests confirm the relationship between size, book-to-market, beta and stock returns in IT stocks is different from that in other non-financial stocks. However, the sub-period results (the periods before and after the technology crash in April 2000) show that the nature of the relationship between stock returns, size, book-to-market, and market factors, or the magnitude of the size, book-to-market, and market premiums, is on average unchanged for both sub-periods. This result suggests the technology stock crash in April 2000 was not a correction of stock prices.

Audits are a means of reducing the information asymmetry between managers and investors. If the quality of the audit is in question, outside investors may face a larger informational disadvantage. We test the hypothesis that this informational disadvantage is manifested in the implied volatilities associated with the equity options of the audited firms. We find that volatilities increased for Andersen audited firms relative to firms audited by other Big Five accounting firms. This finding is consistent with the view that auditors help lessen the information asymmetry problem and that some of this reduction is accomplished by auditor reputation.

This paper examines secondary equity offerings that were done in the Canadian markets through “installment receipts” (IRs). Previous studies on seasoned equity offerings tend to focus on the price reaction around the announcement date. We extend the analysis to cover a longer period so that the issues of liquidity effect and information asymmetry can be adequately addressed. We also offer evidence to indicate that the use of IRs in secondary offerings can reduce the liquidity impact in markets where market depth is not as substantial as in the U.S.

Conventional methods to test for long-term PPP based on the theory of cointegration are typically undertaken in the framework of vector error correction models (VECM). The standard approach in the use of VECMs is to employ a model of full-order, which assumes nonzero entries in all the coefficient matrices. But, the use of full-order VECM models may lead to incorrect inferences if zero entries are required in the coefficient matrices. Specifically, if we wish to test for indirect causality, instantaneous causality, or Granger non-causality, and employ “overparameterised” full-order VECM models that ignore entries assigned a priori to be zero, then the power of statistical inference is weakened and the resultant specifications can produce different conclusions concerning the cointegrating relationships among the variables. In this paper, an approach is presented that incorporates zero entries in the VECM analysis. This approach is a more straightforward and effective means of testing for causality and cointegrating relations. The paper extends prior work on PPP through an investigation of causality between the U.S. Dollar and the Japanese Yen. The results demonstrate the inconsistencies that can arise in the area and show that bi-directional feedback exists between prices, interest rates and the exchange rate such that adjustment mechanisms are complete within the context of PPP.

This study investigates the linkage between the Hong Kong stock market and Singapore stock market and the U.S. stock market during the pre- and post-East Asia Financial Crisis in 1997 and 1998. It uses multivariate regression models to study the impact of Hong Kong’s fixed exchange rate system and Singapore’s free-floating exchange rate system on their respective stock markets. The results indicate that the exchange rate is not a significant determinant of linkage between the U.S. and the two Asian stock markets, but the evidence suggests that stronger post-crisis relationships between the U.S. and the two Asian stock markets. The evidence also supports a stronger short-run relationship between the U.S. and Hong Kong stock markets relative to that between the U.S. and Singapore stock markets.

We show why investors may prefer not to be a firm’s unique lender, even if they are in a strong bargaining position. Some firms need additional funds after a first investment: providing additional funds is rational after the first investment is sunk, but together the two investments are unprofitable. A unique lender will always provide additional funds and make losses. Two creditors can commit not always to provide funds: inefficient negotiations over debt forgiveness may end with a project’s liquidation, which is harmful ex post, but helpful ex ante, if it keeps entrepreneurs with nonpromising projects from initially requesting funds.

This paper develops a model that explains how the creation of a futures clearinghouse allows traders to reduce default and economize on margin. We contrast the collateral necessary between bilateral partners with that required when multilateral netting occurs. Optimal margin levels balance the deadweight costs of default against the opportunity costs of holding additional margin. Once created, it may be optimal for the clearinghouse to monitor the financial condition of its members. If undertaken, monitoring will reduce the amount of margin required but need not affect the probability of default. Once created, it becomes optimal for the clearinghouse membership to expel defaulting members. This reduces the probability of default. Our empirical tests suggest that the opportunity cost of margin plays an important role in clearinghouse behavior particularly their determination of margin amounts. The relationship between volatility and margins suggests that participants face an upward-sloping opportunity cost of margin. This appears to dominate the effects that monitoring and expulsion might have on margin setting.

Using the Dealscan database of large, U.S. corporate loans, we examine the determinants of the number of bank relationships and the presence or absence of collateral. Consistent with prior studies, we find that important explanatory variables are firm quality, desire for financial flexibility, the probability of financial distress, growth opportunities and firm size. Higher quality firms as well as firms with a stronger desire for financial flexibility are less likely to collateralize and borrow from more lenders. Larger firms as well as those with lower probabilities of financial distress and greater growth opportunities prefer multiple lenders.

As of 1982, federal credit unions were allowed to add select employee groups and thus create institutions with multiple-group common bonds. We examine the efficiency of single bond and multiple bond federal-chartered credit unions by using data envelopment analysis (DEA), a non-parametric, linear programming methodology. Results indicate that multiple bond credit unions have better pure technical efficiency than single bond credit unions. However, single bond credit unions appear to be more scale efficient than the multiple bond credit unions. Our results also indicate that members of multiple bond credit unions may derive greater wealth gains than members of single bond credit unions.