Search results

I survey applications of Markov switching models to the asset pricing and portfolio choice literatures. In particular, I discuss the potential that Markov switching models have to fit financial time series and at the same time provide powerful tools to test hypotheses formulated in the light of financial theories, and to generate positive economic value, as measured by risk-adjusted performances, in dynamic asset allocation applications. The chapter also reviews the role of Markov switching dynamics in modern asset pricing models in which the no-arbitrage principle is used to characterize the properties of the fundamental pricing measure in the presence of regimes.

The paper uses 101 years of Chilean and international financial assets returns to investigate mean-variance optimal portfolio allocations. The key conclusion is that the share of international unhedged investments is substantial even in minimum risk portfolios (20%), unless the period 1980–2002 is assumed to be drawn from a different distribution and previous history is disregarded. In addition to that, the paper finds that mean-variance optimal investors would have generated substantial demand for an asset replicating the return profile of an efficient pay-as-you-go pension scheme. Labour income and departures from log-normality of returns might, however, affect the latter conclusion.

We tested for evidence of stock price bubbles in the Malaysian stock market from 1978 to 2004. Four different tests were used namely excess volatility tests, unit root/co-integration tests, duration dependence tests, and the intrinsic bubbles model. All four tests indicate that during the sample period, there was evidence of stock price bubbles. All tests results conform to the theoretical literature on asset price bubbles except for the results on the intrinsic bubbles model, which concludes that Malaysian investors under react to information on dividends. We find this result hardly surprising as anecdotal evidence does indicate that Malaysian investors place more importance on capital gains as compared to dividends. Although we do not go into a debate on whether authorities should be prick the bubble to stem its negative effects, we argue that transparent information dissemination will ensure that the stock market becomes more efficient in pricing stocks.

This paper uses the capital asset pricing model to show that, in realistic circumstances, double taxation and differential tax rates on personal and capital-gains income affect corporate stock values and financial policies in non-neutral ways. This non-neutrality holds whenever inflation is uncertain and tax-avoidance activity is neither costless nor riskless. The model also allows us to explore how a series of frequently proposed changes in the interplay of corporate and personal taxes would affect corporate dividend payouts and debt usage. Our analysis clarifies that conscientious efforts to integrate corporate and personal tax rates must make supporting changes in the size and character of capital-gains tax preferences built into the tax code.

Investors often have much of their portfolios invested in equities that are exposed to interest rate risk. Hedging underlying exposures are not easy; whereas fixed income investors have duration to immunize bond portfolios from small fluctuations in interest rates. US equity duration estimates from dividend discount models result in long durations – often in excess of 50 years. Based on the UK data, we develop an alternative approach to generate equity duration as a by-product of asset pricing. Our analysis suggests that the equity premium puzzle may comprise an important element in reconciling this approach to equity duration, with traditional DDM alternatives.