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– The purpose of this paper is to propose a novel theory of the equilibrium liquidity premia of private equity funds and explore its asset-pricing implications.
Abstract
Purpose
The purpose of this paper is to propose a novel theory of the equilibrium liquidity premia of private equity funds and explore its asset-pricing implications.
Design/methodology/approach
The theory assumes that investors are exposed to the risk of facing surprise liquidity shocks, which upon arrival force them to liquidate their positions on the secondary private equity markets at some stochastic discount to the fund’s current net asset value. Assuming a competitive market where fund managers capture all rents from managing the funds and investors just break even on their positions, liquidity premia are defined as the risk-adjusted excess returns that fund managers must generate to compensate investors for the costs of illiquidity. The model is calibrated to data of buyout funds and is illustrated by using numerical simulations.
Findings
The model analysis generates a rich set of novel implications. These concern how fund characteristics affect liquidity premia, the role of the investors’ propensities of liquidity shocks in determining liquidity premia and the impact of market conditions and cycles on liquidity premia.
Originality/value
This is the first paper that derives liquidity premia of private equity funds in an equilibrium setting in which investors are exposed to the risk of facing surprise liquidity shocks.
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María del Mar Miralles-Quirós, José Luis Miralles-Quirós and Celia Oliveira
The aim of this paper is to examine the role of liquidity in asset pricing in a tiny market, such as the Portuguese. The unique setting of the Lisbon Stock Exchange with regards…
Abstract
Purpose
The aim of this paper is to examine the role of liquidity in asset pricing in a tiny market, such as the Portuguese. The unique setting of the Lisbon Stock Exchange with regards to changes in classification from an emerging to a developed stock market, allows an original answer to whether changes in the development of the market affect the role of liquidity in asset pricing.
Design/methodology/approach
The authors propose and compare two alternative implications of liquidity in asset pricing: as a desirable characteristic of stocks and as a source of systematic risk. In contrast to prior research for major stock markets, they use the proportion of zero returns which is an appropriated measure of liquidity in tiny markets and propose the separated effects of illiquidity in a capital asset pricing model framework over the whole sample period as well as in two sub-samples, depending on the change in classification of the Portuguese market, from an emerging to a developed one.
Findings
The overall results of the study show that individual illiquidity affects Portuguese stock returns. However, in contrast to previous evidence from other markets, they show that the most traded stocks (hence the most liquid stocks) exhibit larger returns. In addition, they show that the illiquidity effects on stock returns were higher and more significant in the period from January 1988 to November 1997, during which the Portuguese stock market was still an emerging market.
Research limitations/implications
These findings are relevant for investors when they make their investment decisions and for market regulators because they reflect the need of improving the competitiveness of the Portuguese stock market. Additionally, these findings are a challenge for academics because they exhibit the need for providing alternative theories for tiny markets such as the Portuguese one.
Practical implications
The results have important implications for individual and institutional investors who can take into account the peculiar effect of liquidity in stock returns to make proper investment decision.
Originality/value
The Portuguese market provides a natural experimental area to analyse the role of liquidity in asset pricing, because it is a tiny market and during the period studied it changed from an emerging to a developed stock market. Moreover, the authors have to highlight that previous evidence almost exclusively focuses on the US and major European stock markets, whereas studies for the Portuguese one are scarce. In this context, the study provides an alternative methodological approach with results that differ from those theoretically expected. Thus, these findings are a challenge for academics and open a theoretical and a practical debate.
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Tucked in the back of Venkataraman’s 1997 work on the distinctive domain of entrepreneurship (DDE) lies a pointer to a question each individual must face when choosing to start a…
Abstract
Tucked in the back of Venkataraman’s 1997 work on the distinctive domain of entrepreneurship (DDE) lies a pointer to a question each individual must face when choosing to start a new venture; “is entrepreneurship worth it?” Inventorying costs associated with risk, uncertainty, and illiquidity against surpluses from financial and psychological factors unique to entrepreneurship, Venkataraman tempts readers to tally entrepreneurial returns. The authors summarize and integrate an academic study of these various cost and return components over the past 20 years using Venkataraman’s original framework. The authors find the answer to the question of “is entrepreneurship worth it?” varies with time. Researcher’s answer to the question has shifted from an early view that entrepreneurs sacrifice financial gain in exchange for soft psychological benefits to a more positive view that entrepreneurs are rewarded both financially and psychologically for the unique costs borne in the DDE. But the rewards are not immediate. In entrepreneur time, break-even emerges by gradually overcoming an initial deficit. As surpluses accrue, returns to entrepreneurs likely eventually exceed those of their wage-earning peers.
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Luis Berggrun, Emilio Cardona and Edmundo Lizarzaburu
This article examines whether deviations from fundamental value or closed-end country fund's discounts or premiums forecast future share price returns or net asset returns.
Abstract
Purpose
This article examines whether deviations from fundamental value or closed-end country fund's discounts or premiums forecast future share price returns or net asset returns.
Design/methodology/approach
The main empirical (econometric) tool is a vector autoregressive (VAR) model. The authors model share price returns and net asset returns as a function of their lagged values, the discounts or premiums, and a control variable for local market returns. The authors also conduct Dickey Fuller and Granger causality tests as well as impulse response functions.
Findings
It was found that deviations from fundamental value do predict share price returns. This predictability is contrary to weak-form market efficiency. Premiums or discounts predict net asset returns but weakly.
Originality/value
The findings point to the idea that the closed-end fund market is somewhat predictable and inefficient (in its weak form) since the market appears to be able to anticipate a fund's future returns using information contained in the premiums (or discounts). In particular, the market has the ability to anticipate future behaviour because growing premiums forecast declining share price returns for one or two periods ahead.
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Residential property in a multi‐asset portfolio context has been considered from two substantially different perspectives: institutional investor's and the household's…
Abstract
Residential property in a multi‐asset portfolio context has been considered from two substantially different perspectives: institutional investor's and the household's perspective. This paper constitutes the first of two related surveys on the role of residential property in a multi‐asset portfolio. The paper provides an introduction to housing property investment at a macro level and reviews the main empirical issues related to housing investment in an institutional portfolio context. The literature in this regard generally supports the evidence that residential property is a more effective hedge against inflation than both shares and bonds. Additionally, the reviewed studies generally report that unsecuritised housing investment not only generates risk‐adjusted returns comparable to those of bonds and shares, but also exhibits low levels of correlation with classic asset groups of institutional portfolios.
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The positive illiquidity–return relationship (so-called liquidity premium) is a well-established pattern in international developed stock markets. The magnitude of liquidity…
Abstract
Purpose
The positive illiquidity–return relationship (so-called liquidity premium) is a well-established pattern in international developed stock markets. The magnitude of liquidity premium should increase with market illiquidity. Existing studies, however, do not confirm this conjecture with regard to frontier markets. This may result from applying different approaches to the investors' holding period. The paper aims to identify the role of the holding period in shaping the illiquidity–return relationship in emerging and frontier stock markets, which are arguably considered illiquid.
Design/methodology/approach
The authors utilise the data on stocks listed on fourteen exchanges in Central and Eastern Europe. The authors regress stock returns on liquidity measures variously transformed to reflect the clientele effect in a liquidity–return relationship.
Findings
The authors show that the investors' holding period moderates the illiquidity–return relationship in CEE markets and also show that the liquidity premium in these markets is statistically and economically relevant.
Practical implications
The findings may be of great interest to investors, companies and regulators. Investors and companies should take liquidity into account when making decisions; regulators should employ liquidity-enhancing actions to decrease companies' cost of capital and expand firms' investment opportunities, which will improve growth perspectives for the entire economy.
Originality/value
These findings enrich the understanding of the role that the investors' holding period plays in the illiquidity–return relationship in CEE markets. To the best knowledge, this is the first study which investigates the effect of holding period on liquidity premium in emerging and frontier markets.
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Margarita Kaprielyan, Md Miran Hossain and Charles Armah Danso
The purpose of this paper is to investigate whether mutual funds (MFs) take positions in companies that subsequently engage in M&As and whether fund managers adjust portfolio…
Abstract
Purpose
The purpose of this paper is to investigate whether mutual funds (MFs) take positions in companies that subsequently engage in M&As and whether fund managers adjust portfolio holdings in the same direction as wealth creation from mergers. Further, the study is the first to examine the relation between active trading surrounding M&As and risk-adjusted performance in MFs.
Design/methodology/approach
The sample includes mergers conducted by publicly traded acquirers of public and private targets over 2003–2016. Several measures of MF managerial activeness in M&As are introduced: merger trading intensity (proportional change in fund’s holdings of M&A stocks), active merger weight (deviation of the fund’s actual weights in M&A stocks and value weights) and active merger trading (deviation of the fund’s actual weights in M&A stocks from the average weights in M&A stocks across the funds within the same Center for Research in Security Prices objective).
Findings
Fund managers who are more vested in the firms engaged in M&As and who are more active in their trades of M&A firms generate higher contemporaneous and subsequent risk-adjusted performance, indicative of managerial skill. Active M&A trading effect on performance is economically meaningful.
Originality/value
This is the first study to examine whether previously documented predictive power of active institutions regarding M&As’ profitability leads to higher risk-adjusted returns for MF investors. The study introduces several measures to gauge how actively fund managers trade companies engaged in M&As and contributes to the literature on MF managers’ ability to pick stocks.
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Rintu Anthony and Krishna Prasanna
The study attempts to identify the linkages in the term structure of illiquidity and the impact of global and domestic factors on sovereign bonds in emerging Asia. The objective…
Abstract
Purpose
The study attempts to identify the linkages in the term structure of illiquidity and the impact of global and domestic factors on sovereign bonds in emerging Asia. The objective of the study ensues on defining the direction of illiquidity spillover across bonds of varying tenors.
Design/methodology/approach
This study explores the joint dynamics of contemporary liquidity risk premia and its time-varying effect on the term structure spectrum using the Diebold and Yilmaz (2012) spillover framework.
Findings
A substantial relationship was found to exist between the liquidity of bonds with closer terms to maturity. The macroeconomic environment primarily impacts the liquidity of 10-year bonds, and they spiral down to the subsequent bond liquidity, exhibiting a rippling effect. The authors further show that the direction of liquidity shock transmission is from long- to medium- and thence to short-term bonds. Among the global factors, foreign investments and S & P 500 VIX significantly affect the liquidity of 10-year bonds.
Research limitations/implications
The study has several implications for academicians, policymakers and domestic and global investment professionals. The drivers of liquidity risk and the transmission across the term structure help investors in designing efficient portfolio diversification strategies. The results are relevant for cross-border investors in the valuation of emerging Asian sovereign bonds while deciding on asset allocations and hedging strategies. The monetary regulators strive on a continuous basis to improve the liquidity in sovereign bond markets in order to ensure efficient funding of development activities. This study finds that short-term bonds are more liquid than long-term bonds. Their auction framework with higher series of short-term bond issues helps to provide the required liquidity in the markets.
Practical implications
The term structure of illiquidity is upward sloping, inferring a higher underlying liquidity risk of long-term bonds compared to short-term bonds. This finding suggests that a higher representation of short-term bonds in the auction framework helps to enhance the overall market liquidity.
Originality/value
This study offers insights into the debate on the shape of the term structure of illiquidity and the point of origination of liquidity shocks. Further, the direction of spillover across a wide spectrum of bonds is also demonstrated.
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This paper examines the role of illiquidity and duration factor in understanding the momentum profit in the Korean stock market. We find that the foreigner/institutional…
Abstract
This paper examines the role of illiquidity and duration factor in understanding the momentum profit in the Korean stock market. We find that the foreigner/institutional illiquidity factor explains the momentum effect. In addition, this paper finds that duration factor defined as the difference in returns of short-duration and long-duration stocks captures well the momentum profits. That is, a two-factor model with the market and duration factor performs much better than competing asset pricing models in explaining the momentum effect. Finally, when controlling for the duration factor, the explanatory power of the foreign/institutional illiquidity factor on the momentum profits disappears. In sum, our empirical finding indicates that the duration factor is the most important ingredient in understanding the momentum effect in the Korean stock market.
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Baah Aye Kusi, Abdul Latif Alhassan, Daniel Ofori-Sasu and Rockson Sai
This study aims to examine the hypothesis that the effect of insurer risks on profitability is conditional on regulation, using two main regulatory directives in the Ghanaian…
Abstract
Purpose
This study aims to examine the hypothesis that the effect of insurer risks on profitability is conditional on regulation, using two main regulatory directives in the Ghanaian insurance market as a case study.
Design/methodology/approach
This study used the robust ordinary least square and random effect techniques in a panel data of 30 insurers from 2009 to 2015 to test the research hypothesis.
Findings
The results suggest that regulations on no credit premium and required capital have insignificant effects on profitability of insurers. On the contrary, this study documents evidence that both policies mitigate the effect of underwriting risk on profitability and suggests that regulations significantly mitigate the negative effect of underwriting risk to improve profitability.
Practical implications
The finding suggests that policymakers and regulators must continue to initiate, design and model regulations such that they help tame risk to improve the performance of insurers in Ghana.
Originality/value
This study provides first-time evidence on the role of regulations in controlling risks in a developing insurance market.
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