Multinational Finance Journal
© Global Business Publications. All rights reserved.
Quarterly publication of the Multinational Finance Society, a non-profit corporation ISSN 1096-1879
Volume 13, Numbers 1 & 2, March/June 2009
An
Admissible Macro-Finance Model of the US Treasury Market.
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 1–38)
Peter Spencer
University of York, U.K.
This paper develops a macro-finance model of the yield curve and uses this to
explain the behavior of the US Treasury market. Unlike previous macro-finance
models which assume a homoscedastic error process and suppose that the
one-period return is directly observable, I develop a general affine model which
relaxes these assumptions. My empirical specification uses a single conditioning
factor and is thus the macro-finance analogue of the EA1(N) specification of the
mainstream finance literature. This model provides a decisive rejection of the
standard EA0(N) macro-finance specification. The resulting specification
provides a flexible 10-factor explanation of the behavior of the US yield curve,
keying it in to the behavior of the macroeconomy. (JEL: C13, C32, E30, E44, E52)
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European Put-Call Parity and the Early Exercise Premium
for American Currency Options
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 39–54)
Geoffrey Poitras
Simon Fraser University, Canada
Chris Veld
University of Stirling, U.K.
Yuriy Zabolotnyuk
Carleton University, Canada
The European put-call parity condition is used to estimate the early exercise
premium for American currency options traded on the Philadelphia Stock Exchange.
Using a sample of 331 pairs of call and put options with the same exercise price
and time to expiration, evidence is provided for early exercise premiums that
average 5.03% for put options and 4.60% for call options. The premiums for both
call and put options are strongly related to the interest rate differential and
time to expiration. These results have implications for the use of European
option pricing models in the valuation of American options. (JEL: G10, G12, G13,
G14)
Keywords: European put-call parity; currency options; early exercise premium
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The Risks in CDO-Squared Structures
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 55–74)
Andrew Adams
University of Edinburgh Business School, U.K.
Rajiv Bhatt
Deloitte Touche Tohmatsu India Pvt. Ltd., India
James Clunie
Scottish Widows Investment Partnership, U.K.
The recent sub-prime debacle has brought ‘innovative’ structured credit products
such as collateralized debt obligations under severe criticism. The complexity
of some structured finance securities and difficulties in understanding their
risks has been a common theme. This paper argues that CDO-squared structures can
be so complex as to make risk assessment difficult. By modeling a simplified CDO-squared
structure using Monte Carlo simulation, two of the risks unique to such
structures are examined: default location risk and overlap risk. Failure to take
account of these risks during a distressed credit environment will result in
greater than anticipated losses among senior CDO-squared tranches.(JEL: G11,
G15, G24)
Keywords: collateralized debt obligation; CDO-squared; default location risk;
overlap risk; Monte Carlo simulation
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The Effect of Extreme Markets on the Benefits of
International Portfolio Diversification
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 75–108)
Daniella Acker
University of Bristol, U.K.
Nigel W. Duck
University of Bristol, U.K.
We investigate the effects of bull and bear markets on correlations between
developed and emerging country equity returns, and on the benefits of combining
international markets in a portfolio. Contrary to most other studies we find
that correlations fall in both bull and bear markets, although far more in the
former; that emerging markets provide both additional diversification benefits
for investors in developed markets and, especially, some protection during bear
markets.(JEL: F3, G1, G10, G11, G15)
Keywords: International equity markets, correlations, portfolio choice.
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Towards Decoding Currency Volatilities
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 109–140)
D. Johannes Jüttner
Macquarie University, Sydney
Wayne Leung
Macquarie University, Sydney
This study examines on the basis of economic theory the determinants of exchange
rate volatilities for a large number of currencies. We relate daily changes in
GARCH(1,1) volatilities of exchange rates to the volatility changes of several
of their presumed fundamental economic determinants in the context of a
portfolio balance model. The use of high-frequency data limits the choice of the
explanatory economic variables that can be included in empirical estimates. The
first differences of GARCH(1,1) volatilities of share and bond price indices
reflect portfolio trading decisions in corresponding markets for both assets. In
the same vein, first differences of the gold price volatility, as an additional
determinant, are related to exchange rate volatilities of two commodity
currencies in the sample. The panel data estimates, using the Seemingly
Unrelated Regression technique, produce coefficients with the expected signs and
statistical significance. The results of our study enhance our understanding of
high-frequency currency volatility changes for 19 currencies beyond the purview
of announcement effects in the event studies framework (JEL: F31, G154, C22)
Keywords: Exchange rate volatilities, volatility relationships, GARCH modelling
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Taxation, Dividend Payments and Ex-Day Price-Changes
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 141–160)
Sven-Olov Daunfeldt
The Ratio Institute, Sweden
Carina Selander
Umeå University, Sweden
Magnus Wikström
Umeå University, Sweden
The purpose of the paper is to study the effect of taxation on dividend payments
and ex-dividend price-changes in Sweden during 1991-1995. Tax changes in Sweden
during the 1990s were implemented in such a way that they provide an opportunity
to include direct measures of the tax-treatment of dividends and capital gains
in the empirical analysis, in contrast to previous studies. The results indicate
that tax-reforms can have large effects on dividend payments, while the effects
on ex-dividend price-changes are less conclusive.(JEL: G12, G35)
Keywords: censoring, dividend, ex-dividend, taxation.
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Benchmark Concentration: Capitalization Weights Versus
Equal Weights in the FTSE 100 Index
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 161–180)
Isaac T. Tabner
University of Stirling, U.K.
Identifying a suitable benchmark is essential when testing asset pricing models,
measuring the performance of active investors, or providing market proxy
portfolios for passive investors. Concern that increased domination of
capitalization weighted stock indices by a few large firms will lead to
inefficient portfolio diversification is leading some investors and researchers
to argue that index providers should adjust their weighting methods to limit
concentration. This study tests and rejects the hypothesis that concentration
arising as a result of capitalization weights in the FTSE 100 Index increases
risk, either during normal market conditions or during negative tail events in
the return distribution. On the contrary, during the left tail of the return
distribution, the equally weighted portfolio of FTSE 100 Index constituents
exhibits higher risk and lower returns than the capitalization weighted FTSE 100
Index portfolio, a finding consistent with variations of the CAPM that allow for
time varying risk premia.(JEL: G11, G12, G14)
Keywords: stock index benchmarks, incremental returns, incremental standard
deviation, portfolio diversification, capitalization weights, index
concentration, performance measurement.
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Modeling Volatility in Foreign Currency Option Pricing
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 181–200)
Ariful Hoque
Curtin University of Technology, Australia
Felix Chan
Curtin University of Technology, Australia
Meher Manzur
Curtin University of Technology, Australia
This paper presents a general optimization framework to forecast put and call
option prices by exploiting the volatility of the options prices. The approach
is flexible in that different objective functions for predicting the underlying
volatility can be modified and adapted in the proposed framework. The framework
is implemented empirically for four major currencies, including Euro. The
forecast performance of this framework is compared with those of the
Multiplicative Error Model (MEM) of implied volatility and the GARCH(1,1). The
results indicate that the proposed framework is capable of producing reasonable
accurate forecasts for put and call prices.(JEL: G12, G13)
Keywords: Foreign currency options, implied volatility, optimal volatility,
multiplicative error model, GARCH model
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Merging Activity as a Rational Explanation for the
Long-Run Underperformance of IPO
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 201–228)
Patrick Sentis
University Montpellier, France
The phenomena of IPO underpricing and underperformance are examined in the same
rational model. In this model, underpricing is caused by the presence of
uninformed investors. Low-type firms carry out an IPO under the same conditions
as high-type firms. Instead of investing by themselves, the latter prefer to
merge with a bidder, which entails their delisting from the market. The behavior
of these firms provides a rational explanation for the underperformance
phenomenon since only low-type firms remain on the market. Initial preliminary
findings are consistent with the basic idea of the model. We show that when
mergers occur, the monthly average return of the remaining firms is
significantly negative, whereas the monthly average return is not significantly
different from zero for the months without mergers. This result suggests that
mergers induce a depreciation effect on the remaining firms and could be a
source of underperformance.(JEL: G32, G34)
Keywords: initial public offerings, underpricing, underperformance, delisted,
takeover, merger.
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A Structural form Default Prediction Model for SMEs,
Evidence from the Dutch Market
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 229–264)
Frieda Rikkers
Tilburg University, Netherlands
André E. Thibeault
Vlerick Leuven Gent Management School, Belgium
The objective of this research is to develop a structural form probability of
default model for small and medium-sized enterprises, dealing with the
methodological issues which arise in the modelling of small commercial loan
portfolios, and to test the applicability of the model in practice. Other
motivations are to provide an extensive overview of the characteristics of SMEs,
and to provide a list of characteristics that a PD model for SMEs should
contain, e.g. time and cost efficiency, broad applicability, limited data
requirements, and powerful in predicting default. The structural form model is
developed and tested on a unique dataset of private firm’s bank loans of a Dutch
bank. The results are promising; the model output differs significantly between
defaulted and non-defaulted firms. The structural form model can be used on its
own, or as an additional variable in a credit risk model. A second PD model is
developed using logistic regression with a number of financial ratios, including
the structural form measure. This variable is significant in default prediction
of SMEs and has some additional predictive power, next to the popular financial
ratios. Overall, the results indicate that the structural form model is a good
indicator for default of SMEs. (JEL: C51, C52, G21, G28, G33)
Keywords: SME, probability of default, structural form credit risk model, Basel
II
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version)