[We test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk. The empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and equity returns are negatively correlated with domestic inflation. We then develop a model of international portfolio choice and equity market equilibrium that integrates inflation risk and deadweight costs. Using this model we estimate the levels of costs required to generate the observed home bias in portfolios consistent with different levels of risk aversion. For a level of risk aversion consistent with standard estimates of the domestic equity market risk premium, these costs are about a few percent per annum, greater than observable costs such as withholding taxes. Thus, the home bias cannot be explained by either inflation hedging or direct observable costs of international investment unless investors have very low levels of risk aversion.]

Abstract This article examines the contribution of hedging to firm value and the cost of hedging in a unified framework. Optimal hedging and firm value are explicitly linked to firm risk, the type of debt covenants and the relative priority of the hedging contract. It is shown that in some cases hedging is possible only if the counterparty to the forward contract also holds a significant portion of the debt. Also, the spread in the hedging contract reduces the optimal amount of hedging to less than the minimum-variance hedge ratio. Among other results this article elucidates why some firms hedge using forward contracts while other firms hedge in the futures markets, as well as why higher priority forward contracts are more efficient hedging vehicles. JEL Classification numbers: G13, G22 and G33.

The authors characterize the exchange of financial claims from risky swaps. These transfers are among three groups: shareholders, debtholders, and the swap counterparty. From this analysis, the authors derive equilibrium swap rates and relate them to debt market spreads. They then show that equilibrium swaps in perfect markets transfer wealth from shareholders to debtholders. In a simplified case, the authors obtain closed-form solutions for the value of the default risk in the swap. For interest-rate swaps, they obtain numerical solutions for the equilibrium swap rate, including default risk. The authors compare these with equilibrium debt market default risk spreads.

[Using a large sample of cross-border mergers, we measure the effect of a change in location on systematic risk. When a target firm's location moves, a large part of its systematic risk switches from being related to its home equity market to that of the acquirer. On average, the change in betas is equivalent to an excess shift of about 0.5 in the target's beta from its home market to that of the acquirer. We test whether the change in systematic risk can be explained by fundamental factors related to changes in the operations of the firm or merger synergy and find that it cannot.]

We test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk. The empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and equity returns are negatively correlated with domestic inflation. We then develop a model of international portfolio choice and equity market equilibrium that integrates inflation risk and deadweight costs. Using this model we estimate the levels of costs required to generate the observed home bias in portfolios consistent with different levels of risk aversion. For a level of risk aversion consistent with standard estimates of the domestic equity market risk premium, these costs are about a few percent per annum, greater than observable costs such as withholding taxes. Thus, the home bias cannot be explained by either inflation hedging or direct observable costs of international investment unless investors have very low levels of risk aversion.

Richard A. Brealey, Ian A. Cooper, Evi Kaplanis; What is the International Dimension of International Finance?, European Finance Review, Volume 3, Issue 1,

This study documents the fact that large dividend increases are followed by a significant increase in leverage, consistent with management increasing the dividend to use up excess debt capacity. However, the leverage increase is not captured by a standard partial adjustment model of leverage. Nor does it reflect variables known to be related to dividend increases, such as firm maturity, investment, and risk. Instead, the dividend increase signals a complex change in the way firms adjust to their leverage target, but it does not signal a change in the target.

Using a large sample of cross-border mergers, we measure the effect of a change in location on systematic risk. When a target firm's location moves, a large part of its systematic risk switches from being related to its home equity market to that of the acquirer. On average, the change in betas is equivalent to an excess shift of about 0.5 in the target's beta from its home market to that of the acquirer. We test whether the change in systematic risk can be explained by fundamental factors related to changes in the operations of the firm or merger synergy and find that it cannot. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please e-mail: [email protected], Oxford University Press.

ABSTRACT We characterize the exchange of financial claims from risky swaps. These transfers are among three groups: shareholders, debtholders, and the swap counterparty. From this analysis we derive equilibrium swap rates and relate them to debt market spreads. We then show that equilibrium swaps in perfect markets transfer wealth from shareholders to debtholders. In a simplified case, we obtain closed‐form solutions for the value of the default risk in the swap. For interest‐rate swaps, we obtain numerical solutions for the equilibrium swap rate, including default risk. We compare these with equilibrium debt market default risk spreads.