Knowledge that Transforms

The paper deals with optimal portfolio choice problems when risk levels are given by coherent risk measures, expectation bounded risk measures or general deviations. Both static and dynamic pricing models may be involved. Unbounded problems are characterized by new notions such as (strong) compatibility between prices and risks. Surprisingly, the lack of bounded optimal risk and/or return levels arises for important pricing models (Black and Scholes) and risk measures (VaR, CVaR, absolute deviation, etc.). Bounded problems present a Market Price of Risk and generate a pair of benchmarks. From these benchmarks we introduce APT and CAPM-like analyses, in the sense that the level of correlation between every available security and some economic factors explains the security expected return. The risk level non correlated with these factors has no influence on any return, despite the fact that we are dealing with risk functions beyond the standard deviation.

We examine the relation between managerial rights in acquiring firms and the decision to use an investment bank in merger and acquisition deals, and explore whether this relation impacts the wealth effects for acquiring firms’ shareholders. We find that acquiring firms whose managers have relatively strong rights are more likely to use investment banks to facilitate deals and are more likely to use reputable banks. The wealth effects to acquiring firms are inversely related to the use of investment banks when managerial rights are relatively strong. However, the wealth loss is mitigated when acquiring firms use reputable investment banks.

We define a battery of Sharpe performance measures, which differ by the information taken into account in their computation, but also by the potential use of the fund by the investor. Four advantages of Sharpe performance based rating are especially important for the investor. First, the performance measures correspond to the standard measures used for mutual funds and known by retail investors. Second, we can compare the numerical results, even if they are obtained with different assumptions. Third, the rankings are based on regression analysis and easy to compute. Fourth, we can easily use these performance measures in the design of an optimal basket of hedge funds. Finally, we can use the performance measures to partition the set of funds into homogenous segments.

This study empirically examines the impact of the interaction between market and default risk on corporate credit spreads. Using credit default swap (CDS) spreads, we find that average credit spreads decrease in GDP growth rate, but increase in GDP growth volatility and jump risk in the equity market. At the market level, investor sentiment is the most important determinant of credit spreads. At the firm level, credit spreads generally rise with cash flow volatility and beta, with the effect of cash flow beta varying with market conditions. We identify implied volatility as the most significant determinant of default risk among firm-level characteristics. Overall, a major portion of individual credit spreads is accounted for by firm-level determinants of default risk, while macroeconomic variables are directly responsible for a lesser portion.

This paper proposes a pragmatic, discrete time indicator to gauge the performance of portfolios over time. Integrating the shortage function (Luenberger, 1995) into a Luenberger portfolio productivity indicator (Chambers, 2002), this study estimates the changes in the relative positions of portfolios with respect to the traditional Markowitz mean-variance efficient frontier, as well as the eventual shifts of this frontier over time. Based on the analysis of local changes relative to these mean-variance and higher moment (in casu, mean-variance-skewness and mean-variance-skewness-kurtosis) frontiers, this methodology allows to neatly separate between on the one hand performance changes due to portfolio strategies and on the other hand performance changes due to the market evolution. This methodology is empirically illustrated using a mimicking portfolio approach (Fama and French, 1996, Fama and French, 1997) using US monthly data from January 1931 to August 2007.

Early warning systems (EWS) for banking crises generally omit bank capital, bank liquidity and property prices. Most work on EWS has been for global samples dominated by emerging market crises where time series data on bank capital adequacy and property prices are typically absent. We estimate logit crisis models for OECD countries, finding strong effects from capital adequacy and liquidity ratios as well as property prices, and can exclude traditional variables. Higher capital adequacy and liquidity ratios have a marked effect on the crisis probabilities, implying long-run benefits to offset some of the costs that such regulations may impose.

This paper examines the impact of multiple directorships on stockholder wealth around the announcements of mergers and acquisitions. Grounded in agency theory, we argue that multiple directorships affect the quality of managerial oversight and thus influence agency conflicts in acquisition decisions. We show that acquiring firms where directors hold more outside board seats experience more negative abnormal returns. This adverse effect, nonetheless, does not extend across the entire range of multiple directorships. Rather, the detrimental impact is significant only when the number of outside board seats surpasses a certain threshold. We interpret this result as suggesting that directors serving on multiple boards allow value-destroying acquisitions when they become too busy beyond a certain point, and the effect of directors’ busyness on acquisition performance appears to be nonlinear. We employ several alternative definitions of directors’ busyness and obtain consistent results.

Agency theory suggests that governance matters more among firms with greater potential agency costs. Rational investors are unlikely to value safeguards against unlikely events. Yet, few studies of the relation between governance and firm value control for investor perceptions of the likelihood of agency conflicts. Shleifer and Vishny [Shleifer, A., Vishny, R.W., 1997. A survey of corporate governance. Journal of Finance 52, 737–783] identify investment-related agency conflicts as the more severe type of agency conflicts in the US. We measure the perceived likelihood of this type of agency conflict using free cash flow (Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review 76, 323–329). We find that firm value is an increasing function of improved governance quality among firms with high free cash flow. In contrast, governance benefits are lower or insignificant among firms with low free cash flow. We show that not controlling for this conditional relation between governance and firm value could lead to erroneous conclusions that governance and firm value are unrelated.

We extend the benchmark nonlinear deterministic volatility regression functions of Dumas et al. (1998) to provide a semi-parametric method where an enhancement of the implied parameter values is used in the parametric option pricing models. Besides volatility, skewness and kurtosis of the asset return distribution can also be enhanced. Empirical results, using closing prices of the S&P 500 index call options (in one day ahead out-of-sample pricing tests), strongly support our method that compares favorably with a model that admits stochastic volatility and random jumps. Moreover, it is found to be superior in various robustness tests. Our semi-parametric approach is an effective remedy to the curse of dimensionality presented in nonparametric estimation and its main advantage is that it delivers theoretically consistent option prices and hedging parameters. The economic significance of the approach is tested in terms of hedging, where the evaluation and estimation loss functions are aligned.

One distinguishable feature of storable commodities is that they relate to two markets: cash market and storage market. This paper proves that, if no arbitrage exists in the storage-cash dual markets, the commodity convenience yield has to be non-negative. However, classical reduced-form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield. To avoid negative convenience yield, this paper proposes a semi-affine arbitrage-free model, which prices futures analytically and fits futures term structures reasonably well. Importantly, our model prices commodity-related contingent claims (such as calendar spread options) quite differently with classical models.