Knowledge that Transforms

This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.

We study trading in option strategies in the FTSE-100 index market. Trades in option strategies represent around 37% of the total number of trades and over 75% of the total trading volume in our sample. We find some evidence that order flow in volatility–sensitive option strategies contains information about future realized volatility. We do not find evidence that order flow in directionally–sensitive option strategies contains information about future returns. Overall, our evidence suggests that option strategies are used both by traders who possess non-public information about future volatility and by uninformed speculators who appear to follow unprofitable trend chasing strategies.

Widely-cited research by Kamstra et al. (2003) argues that changes in mood resulting from Seasonal Affective Disorder (SAD) drive changes in investor risk aversion and cause seasonal patterns in aggregate stock returns around the world. In this paper we reexamine the so-called SAD effect by replicating and extending Kamstra et al. (2003). We study the psychological underpinnings of the SAD hypothesis and show that the time-series predictions of the SAD model do not correspond to the seasonal patterns in depression found in the general population. We also investigate the cross-sectional prediction that SAD has a greater effect on stock markets in countries where SAD is more prevalent and find no relation between the prevalence of SAD and stock returns. Finally, we document that the SAD effect is mechanically driven by an overlapping dummy-variable specification and higher returns around the turn of the year.

With the majority of large UK and many US banks collapsing or being forced to raise capital over the 2007–9 period, blaming bankers may be satisfying but is patently insufficient; Basel II and Federal oversight frameworks also deserve criticism. We propose that the current methodological void at the heart of Basel II, Pillar 2 is filled with the recommendation that banks develop fully-integrated models for economic capital that relate asset values to fundamental drivers of risk in the economy to capture systematic effects and inter-asset dependencies in a way that crude correlation assumptions do not. We implement a fully-integrated risk analysis based on the balance sheet of a composite European bank using an economic-scenario generation model calibrated to conditions at the end of 2007. Our results suggest that the more modular, correlation-based approaches to economic capital that currently dominate practice could have led to an undercapitalisation of banks, a result that is clearly of interest given subsequent events. The introduction of integrated economic-scenario-based models in future can improve capital adequacy, enhance Pillar 2’s application and rejuvenate the relevance of the Basel regulatory framework.

This paper examines, using a global M&A data set, the relationship between the target firm’s minority shareholders’ returns and a country’s stock market development in deals in which large shareholders increase their ownership stakes. For the purpose of this study, we use two measures of stock market development: (1) turnover over GDP, and (2) turnover over market capitalization. We provide evidence supporting the view that minority shareholders in target firms gain significantly more in countries with high stock market development than their counterparts in less-developed markets. Our results are robust to several firm and deal characteristics and provide evidence to policy makers that the degree of stock market development is a key determinant in improving minority shareholders’ welfare.

The use of technical analysis by financial market professionals is not well understood. This paper thus analyzes survey evidence from 692 fund managers in five countries, the vast majority of whom rely on technical analysis. At a forecasting horizon of weeks, technical analysis is the most important form of analysis and up to this horizon it is thus more important than fundamental analysis. Technicians are as experienced, as educated, as successful in their career and largely just as overconfident in decision-making as others. However, technical analysis is somewhat more popular in smaller asset management firms. What we find most significant is the relation of technical analysis with the view that prices are heavily determined by psychological influences. Consequently, technicians apply trend-following behavior.

This paper investigates how banks’ activity is affected by the corporate income tax. For this purpose it uses aggregate data on all main components of the profit and loss account and on the interest rate applied on loans and on deposits for the banking sector of the main industrialized countries during the period 1981–2003. With such information we are able to disentangle the extent to which a bank is able to shift its tax-burden forward to its borrowers, depositors, and purchasers of fee-generating services. The main result is that the taxation of banks’ profit is equivalent to a taxation on loans and as such it exerts a substantial impact on the composition of banking sector revenues. However credit intermediaries have the ability to shift a substantial part of their corporate income tax burden and therefore differences in the level of taxation cannot explain the dispersion observed in banks’ net profitability across industrialized countries.

This paper analyzes observed prices of US temperature futures at the Chicago Mercantile Exchange (CME). Results show that an index modeling approach without detrending captures the prices exceptionally well. Moreover, weather forecasts significantly influence prices up to 11 days ahead. It is shown that valuations of temperature futures relying on a model without detrending yield biased valuations by overpricing winter contracts and underpricing summer contracts. Several trading strategies are devised to exploit the mispricing observed at the CME and to demonstrate that speculating on temperature futures can not only generate high overall returns, but also perform well on a risk-adjusted basis.

This paper empirically examines whether de facto exchange rate regimes affect the occurrence of currency crises in 84 countries over the 1980–2001 period by using the probit model. We employ the de facto classification of Reinhart and Rogoff (2004) that allows us to estimate the impact of relatively long-lived exchange rate regimes on currency crises with much greater precision. We find that pegged regimes significantly decrease the likelihood of currency crises compared with floating regimes. By using the combined data of exchange rate regimes and the existence of capital controls, we also find interesting evidence that pegged regimes with capital account liberalization significantly lower the likelihood of currency crises compared with other regimes. These results are robust to a wide variety of samples and models. From the standpoint of the macroeconomic policy trilemma, we can conjecture that pegged regimes with capital account liberalization are substantially less prone to speculative attacks because they can enhance greater credibility in their currencies by abandoning monetary policy autonomy.

We propose an identified structural GARCH model to disentangle the dynamics of financial market crises. We distinguish between the hypersensitivity of a domestic market in crisis to news from foreign non-crisis markets, and the contagion imported to a tranquil domestic market from foreign crises. The model also enables us to connect unobserved structural shocks with their source markets using variance decompositions and to compare the size and dynamics of impulses during crises periods with tranquil period impulses. To illustrate, we apply the method to data from the 1997–1998 Asian financial crisis which consists of a complicated set of interacting crises. We find significant hypersensitivity and contagion between these markets but also show that links may strengthen or weaken. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crises and covariance responses demonstrate multiple layers of contagion effects.