The contextual nature of the predictive power of statistically-based quarterly earnings models

We present new empirical evidence on the contextual nature of the predictive power of five statistically-based quarterly earnings expectation models evaluated on a holdout period spanning the twelve quarters from 2000–2002. In marked contrast to extant time-series work, the random walk with drift (RWD) model provides significantly more accurate pooled, one-step-ahead quarterly earnings predictions for a sample of high-technology firms (n = 202). In similar predictive comparisons, the Griffin-Watts (GW) ARIMA model provides significantly more accurate quarterly earnings predictions for a sample of regulated firms (n = 218). Finally, the RWD and GW ARIMA models jointly dominate the other expectation models (i.e., seasonal random walk with drift, the Brown-Rozeff (BR) and Foster (F) ARIMA models) for a default sample of firms (n = 796). We provide supplementary analyses that document the: (1) increased frequency of the number of loss quarters experienced by our sample firms in the holdout period (2000–2002) vis-à-vis the identification period (1990–1999); (2) reduced levels of earnings persistence for our sample firms relative to earnings persistence factors computed by Baginski et al. (2003) during earlier time periods (1970s–1980s); (3) relative impact on the predictive ability of the five expectation models conditioned upon the extent of analyst coverage of sample firms (i.e., no coverage, moderate coverage, and extensive coverage); and (4) sensitivity of predictive performance across subsets of regulated firms with the BR ARIMA model providing the most accurate predictions for utilities (n = 87) while the RWD model is superior for financial institutions (n = 131).

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An alternative interpretation of the discontinuity in earnings distributions

We show that the asymmetric effects of income taxes and special items for profit and loss firms contribute to a discontinuity at zero in the distribution of earnings. Income taxes draw profit observations towards zero while negative special items pull loss observations away from zero. These earnings components are thus expected to contribute to a discontinuity even in the absence of discretion. We show our results are not an artifact of deflation and that other common components of earnings do not have similar effects on the earnings distribution around zero.

Introduction to <Emphasis Type="Italic">JREFE</Emphasis> Special Issue on the 2007 MCM International Symposium

This article introduces the 2007 Maastricht-Cambridge-MIT Symposium articles in this special issue. The introduction not only briefly describes each of the four articles from that symposium included in this special issue, but also describes the symposium including links to other papers and presentations of the symposium not published in this issue.

Economic consequences of financial reporting changes: diluted EPS and contingent convertible securities

This paper examines the economic consequences of changes in the financial reporting requirements for contingent convertible securities (COCOs). Using a sample of 199 COCO issuers from 2000 to 2004, we find that issuers are more likely to restructure or redeem existing COCOs to obtain more favorable accounting treatment when the financial reporting impact on diluted earnings per share (EPS) is greater and when EPS is used as a performance metric in CEO bonus contracts. These results provide new evidence that managers are willing to incur costs to retain perceived financial reporting and compensation benefits. We also present evidence of significantly negative stock returns around event dates associated with the financial reporting changes, consistent with investor anticipation of the agency costs associated with the rule change.

Monetary Shocks and REIT Returns

We investigate the influence of unanticipated changes in US monetary policy on Equity Real Estate Investment Trusts (REIT’s). Although a number of studies have investigated the issue of interest rate changes, the effect of unanticipated changes has not previously been addressed in terms of possible effects on both REIT’s returns and volatility. The results show a strong response in both the first and second moments of REIT returns to unexpected policy rate changes. The results for the impact of the shock on both mean and volatility of returns is consistent with results from studies addressing broader equity markets. However, we find evidence both against behavioral changes in volatility coincident to US monetary policy decisions and asymmetric responses to the monetary policy shock.

Securitization of mezzanine capital in Germany

A recent trend in the German asset-backed securities (ABS) market is the securitization of subordinated loans and profit participation agreements (PPAs) granted to medium-sized enterprises (MEs). This paper provides an overview of this growing market and analyzes the benefits of such transactions for portfolio companies as well as for originators and potential investors. Simulations of 10 recent transactions indicate that despite the relatively low interest rates charged on obligors, originators and investors can earn attractive returns at fairly low risk. In particula, the junior tranches of these securitizations exhibit quite attractive risk-return profiles.

Performance persistence and its influence on money and investor flows into Spanish pension plans

This article analyzes the phenomenon of performance persistence in Spanish equity pension plans between 1999 and 2006 to determine whether plans with higher performance in one period continue obtaining higher performance in the future. It also aims to determine the influence of past performance on investor behavior in order to examine whether money and investor flows of these portfolios are affected by past performance. The results reveal the existence of short-term performance persistence and a statistically significant relationship between historical returns and investment flows.

A multi-factor Markovian HJM model for pricing American interest rate derivatives

This article presents a numerically efficient approach for constructing an interest rate lattice for multi-state variable multi-factor term structure models in the Makovian HJM [Econometrica 70 (1992) 77] framework based on Monte Carlo simulation and an advanced extension to the Markov Chain Approximation technique. The proposed method is a mix of Monte Carlo and lattice-based methods and combines the best from both of them. It provides significant computational advantages and flexibility with respect to many existing multi-factor model implementations for interest rates derivatives valuation and hedging in the HJM framework.

On the role of market insurance in a dynamic model

Durables like cars or houses are a substantial component in the balance sheets of households. These durables are exposed to risk and can be insured in the market. We build a dynamic model in which agents have three possibilities to cope with the risk exposure of the durable stock: (i) purchase of market insurance, (ii) buffer-stock saving of the riskless asset or (iii) adjustment of the durable stock. We calibrate our model to the US economy and find a small role for market insurance.

Mortgage Put Options and Real Estate Markets

In this paper we offer direct evidence that financial intermediation does impact underlying asset markets. We develop a specific observable symptom of a banking system that underprices the put option imbedded in non-recourse asset-backed lending. Using a dataset for 19 countries and over 500 real estate investment trusts, we find that, following a negative demand shock, the “underpricing” economies experience far deeper asset market crashes than economies in which the put option is correctly priced.

Valuing corporate securities: some effects of bond indenture provisions—a correction

This paper identifies and corrects a typographical error in Black and Cox (J Finance 31:351–367, 1976). While the typographical error is seemingly trivial, the magnitude of the pricing error that it generates can be substantial.

Implied measures of relative fund performance

We evaluate the relative performance of funds by conditioning their returns on the cross-section of portfolio characteristics across fund managers. Our implied procedure circumvents the need to specify benchmark returns or peer funds. Instead, fund-specific benchmarks for measuring selection and market timing ability are constructed. This technique is robust to herding as well as window dressing and mitigates survivorship bias. Empirically, the conditional information contained in portfolio weights defined by industry sectors, assets, and geographical regions is important to the assessment of fund management. For each set of portfolio characteristics, we identify funds with success at either selecting securities or timing-the-market.

Information, Credit Risk, Lender Specialization and Loan Pricing: Evidence from the DIP Financing Market

We provide an empirical support for theories of lender specialization using the recently developed market for Debtor-in-Possession (DIP) financing. The legal environment in which DIP financing operates represents a natural laboratory for testing determinants of lending specialization (e.g. lender choice). We find that the choice of lender is not driven by credit risk, but by information considerations and that this lending specialization has loan pricing effects. In short, banks (non-bank lenders) lend to more (less) transparent firms and at lower (higher) loan spreads. Our results are consistent with the interpretation that banks provide important and useful services.

IMF Bank-Restructuring Efficiency Outcomes: Evidence from East Asia

We report new findings on bank efficiency in East Asian countries for the pre- and post-IMF restructuring periods. We find that bank efficiency has improved, but only to the pre-IMF intervention level, and that restructured banks are not more efficient than their unrestructured counterparts. Different restructuring measures have different effects. Bank closures are economically justified, but mergers show short-term efficiency losses. Recapitalization and reprivatization of badly performing banks lead to efficiency improvement, but also increase government ownership. Ease of entry that has allowed for more foreign bank participation results in slightly improved performance of badly performing banks.

Experimental evidence of how prior experience as an auditor influences managers’ strategic reporting decisions

We design an experiment to examine the influence of audit experience on subsequent reporting decisions when auditors become managers of audited firms. In contrast to the independence issues that can arise when auditors and their clients are related by prior affiliation, we focus this study on the more common case in which auditors assume subsequent employment with other firms’ clients. In a bi-matrix experimental game that captures key features of the strategic tension between auditors and reporters, we find that reporters who have prior experience as an auditor, particularly the experience of having been a diligent auditor, are more sensitive to large penalties for aggressive reporting than are reporters whose experience is exclusively as a reporter. Our results suggest implications for regulators in predicting the effects of reporting penalties and for firms in considering the effects of CPA experience when hiring for reporting positions.

Asset Price Spillover,Collateral and Crises: with an Application to Property Market Policy

This paper studies the impact of land supply elasticity and land use regulation. For sufficiently adverse shocks constrained entrepreneurs liquidate their assets for debt repayment. This effect can spillover to the residential property market. A crisis occurs when households are forced to default on their mortgages as well. While both converting costs and land use regulation tend to magnify the effect of adverse shock, the former generates an asymmetric effect between a positive and a negative shock on the land market, and the latter tends to raise the likelihood of a crisis, by raising the threshold value of liquidation.

Estimating Default Probabilities Implicit in Commercial Mortgage Backed Securities (CMBS)

This paper uses a structural credit risk model, providing an analytical formula to estimate default probabilities implicit in commercial mortgage backed security prices. Empirical studies of CMBS default have focused on the probability of default depending on loan characteristics at the origination and market indices. Recent studies show that unobservable current loan-to-value (LTV) ratio is a key state variable driving default. We update this variable using Real Estate Investment Trust (REIT) property-type indices over time. Later, we employ first passage time approach to study CMBS default using implied LTV.

How do commodity futures respond to macroeconomic news?

This paper investigates the impact of seventeen US macroeconomic announcements on two broad and representative commodity futures indices. Based on a large sample from 1989 to 2005, we show that the daily price response of the CRB and GSCI commodity futures indices to macroeconomic news is state-dependent. During recessions, news about higher (lower) inflation and real activity lead to positive (negative) adjustments of commodity futures prices. In contrast, we find no significant reactions during economic expansions. We attribute this asymmetric response to the state-dependent interpretation of macroeconomic news. Our findings are robust to several alternative business cycle definitions.

Price–volume relations of DAX companies

This study provides empirical evidence of the joint dynamics between stock returns and trading volume using stock data of DAX companies. Contemporaneous as well as dynamic interactions are investigated for a period from January 1994 to December 2005 on a daily basis. Our results suggest that there is almost no relationship between stock return levels and trading volume in either direction. We find that trading volume is contemporaneously positively related to return volatility. In addition, we establish that lagged return volatility induces trading volume movements. Finally, we examine dependencies in the tails and find no significant support for the hypothesis of the independence of the maximal values of absolute returns and trading volume.

Strategic timing of annual earnings announcements: evidence from an order-driven market

Using Spanish data, this paper examines, for the first time, the differences in the intraday response of an order-driven market to earnings announcements made during trading and non-trading hours. We show that the speed of reaction depends on timing of the announcement: for overnight (daytime) announcements, the improvement in liquidity is (not) immediate. This finding could explain why Spanish firms prefer to release the bad (good) earnings announcement in trading (non-trading) hours. This strategic timing differs from the traditional disclosure policy in American markets, suggesting that different microstructures may react differently to news releases and, consequently, drive the strategic timing of corporate disclosures.