Developing a financial conditions index for a post-transition country: the case of Croatia

The interconnection between financial and business cycles and the importance of surveillance over financial markets emphasise the need for the development of indicators that could trace financial conditions in a country. In this paper, we focus on developing a financial conditions index for a post-transition country – Croatia. Since financial conditions indices for post-transition markets differ from those for developed markets due to differences in the development of their financial systems and the availability of data, we show that financial conditions indices constructed for post-transition markets need to be tailored to the specifics of such markets.     

Measuring responsible financial consumption behaviour

Sound consumption decisions determine individuals’ well‐being; responsible financial consumption behaviour (RFCB) affects not only their finances but also their societal status and emotional state. The failure to manage personal finances responsibly may result in serious long‐term consequences for individuals and society overall. In order to evaluate the concept of RFCB, this study combines two established theoretical frameworks—the family management system and the theory of planned behaviour. The paper investigates the relationships among RFCB, responsible financial attitudes, financial literacy and behavioural control. Its theoretical model is tested on a random sample of 494 respondents and analysed using PLS‐SEM. The results confirm the formation of responsible consumption behaviour by six formative elements: self‐control in spending, planning for the future, seeking information, education, rational decision‐making and solvency. The findings also indicate that all three focal variables have a direct effect on RFCB.     

The risk-shifting effect and the value of a warrant

The exercise of a warrant leads to the well-known dilution phenomenon, the effects of which have been extensively studied over the last four decades. In contrast, the existing literature has paid inadequate attention to the volatility spillover between stockholders and warrant holders. This ‘risk-shifting effect’ has significant implications for warrant pricing, since any formula that assumes a constant volatility of stock returns produces a bias. In this paper we show that a CEV process with a specific elasticity parameter properly models the stochastic volatility of stock returns for a firm with warrants outstanding. In addition, we propose an approximate analytical formula, exclusively based on observable market variables, that is able to absorb the risk-shifting bias.     

The role of institutional investors in public-to-private transactions

In Italy, as in many other European countries, listed firms will normally go dark through controlling owner-initiated tender offers. We find that institutional investors play a central role in the bid process and can protect minority shareholders from being frozen out in the bid. Specifically, tender offers are less likely to succeed when a firm has institutional investors in its ownership structure. When public-to-private offers are accepted, bid premiums are significantly greater if a financial institution (particularly when it is foreign, independent or activist) has a stake in the firm. We explore the effect of a number of hitherto unexplored factors on the takeover premium and find that shareholder agreements facilitate public-to-private acquisitions. Other factors, such as a threat to merge the target if the bid fails, or external validation of the offer price, have no impact on either the likelihood of delisting or the premium paid by the bidder.     

Diamonds and precious metals for reduction of portfolio tail risk

ABSTRACT

We study the performance of diamonds compared to gold and other precious metals in mitigating the tail risk of a diversified equity market portfolio over the period June 2007 to October 2018. Our results display a diversification benefit of some diamond indices, which also improve the portfolio reward-to-risk ratio. To corroborate this evidence, we study the dependence structure and tail dependence of diamonds and a broad equity market portfolio and compare it to the dependence obtained with gold and other precious metals. Results from fitting a bivariate copula show that the average left tail dependence reaches its minimum when diamonds are used. We also show that using shares of diamond-mining companies does not provide the same benefits.     

A generalized approach to optimal hedging with option contracts

In this paper, we develop a theoretical model in which a firm hedges a spot position using options in the presence of both quantity (production) and basis risks. Our optimal hedge ratio is fairly general, in that the dependence structure is modeled through a copula function representing the quantiles of the hedged position, and hence any quantile risk measure can be employed. We study the sensitivity of the exercise price which minimizes the risk of the hedged portfolio to the relevant parameters, and we find that the subjective risk aversion of the firm does not play any role. The only trade-off is between the effectiveness and cost of the hedging strategy.     

The role of time value in convertible bond call policy

Since the seminal work of Ingersoll (1977b) the optimal time in which a firm should redeem its outstanding convertible bonds has received large attention by the financial literature. Several studies have put forward a number of possible costs and benefits for a firm if it interrupts the life of its convertible bonds prior to their contractual maturity. However, in this paper we argue that the managerial decision to call back a convertible bond is mainly driven by a fundamental variable almost neglected up until now: the time value extraction from bondholders’ conversion option. Accordingly, we propose a measure for the effective convenience of calling—which we define as net time value advantage—and we show, using a survival analysis, that it is more effective than previously proposed measures in explaining the firms’ observed call policy.     

Optimal hedge ratio under a subjective re-weighting of the original measure

In this article we study a risk-minimizing hedge ratio with futures contracts, where the risk of the hedged portfolio is measured through a spectral risk measure (SRM), thus incorporating the degree of agent’s risk aversion. We empirically estimate the optimal hedge ratio (OHR) using a long time series of UK and US equity indices, the EURUSD and EURGBP exchange rates and four liquid commodities (Brent crude oil, corn, gold and copper), to represent different asset classes. Comparing the results with common OHRs (such as the minimum variance and the minimum expected shortfall), we find that the agent’s risk aversion has a material impact, and should not be ignored in risk management.