Forms of Foreign Investment Liberalization and Risk in Emerging Stock Markets

I examine the effect of different forms of foreign investment liberalization on risk in emerging equity markets, including international cross-listings and closed-end country funds, and in the domestic equity market as foreign investment restrictions are eliminated. I find that in Latin American markets volatility declines significantly with different forms of foreign investment liberalization, and in Asian markets volatility does not increase significantly. Volatility is driven by domestic factors in South America, but the transmission of volatility from the United States to Mexico increases after liberalization. The market risk exposure increases in Argentina after liberalization, in Chile with an index of American Depositary Receipts, and in Thailand with greater foreign ownership, reducing the diversification benefits of these markets.     

Monetary Policy and the Cross-Section of Expected Stock Returns

Ample evidence shows that size and book-to-market equity explain significant cross-sectional variation in stock returns, whereas beta explains little or none of the variation. Recent studies also demonstrate that proxies for monetary stringency increase the explained variation in stock returns. We reexamine a three-factor model that includes beta, size, and book-to-market equity, while allowing monetary conditions to influence the relations between these risk factors and average stock returns. We find that ex-ante proxies for monetary stringency significantly influence the relations between stock returns and all three risk factors. Additionally, all three variables are found to contribute significantly to explaining cross-sectional returns in a three-factor model that includes the monetary sector.     

Consolidating Corporate Control: Divisional Versus Whole-Company Leveraged Buyouts

We examine the empirical relation between firm characteristics and the likelihood of choosing a restructuring choice between two types of leveraged buyouts: a whole‐company leveraged buyout (WLBO) and a divisional leveraged buyout (DLBO). Our findings suggest that firm characteristics such as volatility of cash flow and growth potential play an important role in determining a firm's restructuring choice between a WLBO and a DLBO. In particular, firms with greater volatility of cash flow and/or greater future growth potential are more likely to adopt a DLBO than a WLBO as their restructuring choice. These results are consistent with the notion that although low‐growth, high‐cash‐flow firms would create the most value for stockholders by paying out cash and tying future cash flows to the firm's debt service through a WLBO, high‐growth, low‐cash‐flow firms would be better off by selling assets if those assets would be better managed under a DLBO.     

Asian Economic Integration and Stock Market Comovement

Using daily returns from 1988 to 1998, we investigate to what degree twelve equity markets in Asia are integrated with Japan's equity market and examine the factors that affect the level of economic integration. We find that the equity markets of Australia, China, Hong Kong, Malaysia, New Zealand, and Singapore are highly integrated with the stock market in Japan. There is also evidence that these Asian markets become more integrated over time, especially since 1994. A higher import share as well as a greater differential in inflation rates, real interest rates, and gross domestic product growth rates have negative effects on stock market comovements between country pairs. Conversely, increased export share by Asian economies to Japan and greater foreign direct investment from Japan to other Asian economies contribute to greater comovement.     

Gains to Mutual Fund Sponsors Offering Multiple Share Class Funds

Although the number of mutual funds grew during the 1990s, much of the growth is attributable to the introduction of multiple share class (MS) funds. Proponents argue that the MS structure leads to cost savings, which can be passed onto investors as lower expenses. However, if the structure lowers costs, sponsors are likely to profit from it. Though investors are concerned about the base expense ratio, the sum of administrative and management fees, fund sponsors generate profits from the management fees. As such, they would prefer to increase the management fee if they can simultaneously lower administrative fees. Our results indicate that MS fund investors pay lower administrative fees, but management fees are approximately 7 basis points higher than single-class funds. Overall, base expense ratios are higher than for single-class funds, suggesting fund sponsors capture the cost benefits the MS structure provides. Our results are robust to different model specifications and different estimation techniques.     

News Releases, Market Integration, and Market Leadership

Using intraday data we examine the response of futures on the British Long Gilt (Gilt), the German Government Bond (Bund), the U.S. Treasury Bond (Bond), the Japanese Government Bond (JGB), and the Italian Government Bond (IGB) to the release of U.S. macroeconomic news. Bond, Gilt, and Bund futures respond strongly to the news releases. The response of JGB futures is less pronounced, and IGB futures display weak responses at best. The instruments take time to adjust to news in the announcements. Following the announcements, Bond futures exert a high degree of market leadership. Evidence of increasing market integration is also noted.     

Firm Transparency and the Costs of Going Public

We demonstrate that firms that are more transparent pay less, in all components of issuance costs, to go public. We employ a sample of 334 previous leveraged buyouts and a characteristic-matched control sample to test the hypothesis that greater firm transparency before the issue decreases the flotation costs of the initial public offering. These flotation costs are divided into initial underpricing, underwriter discount, administrative expenses, and the overallotment option required to take the firm public. Our results provide further evidence of the asymmetric information hypothesis as it applies to initial public offerings.     

Merger Announcements and Trading

We test whether an increase either in informed trades or in large liquidity trades leads to greater correlation of trading volume across markets. We confirm that both trading volume and positive returns of target companies are abnormally high before merger announcements. We find a statistically significant increase in the correlation between New York Stock Exchange and Nasdaq/regional trading volume before merger announcements. Furthermore, after merger announcements, we find evidence of both large liquidity trading and a statistically significant increase in the correlation of trading volume across markets.     

Valuing the Option to Purchase an Asset at a Proportional Discount

I analyze the value of a nonstandard call option that allows the holder to purchase an underlying asset at a discount proportional to the asset's market price. Several applications for this type of option exist, including its use in employee compensation contracts. I derive the value of this option for a dividend-paying asset and for an option whose exercise price reflects a time-varying discount factor. The derived value incorporates the optimal time at which the option should be exercised. One application of this option relates to a residential real estate program in China.     

The Firm Size Effect and the Economic Cycle

Small firms have, on average, lower return on assets and higher leverage than do large firms. Small firms tend to do well in good economic conditions but to perform poorly in the worst economic conditions. We investigate the hypothesis that the small firm effect is manifest in the expansion phase of the economic cycle but not in the contraction phase. The empirical results of our study confirm the hypothesis for 1976–95. We use the alpha, residual, and regression methods in testing the hypothesis.     

A Comparison of Seasonal Adjustment Methods When Forecasting Intraday Volatility

In this article we compare volatility forecasts over a thirty‐minute horizon for the spot exchange rates of the Deutsche mark and the Japanese yen against the U.S. dollar. Explicitly modeling the intraday seasonal pattern improves the out‐of‐sample forecasting performance. We find that a seasonal estimated from the log of squared returns improves with the use of simple squared returns, and that the flexible Fourier form (FFF) is an efficient way of determining the seasonal. The two‐step approach that first estimates the seasonal using the FFF and then the parameters of the generalized autoregressive conditional heteroskedasticity (GARCH) model for the deseasonalized returns performs only marginally worse than the computationally expensive periodic GARCH model that includes the FFF.     

Skewness and Kurtosis Implied by Option Prices: A Correction

Corrado and Su (1996) provide skewness and kurtosis adjustment terms for the Black‐Scholes model, using a Gram‐Charlier expansion of the normal density function. In this note we provide a correction to the expression for the skewness coefficient and illustrate the effect on call option prices of the error found.     

Government Bond Market Seasonality, Diversification, and Cointegration: International Evidence

Using government bond market data for the United States, Canada, the United Kingdom, Germany, France, and Japan, I investigate several hypotheses. Market efficiency is investigated by testing for seasonality and cointegration. The seasonality results are mixed. In regression tests, a January effect is detected in several markets (United States, Germany, France, United Kingdom, and Canada) using local currencies. However, in a nonparametric test, the January effect is supported only for France. When U.S. dollar returns are used, regression results also reveal a January effect for several markets (United States, Germany, France, and United Kingdom). These results are not confirmed by a nonparametric test. Correlation analysis shows considerable diversification opportunities for short‐term investors. Cointegration tests indicate that several of the markets share cointegrating vectors, increasing the possibilities of using other endogenous bond markets to better predict movements in a particular market.     

Are the Best Small Companies the Best Investments?

Previous research finds that large companies previously judged to be excellent growth companies have subsequently been poor investments. We examine small companies selected by Business Week on the basis of multiple criteria used in annual articles featuring highly rated growth companies. We study the investment performance over the three years before eleven annual Business Week publications and the three years after publication. We find positive excess returns in the pre‐publication period, but negative excess returns in the post‐publication period. This reversal in investment performance appears to be due to a mean‐reversion tendency in operating performance, in which the earnings and the past rates of return on capital of such companies subsequently decrease significantly.     

Differences in Performance of Independent and Finance-Affiliated Venture Capital Firms

We examine the differences in the investment behavior of independent and finance-affiliated venture capital firms (VCFs). We find that differences in internal management mechanisms and staff backgrounds lead to external performance differences. Using VC-backed companies listed in Singapore as our sample, we find significant differences between these two types of VCFs in industry preference, investment duration, VCF syndication, number of board seats, initial underpricing, and long-term market returns. Independent VCFs add more value to their portfolios. Thus, we conclude that the participation of independent VCFs is an important corporate-level factor for the success of the venture capital market.     

Stock price fragility

We study the relation between the ownership structure of financial assets and non-fundamental risk. We define an asset to be fragile if it is susceptible to non-fundamental shifts in demand. An asset can be fragile because of concentrated ownership, or because its owners face correlated or volatile liquidity shocks, i.e., they must buy or sell at the same time. We formalize this idea and apply it to mutual fund ownership of US stocks. Consistent with our predictions, fragility strongly predicts price volatility. We then extend the logic of fragility to investigate two natural extensions: (1) the forecast of stock return comovement and (2) the potentially destabilizing impact of arbitrageurs on stock prices.     

Liquidity, analysts, and institutional ownership

In this paper, we investigate the empirical relationship between institutional ownership, number of analysts following and stock market liquidity. We find that firms with larger number of financial analysts following have wider spreads, lower market quality index, and larger price impact of trades. However, we find that firms with higher institutional ownership have narrower spreads, higher market quality index, and smaller price impact of trades. In addition, we show that changes in our liquidity measures are significantly related to changes in institutional ownership over time. These results suggest that firms may alleviate information asymmetry and improve stock market liquidity by increasing institutional ownership. Our results are remarkably robust to different measures of liquidity and measures of information asymmetry.     

Stock market trading activity and returns around milestones

We study the relation between daily stock market trading activity and the Dow Jones Industrial Average's (DJIA) movement around millenary milestones—numbers that end in three zeros. We find aggregate turnover to be 5% lower when the DJIA level is less than 1% away from the nearest milestone. The effect emerges as the DJIA approaches a milestone from below, and is stronger for first-time milestones compared to subsequent passages. The aggregate price impact is large, such that daily stock returns show a negative abnormal performance of − 10 basis points. Our findings suggest that millenary milestones of the DJIA play a role in some investors' decision making.