Can long-term performance plans mitigate the negative effects of stock consideration and high cash for acquirers?

Following Travlos (J Finance 42: 943–963, 1987), Loughran and Vijh (J Finance 52: 1765–1790, 1997), Harford (J Finance 54: 1969–1997, 1999), and Oler (Rev Acc Stud 13: 479–511, 2008), we investigate whether acquisitions involving stock consideration and acquirers with high cash levels are associated with poor performance or not. In addition, we investigate whether including a long-term performance plan in top management’s compensation package can mitigate these negative effects. We find that acquirers with a long-term performance plan are less likely to hold a high cash balance and are less likely to use stock consideration, thus avoiding scenarios that are more likely to be value-destructive. Even if an acquirer with a long-term performance plan carries a high cash balance or uses stock, we find that the plan is associated with improved fundamental performance; however, this relationship does not flow through to improved post-acquisition returns.     

Re-examining the investment-uncertainty relationship in a real options model

The main purpose of this paper is to re-examine the investment-uncertainty relationship in a real options model, and demonstrates that the Sarkar (J Econ Dyn Control 24:219–225, 2000) model is a special case of our model. This paper uses a general dynamic process, which incorporates mean reversion and jumps in a firm’s project earnings. We further derive a quasi-analytical form solution for the critical investment value and investment probability of a firm’s projects. From the simulation results, we find that an increase in uncertainty can always lead to an increase in the probability of investment, and thus has a positive impact on investment. These results, which differ from the findings of Sarkar (J Econ Dyn Control 24:219–225, 2000), could be explained by the mean-reversion and jump effects on a firm’s earnings.     

Issuers’ incentives and tests of Baron’s model of IPO underpricing

This paper reexamines the validity of Baron’s (J Financ 37:955–976, 1982) model of IPO underpricing, in which IPO underpricing is caused by asymmetric information between issuers and investment bankers. Muscarella and Vetsuypens (J Financ Econ 24:125–135, 1989) find that lead-manager IPOs are significantly more underpriced than non-self-marketed IPOs and conclude that their empirical results do not support Baron’s model. We compare self-marketed underwriters’ IPOs with non-self-marketed underwriters’ IPOs and with IPOs they lead. Our empirical results show that it is premature to reject Baron’s model of IPO underpricing when we take issuer incentives into account.     

Underwriting and investment risks in the property-liability insurance industry: evidence prior to the 9–11 event

Underwriting and investment are two important and related business activities of insurance companies. However, studies on the interrelation between underwriting and investment risks of Property-Liability (P-L) insurance companies are sparse in the literature. Using a sample of US P-L insurers, this article conducts an empirical investigation of how these two risks are associated with each other in the 1994–2000 period (before the September 11th terrorist attack in 2001). Our results, robust to various estimations, suggest that there is no significant relationship between the underwriting and investment risks among our sample firms. Such results based on pre 9–11 event period provide some support for the conjecture of Achleitner et al. (Geneva Pap Risk Insur Issues Pract 27:275–282, 2002) that many insurance companies may have failed to take an integrated approach to risk management. This resulted in a heavy loss due to dual exposures in both underwriting and investment in the 9–11 event. In the aftermath of the recent global financial crisis, risk taking and risk management of financial institutions have received more attention and increasing scrutiny. We believe the current paper provides some useful insights in this vein.     

A note on portfolio choice for sovereign wealth funds

The current vast account surpluses of commodity-rich nations, combined with record account deficits in developed markets (the United States, Britain) have created a new type of investor. Sovereign wealth funds (SWF) are instrumental in deciding how these surpluses will be invested. We need to better understand the investment problem for an SWF in order to project future investment flows. Extending Gintschel and Scherer (J. Asset Manag. 9(3):215–238, 2008), we apply the portfolio choice problem for a sovereign wealth fund in a Campbell and Viceira (Strategic Asset Allocation, 2002) strategic asset allocation framework. Changing the analysis from a one to a multi-period framework allows us to establish a three-fund separation. We split the optimal portfolio for an SWF into speculative demand as well as hedge demand against oil price shocks and shocks to the short-term risk-free rate. In addition, all terms now depend on the investor’s time horizon. We show that oil-rich countries should hold bonds and that the optimal investment policy for an SWF as a long-term investor is determined by long-run covariance matrices that differ from the correlation inputs that one-period (myopic) investors use.

Funds of hedge funds: performance, risk and capital formation 2005 to 2010

Using a comprehensive data set of funds-of-hedge funds, we extend the results of Fung et al. (J. Finance 63:1777–1803, 2008) (FHNR) with an augmented version of the Fung and Hsieh (Financ. Anal. J. 60:65–80, 2004a; J. Empir. Finance 18:547–569, 2004b) model to document performance characteristics from January 2005 to December 2010. We find that our sample period is divided into three distinct subperiods: January 2005 to June 2007 (pre-subprime crisis); July 2007 to March 2009; and April 2009 to December 2010 (post-credit crunch) during which the average fund of hedge funds delivered positive alpha only in the first subperiod. We divide the funds of hedge funds sample into those who have alpha and the rest, which we call beta-only. The empirical results show a dramatic decline in the population of alpha producing funds of hedge funds post 2008 compared to the FHNR findings. When we repeat our analysis with a synthetic hedge fund index replicator, we find qualitatively similar results.     

Momentum in Residential Real Estate

This paper examines whether there is return momentum in residential real estate in the U.S. Case and Shiller (American economic review 79(1):128–137, 1989) document evidence of positive return correlation in four U.S. cities. Similar to Jegadeesh and Titman’s (Journal of finance 56:699–720, 1993) stock market momentum paper, we construct long-short zero cost investment portfolios from more than 380 metropolitan areas based on their lagged returns. Our results show that momentum of returns in the U.S. residential housing is statistically significant and economically meaningful during our 1983 to 2008 sample period. On average, zero cost investment portfolios that buy past winning housing markets and short sell past losing markets earn up to 8.92% annually. Our results are robust to different sub-periods and more pronounced in the Northeast and West regions. While zero cost portfolios of residential real estate indices is not a tradable strategy, the implications of our results can be useful for builders, potential home owners, mortgage originators and traders of real estate options.     

Discussion of “Contagion of accounting methods: evidence from stock option expensing”

Reppenhagen (Rev Account Stud, 2010) investigates how and through which channels contagion, i.e., accounting methods used by related firms, can influence a firm’s accounting choice. My discussion focuses on research design choices and the potential effect of factors other than those investigated in the study.     

Pricing growth-rate risk

We characterize the compensation demanded by investors in equilibrium for incremental exposure to growth-rate risk. Given an underlying Markov diffusion that governs the state variables in the economy, the economic model implies a stochastic discount factor process S. We also consider a reference growth process G that may represent the growth in the payoff of a single asset or of the macroeconomy. Both S and G are modeled conveniently as multiplicative functionals of a multidimensional Brownian motion. We consider the pricing implications of parametrized family of growth processes G ^ε , with G ⁰=G, as ε is made small. This parametrization defines a direction of growth-rate risk exposure that is priced using the stochastic discount factor S. By changing the investment horizon, we trace a term structure of risk prices that shows how the valuation of risky cash flows depends on the investment horizon. Using methods of Hansen and Scheinkman (Econometrica 77:177–234, 2009), we characterize the limiting behavior of the risk prices as the investment horizon is made arbitrarily long.     

A pure martingale dual for multiple stopping

In this paper, we present a dual representation for the multiple stopping problem, hence multiple exercise options. As such, it is a natural generalization of the method in Rogers (Math. Finance 12:271–286, 2002) and Haugh and Kogan (Oper. Res. 52:258–270, 2004) for the standard stopping problem for American options. We term this representation a ‘pure martingale’ dual as it is solely expressed in terms of an infimum over martingales rather than an infimum over martingales and stopping times as in Meinshausen and Hambly (Math. Finance 14:557–583, 2004). For the multiple dual representation, we propose Monte Carlo simulation methods which require only one degree of nesting.     

Using Nonnormal Distributions to Analyze the Relationship Between Stock Returns in Japan and the US

The Pearson distribution system is researched and applied to financial engineering (Nagahara, Financ Eng Jpn Mark 2(2):139–154 in 1995, Financ Eng Jpn Mark 3(2):121–149 in 1996, Stat Prob Lett 43:251–264 in 1999, J Time Ser Anal 24(6):721–738 in 2003, A method of fitting multivariate nonnormal distributions to financial data. Discussion paper of Institute of Social Sciences, F-2006-2, Meiji University in 2006, Asia Pac Financial Markets 15(3–4):175–184 in 2008a). And a method of fitting multivariate nonnormal distributions by using random numbers from the Pearson distribution system was developed (Nagahara, Comput Stat Data Anal 47(1):1–29 in 2004). This method uses the grid search of the parameters for the maximum likelihood. In this paper, we adopt Grid-Computing and its middleware for the parameter sweep in order to reduce the computational time and the workload of this method. In the area of the financial risk management, it is very important to analyze the relationship between stock returns in Japan and the US. We analyze the data based on the same date and the following date because Japanese stock market opens before the US stock market opens in a day. We compare these returns by means of the multivariate nonnormal distributions by using this method. And we test the international transmission of stock markets movement. Furthermore, we obtain the optimal job schedule for our computer system using the middleware in order to reduce the computational time.     

Base independence in the analysis of tax policy effects: with an application to Norway 1992–2004

The analysis contrasts results of two recently expounded microlevel data approaches to derive robust intertemporal characterizations of redistributional effects of income tax schedules; the fixed-income procedure of Kasten et al. (Tax progressivity and Income Inequality, Cambridge University Press, 1994) and the transplant-and-compare method of Dardanoni and Lambert (J. Public Econ. 86:99–122, 2002). Our study is normative in that the Blackorby and Donaldson (Can. J. Econ. 17:683–694, 1984) index of tax progressivity is employed. This enables contributions from vertical redistribution and horizontal inequity also to be assessed, using for the latter one classical measure and one no reranking measure. When the competing methodologies are applied to Norwegian data for 1992–2004, their respective strengths and weaknesses are revealed. The transplant-and-compare procedure is found to have a number of advantages.      

On the validity of the augmented Fama and French’s (1993) model: evidence from the Hong Kong stock market

This paper investigates the performance of four-factor asset pricing model using Hong Kong stock returns. Our four-factor model is constructed by adding a momentum factor into the Fama and French’s (J Finance Econ 33(1):3–56, 1993) three-factor model. We find that the four-factor model may explain return variation using Hong Kong data. Our results show evidence that all the four factors are significant in the model and intercepts are not significant. In addition, the reasonably high values of adjusted R ² and the insignificance of an additional explanatory variable of residual standard deviation provide supportive evidence to the model. The robustness of the model is also checked for two effects: up- and down-market conditions and seasonal behavior.     

Is there a viable alternative to ordinary least squares regression when security abnormal returns are the dependent variable?

Regression analysis is often used to estimate a linear relationship between security abnormal returns and firm-specific variables. If the abnormal returns are caused by a common event (i.e., there is “event clustering”) the error term of the cross-sectional regression will be heteroskedastic and correlated across observations. The size and power of alternative test statistics for the event clustering case has been evaluated under ideal conditions (Monte Carlo experiments using normally distributed synthetic security returns) by Chandra and Balachandran (J Finance 47:2055–2070, 1992) and Karafiath (J Financ Quant Anal 29(2):279–300, 1994). Harrington and Shrider (J Financ Quant Anal 42(1):229–256, 2007) evaluate cross-sectional regressions using actual (not simulated) stock returns only for the case of cross-sectional independence, i.e., in the absence of clustering. In order to evaluate the event clustering case, random samples of security returns are drawn from the data set provided by the Center for Research in Security Prices (CRSP) and the empirical distributions of alternative test statistics compared. These simulations include a comparison of OLS, WLS, GLS, two heteroskedastic-consistent estimators, and a bootstrap test for GLS. In addition, the Sefcik and Thompson (J Accounting Res 24(2):316–334, 1986) portfolio counterparts to OLS, WLS, and GLS, are evaluated. The main result from these simulations is none of the other estimator shows clear advantages over OLS or WLS. Researchers should be aware, however, that in these simulations the variance of the error term in the cross-sectional regression is unrelated to the explanatory variable.

Irreversible investment in oligopoly

We take a general perspective on capital accumulation games with open loop strategies, as they have been formalized by Back and Paulsen (Rev. Financ. Stud. 22, 4531–4552, 2009). With such strategies, the optimization problems of the individual players are of the monotone follower type. Consequently, one can adapt available methods, in particular the approach of Bank (SIAM J. Control Optim. 44, 1529–1541, 2005). We obtain consistency in equilibrium by proving that with common assumptions from the oligopoly literature on instantaneous revenue, equilibrium determination is equivalent to solving a single monotone follower problem. In the unique open loop equilibrium, only the currently smallest firms invest. This result is valid for arbitrary initial capital levels and general stochastic shock processes, which may be non-Markovian and include jumps. We explicitly solve an example, the specification of Grenadier (Rev. Financ. Stud. 15, 691–721, 2002) with a Lévy process.     

The makings of an information leader: the intraday price discovery process for individual stocks in the DJIA

The main purpose of this paper is to construct an intraday arbitrage price series for each stock in the DJIA using information in the Diamond Trust Fund ETF. We then compute the information shares (Hasbrouck in J Finan 50(4):1175–1199, 1995) for the actual versus the arbitrage prices for each stock. While previous literature documents that ETFs lead stock indices in information origination, we find that some firms are “information leaders” in that the information share that comes from the stock price is larger than that which comes from the ETF-related arbitrage price. Further analysis is conducted to uncover the firm-specific factors that are related to a stock’s role in information generation.     

Security returns, beta, size, and book-to-market equity: evidence from the Shanghai A-share market

The main purpose of this paper is to explore the cross-sectional relationship between security returns and beta, size and book-to-market equity in the Shanghai A-share market. This study takes place during the period January 1997–December 2006. The methodology of Fama and French (J Finance 51:55–84, 1992) and Pettengill et al. (J Financial Quant Anal 30:101–116, 1995) is adopted. The Results show no evidence of an unconditional relationship between beta and returns. However, a conditional relationship is found when the data is split into up and down markets. The relationship holds even in the presence of size and book-to-market equity. Both size and book-to-market equity is found to be priced by the market and thereby regarded as significant determinants of security returns.     

Marketing Period Risk in a Portfolio Context: Theory and Empirical Estimates from the UK Commercial Real Estate Market

The role of selling (or marketing) period uncertainty in understanding risk associated with property investment is examined in this paper. Using an approach developed by Lin (2004), and Lin and Vandell (2001, 2005), combined with a statistical model of UK commercial property transactions, we show that the ex ante level of risk exposure for a commercial real estate investor is around one and a half times that obtained from historical statistics. The risk related to marketing time uncertainty can be reduced by constructing a portfolio. We find that at least ten properties are necessary to reduce this risk, assuming independence between marketing period risk and price risk. These findings have important implications for mixed-asset portfolio allocation decisions.      

The valuation of multivariate contingent claims under transformed trinomial approaches

This study develops a transformed-trinomial approach for the valuation of contingent claims written on multiple underlying assets. Our model is characterized by an extension of the Camara and Chung (J Futur Mark 26: 759–787, 2006) transformed-binomial model for pricing options with one underlying asset, and a discrete-time version of the Schroder (J Finance 59(5): 2375–2401, 2004) model. However, unlike the Schroder model, our model can facilitate straightforward valuation of American-style multivariate contingent claims. The major advantage of our transformed-trinomial approach is that it can easily tackle the volatility skew observed within the markets. We go on to use numerical examples to demonstrate the way in which our transformed-trinomial approach can be utilized for the valuation of multivariate contingent claims, such as binary options.     

Do option open-interest changes foreshadow future equity returns?

Recent work considers whether information is simultaneously reflected in both option and equity markets. We provide new evidence supporting Black’s (Financ. Anal. J. 31:36–72, 1975) conjecture that information is first revealed in option markets. Specifically, changes in call and put open-interest levels have predictive power for future equity returns. Large increases in call open interest are followed by significantly increased equity returns. Put open-interest increases precede weaker future returns, but the relationship is considerably less pronounced in the presence of certain controls. The recent change in the call-to-put open-interest ratio has predictive power as to equity returns over the following week, even after controlling for numerous factors.