An Investigation of the Impact of Interest Rates and Interest Rate Volatility on Australian Financial Sector Stock Return Distributions

Abstract:   This paper extends the existing literature by analysing the dual impact of changes in the interest rate and interest rate volatility on the distribution of Australian financial sector stock returns. In addition, a multivariate GARCH‐M model is used to analyse the impact of deregulation on the financial institutions sector. It was found that there is a consistent inter‐temporal trade off between risk and return over the different regulatory periods. Moreover, finance corporations were found to be highly sensitive to new shocks across the financial sector and deregulation increased the risk faced by finance corporations and small banks – effectively increasing the required rate of return and explaining the continued rationalisation of these sectors. Furthermore, deregulation has changed the fundamental relationship between interest rates and large bank stock excess returns from positive in the pre‐deregulation period to negative in the post‐deregulation period. This reflects the changing institutional environment from one of controlled credit rationing to a more competitive environment.     

Regulation and Systematic Risk in the Electric Utility Industry: A Test of the Buffering Hypothesis

In this paper, the authors test Peltzman's [19] buffering hypothesis—whether regulatory environment impacts systematic risk for regulated electric utilities. The paper differs from previous research in that an exogenously defined measure of regulatory environment, a large sample, and a method that controls for time-series and crosssectional autocorrelation are used. The results are consistent with the buffering hypothesis but only in years of increasing input factor prices for the utilities. Using causality tests, the results also show that it is the regulatory environment that influences systematic risk and not vice versa.     

Towards a Semiology of the Periodic Review of UK Regulated Utilities

This note explores the regulatory process of UK privatised utilities through the periodic review of prices. It provides a brief history of the privatisation programme in the UK and the theoretical arguments for the price-cap regulation that has been used. It argues that regulatory process appears to involve a covert dialogue and exchange of information between the regulator and regulated and also a second separate review process that consists of an overt dialogue. Using a semiotic analysis the authors suggest that the unfolding of each of these overt reviews follows a very similar pattern that is constantly being re-enacted. It is concluded that further research is required into the relative importance of the two separate review processes in the setting of the price-cap.     

Pro-producer regulation and accounting for assets: The case of electric utilities

This paper's thesis is that rate-of-return regulation of the electric utility industry was a pro-producer regulatory policy, and that supra-competitive returns were earned by regulated utilities even while their accounting rate-of-returns met the ‘fair’ return constraint established by law. It is argued that this was accomplished by using the accounting system to revalue upward the asset bases of regulated utilities. The empirical results support this hypothesis in that utilities regulated by state commissions had abnormally high book values for their assets compared with unregulated utilities in 1917 and 1922.     

The Effect of Bond Rating Changes and New Ratings on UK Stock Returns

This is the first study to use daily data from a major capital market outside of the US to examine the role of corporate bond and commercial paper rating changes on common stock returns. Using data published by Standard and Poors' credit rating agency between 1984 and 1992, we examine the impact of new credit ratings, credit rating changes and Credit Watch announcements on UK common stock returns. We find significant negative excess returns around the date of a downgrade and positive returns close to the date of a positive CreditWatch announcement. Hence, the financial markets would appear to place some importance on rating agency pronouncements in the UK. New ratings, whether short or long-term, have no significant impact on returns. We also attempt to quantify the impact of a new credit rating upon firm cost of capital through measures of conditional volatility and systematic risk. However, we find only weak evidence to suggest that a stock's cost of capital is reduced after a long-term credit rating is awarded for the first time.     

Liquidity risk and the cross-section of hedge-fund returns

This paper demonstrates that liquidity risk as measured by the covariation of fund returns with unexpected changes in aggregate liquidity is an important determinant in the cross-section of hedge-fund returns. The results show that funds that significantly load on liquidity risk subsequently outperform low-loading funds by about 6% annually, on average, over the period 1994–2008, while negative performance is observed during liquidity crises. The returns are independent of the liquidity a fund provides to its investors as measured by lockup and redemption notice periods, and they are also robust to commonly used hedge-fund factors, none of which carries a significant premium during the sample period. These findings highlight the importance of understanding systematic liquidity variations in the evaluation of hedge-fund performance.     

Determinants of bank interest margins: Impact of maturity transformation

This paper explores the extent to which interest risk exposure is priced into bank margins. Our contribution to the literature is twofold: First, we extend the Ho and Saunders (1981) model to capture interest rate risk and expected returns from maturity transformation. Banks price interest risk according to their individual exposure separately in loan and deposit intermediation fees, but reduce (increase) these charges for loans (deposits) when positive excess holding period returns from long-term exposures are expected. Second, we test the model-derived hypotheses not only for the commonly investigated net interest margin but also for interest income and expense margins separately in a sample encompassing the German universal banking sector between 2000 and 2009. Our results suggest that banks price their individual interest rate risk and corresponding expected excess holding period returns via the asset side into the net interest margin. For liabilities, we find that interest rate risk exposure is only priced in by smaller, local banks.     

Commercial Real Estate Return Performance: A Cross-Country Analysis

This paper investigates the return performance of publicly traded real estate companies. The analysis spans the 1984–1999 time period and includes return data on over 600 companies in 28 countries. The return data reveal a substantial amount of variation in mean real estate returns and standard deviations across countries. Moreover, standard Treynor ratios, which scale country excess returns by the estimated beta on the world wealth portfolio, also reveal substantial variation across countries in excess real estate returns per unit of systematic risk. However, when we estimate Jensens alphas using both single and multifactor specifications, we detect little evidence of abnormal, risk-adjusted returns at the country level. We do, however, find evidence of a strong world-wide factor in international real estate returns. Furthermore, even after controlling for the effects of world-wide systematic risk, an orthogonalized country-specific factor is highly significant. This suggests that real estate securities may provide international diversification opportunities.     

The Pricing of Initial Offerings of Privatised Companies on the London Stock Exchange

This paper investigates UK privatisation issues as initial public offerings (IPOs) of equities on the International Stock Exchange (London). Excess returns on such issues are compared with private sector initial public offerings. The results, which are unaffected by firm size and underwriting commission, indicate that, on an ex post basis, the issues provide excess returns above those of private sector firms on average by about 31% over a 32-week period. None of the existing theories of underpricing of IPOs is consistent with our results which imply wealth transfer to those who acquired the shares in privatised issues. After-market pricing was, however, found to be consistent with secondary market efficiency.     

M&As performance in the European financial industry

This paper looks at the performance record of M&As that took place in the European Union financial industry in the period 1998–2002. First, the paper reports evidence on shareholder returns from the merger. Merger announcements implied positive excess returns to the shareholders of the target company around the date of the announcement, with a slight positive excess-return on the 3-months period prior to announcement. Returns to shareholders of the acquiring firms were essentially zero around announcement. One year after the announcement, excess returns were not significantly different from zero for both targets and acquirers. The paper also provides evidence on changes in the operating performance for the subsample of merges involving banks. M&As usually involved targets with lower operating performance than the average in their sector. The transaction resulted in significant improvements in the target banks performance beginning on average 2 years after the transaction was completed. Return on equity of the target companies increased by an average of 7%, and these firms also experience efficiency improvements.     

The pricing of sentiment risk in European stock markets

This paper studies whether sentiment is rewarded with a significant risk premium in the European stock markets. We examine several sentiment proxies and identify the Economic Sentiment Indicator from the EU Commission as the most relevant sentiment proxy for our sample. The analysis is performed for the contemporaneous excess returns of EA-11 stock markets in the period from February 1999 to September 2015. We apply a conditional multi-beta pricing model in order to track the variation of the sentiment risk premium over time. The results demonstrate a positive significant relationship between sentiment and contemporaneous excess returns which is consistent with previous studies. The calculated sentiment risk premium is significant as well but negative implying that an investment in EA-11 countries over the examined time period – that is bearing sentiment risk – would have been unattractive to the investors on average.     

Anomalies in Security Returns and the Specification of the Market Model

We examine the hypothesis originally advanced by Roll 12 that observed anomalies in excess returns can be explained by misspecification of the market model used to estimate systematic risk. We find substantial misspecifications in the model systematically related to size and period of listing of the securities in question. There is some evidence that these misspecifications are associated with systemic biases in measured betas used to construct excess returns.     

Benchmarking Risk Management Within the International Water Utility Sector. Part II: A Survey of Eight Water Utilities

Risk management in the water utility sector is fast becoming explicit. Here, we describe application of a capability model to benchmark the risk management maturity of eight water utilities from the UK, Australia and the USA. Our analysis codifies risk management practice and offers practical guidance as to how utilities may more effectively employ their portfolio of risk analysis techniques for optimal, credible, and defensible decision making. For risk analysis, observed good practices include the use of initiation criteria for applying risk assessment techniques; the adoption of formalised procedures to guide their application; and auditing and peer reviews to ensure procedural compliance and provide quality assurance. Additionally, we have identified common weaknesses likely to be representative of the sector as a whole, in particular a need for improved risk knowledge management and education and training in the discipline.     

Office Property Returns in Shanghai,Guangzhou, and Shenzhen

Commercial property development in China has been a growth industry in recent years. This article examines the returns on office property in the three major cities of Shanghai, Guangzhou, and Shenzhen in the period 1991 to 1997. Analyses based on the Security Market Line (SML) show that property investments in the office sector in Shanghai and Guangzhou have excess returns and that Shanghai office property tends to dominate the optimal portfolios due to its superior risk-adjusted returns. While equal returns in Shanghai, Guangzhou, and Shenzhen cannot be rejected, the Shanghai office property is subject to the least systematic risk, compared with all other cities. Hong Kong office property is included only in the less risky optimal portfolios. In addition, our results indicate that there is little correlation between the office property returns in Hong Kong and the office property in Guangzhou and Shenzhen. Guangzhou and Shenzhen office markets, which are geographically relatively close to Hong Kong, tend to be more volatile than the Shanghai office market. However, owing to Shenzhens proximity to Hong Kong, there is significant correlation between the returns of the office property in Shenzhen and the office property in Hong Kong.     

Excess Volatility and UK Investment Trusts

Abstract:   The issue of whether or not asset prices are more volatile than the underlying fundamentals is an empirical question with implications for market efficiency. Recent research suggests that the volatility of closed end fund returns in the USA is significantly higher than the returns on assets held by the funds. This has been attributed to noise trading as closed‐end fund shares are predominantly held by individual investors. This study demonstrates that UK investment trust returns exhibit similar excess volatility in spite of the prevalence of institutional investors. However, big investment trusts in terms of market capitalisation show greater excess volatility than small trusts. Although most of the excess volatility appears to be idiosyncratic, investor sentiment index is the most important variable associated with residual returns.     

DUAL BETAS FROM BULL AND BEAR MARKETS: REVERSAL OF THE SIZE EFFECT

Significant firm-size-related differences in abnormal returns and systematic risks occur in bull and bear market months from 1926 to 1988. Potential differential return premiums between recessions and expansions appear to be captured by the varying risk model and not the constant risk model. Using a dual-beta market model to adjust for risk differences in bull and bear markets, we find that large firm stocks on average earn significant positive excess returns and small firm stocks earn significant negative excess returns. Superior performance of large firm stocks is even more pronounced outside January.     

Contrarian Investment and Macroeconomic Risk

It is now widely accepted that contrarian, or value investment strategies deliver superior returns. Gregory, Harris and Michou (2001) examine the performance of contrarian investment strategies in the UK and find that value strategies formed on the basis of a wide range of measures of value have delivered excess returns that are both statistically and economically significant. However, while value strategies appear to be profitable, the reason for their superior perform‐ ance is far from clear. Under the contrarian model, value strategies are profitable because they are contrarian to naïve strategies such as those that erroneously extrapolate past performance, while under the rational pricing model, value strategies are profitable because they are fundamentally riskier in some sense. In this paper, we discriminate between these two possibilities by undertaking a comprehensive investigation of the relationship between the returns to value investment strategies and various macroeconomic state variables that in a multi‐factor asset pricing model could reasonably be taken as proxies for risk. Moreover, we examine whether the returns to value strategies predict future GDP, consumption and investment growth over and above the contribution of the Fama and French (1993 and 1996) SMB, HML and market factors. While the SMB and HML factors behave in a manner consistent with the rational pricing model, we show that some value strategies in the UK are able to generate excess returns that do not seem to be related to known risk factors.     

RISK, SEASONALITY AND THE ASYMMETRIC BEHAVIOUR OF STOCK RETURNS

For some time there has been a puzzle surrounding the seasonal behaviour of stock returns. This paper demonstrates that there is an asymmetric relationship between systematic risk and return across the different months of the year for both large and small firms. In the case of both large and small firms systematic risk appears to be priced in only two months of the year, January and April. During the other months no persistent relationship between systematic risk and return appears to exist. The paper also shows that when systematic risk is priced, the size of the systematic risk premium is higher for large firms than for small firms and varies significantly across the months of the year.     

Managerial sentiment,consumer confidence and sector returns

This paper investigates the relationship between managerial sentiment and sector returns. Using UK monthly data from January 1985 to December 2014 and a sample of consumer and business confidence indicators provided by the European Commission, we provide novel evidence on how managerial and consumer sentiment indicators affect stock returns. We find no support for consumer confidence as a predictor of stock returns. However, managerial sentiment shows a significant impact on aggregate market and sector return indices. Furthermore, we find that parameter estimates for sector groupings are not consistent, implying that the sentiment-return relationship differs across sectors. We also find parameters are sensitive to industry characteristics. Importantly, the overall sentiment-return relationship is dominated by sentiment associated with manufacturing firms.     

Estimating the Equity Risk Premium Using Accounting Fundamentals

This study uses recent developments in the theoretical modelling of the links between unrecorded accounting goodwill, accounting profitability and the cost of equity, together with Capital Asset Pricing Model (CAPM) betas, to estimate the ex-ante equity risk premium in the UK. The results suggest that, over our sample period from 1968 to 1995, the premium has been in the region of 5%. Our estimate lends support to the view that the ex-ante equity risk premium is substantially less than the historical average of the excess of equity returns over the risk-free rate, and is similar to the rates applied recently by UK competition regulators.