Development, Present Status and Some Prospects of the Financial Markets in Korea

This paper describes the historical background and the present structure of Korea's financial markets to provide the basic understanding of issues facing the Korean financial system. The financial system in Korea has been introduced and developed to serve specific political or economic purposes, putting the financial markets in a tight control of government. As a result of the government-controlled financial policies market mechanism has oftentimes been ignored or distorted, making the Korean financial market inefficient and not competitive. To increase the efficiency of the financial system the Korean government plans to launch a Big Bang style financial reform. Attention is paid to the ongoing efforts of the Korean government for financial reforms. As the financial reform takes effect in the near future there will be far fewer regulations and government interventions in financial sector.     

Estimating the term structures of corporate debt

This paper investigates the corporate bond market by estimating monthly interest rate term structures for investment grade credit classes using both S&P's and Moody's ratings. Term structures are modeled by a piecewise constant forward rate curve and estimated on noncallable coupon paying bonds issued by industrial firms. The iterative estimation algorithm minimizes the sum of squared errors between market prices and model prices while identifying and removing outliers from the sample. Although the forward rate model is successful at pricing corporate debt, additional factors are found to be significant at explaining the residual price error that remains after the forward rate model is fit to market prices. Six necessary no-arbitrage conditions are derived for the term structures of risky and risk-free debt. Occasionally, some of these no-arbitrage conditions are violated and a few violations are asymptotically statistically significant. Finally, trading strategies that capture mispricing in the corporate debt market and violations of no-arbitrage bounds are discussed.This paper was adapted from my dissertation, completed at Cornell University. An earlier version of this paper was titled The Term Structures of Corporate Debt. Thanks to participants at the Cornell University finance workshop, Warren Bailey, Peter Carr, Antoine Giannetti, and especially Robert Jarrow for their helpful comments.     

The Role of Analysts’ Forecasts in Accounting-Based Valuation: A Critical Evaluation

This paper critically evaluates the use of analysts forecasts in accounting-based valuation. Specifically, I assess the usefulness and the limitation of analysts forecasts in predicting future earnings and in explaining the market-to-book ratio, in light of a comprehensive set of 22 explicit information items, including: economic rent proxies, conservative accounting proxies, earnings quality signals, transitory earnings proxies, industry characteristics, and risk and growth proxies. While analysts forecasts capture 45–83% of the information from these sources depending on model specifications, they do not appear to fully incorporate certain information items. In particular, proxies for conservative accounting and transitory earnings are incrementally useful in predicting future earnings; proxies for economic rents, conservative accounting, and risk are incrementally useful in explaining the market-to-book ratio. Collectively, these results validate the use of analysts forecasts as a parsimonious proxy for forward-looking information in accounting-based valuation and suggest how to improve on their use.JEL Classification: D4, G12, M4     

An analysis of “exactly distributed” test statistics for multivariate event tests

In this paper we derive a rule that identifies when exact tests may be used in the context of the multivariate regression model. Our derivation extends distribution theory reported in Rao (1973) and leads to the specification of exact tests for several event study hypothesis forms of interest to accounting and finance researchers. For tests where the event parameter is constrained to be equal across firms, we show that an infinite set of exact tests is available, of which the well known portfoliot-test is a special case. We conduct simulations using data from the CRSP Daily Returns file, and find that several test statistics, including exactly distributed statistics derived using the multivariate regression model, significantly over-reject the hypotheses examined.     

On the pricing of forward starting options in Heston’s model on stochastic volatility

We consider the problem of pricing European forward starting options in the presence of stochastic volatility. By performing a change of measure using the asset price at the time of strike determination as a numeraire, we derive a closed-form solution within Hestons stochastic volatility framework applying distribution properties of the volatility process. In this paper we develop a new and more suitable formula for pricing forward starting options. This formula allows to cover the smile effects observed in a Black-Scholes environment, in which the extreme exposure of forward starting options to volatility changes is ignored.Received: July 2004, Mathematics Subject Classification (2000): 91B28, 60G44, 60H30, 60E10JEL Classification: G13It is a pleasure to thank the anonymous referee for his valuable comments and suggestions on this paper. Furthermore, we would like to thank Holger Kraft, University of Kaiserslautern, and Alexander Giese, HypoVereinsbank AG Munich, for fruitful discussions and suggestions.     

Edokko Options: A New Framework of Barrier Options

In this paper, we will give a new framework of barrier options to generalize`Parisian Option' and `Delayed Barrier Option'. Take a stopping time asthe caution time. When occurs, derivatives are given `Caution'. After, if K.O. time =() occurs, derivative contractsvanish. We simply say that first `Caution' second `K.O.'. Using thisframework, designs of barrier options become more flexible than before and newrisk management will be possible. New barrier options in this category arecalled Edokko Options or Tokyo Options.     

Additional utility of insiders with imperfect dynamical information

In this paper we consider a market driven by a Wiener process where there is an insider and a regular trader. The insider has privileged information which has been deformed by an independent noise vanishing as the revelation time approaches. At this time, the information of every trader is the same. We obtain the semimartingale decomposition of the original Wiener process under dynamical enlargement of the filtration, and we prove that if the rate at which the additional noise in the insiders information vanishes is slow enough then there is no arbitrage and the additional utility of the insider is finite.Received: 1 October 2003, Mathematics Subject Classification: 60G48, 90A09, 60H07, 90A60JEL Classification: D82, G11, G14     

A Note on the Joint Distribution of α, β-Percentiles and Its Application to the Option Pricing

In this paper, using Laplace transform, we will calculate the joint density of twopercentiles of stock prices in the Black–Sholes model and make the price of exchange options of such twopercentiles.     

Pricing derivatives of American and game type in incomplete markets

In this paper the neutral valuation approach is applied to American and game options in incomplete markets. Neutral prices occur if investors are utility maximizers and if derivative supply and demand are balanced. Game contingent claims are derivative contracts that can be terminated by both counterparties at any time before expiration. They generalize American options where this right is limited to the buyer of the claim. It turns out that as in the complete case, the price process of American and game contingent claims corresponds to a Snell envelope or to the value of a Dynkin game, respectively.On the technical level, an important role is played by -sub- and -supermartingales. We characterize these processes in terms of semimartingale characteristics.Received: June 2003, Mathematics Subject Classification (2000):   91B24, 60G48, 91B16, 91A15, 60G40JEL Classification:   G13, D52, C73The authors want to thank PD Dr. Martin Beibel for the idea leading to the proof of Proposition A.4 and both anonymous referees for many valuable comments. The second author gratefully acknowledges financial support by the Deutsche Forschungsgemeinschaft through the Graduiertenkolleg Angewandte Algorithmische Mathematik at Munich University of Technology and by the Fonds zur Förderung der wissenschaftlichen Forschung at Vienna University of Technology.     

Nonparametric Inference of Value-at-Risk for Dependent Financial Returns

The article considers nonparametric estimation of value-at-risk(VaR) and associated standard error estimation for dependentfinancial returns. Theoretical properties of the kernel VaRestimator are investigated in the context of dependence. Thepresence of dependence affects the variance of the VaR estimatesand has to be taken into consideration in order to obtain adequateassessment of their variation. An estimation procedure of thestandard errors is proposed based on kernel estimation of thespectral density of a derived series. The performance of theVaR estimators and the proposed standard error estimation procedureare evaluated by theoretical investigation, simulation of commonlyused models for financial returns, and empirical studies onreal financial return series.     

A Test for Symmetry with Leptokurtic Financial Data

Most of the tests for symmetry are developed under the (implicitor explicit) null hypothesis of normal distribution. As is wellknown, many financial data exhibit fat tails, and thereforecommonly used tests for symmetry (such as the standard test based on sample skewness) are not valid fortesting the symmetry of leptokurtic financial data. In particular,the test uses third moment, which may not be robust in presence of gross outliers. In this article wepropose a simple test for symmetry based on the Pearson typeIV family of distributions, which take account of leptokurtosisexplicitly. Our test is based on a function that is boundedover the real line, and we expect it to be more well behavedthan the test based on sample skewness (third moment). Resultsfrom our Monte Carlo study reveal that the suggested test performsvery well in finite samples both in terms of size and power.Simulation results also support our conjecture of the teststo be well behaved and robust to excess kurtosis. We apply thetest to some selected individual stock return data to illustrateits usefulness.     

Transaction Costs and Price Volatility: New Evidence from the Tokyo Stock Exchange

We investigate the volatility impacts of the full commission deregulation in Japan in October 1999, and find that the deregulation overall tends to significantly increase price volatility in the Japanese equity market, using alternative model specifications and control variables. This finding contrasts with previous evidence that implies a positive relation between transaction costs and price volatility, while consistent from the converse with the hypothesis proposed by Stiglitz (1989) and Summers and Summers (1989). Our results suggest that imposing higher transaction costs might still be a feasible policy tool for stabilizing the market by curbing short-term noise trading.

Investor protection, adverse selection, and the probability of informed trading

The purpose of this study is to investigate the relation between investor protection, adverse selection, and the probability of informed trading. Previous research has established a direct relation between investor protection and firm liquidity, measured by bid-ask spreads and depths. In this study, we test the hypothesis that adverse selection is the mechanism through which poor investor protection leads to higher costs of liquidity. The Hong Kong equity market provides a unique opportunity to compare adverse selection differences across distinct investor protection environments, holding constant the trading platform and currency. Using various bid-ask spread decomposition models and probability of informed trading estimates, we confirm the hypothesized relation between investor protection quality and adverse selection costs. These findings contribute to the literature by establishing one of the links in the chain connecting investor protection to firm valuation.

The Costs, Wealth Effects, and Determinants of International Capital Raising: Evidence from Public Yankee Bonds

This paper examines the costs, wealth effects, and determinants of international capital raising for a sample of 260 public debt issues made by non-U.S. firms in the Yankee bond market. We find that investors demand economically significant premiums on bonds issued by firms that are located in countries that do not protect investors' rights and do not have a prior history of ongoing disclosure. The results provide support for the literature that suggests better legal protections and more detailed information disclosure increases the price investors will pay for financial assets. Journal of Economic Literature Classification Numbers: F3, G1.     

An equitable,efficient and implementable scheme to control global carbon dioxide emissions

We design an international scheme to control global externalities in which autonomous regions choose their own emissions levels in anticipation of interregional resource transfers implemented by an international agency. This agency follows a proportional equity principle, which preserves the status-quo ratio of regional welfare levels. We show that it is individually rational for each region to participate in the proposed international scheme and that regional environmental authorities choose policies that fully internalize the global externality. Although based on an admittedly ideal scheme, these results are especially noteworthy in light of the call for various forms of transfers in international agreements such as the Kyoto Protocol. JEL Code: C72 · D62 · D78 · H41 · H77 · Q28     

Transfers and bequests: a portfolio analysis in a Nash game

This paper develops a two-stage non-cooperative Nash game framework of parental–children interactions to explain the equal division puzzle in bequests. In the analysis, a portfolio approach is adopted for characterizing how altruistic parents allocate their inheritable wealth between inter-vivos transfers and post-mortem bequests. The model includes elements of strategic altruism, exchange of family-specific merit goods, transfer-seeking behavior by competing siblings, and parents’ “post-mortem reputation” in bequest division. Allowing for children’s heterogeneity and interactions, we find that inter-vivos transfers are unevenly distributed between the children, despite an equal degree of parental altruism. Moreover, we show the compatibility of unequal inter-vivos transfers and equal bequests, regardless of earnings differentials across children.      

Self-enforcing agreements under unequal nationally determined contributions

The Paris Agreement builds on intended nationally determined contributions (INDCs) submitted by most participating nations. The INDCs vary across nations, since national circumstances differ, including national incomes and damages. The INDCs follow a bottom-up approach, whereby nations submit their plans of actions in a Nash-like form (i.e., taking the other nations’ plans as given). We build a model with normal goods and an unequal world income distribution to consider the endogenous formation and stability of an international environmental agreement (IEA) under the bottom-up approach. Nations provide carbon abatement and produce R&D efforts that promote improvements in environmental efficiency of their outputs. Nations share R&D efforts and enjoy R&D spillovers if they join an IEA. Non-members do not enjoy R&D spillovers. Global carbon abatement rises as the IEA expands in size due to the R&D spillovers. We show that the Grand Coalition is stable under a nearly perfectly equitable income distribution, where all nations make positive carbon abatement and R&D contributions. We also consider a more realistic world income distribution, in which some nations lack sufficient income to provide carbon abatement and R&D. In this case, the stable coalition contains all (wealthier) nations that make positive abatement and R&D contributions. For a very unequal world income distribution, not even a bilateral IEA, with the two richest nations in the world, is stable. The stable IEAs provide too little carbon abatement relative to the first best.     

The Effect of Volume of Intrafirm Transfers on Market Metrics

In this paper, we examine the relationship between international intrafirm area transfers and market metrics as measured by market-to-book value and systematic risk. Intrafirm transfers – the amount that multinational corporations charge one another for the transfer of goods, intellectual property, and services – have become an increasingly important issue for policymaking, managerial, financial, and tax purposes. This paper also examines whether international intrafirm intergeographic area transfers are attributed to corporate tax. We find that firms with a sizable volume of international intrafirm transfers have higher systematic risk than comparable firms without these transfers. We show cross-sectionally that firms engage in international transfers have a higher market-to-book ratio, suggesting that transfers add value through their effect on earnings and taxes. Consistent with Mills and Newberry (2003) and Collins, Kemsley, and Lang (1998), we document that U.S. (global) income tax is positively (negatively) related to intrafirm transfers, implying that U.S. multinational firms shifted taxable income to the United States from 1995 to 1999.