An Approach to Fair Valuation of Insurance Liabilities Using the Firm’s Cost of Capital

Abstract

There are two competing and seemingly different methodologies for calculating fair values—the direct and indirect methods. The direct approach has the advantage of providing a more reliable assessment of the risk of financial leverage. The indirect method can be structured to adjust for financial leverage, however, the methodology becomes excessively complex. The advantage of the indirect method is that it can be more easily related to exit prices. Intuitively, an exit price should reflect both the creditworthiness of the firm and the cost of capital of the firm. How are these two concepts related? This paper attempts to advance the fair valuation methodology by addressing these questions and presenting a methodology for deriving the firm or own credit risk assumption (to be used with the direct method) that is consistent with the cost of capital assumption used with the indirect method.     

Hotel Efficiency Analysis from the Customer’s Point of View in Romania: A Stochastic Production Frontier Approach

The purpose of this article is to measure the efficiency of hotel units in Romania from the customers’ point of view and to identify factors that explain the differences in efficiency between hotel units. A stochastic production frontier is estimated together with a technical inefficiency model using cross-sectional data from 622 hotel units in Romania. The results show that the average efficiency is high. However, there are significant differences between hotels in different regions and with different star ratings. The most influential factor affecting efficiency is the online visibility of a hotel unit on social media platforms and on travel planning sites. The study’s results offer insight for hotel decision-makers to be able to improve the perception of hotel efficiency by taking appropriate action to meet customer needs.     

Total Factor Productivity Growth in U.S. Commercial Banking for 1935–1991: A Latent Variable Approach Using the Kalman Filter

This paper studies total factor productivity (TFP) in U.S. commercial banking for 1935–1991. TFP can contain a procyclical bias when some input factors are not freely variable, causing their shadow and market prices to differ. We correct this bias in TFP by decomposing it into its latent stochastic trend and cyclical components by employing the Kalman filter. Using the FDIC's annual aggregate data on U.S. insured commercial banks, we report that the stochastic trend has been positive during 1935–1991, with an average annual growth rate of 2.27%, and that it exhibits a decaying time path. We attribute the positive TFP growth to technical change.     

Structural Changes in China’s Import Market: A Comparison with Korea’s Exports to China

The article examines the structural changes of China’s import market for domestic demand and the corresponding structural changes of Korea’s exports to China for Chinese domestic demand. Using 8-digit HS code data covering the period 2006–2014 and analyzing the processing steps as well as by industry, this study reveals that while the share of ordinary trade in total China’s imports has increased rapidly, the share of processing trade has decreased continuously since the mid-2000s. The article also shows that Korea’s exports to China is still processing trade-oriented. The slowdown of Korea’s exports to China is because of the concentration on processing trade, intermediate goods, electronics and chemistry.     

Leadership through action learning: a bottom-up approach to ‘best practice’ in ‘infection prevention and control’ in a UK NHS trust

This article reports on the outcomes of an action learning leadership intervention in a National Health Service (NHS) acute trust in partnership with a UK business school. This contribution provides an empirical example of the potential benefits of non-hierarchical leadership. Over a three-year period, 45 nurses took part in an initiative designed to reduce the number of health care associated infections (HCAI) in a large NHS acute trust. By 2010, serious reportable infections were reduced by around 300, providing an efficiency benefit in the region of £3 million and improved patient safety. The turnaround is significant, and although not exclusively attributable to this initiative, the trust is convinced that the intervention has been pivotal.     

Anatomy of a regulatory race to the top: Changes in delisting rules at Korea's two stock exchanges, 1999–2002

One dimension of competition among stock exchanges is the quality of products they have to offer. In order to attract listings and trading volume, exchanges can affect the quality of their listed firms by altering their standards for firm disclosure and governance. We identify a competition with respect to delisting standards between Korea's two stock exchanges and show that it complies with the three components of a regulatory race to the top: external trigger, mobility among diverse regimes and meaningful changes that converge to similar rules. The race between the two Korean exchanges ended with stricter rules and better protected minority shareholders. The race also ended, however, with neither exchange gaining market share with respect to trading volume or new listings. Korea's experience, therefore, suggests a reason why these races are rare. In the absence of an external trigger, exchanges will be reluctant to enter a race if they think it will result in rule convergence and no winner.     

Make or buy new technology: The role of CEO compensation contract in a firm’s route to innovation

A firm’s board of directors, based on its risk tolerance or “appetite,” sets the corporate objectives. It is then the management’s job to meet the objectives by adopting appropriate strategies. However, the board can design compensation policies to encourage desired management strategy choices. This paper explores the extent to which management compensation policies are aligned with strategy choices for obtaining new technology. Firms obtain new technology either through internal R&D or through acquisitions, often labeled “make” and “buy” strategies, respectively. The “make” strategy is inherently more risky, with much of the high risk idiosyncratic. Furthermore, U.S. GAAP requires that R&D expenditures be expensed but allows capitalization of acquisition costs, thus a firm using the “make” as opposed to the “buy” strategy will experience a greater negative effect on accounting earnings. I hypothesize that these differences will lead risk-averse and utility-maximizing managers to implement the “buy” strategy if their compensation is heavily weighted on accounting-based performance measures. Conversely, managers with more stock-based compensation, especially stock options, are more likely to choose to develop new technology internally. Using data from U.S. high-tech industries and a simultaneous equations regression framework, I find evidence consistent with the above hypotheses.

Optimal time to sell a stock in the Black–Scholes model: comment on ‘Thou shalt buy and hold’, by A. Shiryaev,Z. Xu and X.Y. Zhou

We reconsider the problem of the optimal time to sell a stock studied by Shiryaev et al. (2008 Shiryaev, A, Xu, Z and Zhou, XY. 2008. Thou shalt buy and hold. Quant. Finan., 8: 765–776. [Taylor & Francis Online], [Web of Science ®] , [Google Scholar]) (following in this issue of Quantitative Finance) using path integral methods. These methods allow us to confirm the results obtained by these authors and extend them to the entire parameter region. We also obtain the full distribution of the time t_m at which the maximum of the price is reached for arbitrary values of the drift.