Option implied cost of equity and its properties

The estimation of the cost of equity capital (COE) is one of the most important tasks in financial management. Existing approaches compute the COE using historical data, i.e. they are backward‐looking methods. This study derives a method to calculate forward‐looking estimates of the COE using the current market prices of stocks and stock options. Our estimates of the COE reflect the expectation of the market investors about the COE during the life of the investment project. We test empirically our method and compare it with the Fama/French (1993) three‐factor model for the S&P 100 firms. The empirical results indicate that our COE estimates (1) are plausible and stable over the years as required by appropriate discount rates for capital budgeting, (2) yield an equity risk premium close to the market equity risk premium reported by Fama E. F. and French K. R. (2002), (3) generate strong return‐risk relationships, and (4) are significantly related with investor sentiment. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29: 599–629, 2009     

Factor Exposures of Foreign Equity Capital in a Domestic Stock Market: Evidence from Korea

In this paper, we examine the factor exposures of foreign equity capital in a domestic stock market in order to understand its risk‐taking behavior and sources of returns in the market. Using data from Korea for the 1999–2013 period, we find that foreigners are strongly exposed to the idiosyncratic volatility (IVOL) factor, which is long on low‐IVOL stocks and short on high‐IVOL stocks. That is, foreign equity capital is typically allocated to low‐IVOL stocks and profits from the return differential between low‐IVOL and high‐IVOL stocks. We also find that foreign equity capital moves in a way that it is loaded more on the IVOL factor when the IVOL factor premium is larger. We discuss the comparative advantage of foreign equity capital in bearing the IVOL factor risk and the role of information asymmetry between locals and foreigners in this risk sharing. We also provide additional empirical results that support our interpretation.     

Forecasting equity returns: The role of commodity futures along the supply chain

This paper examines equity return predictability using the returns of commodity futures along the supply chain in China's financial market. We find that a considerable number of commodities exhibit significant in‐sample forecasting ability at the daily horizon, especially for supplier‐side equity returns. The macroeconomic risk premium effect, captured by the aggregate commodity prices, is an important source for this predictability. The out‐of‐sample results show that for most commodities, the predictability remains both statistically and economically significant, and the forecasting performance improves substantially during recessions or with economic constraints.     

Corporate Governance,Commitment to Business Ethics,and Firm Valuation: Evidence from the Korean Stock Market

A variety of stakeholders have long been interested in the factors that are related to firm valuation. This article investigates why companies with more comprehensive corporate governance (CG) have a value premium over companies with less comprehensive CG. We posit and find that the cost of equity capital (COC) decreases with the strength of CG, suggesting that the value premium stems from the lower COC for more comprehensive CG. We also find that the COC is lower for companies with strong commitment to business ethics (BE) than for those with weak commitment to BE and that the beneficial effect of CG on the COC is more pronounced for companies with weak commitment to BE than for those with strong commitment to BE. Companies with more comprehensive CG tend to exhibit strong commitment to BE, but the beneficial effect of corporate ethical commitment is not completely subsumed by CG. Our results suggest that companies could lower their cost of equity capital and increase firm value by adopting more comprehensive CG practices and committing to higher standards of BE.     

Exchange-listing effects on a firm's cost of equity capital

Matched pairs (based on asset size and industry) of a sample of exchange-listed and over-the-counter (OTC) firms are utilized to test for the existence of a statistically significant difference between them with respect to their cost of equity capital. It is found that exchange-listed firm's cost of equity capital (alternatively measured by the systematic risk and the total risk associated with a firm's rate of return) is significantly less than that of comparable OTC firms.     

The information content in implied idiosyncratic volatility and the cross‐section of stock returns: Evidence from the option markets

Current literature is inconclusive as to whether idiosyncratic risk influences future stock returns and the direction of the impact. Earlier studies are based on historical realized volatility. Implied volatilities from option prices represent the market's assessment of future risk and are likely a superior measure to historical realized volatility. Implied idiosyncratic volatilities on firms with traded options are used to examine the relationship between idiosyncratic volatility and future returns. A strong positive link was found between implied idiosyncratic risk and future returns. After considering the impact of implied idiosyncratic volatility, historical realized idiosyncratic volatility is unimportant. This performance is strongly tied to small size and high book‐to‐market equity firms. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28: 1013–1039, 2008     

Does Policy Instability Matter for International Equity Markets?

We test whether policy risk is systematically priced in equity returns across 49 countries from 1995 to 2013. We construct two global policy risk factors based on the ratings from international country risk guide. They capture the policy risk from government instability (GOVLMH) and the quality of bureaucracy (BURLMH). Both factors are significantly and positively related to equity returns and the BURLMH factor carries a monthly risk premium of 65 basis points. A country with weaker economic and institutional conditions has more risk exposure to the BURLMH factor whereas a country with high democracy has more risk exposure to the GOVLMH factor. Overall, our study reveals the importance and complexity of policy risk in international equity markets.     

Information Search and Product Returns Across Mobile and Traditional Online Channels

Product returns will soon cost firms a trillion dollars annually; e-commerce appears more at risk for these costs relative to offline channels. Retailers thus need strategic insights into which factors increase customers’ return propensity and when the short-term costs of returns might be offset by future customer purchases. This article reports two studies that use transaction data from two large apparel e-tailers. Study 1 demonstrates that due to the differences between mobile and traditional online channels, consumers form a larger consideration set when they shop through mobile channels, and this distinctive search practice spills over onto return rates. That is, return rates are lower in mobile channels, and the use of the mobile channel also alters the effect of discount promotions. The findings in Study 2 suggest that future purchases by consumers, after a return, are contingent on category characteristics. In categories in which customers can easily learn from their previous return experience, product returns positively increase future spending, but the opposite is true in categories in which it is difficult to learn.     

Risk and ex ante cost of equity estimates of emerging market firms

We examine the empirical relationship between estimates of ex ante cost of equity and risk for a sample of individual emerging market equities for the period 1990–2000. The ex ante cost of equity estimates are obtained using the residual income valuation model. As in studies that use mean realized returns on emerging market indexes, a measure of total risk (return volatility) is the most significant risk factor in explaining ex ante expected return estimates. For emerging market equities with substantial investability to global investors, global beta adds some explanatory power.     

Publicly traded venture capital funds: implications for institutional “fund of funds” investors

Institutional investors supply the bulk of the funds which are used by venture capital investment firms in financing emerging growth companies. These investors typically place their funds in a number of venture capital firms, thus achieving diversification across a range of investment philosophy, geography, management, industry, investment life cycle stage and type of security. Essentially, each institutional investor manages a “fund of funds,” attempting through the principles of portfolio theory to reduce the risk of participating in the venture capital business while retaining the up-side potential which was the original source of attraction to the business. Because most venture capital investment firms are privately held limited partnerships, it is very difficult to measure risk adjusted rates of return on these funds on a continuous basis.In this paper, we use the set of twelve publicly traded venture capital firms as a proxy to develop insight regarding the risk reduction effect of investment in a portfolio of venture capital funds, i.e., a fund of funds. Measurements of weekly total returns for the shares of these funds are compared with similar returns on a set of comparably sized “maximum capital gain” mutual funds and the daily return of the S&P 500 Index. A comparison of returns on an individual fund basis, as well as a correlation of daily returns of these individual funds, were made. In order to adjust for any systematic bias resulting from the “thin market” characteristic of the securities of the firms being observed, the Scholes-Williams beta estimation technique was used to reduce the effects of nonsynchronous trading.The results indicate that superior returns are realized on such portfolios when compared with portfolios of growth-oriented mutual funds and with the S&P 500 Index. This is the case whether the portfolios are equally weighted (i.e., “naive”) or constructed to be mean-variant efficient, ex ante, according to the capital asset pricing model. When compared individually, more of the venture funds dominated the S&P Market Index than did the mutual funds and by much larger margins. When combined in portfolios, the venture capital funds demonstrated very low beta coefficients and very low covariance of returns among portfolio components when compared with portfolios of mutual funds. To aid in interpreting these results, we analyzed the discounts and premia from net asset value on the funds involved and compared them to Thompson's findings regarding the contribution of such differences to abnormal returns. We found that observed excess returns greatly exceed the level which would be explained by these differences.The implications of these results for the practitioner are significant. They essentially tell us that, while investment in individual venture capital deals is considered to have high risk relative to potential return, combinations of deals (i.e., venture capital portfolios) were shown to produce superior risk adjusted returns in the market place. Further, these results show that further combining these portfolios into larger portfolios (i.e., “funds of funds”) provides even greater excess returns over the market index, thus plausibly explaining the “fund of funds” approach to venture capital investment taken by many institutional investors.While the funds studied are relatively small and are either small business investment companies or business development companies, they serve as a useful proxy for the organized venture capital industry, despite the fact that the bulk of the funds in the industry are institutionally funded, private, closely held limited partnerships which do not trade continuously in an open market. These results demonstrate to investors the magnitude of the differences in risk adjusted total return between publicly traded venture capital funds and growth oriented mutual funds on an individual fund basis. They also demonstrate to investors the power of the “fund of funds” approach to institutional involvement in the venture capital business. Because such an approach produces better risk adjusted investment results for the institutional investor, it seems to justify a greater flow of capital into the business from more risk averse institutional investment sources. This may mean greater access to institutional funds for those seeking to form new venture capital funds. For entrepreneurs seeking venture capital funds for their young companies, it may also mean a lower potential cost of capital for the financing of business venturing. From the viewpoint of public policy makers interested in facilitating the funding of business venturing, it may provide insight regarding regulatory issues surrounding taxation and the barriers and incentives which affect venture capital investment.     

Are environmental social governance equity indices a better choice for investors? An Asian perspective

This article examines the risk and return profiles of stock indices composed of companies meeting environmental, social and governance (ESG) screening criteria [such as the Dow Jones Sustainability Indices (DJSI)] and conventional composite indices of eight Asian countries from 2002 to 2014. The results indicate that there are no significant differences in the returns or risk‐adjusted returns between the ESG indices and the composite indices within countries. The results do reveal that the market volatility of the ESG indices is higher than the market volatility of the conventional indices. Market betas of DJSI and ESG equity indices are significantly lower than betas of the composite equity indices. The overall results indicate that the performance of ESG equity indices of many Asian countries is similar to the performance of conventional indices, suggesting that investors can pursue socially responsible investing objectives without a material difference in portfolio performance from conventional investing.     

Determining the cost of common equity capital: The direct method

One of the most critical aspects of the corporate capital budgeting process is the determination of a proper “hurdle rate” or “cut-off” rate to employ in the screening of proposed uses of funds. This hurdle rate is now commonly referred to in both industry and the literature of financial management as the cost of capital. General agreement on how to measure the equity component of the cost of capital (i.e., the cost of common equity) has not yet been achieved by either practitioners or theorists. A unique approach that shows considerable promise differs from the abstract mathematical techniques typically used. It involves quizzing directly a sample of the corporation's existing common stockholders as to their dividend and capital gain expectations. Proper interpretation of the responses can provide top corporate management with an estimate of the cost of equity capital, as represented by the returns (expected) by shareholders. Thus, top level management has more complete information from the firm's owners on the returns that are expected from the investment of retained earnings.     

Industry Merger Intensity and Cost of Capital

Using a panel of industry‐average implied cost of equity capital and the value of prior year aggregate industry mergers, we find strong evidence that the industry cost of equity capital is negatively associated with industry merger activity. Our evidence is consistent with greater media coverage, analyst following, or increase in investor attention associated with industry merger activity lowering the required return on equity for firms in an industry that is not involved in merger activity via the ‘information risk’ or ‘incomplete information’ channels.     

Bid and ask prices of index put options: Which predicts the underlying stock returns?

In this study, we separately estimate the implied volatility from the bid and ask prices of deep out-of-the-money put options on the S&P500 index. We find that the implied volatility of ask prices has stronger predictive power for stock returns than does the implied volatility of bid prices. We identify two sources of the better performance of the ask price implied volatility: one is its stronger predictive power during economic recessions and in the presence of increasing intermediary capital risk, and the other is its richer information about the future market variance risk premium.     

隐性交易成本与资产定价——基于上证180指数成份股票交易数据的实证研究

文章利用上证180指数成份股票的高频数据计算隐性交易成本,探讨其与资产定价的关系。发现:(1)隐性交易成本与换手率、规模和收益率都存在着明显的线性负相关关系。在股票收益率下降时期,隐性交易成本通过流动性深度成本间接影响股票收益率。(2)较之隐性交易成本,规模因素与换手率因素对收益率的影响有着更好的测度性。很可能是因为这两个因素与流动性深度成本也有着显著相关性。(3)隐性交易成本与规模因素整体上呈线性负相关关系,分段上的关系则很可能是凹函数与凸函数的组合。     

The Relationship Between the Intensity of Competition in China’s Real Estate Industry and its Return on Equity

Does the rate of return from the Chinese real estate industry correlate with the intensity of competition among real estate firms? If China’s equity market performs efficiently, the rates of return of real estate firms should vary indirectly with their level of monopoly power. Greater monopoly power reduces earnings risk and leads to lower costs of capital. The authors analyze empirical evidence and indicate no relationship exists between returns and competition. Speculation may induce stock prices to deviate from normal values. Because normal values assume no speculation, Chinese markets are not likely to be economically efficient.     

相对财富与股票溢价之谜

Mehra和Prescott( 1 985 )提出著名的股票溢价之谜 (EquityPremiumPuzzle) :合理的相对风险规避系数 ,不能解释美国S&P5 0 0指数的收益率为什么比无风险债券的收益率高出 6个百分点。本文提出了一个基于相对财富的资产定价模型 ,其中代表性投资者的效用函数不但依赖于消费 ,还依赖于投资者的绝对财富 ,及社会平均财富。本文使用该模型 ,解释了股票溢价之谜。     

International capital flows,returns and world financial integration

International capital flows have increased dramatically since the 1980s, with much of the increase being due to trade in equity and bond markets. Such developments are often attributed to the increased integration of world financial markets. We present a model that allows us to examine how greater integration in world financial markets affects the behavior of international capital flows and financial returns. Our model predicts that international capital flows are large (in absolute value) and very volatile during the early stages of financial integration when international asset trading is concentrated in bonds. As integration progresses and households gain access to world equity markets, the size and volatility of international bond flows decline. This is the natural outcome of greater risk sharing facilitated by increased integration. This pattern is consistent with declining volatility observed during 1975–2007 period in the G-7 countries. We also find that the equilibrium flows in bonds and stocks predicted by the model are larger than their empirical counterparts, and are largely driven by variations in equity risk premia. The model also predicts that volatility of equity and bond returns decline with integration, again consistent with the data for G-7 economies.     

论风险投资的收益机制

风险投资的收益机制是一种基于非对称、非充分信息的"合理预期的高收益"机制。风险投资合理预期的高收益来源于以转换的形式分享的被投资企业的"行业超额利润"和"垄断利润"以及基于这一基础条件和被投资企业管理素质而获得的"现值收益"和"透支收益"。     

Are green bonds priced lower than their conventional peers?

The green bond market's rapid growth has alerted issuers and investors to this sustainable area of investment. This study ascertains whether green bonds are priced lower than conventional bonds—whether a negative green bond premium exists in both Chinese and global bond markets—and the driving forces behind any such green bond premium. First, an event study is set up to observe stock market's reaction upon issuance of green bonds to test whether green bonds are embedded with additional value by improving the issuer's equity market performance. Then, using the matching method and a two-layer regression process, the study estimates the green bond premium in the Chinese and global markets, respectively, and analyses factors affecting the green bond premium. The event study reveals that green bond issuance could reduce the issuer's equity return performance. The regression models found no significant negative green bond premium in either Chinese or global markets, indicating that green bonds are not priced significantly lower than conventional bonds. However, global market models show that issuing green bonds in CNY could reduce the green bond premium, unlike in USD or EUR.