Asymmetric information and liquidity constraints: A new test

Using a novel measure of the degree of information asymmetry across firms, this study shows that information-related financial market imperfections do matter for a firm’s access to external finance. Prior studies of the importance of liquidity constraints faced by nonfinancial firms have suffered from a glaring weakness. They have been based on a sample of publicly traded firms, omitting precisely those firms most likely to be liquidity constrained. Furthermore, they have tended to rely on indirect measures of the degree of information asymmetry, such as firm size. We overcome these limitations by focusing on the banking sector. Unlike the nonfinancial sector, the banking sector has balance sheet and income data available for all firms, whether or not they are publicly traded. This allows the use of a superior measure of the degree of information asymmetry across firms by distinguishing between publicly traded and non-publicly traded banks.     

Currency hedging failure in international equity investments and an efficient hedging strategy: The perspective of Korean investors

Korean fund investors suffered significant financial losses from their international equity investments during the recent global financial crisis. Contrary to expectations for improved investment performance, the currency position for hedging purposes worsened performance. In this paper, we critically assess currency-hedging practices for international equity investments from the perspective of Korean investors. We find that international equity portfolios are concentrated in a limited number of emerging market regions; most international equity funds employ near-fixed and near-perfect currency-hedging policies; the minimum-variance currency-hedging strategy performs the best in emerging market regions and its relative gains over the current hedging policy are significant; the no-hedging strategy provides the best performance for the investments into the US and Europe during a turbulent period.     

Optimal liquidation under stochastic liquidity

We solve explicitly a two-dimensional singular control problem of finite fuel type for an infinite time horizon. The problem stems from the optimal liquidation of an asset position in a financial market with multiplicative and transient price impact. Liquidity is stochastic in that the volume effect process, which determines the intertemporal resilience of the market in the spirit of Predoiu et al. (SIAM J. Financ. Math. 2:183–212, 2011), is taken to be stochastic, being driven by its own random noise. The optimal control is obtained as the local time of a diffusion process reflected at a non-constant free boundary. To solve the HJB variational inequality and prove optimality, we need a combination of probabilistic arguments and calculus of variations methods, involving Laplace transforms of inverse local times for diffusions reflected at elastic boundaries.     

Payments and liquidity under adverse selection

Informational asymmetries regarding the future value of assets affect their role in exchange. I construct a random-matching economy composed of two assets: a risk-free bond and a Lucas tree whose terminal value is privately known to its holder. No restrictions are imposed on payment arrangements. The main finding supports a pecking-order theory of payments: Agents use their risk-free bonds first in order to finance their spending shocks, and they use their information-sensitive assets only if their holdings of bonds are depleted. The theory has implications for the optimal provision of risk-free bonds, the structure of asset returns, and liquidity.     

Calibration and hedging under jump diffusion

A jump diffusion model coupled with a local volatility function has been suggested by Andersen and Andreasen (2000). By generating a set of option prices assuming a jump diffusion with known parameters, we investigate two crucial challenges intrinsic to this type of model: calibration of parameters and hedging of jump risk. Even though the estimation problem is ill-posed, our results suggest that the model can be calibrated with sufficient accuracy. Two different strategies are explored for hedging jump risk: a semi-static approach and a dynamic technique. Simulation experiments indicate that each of these methods can sharply reduce risk exposure. JEL Classification G12 · G13     

Cross hedging under multiplicative basis risk

Cross hedging price risk in an incomplete financial market creates basis risk. We propose a new way of modeling basis risk where price risk and basis risk are combined in a multiplicative way. Under this specification, positive prudence is a necessary and sufficient condition for underhedging in an unbiased market. Using the example of cross hedging jet fuel price risk with crude oil futures, we show that the new specification is superior in describing the price series and that optimal cross hedges differ significantly from those derived under the traditional additive cross hedging model.     

Perfect hedging under endogenous permanent market impacts

We model a nonlinear price curve quoted in a market as the utility indifference curve of a representative liquidity supplier. As the utility function, we adopt a \(g\)-expectation. In contrast to the standard framework of financial engineering, a trader is no longer a price taker as any trade has a permanent market impact via an effect on the supplier’s inventory. The P&L of a trading strategy is written as a nonlinear stochastic integral. Under this market impact model, we introduce a completeness condition under which any derivative can be perfectly replicated by a dynamic trading strategy. In the special case of a Markovian setting, the corresponding pricing and hedging can be done by solving a semilinear PDE.     

Optimal futures hedging under jump switching dynamics

The article develops a Markov regime switching Generalized Orthogonal GARCH model with conditional jump dynamics (JSGO) for optimal futures hedging. To the author's knowledge, there is no existing study on dynamic futures hedging investigating both the effects of regime switching and conditional jumps. This might be the fact that there is no existing hedging model encompassing both of these features. The JSGO solves this problem by introducing a jump switching filtering algorithm to infer ex post both the distributions of jumps and state variables and a recombining procedure to solve the path-dependency problem. To justify the usefulness of the JSGO on dynamic futures hedging, hedging exercises are performed using FTSE 100 futures data traded in the London International Financial Futures and Options Exchange (LIFFE). JSGO exhibits good out-of-sample performance compared to its jump-free and state-independent counterparts in terms of both criteria of variance reductions and utility improvements.     

Corporate liquidity and dividend policy under uncertainty

We examine optimal liquidity (retained earnings) and dividend choice incorporating debt financing with risk of default and bankruptcy costs as well as growth options under revenue uncertainty. We revisit the conditions for dividend policy irrelevancy and the broader role of retained earnings and dividends. Retained earnings have a net positive impact on firm value in the presence of growth options, high external financing costs and low default risk. High levels of retained earnings enhance debt capacity but have a negative effect on equity value due to the likelihood of losing accumulated cash balances in case of default, unless offset by high external financing costs. Opposite directional effects of retained earnings on equity and debt create a U-shaped relation with firm value. The framework is extended to analyze management-shareholder conflicts, demonstrating that managers accumulate higher than optimal cash.     

Auditing internal transfer prices in multinationals under monopolistic competition

This paper derives an appropriate standard price that can be used by the tax authorities of a country for auditing transfer prices in multinational firms (MNFs) for the purpose of social welfare maximization of the country. We assume that the corporate tax rate in the host country, where MNFs undertake foreign direct investment to locate their manufacturing divisions, is lower than that in the home country. Our conclusion is that the tax authorities of the home country should not always force MNFs to hold down the transfer price through a too strict audit standard if it aims to maximize social welfare of the country in the long-run equilibrium. This result implies that tax authorities face a trade-off between consumer welfare and tax revenue when determining the standard price used for auditing. One notable implication is that the tax authorities should raise the upper-limit price allowed for internal transfers as the elasticity of substitution between brands for consumers decreases.     

Corporate liquidity,investment and financial constraints: Implications from a multi-period model

In single period models, financially constrained firms invest more in response to increases in their net worth or interest rate cuts. We examine whether or not these results necessarily hold in a multi-period setting. We present a multi-period version of the Holmstrom and Tirole moral hazard model and show that the probability of investment (or the hurdle rate for investment) in the first period of a two-period model is non-monotonic in the level of liquid balances [Holmstrom, B., Tirole, J., 1997. Financial intermediation, loanable funds, and the real sector. Quart. J. Econ. 112 (3), 663–691. August; Holmstrom, B., Tirole, J., 1998. Private and public supply of liquidity. J. Polit. Economy 106 (1), 1–40. February; Holmstrom, B., Tirole, J., 2000. Liquidity and risk management. J. Money, Credit, Banking 32 (3), 295–319. August]. When a risk-free interest rate is introduced in the model, we show that a lower interest rate (or a downward shift or the yield curve) can lead to less current investment due to the interaction of future financial constraints and discounting of cash flows. Our results have implications for the effect of monetary policy on investment by financially constrained firms. They also address several recent empirical debates, such as the relationship between liquidity and the cash-flow sensitivity of investment, and whether or not accumulation of cash balances by Japanese firms can be consistent with the existence of financial constraints affecting investment.     

Strategic technology adoption and hedging under incomplete markets

We investigate the implications of technological innovation and non-diversifiable risk on entrepreneurial entry and optimal portfolio choice. In a real options model where two risk-averse individuals strategically decide on technology adoption, we show that the impact of non-diversifiable risk on the option timing decision is ambiguous and depends on the frequency of technological change. Compared to the complete market case, non-diversifiable risk may accelerate or delay the optimal investment decision. Moreover, strategic considerations regarding technology adoption play a central role for the entrepreneur’s optimal portfolio choice in the presence of non-diversifiable risk.     

Risk arbitrage and hedging to acceptability under transaction costs

The classical discrete-time model of proportional transaction costs relies on the assumption that a feasible portfolio process has solvent increments at each step. We extend this setting in two directions, allowing convex transaction costs and assuming that increments of the portfolio process belong to the sum of a solvency set and a family of multivariate acceptable positions, e.g. with respect to a dynamic risk measure. We describe the sets of superhedging prices, formulate several no (risk) arbitrage conditions and explore connections between them. In the special case when multivariate positions are converted into a single fixed asset, our framework turns into the no-good-deals setting. However, in general, the possibilities of assessing the risk with respect to any asset or a basket of assets lead to a decrease of superhedging prices and the no-arbitrage conditions become stronger. The mathematical techniques rely on results for unbounded and possibly non-closed random sets in Euclidean space.

     

Investment timing and optimal capital structure under liquidity risk

Deterioration in debt market liquidity reduces debt values and affects firms' decisions. Considering such risk, we develop an investment timing model and obtain analytic solutions. We carry out a comprehensive analysis in optimal financing, default, and investment strategies, and stockholder–bondholder conflicts. Our model explains stylized facts and replicates empirical findings in credit spreads. We obtain six new insights for decision makers. We propose a ‘new trade-off theory’ for optimal capital structure, a new tax effect, and new explanations of ‘debt conservatism puzzle’ and ‘zero-leverage puzzle’. Failure in recognizing liquidity risk results in substantially over-leveraging, early bankruptcy or investment, overpriced options, and undervalued coupons and credit spreads. In addition, agency costs are surprisingly small for a high liquidity risk or a low project risk. Interestingly, the risk shifting incentive and debt overhang problem decrease with liquidity risk under moderate tax rates while they increase under high tax rates.     

Performance measurement for investment decisions under capital constraints

An owner delegates investment decisions to a better informed manager whose time preferences are unknown to the owner. Due to exogenous capital constraints, not all profitable projects can be undertaken, and therefore the owner wants the manager to select the NPV-maximizing set of projects. We show that the relative benefit cost allocation scheme proposed by prior literature does not solve this problem. Adopting the same information structure as in Rogerson (J Polit Econ 105, 770–795, 1997) and Reichelstein (Rev Account Stud 2, 157–180, 1997), we demonstrate how to obtain robust goal congruence using residual income. The resulting revenue recognition and cost allocation rules lead to a performance measure reflecting the expected NPV-ranking of projects in each and every period.

论国际货币清算规则下的本币金融开放

与目前社会上普遍存在的认知不同,本文认为我国的金融对外开放早已启动,只不过是以外币开放的形式进行。根据货币的国际清算规则,这种以外币主导的金融开放,其结果只是使国内涉外领域中的货币错配现象日趋严重．迄今为止,也还没有任何一个发展中国家能够在外币主导的金融对外开放中获得成功。而以人民币开展跨境贸易结算所带来的本币金融对外开放则有实质性的不同,依据目前跨境贸易人民币结算的两种清算模式．人民币的对外开放,不仅降低了开放难度和货币错配风险,且对外风险可控,有利于金融市场自然形成对外开放和金融服务水平的提高。     

Pricing and hedging volatility smile under multifactor interest rate models

The paper extends Amin and Morton (1994), Zeto (2002), and Kuo and Paxson (2006) by considering jump-diffusion model of Das (1999) with various volatility functions in pricing and hedging Euribor options across strikes and maturities. Adding the jump element into a diffusion model helps capturing volatility smiles in the interest rate options markets, but specifying the mean-reversion volatility function improves the most. A humped volatility function with the additional jump component yields better in-sample and out-of-sample valuation, but level-dependent volatility becomes more crucial for hedging. The specification of volatility function is more crucial than merely adding jumps into any model and the effect of jumps declines as the maturity of options is longer.     

Optimal hedging in an extended binomial market under transaction costs

We develop an approach to optimal hedging of a contingent claim under proportional transaction costs in a discrete time financial market model which extends the binomial market model with transaction costs. Our model relaxes the binomial assumption on the stock price ratios to the case where the stock price ratio distribution has bounded support. Non-self-financing hedging strategies are studied to construct an optimal hedge for an investor who takes a short position in a European contingent claim settled by delivery. We develop the theoretical basis for our optimal hedging approach, extending results obtained in our previous work. Specifically, we derive a no-arbitrage option price interval and establish properties of the non-self-financing strategies and their residuals. Based on the theoretical foundation, we develop a computational algorithm for optimizing an investor relevant criterion over the set of admissible non-self-financing hedging strategies. We demonstrate the applicability of our approach using both simulated data and real market data.     

Hedging under multiple risk constraints

Motivated by the asset–liability management problems under shortfall risk constraints, we consider in a general discrete-time framework the problem of finding the least expensive portfolio whose shortfalls with respect to a given set of stochastic benchmarks are bounded by a specific shortfall risk measure. We first show how the price of this portfolio may be computed recursively by dynamic programming for different shortfall risk measures, in complete and incomplete markets. We then focus on the specific situation where the shortfall risk constraints are imposed at each period on the next-period shortfalls, and obtain explicit results. Finally, we apply our results to a realistic asset–liability management problem of an energy company, and show how the shortfall risk constraints affect the optimal hedging of liabilities.