Stabilising economic growth through risk sharing macro instruments

The risk sharing principles of Islamic Finance have ironically been studied and used extensively outside the Muslim World. The development of early European city states was founded on the risk sharing principle. The risk sharing financing helped these city states to develop their infrastructure and rule the scientific and economic landscape of the west. The Western financial system of today still carries traces of risk sharing in the form of venture capital financing, albeit the primary focus has diverted to risk shifting‐based debt financing. Over the past decades, much effort and research has gone into establishing a viable set of Islamic financial institutions. Most Muslim nations are heavily indebted with high reliance on multilateral financing primarily based on high interest rates. This vicious cycle of interest rates and debt has stunted the growth of these nations and worsened the conditions of the masses. This research brings to the forefront the concept of an equity in nature GDP ‐linked paper, which allows for enhanced risk sharing‐based sovereign financing. It aims to present empirical proof of the stability this instrument offers in economic growth, for a large sample of developing economies, comprising bulk of Islamic countries. While analysing the empirical work, a strong favourable argument for this instrument is derived for its benefits in stability. Through this study, we endeavour to initiate a thought‐provoking and practical discussion for further development of these instruments for the betterment of developing countries.     

Funding development infrastructure without leverage: A risk‐sharing alternative using innovative sukuk structures

Muslim countries of the developing world suffer indebtedness resulting mostly from funding development infrastructure. Faced with a dire need for development infrastructure but with inadequate resources to fund them domestically, these governments often resort to foreign borrowing. As neither foreign banks nor international debt markets would allow for the debt to be in home currency, the funding is invariably denominated in foreign currency. For the borrowing country, in addition to currency exposure such borrowing increases the country's leverage and economic vulnerability. As these countries typically have a narrow economic base with heavy reliance on commodity exports, they are susceptible to the vagaries of commodity price fluctuation. Leverage increases the amplitude of the economy's fluctuation, resulting if not in outright crisis, then, at least in financial distress and depreciating home currency. As a result, when the foreign currency funded project comes on stream, it is burdened with huge accumulated debt which in many cases makes the project unmanageable without further government help through subsidy of operating costs. This further stresses already stretched government budgets and perpetuates indebtedness. This cycle of borrowing, leverage and vulnerability can be broken by innovative use of sukuk. The problem with debt financing is that the servicing requirements are independent of the underlying project's risk or cash flows. This paper presents two sukuk structures based on the risk sharing principles of Islamic finance. Sukuk that have returns linked to the nation's gross domestic product growth if the funded project is non‐revenue generating and linked to earnings of the project if it is revenue generating can avoid the problems above. The pay‐off profile, estimated cost of funds and returns to investors of these sukuk are discussed. When designed in small denomination, such sukuk can enhance financial inclusion, help build domestic capital markets and enable the financing of development without stressing government budgets.     

Quantification of sovereign risk: Using the information in equity market prices

This paper proposes a new approach to quantify the sovereign risk. We use the information of the stock price index as a proxy for the equity value of the country, and introduce a size parameter, which is a conversion factor of the stock price index to the equity value of the country, and adopted the extended Black–Scholes–Merton option-pricing model for the calculation of the probability of default. Our model is applied on two countries, Argentina as the case of debt crisis and Thailand as currency crisis. We demonstrated a capability of our model as an early warning indicator for both crises.     

External Public Debt,Trade Linkages and Contagion During the Eurozone Crisis

Against the backdrop of the contagion literature, the paper analyses the impact of financial and trade linkages on sovereign bond spreads in the Eurozone crisis. Using quarterly data for a sample of EMU countries during the period 2000–13, we estimate fixed‐effect panel models with Driscoll and Kraay standard errors that are robust to general forms of spatial and temporal dependence. Our main results can be summarised as follows: first, we suggest that the ‘sudden stop’ of capital inflow towards the peripheral sovereign debt triggered a re‐segmentation of financial markets and economic systems along national borders, with negative implications for risk‐sharing and the efficient allocation of capital. The ‘home bias’ effect – that is the increase in the share of sovereign debt held by domestic banks – worsened the country‐specific risk because the twin crisis (sovereign and banking) began to be conceived as more closely intertwined within countries than before. Second, the structure of international trade helps to account for the geographic scope of contagion, even after controlling for macroeconomic and fiscal vulnerabilities. Finally, the ‘substitution effect’ of public debt securities of stand‐alone emerging countries has affected more the sovereign spreads in the core than in the periphery.     

Firm Characteristics as Determinants of Capital Structures in Australia

This study investigates capital structures of Australian firms in relation to firm characteristics. Using an unbalanced panel of 367 firms observed over a 15‐year period from 1992 to 2006, our panel data regression results show that debt–asset ratio is positively related to asset tangibility but inversely related to growth prospects and business risk measured by unlevered beta of equity. We also find that although levered firms are generally more profitable than unlevered firms, profitability decreases the debt ratio of levered firms. We do not find that firm size affects the capital structure of Australian firms. These results are consistent with the pecking order and the agency cost theories but contradict the trade‐off theory.     

The Impact of Liquidity Risk: A Fresh Look*

This paper takes a fresh look at the importance of liquidity risk using a comprehensive liquidity measure, weighted spread, in a Value‐at‐Risk (VaR) framework. The weighted spread measure extracts liquidity costs by order size from the limit order book. Using a unique, representative data set of 160 German stocks over 5.5 years, we show that liquidity risk is an important risk component. Actually, liquidity risk is increasing the total price risk by over 25%, even at 10‐day horizons and for liquid blue chip stocks and especially in larger, yet realistic order sizes beyond €1 million. When correcting for liquidity risk, it is commonly assumed that liquidity risk can be simply added to price risk. Our empirical results show that this is not correct, as the correlation between liquidity and price is non‐perfect and total risk is thus overestimated.     

Managerial Stock Ownership and Debt Diversification

In this study, we examine the impact of managerial behavior on the debt diversification decisions of firms using the agency cost of debt framework. We hypothesize that managers with higher equity ownership should favor debt diversification to avoid efficient monitoring by debt holders and thus, be able to engage in risk‐shifting behavior. Our empirical results provide strong evidence for a positive association between managerial ownership and debt diversification. This relationship is observed to be stronger for smaller firms, which are traditionally more susceptible to the moral hazard problem. Our results remain robust for an alternate measure of debt diversification.     

How does capital control spur economic growth?

This paper provides a conceptual and empirical framework for evaluating the effect of capital controls on long‐term economic growth. In a small open economy which relies on successful investment projects to provide capital goods, taking out short‐term loans has two contradictory impacts: (i) it reduces the interest costs of financing investment projects; and (ii) it also leads to larger asset losses in the scenario of short‐term debt run. In this work, we hypothesise that private financing decisions made by domestic investors are distorted towards excessive risk‐taking, leading to ineffective capital formation. Thus, capital control policies, particularly regulations on short‐term loans, can be socially beneficial as they alter the debt composition, promote capital formation and achieve a higher output level. Using a panel data set covering 77 countries from 1995 to 2009, we employ a system generalised method of moments (GMM) estimator to sequentially test three hypotheses and find strong empirical evidence that supports our theory.     

人口老龄化与房价波动对居民部门债务风险的影响研究

本文基于人口老龄化、房价波动与我国居民部门资产债务结构的基本事实及相关文献研究,探讨人口老龄化与房价对居民部门债务潜在风险的影响,并以世代交叠模型为基础,论证人口老龄化对房价及其居民杠杆率的影响机制,最后构建相关变量与误差修正模型等进一步考察了三者之间的动态相关性关系.实证结果表明,长期内人口老龄化加剧与房价下跌都会加大居民部门的债务风险,短期内人口老龄化对居民部门债务风险有正向影响但不如长期显著,房价下跌对居民部门债务风险的加剧效应也不会短期内显现出来.这说明居民部门仍存在潜在的债务风险,且在一定程度上受人口周期、房地产周期长期影响,表现在人口老龄化会降低房产需求形成房价下跌导致居民部门资产缩水、信贷增加,形成债务风险.     

A maximal affine stochastic volatility model of oil prices

This study develops and estimates a stochastic volatility model of commodity prices that nests many of the previous models in the literature. The model is an affine three‐factor model with one state variable driving the volatility and is maximal among all such models that are also identifiable. The model leads to quasi‐analytical formulas for futures and options prices. It allows for time‐varying correlation structures between the spot price and convenience yield, the spot price and its volatility, and the volatility and convenience yield. It allows for expected mean‐reversion in the short term and for an increasing expected long‐term price, and for time‐varying risk premia. Furthermore, the model allows for the situation in which options' prices depend on risk not fully spanned by futures prices. These properties are desirable and empirically important for modeling many commodities, especially crude oil. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:101–133, 2010     

The signaling effects associated with convertible debt design

In this paper we investigate whether the terms used in the design of a convertible debt issue act as a signal of the issuing firm's future growth prospects. Our general premise is that convertible debt design terms are interrelated and arranged in a manner that signals asymmetric information to market participants. Empirical tests support our hypothesis, even after controlling for risk, firm size, time-to-maturity, and industry effects. Firms issuing convertible debt that arrange terms to take advantage of relatively better future growth prospects are found to have a relatively lower negative price reaction around the announcement of the offer.     

Corporate environmental performance and financing decisions

We investigate the financing strategies of environmentally responsible firms to understand how they set target capital structures and make incremental financing decisions. Literature shows that firms with better environmental performance have lower risk and better access to financing. However, it is not obvious how these firms choose to finance their investments. Using an extensive data set of U.S. firms, we find that firms with superior environmental performance have significantly lower debt ratios and use mostly short‐term debt for temporary financing needs. In doing so, environmentally responsible firms are able to achieve more tax savings and experience lower costs of financial distress. Our results provide new empirical facts about environmental performance and financing decisions, and they help explain the observed relationship between environmental performance and economic performance.     

Do brokers act in the best interests of their clients? New evidence from electronic trading systems

Prior research suggests brokers do not always act in the best interests of clients, although morally obligated to do so. We empirically investigated this issue focusing on trades executed at best execution price, before and after the introduction of electronic limit‐order trading, on the London Stock Exchange. As a result of limit‐order trading, the proportion of trades executed at the best execution price for the customer significantly increased. We attribute this to a sustained increase in the liquidity of stocks as a result of limit‐order trading, regardless of market capitalisation. We discuss the ethical implications of our findings and conclude that market structures that enhance market competitiveness may help reconcile broker and client interests.     

Multiple Ratings Model of Defaultable Term Structure

A new approach to modeling credit risk, to valuation of defaultable debt and to pricing of credit derivatives is developed. Our approach, based on the Heath, Jarrow, and Morton (1992) methodology, uses the available information about the credit spreads combined with the available information about the recovery rates to model the intensities of credit migrations between various credit ratings classes. This results in a conditionally Markovian model of credit risk. We then combine our model of credit risk with a model of interest rate risk in order to derive an arbitrage‐free model of defaultable bonds. As expected, the market price processes of interest rate risk and credit risk provide a natural connection between the actual and the martingale probabilities.     

Trade and Financial Integration in East Asia: Effects on Co‐movements

In this paper we explore three important areas where deeper trade and financial integration in East Asia can influence: (1) business cycle co‐movements in the region, (2) the extent of risk sharing across countries and (3) price co‐movements across countries. We find evidence that trade integration enhances co‐movements of output but not of consumption across countries. Especially the fact that trade integration does not raise co‐movements of consumption as much as that of output is interpreted as trade integration does not improve the extent of risk sharing. Co‐movements of price arise most significantly as trade integration deepens, lowering the border effects and allowing better opportunities for resource reallocation across countries. In contrast, financial integration demonstrates much weaker evidence of enhancing co‐movements across countries. Deeper financial integration improves price co‐movements weakly but does not enhance output or consumption co‐movements at all. However, since the current level of financial integration in East Asia is quite low, our evidence is too early to firmly determine the role of financial integration.     

经济增长视角下地方政府债务负担率动态标准研究--基于西部Y省县域非线性Panel Data模型

政府债务负担率标准并非固定,主要由债务边际社会成本与债务边际社会收益相等决定,如果其边际成本降低或边际收益提高,债务负担率标准将提升,相反会下降。本文将地方政府债务置于财政支出与经济增长的关系框架下,通过对西部Y省106个县域地区进行实证研究,发现不同时间段对应的债务负担率标准不同,2005－2006、2007－2008、2009－2010分别为14．28％、11．98％和14．16％,同时也发现各地地方政府在竞相超越既定债务负担率标准举债,带来较大的债务风险隐患。因此,防范我国当前地方政府债务风险需要重视两个问题：一是根据各地实际债务边际社会成本和收益,制定动态债务负担率标准,用于债务风险的监测预警;二是在解决实际债务负担率较高问题上,重点要从数量上化解债务转化为从质量上提高债务边际社会收益和降低债务边际社会成本。     

What to do if a dollar is not a dollar? The impact of inflation risk on production and risk management

An entrepreneur faces two types of risk: one from income generation, one from income spending. His income from firm profits is risky due to output price fluctuations and other risks. As a consumer, he is also exposed to inflation risk since he maximizes expected utility of real income. This article focuses on optimal production and risk management decisions of a risk‐averse entrepreneur jointly facing tradable output price risk and untradable inflation risk. Inflation risk applies multiplicatively to the entrepreneur's entire nominal income. Relative risk aversion and the risks' joint distribution determine the effect of introducing a futures market on production. For dependent risks, this effect may be negative if relative risk aversion is above one. Relative risk aversion and the joint distribution also determine optimal risk management with futures contracts where speculation on a real risk premium and cross hedging may be conflicting objectives. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:371–386, 2002     

Size clustering in the FTSE100 index futures market

Recent literature has begun to explore size clustering in financial markets. If a market is perfectly liquid, traders should be able to trade the exact amount that they desire; however, the presence of size clustering may prevent them from achieving optimal trade sizes. This study is novel in its investigation of size clustering in a futures market. We find that trade sizes cluster in a manner that is similar to the pattern of price clustering found in many financial markets. Importantly, we identify a trade‐off between size resolution and price resolution. We also find that the number of distinct trade sizes increases with trade frequency and with intra‐day volatility, and increases at the end of each calendar quarter. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:432–443, 2010     

Sharing the value‐at‐risk under distributional ambiguity

This paper considers the problem of risk sharing, where a coalition of homogeneous agents, each bearing a random cost, aggregates their costs, and shares the value‐at‐risk of such a risky position. Due to limited distributional information in practice, the joint distribution of agents' random costs is difficult to acquire. The coalition, being aware of the distributional ambiguity, thus evaluates the worst‐case value‐at‐risk within a commonly agreed ambiguity set of the possible joint distributions. Through the lens of cooperative game theory, we show that this coalitional worst‐case value‐at‐risk is subadditive for the popular ambiguity sets in the distributionally robust optimization literature that are based on (i) convex moments or (ii) Wasserstein distance to some reference distributions. In addition, we propose easy‐to‐compute core allocation schemes to share the worst‐case value‐at‐risk. Our results can be readily extended to sharing the worst‐case conditional value‐at‐risk under distributional ambiguity.     

Common Risk Factors Versus a Mispricing Factor of Tokyo Stock Exchange Firms: Inquiries into the Fundamental Value Derived from Analyst Earnings Forecasts*

We search for common factors and/or a mispricing factor for Tokyo Stock Exchange firms. We utilize the Edwards–Bell–Ohlson model to compute the firms' fundamental value and divide this value by the firms' market price to construct a new variable called a ‘value‐to‐price ratio’ (VPR). We find that this VPR variable can generate abnormal returns even after adjusting for the risk factors related to portfolio style differences. To find out whether it is indeed a risk factor or simply a characteristic, we construct return difference portfolios of the high VPR stocks minus the low value‐to‐price stocks and call this portfolio the upward‐forecast minus downward‐forecast (UMD) factor. Fama and MacBeth test indicate that the risk premium for this UMD factor is positive. The best model in terms of the adjusted R² value is the four‐factor model in which the UMD factor is added to the Fama and French three factors. GMM Euler condition tests reveal that the UMD factor helps to price assets and that the four‐factor model is not rejected. We conclude the VPR variable contains new information content that is not contained in the conventional Fama and French's three factors.