RISK MANAGEMENT FOR MIDDLE MARKET COMPANIES

This article reinforces the message of the one immediately preceding by showing that small to medium‐sized firms have even stronger (non‐tax) motives for hedging risks than their large corporate counterparts. Although middle market companies have traditionally been viewed as less sophisticated than their larger corporate counterparts in the risk management arena, the authors suggest that such companies have become increasingly receptive to new hedging strategies using derivative products. When used appropriately, such products allow companies to stabilize their periodic operating cash flow by eliminating specific sources of volatility such as fluctuations in interest rates, exchange rates, and commodity prices. Smaller companies recognize that a single swing in a budgeted cost can have a catastrophic effect on an entire budget, whereas a larger company can more easily absorb such a cost. Moreover, because the principal owners of mid‐sized firms often have a substantial part of their net worth tied up in the business, they are likely to have a far stronger interest than typical outside shareholders in using risk management to reduce the volatility of corporate profits and firm value. Perhaps most important to owners whose firms rely on debt financing, the greater cash flow stability resulting from active risk management significantly reduces the possibility of financial distress or bankruptcy. In this article, three representatives of Bank of America's risk management practice discuss three different exposures faced by middle market companies—those arising from changes in interest rates, foreign exchange rates, and commodity prices—and show how these risks can be managed with derivatives. Besides shielding companies from financial trouble, risk management is also likely to improve their access to the money and capital markets. By protecting the firm's access to capital, risk management increases the odds that the firm will not be forced to pass up good investment opportunities because of capital constraints or fear of getting into financial difficulty.     

The Effect of Decimalization on Trade Size and Adverse Selection Costs

Abstract:   We examine adverse selection costs around NYSE decimalization. Further, we analyze the relation between adverse selection costs and trade size. We find a significant increase in the percentage adverse selection cost and a reduction in dollar adverse selection cost (percentage adverse selection multiplied by the spread) following complete decimalization on the NYSE. On estimating the adverse selection components by trade size classes, we find a decline in dollar adverse selection costs in trades of all sizes, with the strongest evidence coming from medium size trades, followed by small and large size trades. One implication of our findings is that there appears to be less stealth trading following complete decimalization and less institutional trading overall.     

The Role of Alliance Network Redundancy in the Creation of Core and Non-core Technologies

This paper studies the effect of a focal firm, and its partners' local alliance actions, on the creation of technological innovations by the former. More specifically, we study how two types of redundancy in a focal firm's ego network affect its ability to create new technologies in its technology core areas (exploitation) and/or non-core areas (exploration). We analyse this empirically in three different industry settings: chemicals, motor vehicles, and pharmaceuticals. One of our key findings is that individual firms can indeed boost both types of innovative output by shaping the degree of redundancy in their local alliance network, but that the way in which this should be done differs between the creation of core and non-core technologies. Next, we find that it is very useful to unpack the rather abstract notion of redundancy into more specific types of redundancy in ego networks. Overall, these findings reflect an action-oriented view on the role of individual firms in collaborative networks, which may complement the dominant view in the alliance literature emphasizing the role of the overall network structure and firms' network position within it.     

Identifying Permanent and Temporary Components in Daily and Monthly Japanese Stock Prices

The purpose of this study is to analyze time series of daily and monthly values for the Tokyo Stock Price Index (TOPIX) and stock price values for 15 companies listed on the Tokyo Stock Exchange, Section 1 (TSE-I), to determine the contribution of permanent and temporary components to Japanese stock prices. The existence of temporary components in the price series would imply that Japanese stock returns are partially predictable. The method of canonical correlation is used to determine components common to each series and the persistence of each component series is evaluated by estimating the amount of dependence in the series. The results suggest that Japanese stock prices contain a small temporary component. The fractionally integrated ARIMA (ARFIMA) model is used to characterize both the component series and an estimate of the temporary component for each original price series. The contribution of the temporary component to the total variation of the price series estimated. We find that, in general, the temporary component accounts for less than 8% of the variation in the daily price series and from 5% to 15% of variation in the monthly price series, indicating that there may be a small amount of predictability in Japanese stock prices.     

Clustering in the futures market: Evidence from S&P 500 futures contracts

We document trade price clustering in the futures markets. We find clustering at prices of x.00 and x.50 for S&P 500 futures contracts. While trade price clustering is evident throughout time to maturity of these contracts, there is a dramatic change when the S&P 500 futures contract is designated a front‐month contract (decrease in clustering) and a back‐month contract (increase in clustering). We find that trade price clustering is a positive function of volatility and a negative function of volume or open interest. In addition, we find a high degree of clustering in the daily opening and closing prices, but a lower degree of clustering in the settlement prices. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:413–428, 2004