Is there an optimally diversified conglomerate? Gleaning answers from capital markets

Motivated by recent productivity-based theories of diversification, we argue that only conglomerates with an optimal degree of diversification can utilize their comparative advantages across various industries and achieve economies of scope by eliminating redundancies. Evidence from both corporate bond and equity markets suggests that optimally diversified conglomerates consist of either (1) approximately five equally weighted divisions, or (2) one large core business segment that roughly accounts for 75 % sales. Moreover, the relative size of divisions has a critical impact on how diversification affects credit spreads and excess values. Nonparity among divisions correlates with greater costs that increase with the number of divisions.     

Optimal order placement in limit order markets

To execute a trade, participants in electronic equity markets may choose to submit limit orders or market orders across various exchanges where a stock is traded. This decision is influenced by characteristics of the order flows and queue sizes in each limit order book, as well as the structure of transaction fees and rebates across exchanges. We propose a quantitative framework for studying this order placement problem by formulating it as a convex optimization problem. This formulation allows the study of how the optimal order placement decision depends on the interplay between the state of order books, the fee structure, order flow properties and the aversion to execution risk. In the case of a single exchange, we derive an explicit solution for the optimal split between limit and market orders. For the general case of order placement across multiple exchanges, we propose a stochastic algorithm that computes the optimal routing policy and study the sensitivity of the solution to various parameters. Our algorithm does not require an explicit statistical model of order flow but exploits data on recent order fills across exchanges in the numerical implementation of the algorithm to acquire this information through a supervised learning procedure.     

Audit committee characteristics and investment in internal auditing

Regulators and others recently highlighted the increasingly important role of internal auditing in supporting and interacting with the audit committee to ensure the integrity and quality of financial reporting. Likewise, one of the roles of the audit committee is to oversee the quality of monitoring mechanisms implemented by the firm, which includes the internal audit function. However, our understanding of the relationship between the audit committee and internal auditing is limited. We fill this void by providing the first empirical evidence of the association between audit committee characteristics and the investment in internal auditing. Our analyses, from a sample of 181 SEC registrants, suggest that the investment in internal auditing (internal audit budget) is negatively related to the presence of auditing experts on the committee and the average tenure of audit committee members, but positively related to the number of audit committee meetings (a proxy for audit committee diligence). These observations suggest potential complementary and substitution effects between the audit committee and internal auditing, and thus raise important implications for future research.     

Allocation to Anchor Investors,Underpricing, and the After‐Market Performance of IPOs

We study bidding by anchor investors in a two‐stage initial public offering (IPO) process and document a negative, causal relation between allocation to anchor investors and underpricing. We find that anchor investors are likely to invest in hard‐to‐place offerings characterized by valuation uncertainty. We also document a positive relation between allocation to reputed anchor investors and returns up to lock‐up expiration. Our evidence provides support for information revelation and targeting specific investors’ theories of book building. Anchor‐backed IPOs earn superior returns mainly due to monitoring. Who bids in an IPO seems to matter just as particular types of bids do.     

Challenges in Measuring Poverty and Understanding its Dynamics: A South Asian Perspective

South Asia’s success at reducing poverty does not imply that the topic has become passé. Poverty rates are by now low, but this is because poverty lines are low as well. And the assessment of living standards and their dynamics are blurred by measurement and interpretation challenges. This paper relies mostly on South Asian examples to highlight four tensions: poorer versus richer households, rural versus urban locations, monetary versus non‐monetary dimensions of wellbeing, and household characteristics versus context. The discussion is conducted against the backdrop of the two analytical approaches with South Asian roots that have shaped the debate for decades. This review leads to three main recommendations: household survey data has to be exploited in a more thorough manner, data that is increasingly available from other sources needs to be incorporated more systematically in the analysis, and the multiple dimensions of wellbeing should be better integrated in a common framework.     

Exploring the animosity domain and the role of affect in a cross-national context

PurposeThe purpose of this paper is to contribute to the development of animosity theory in three areas; construct domain, the mediating role of affect and model testing.Design/methodology/approachExploratory and empirical research is carried out in two countries in order to explore the domain and to test the factor structure and the hypotheses through confirmatory analysis.FindingsWe find animosity is a four-dimensional construct which impacts buying behavior through affect.Originality/valueThe research extends the domain of the animosity construct to a four-dimensional structure rather than the two-dimensional structure used in most previous studies. It is the first study to empirically test an extended animosity domain and investigate the mediating role of affective emotional responses between animosity and buying intentions.     

The Sri Lankan Unemployment Problem Revisited

High unemployment in Sri Lanka has been attributed to unrealistic expectations, to queuing for public sector jobs, and to stringent job security regulations. However, the empirical evidence supporting these explanations is weak. This paper analyzes individual records from the 1995 Labor Force Survey, and time series for wages in the formal and informal sectors of the economy. The paper rejects the unrealistic‐expectations hypothesis by comparing the impact of education on the actual wages of those who have a job and on the lowest acceptable wages of the unemployed. But it finds substantial rents associated with jobs in the public sector, and in activities protected by high tariffs or covered by job security regulations. A time‐series analysis of the impact of unemployment on wage increases across sectors suggests that many among the unemployed are waiting for “good” job openings, but are not interested in readily available “bad” jobs.     

MODEL UNCERTAINTY AND ITS IMPACT ON THE PRICING OF DERIVATIVE INSTRUMENTS

Uncertainty on the choice of an option pricing model can lead to "model risk" in the valuation of portfolios of options. After discussing some properties which a quantitative measure of model uncertainty should verify in order to be useful and relevant in the context of risk management of derivative instruments, we introduce a quantitative framework for measuring model uncertainty in the context of derivative pricing. Two methods are proposed: the first method is based on a coherent risk measure compatible with market prices of derivatives, while the second method is based on a convex risk measure. Our measures of model risk lead to a premium for model uncertainty which is comparable to other risk measures and compatible with observations of market prices of a set of benchmark derivatives. Finally, we discuss some implications for the management of "model risk."     

RUNNING FOR THE EXIT: DISTRESSED SELLING AND ENDOGENOUS CORRELATION IN FINANCIAL MARKETS

We propose a simple multiperiod model of price impact from trading in a market with multiple assets, which illustrates how feedback effects due to distressed selling and short selling lead to endogenous correlations between asset classes. We show that distressed selling by investors exiting a fund and short selling of the fund’s positions by traders may have nonnegligible impact on the realized correlations between returns of assets held by the fund. These feedback effects may lead to positive realized correlations between fundamentally uncorrelated assets, as well as an increase in correlations across all asset classes and in the fund’s volatility which is exacerbated in scenarios in which the fund undergoes large losses. By studying the diffusion limit of our discrete time model, we obtain analytical expressions for the realized covariance and show that the realized covariance may be decomposed as the sum of a fundamental covariance and a liquidity‐dependent “excess” covariance. Finally, we examine the impact of these feedback effects on the volatility of other funds. Our results provide insight into the nature of spikes in correlation associated with the failure or liquidation of large funds.     

MULTICOLLINEARITY AND CONSUMER DEMAND ELASTICITIES*

Multicollinearity is a common problem in the estimation of consumer demand models and the elasticities. While straight forward application of classical least squares often yields models with good predictive power, this apparently occurs for reasons other than the accuracy of the estimates of the parameters. The implications of multicollinearty in two-stage and three-stage least squares are discussed, with examples from Brookings Quarterly Agricultural Submodel of the United States. A comparison is made of alternative estimators of the parameters of consumer demand functions. The article points to difficulties raised by using a priori coefficients for one variable (eg. income elasticity) as a means of developing an accurate estimate of another coefficient (eg. price elasticity), and indicates evidence of multicollinearity depressing estimated consumer price elasticities. LA COLLINEARITE ET DES ELASTICITES DE LA DEMANDS DE CONSUMMATION - La collinéarité est un problème common de l'estimation des modèles de demande en consummation et des élasticités. Quoique l'application directe de la méthode classique de “moindre carré”, permet souvent d‘êlaborer des modèles ayant beaucoup de prediction, ceci semble-t-il être en function de d'autres facteurs que de l'exactitude des évaluations des paramètres. Les effets de la cottinéarité dans les estimations moindre carré de deux et trois étapes sont évahtés avec des exemples tires du “Brookings Quarterly Agricultural Submodel” des Etats-Unis. Différentes méthodes d'estimation de la fonction de la demande en consummation sont comparées. L'article fait état des difficultés que soulève l'emploi de coefficient a priori pour une variable (ex. l’êlasticité du revenue) comme moyen de développer un estimé précis d'un autre coefficient (ex. l‘élasticité de prix), et apporte de l'evidence sur l'effet attendant de la collinéarité sur les estimés d’élasticité de prix.