Regionality revisited: An examination of the direction of spread of currency crises

What determines the direction of spread of currency crises? We examine data on waves of currency crises in 1992, 1994, 1997, and 1998 to evaluate several hypotheses on the determinants of contagion. We simultaneously consider trade competition, financial links, and institutional similarity to the “ground zero” country as potential drivers of contagion. To overcome data limitations and account for model uncertainty, we utilize Bayesian methodologies hitherto unused in the empirical literature on contagion. In particular, we use the Bayesian averaging of binary models that allows us to take into account the uncertainty regarding the appropriate set of regressors.We find that institutional similarity to the ground zero country plays an important role in determining the direction of contagion in all the emerging market currency crises in our dataset. We thus provide persuasive evidence in favour of the “wake-up call” hypothesis for financial contagion. Trade and financial links may also play a role in determining the direction of contagion, but their importance varies amongst the crisis periods.     

Reining in auditors: On the dynamics of power surrounding an “innovation” in the regulatory space

In the aftermath of Enron and the collapse of Arthur Andersen, new “independent” institutions were created to oversee financial auditing. Based on a modified version of Lukes’ multidimensional model of power, we first investigate how the creation of the Canadian Public Accountability Board (CPAB) has affected the dynamics of power among the main players enlisted in Canada’s regulation of public accounting. Our findings strengthen the view that a “form of allegiance” was, at the time of data collection, developing between CPAB and the largest Canadian accounting firms. Through a second analytical movement, we extend the boundaries of our argument, showing that patterns of resistance against the logic of arm’s length regulation operate in a variety of audit regulatory sites. Our conclusion points, in particular, to the spatial gap - and incidentally the limitations - of any attempt to control and supervise a globalized industry from a national or regional perspective.     

The CEO pay slice

We investigate the relation between the CEO Pay Slice (CPS)—the fraction of the aggregate compensation of the top-five executive team captured by the Chief Executive Officer—and the value, performance, and behavior of public firms. The CPS could reflect the relative importance of the CEO as well as the extent to which the CEO is able to extracts rents. We find that, controlling for all standard controls, CPS is negatively associated with firm value as measured by industry-adjusted Tobin's q. CPS also has a rich set of relations with firms' behavior and performance. In particular, CPS is correlated with lower (industry-adjusted) accounting profitability, lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, higher odds of the CEO receiving a lucky option grant at the lowest price of the month, lower performance sensitivity of CEO turnover, and lower stock market returns accompanying the filing of proxy statements for periods when CPS increases. Taken together, our results are consistent with the hypothesis that higher CPS is associated with agency problems and indicate that CPS can provide a useful tool for studying the performance and behavior of firms.     

Why is Convertible Debt Subordinated? An Investment‐Based Agency Theory

This paper offers an agency‐based explanation for the junior priority status of convertible bonds. Using a simple economic model, I show that when convertible and straight debt have equal priority, shareholders can prefer value‐decreasing projects, which results in wealth transfers from bondholders to shareholders; and I prove that this problem is solved when convertible debt is subordinated. Empirical evidence supports the theory. I find that firms with greater potential for investment‐based agency conflicts are more likely to issue subordinated convertible debt, and firms with senior convertible debt are more likely to deviate from the optimal investment policy.     

The Monday effect revisited: An alternative testing approach

This paper questions traditional approaches for testing the Monday effect of stock returns. We propose an alternative, multiple hypothesis testing approach based on the closure test principle which controls the multiple type I error. We consider the US, the UK and the German stock markets and test Monday related pairwise comparisons of daily expected stock returns, while the probability of committing any type I error is always kept smaller than a prespecified level α, for each combination of true null hypotheses. Overall, the new testing approach supports previous findings of a Monday effect for the 1970s and 1980s, in particular for the US and Germany, while it suggests that the Monday effect has vanished in the 1990s and 2000s in all three markets. The comparison of the closure test procedure, the traditional multiple t-test and the Bonferroni test, a classical multiple test procedure, shows that traditional testing may result in spurious significance while the Bonferroni test may sometimes be too conservative.     

Modeling structural changes in the volatility process

GARCH-type models have been very successful in describing the volatility dynamics of financial return series for short periods of time. However, the time-varying behavior of investors, for example, may cause the structure of volatility to change and the assumption of stationarity is no longer plausible. To deal with this issue, the current paper proposes a conditional volatility model with time-varying coefficients based on a multinomial switching mechanism. By giving more weight to either the persistence or shock term in a GARCH model, conditional on their relative ability to forecast a benchmark volatility measure, the switching reinforces the persistent nature of the GARCH model. The estimation of this benchmark volatility targeting or BVT-GARCH model for Dow 30 stocks indicates that the switching model is able to outperform a number of relevant GARCH setups, both in- and out-of-sample, also without any informational advantages.     

Words that shake traders : The stock market's reaction to central bank communication in real time

This paper investigates the effects of Federal Reserve's decisions and statements on U.S. stock and volatility indices (Dow Jones Industrial Average, NASDAQ 100, S&P 500, and VIX) using a high-frequency event-study analysis. I find that both the surprise component of policy actions and official communication have statistically significant and economically relevant effects on equity indices, with statements having a much greater explanatory power of the reaction of stock prices to monetary policy. For instance, around 90% of the explainable variation in S&P 500 is due to the surprise component of Fed's statements. This paper also shows that equity indices tend to incorporate FOMC monetary surprises within 40 min from the announcement release. Finally, I find that these results are robust along several dimensions. In particular, I consider different estimators, such as the Generalized Empirical Likelihood, and I extend the sample to include the recent period of heightened financial stress. This sensitivity analysis corroborates that central bank communication about its future policy intentions is a key driver of stock returns.     

Product Market Competition,Managerial Incentives and Firm Valuation

This paper contributes to the very small empirical literature on the effects of competition on managerial incentive schemes. Based on a theoretical model that incorporates both strategic interaction between firms and a principal agent relationship, we analyse the relationship between product market competition, incentive schemes and firm valuation. The model predicts a nonlinear relationship between the intensity of product market competition and the strength of managerial incentives. We test the implications of our model empirically based on a unique and hand‐collected dataset comprising over 600 observations on 200 Swiss firms over the 2002–2005 period. Our results suggest that, consistent with the implications of our model, the relation between product market competition and managerial intensive schemes is convex indicating that above a certain level of intensity in product market competition, the marginal effect of competition on the strength of the incentive schemes increases in the level of competition. Moreover, competition is associated with lower firm values. These results are robust to accounting for a potential endogeneity of managerial incentives and firm value in a simultaneous equations framework.     

Default and Recovery Risk Dependencies in a Simple Credit Risk Model

This paper provides evidence for the relationship between credit quality, recovery rate, and correlation. The paper finds that rating grade, rating shift, and macroeconomic factors provide a highly significant explanation for default risk and recovery risk of US bond issues. The empirical data suggest that default and recovery processes are highly correlated. Therefore, a joint approach is required for estimating time‐varying default probabilities and recovery rates that are conditional on default. This paper develops and applies such a model.     

A computing bias in estimating the probability of informed trading

This study identifies a factor that leads to a bias in estimating the probability of informed trading (PIN), a widely-used microstructure measure. It is shown that, along with the numerical maximization of the likelihood function for PIN, the floating-point exception (i.e., overflow or underflow) may eliminate feasible solutions to the actual parameters in the optimization problem. Approximately 44% of PIN estimates for recent stock market data may have been subject to a downward bias that is more pronounced for active stocks than for inactive stocks. This study develops a remedy to mitigate the resulting bias.