Competition between Exchanges: Euronext versus Xetra

Exchanges in Europe are in a process of consolidation. After the failure of the proposed merger between Deutsche Börse and Euronext, these two groups are likely to become the nuclei for further mergers and co‐operation with currently independent exchanges. A decision for one of the groups entails a decision for the respective trading platform. Against that background we evaluate the attractiveness of the two dominant continental European trading systems. Though both are anonymous electronic limit order books, there are important differences in the trading protocols. We use a matched‐sample approach to compare execution costs in Euronext Paris and Xetra. We find that both quoted and effective spreads are lower in Xetra. The differences are more pronounced for less liquid stocks. When decomposing the spread we find no systematic differences in the adverse selection component. Realised spreads, on the other hand, are significantly higher in Euronext. Neither differences in the number of liquidity provision agreements nor differences in the minimum tick size or in the degree of domestic competition for order flow explain the different spread levels. We thus conclude that Xetra is the more efficient trading system.     

Underwriter reputation,earnings management and the long‐run performance of initial public offerings

This study contributes to the extant literature on the nature of earnings management surrounding initial public offerings (IPOs) by investigating the role of underwriter reputation. We argue that prestigious underwriters will protect their reputation by carefully monitoring and certifying financial information on IPO firms, thereby limiting any potential earnings manipulation. As a result, those IPO firms that are associated with more prestigious underwriters are likely to exhibit substantially less‐aggressive earnings management. Conversely, we find the existence of a negative relationship between earnings management and the post‐offer performance of an IPO firm’s stocks only for those firms associated with less‐prestigious underwriters.     

Persistence and the four‐factor model in the Australian funds market: a note

We investigate whether Australian fund managers are able to deliver persistent performance using Carhart’s (1997) four‐factor model. Short‐ and long‐term persistence is examined and the sample is also divided into unit trusts and superannuation funds. We do not find evidence of persistence in any sample of funds. We find that winner (loser) funds tend to hold past winner (loser) stocks. Winner and loser unit trusts both appear to have positive exposure to small stocks.     

Interaction of size,book‐to‐market and momentum effects in Australia

This study seeks to disentangle the effects of size, book‐to‐market and momentum on returns. Initial results show that each characteristic has a role in explaining returns, but that there is interaction between size and momentum, as well as between size and book‐to‐market. Three key findings emerge. First, the size premium is the strongest, particularly in the loser portfolios. Second, the value premium is generally limited to the smallest portfolios. Third, the momentum premium is evident for the large‐ and middle‐sized portfolios, but loser stocks significantly outperform winner stocks in the smallest size portfolio. When these interactions are controlled with multivariate regression, we find a significant negative average relation between size and returns, a significant positive average relation between book‐to‐market and returns, and a significant positive average relation between momentum and returns.     

A High‐Frequency Investigation of the Interaction between Volatility and DAX Returns

One of the most noticeable stylised facts in finance is that stock index returns are negatively correlated with changes in volatility. The economic rationale for the effect is still controversial. The competing explanations have different implications for the origin of the relationship: Are volatility changes induced by index movements, or inversely, does volatility drive index returns? To differentiate between the alternative hypotheses, we analyse the lead‐lag relationship of option implied volatility and index return in Germany based on Granger causality tests and impulse‐response functions. Our dataset consists of all transactions in DAX options and futures over the time period from 1995 to 2005. Analyzing returns over 5‐minute intervals, we find that the relationship is return‐driven in the sense that index returns Granger cause volatility changes. This causal relationship is statistically and economically significant and can be clearly separated from the contemporaneous correlation. The largest part of the implied volatility response occurs immediately, but we also observe a smaller retarded reaction for up to one hour. A volatility feedback effect is not discernible. If it exists, the stock market appears to correctly anticipate its importance for index returns.     

The Federal Home Loan Bank System: The Lender of Next‐to‐Last Resort?

The Federal Home Loan Bank (FHLB) System is a large cooperatively owned government‐sponsored liquidity facility that lends predominately to U.S. depository institutions. This paper documents the significant role played by the FHLB System at the outset of the recent financial crisis and provides evidence on the uses of FHLB funding by member banks and thrifts during that time. We then compare lending activity by the FHLB System and the Federal Reserve during 2007 and 2008, discuss the types of institutions seeking government‐sponsored liquidity at various times, and identify the trade‐offs faced by borrowers eligible to tap liquidity from both facilities.     

Reconsidering the Relationship between Inflation and Relative Price Variability

It has long been popularly believed that the relationship between inflation and relative price variability (RPV) is positive and stable. Using disaggregated CPI data for the United States and Japan, however, this study finds that the relationship is neither linear nor stable over time. The overall relationship is approximately U‐shaped around a nonzero threshold inflation rate. RPV therefore changes not with the inflation rate per se, but with the deviation of inflation from the threshold inflation rate. More importantly, the relationship is by no means stable over time but instead varies significantly in a way that coincides with regime changes of inflation or monetary policy. The relationship was positive during the period of high inflation of the 1970s and the early 1980s, as has been documented by a number of previous studies, whereas it takes a U‐shape profile during the Great Moderation. The results are robust to the use of core inflation, which excludes the traditionally volatile prices of food and energy. This paper then presents a modified version of the Calvo‐type sticky price model to describe the observed empirical regularities. Simulation experiments show that the modified Calvo model fits the data well, and that the underlying relationship hinges upon the degree of price rigidity, which is systematically related to inflation regime. For countries and periods with low inflation rates, the relationship takes a U‐shape as price adjustment is more sticky. In a high‐inflation environment, when price setting becomes more flexible, the U‐shaped profile vanishes.     

Risk Shifting through Nonfinancial Contracts: Effects on Loan Spreads and Capital Structure of Project Finance Deals

We study capital structure negotiation and cost of debt financing between sponsors and lenders using a sample of more than 1,000 project finance loans worth around US$195 billion closed between 1998 and 2003. We find that lenders: (i) rely on the network of nonfinancial contracts as a mechanism to control agency costs and project risks, (ii) are reluctant to price credit more cheaply if sponsors are involved as project counterparties in the relevant contracts, and finally (iii) do not appreciate sponsor involvement as a contractual counterparty of the special purpose vehicle when determining the level of leverage.     

How firms respond to being rated

While many rating systems seek to help buyers overcome information asymmetries when making purchasing decisions, we investigate how these ratings also influence the companies being rated. We hypothesize that ratings are particularly likely to spur responses from firms that receive poor ratings, and especially those that face lower‐cost opportunities to improve or that anticipate greater benefits from doing do. We test our hypotheses in the context of corporate environmental ratings that guide investors to select ‘socially responsible,’ and avoid ‘socially irresponsible,’ companies. We examine how several hundred firms responded to corporate environmental ratings issued by a prominent independent social rating agency, and take advantage of an exogenous shock that occurred when the agency expanded the scope of its ratings. Our study is among the first to theorize about the impact of ratings on subsequent performance, and we introduce important contingencies that influence firm response. These theoretical advances inform stakeholder theory, institutional theory, and economic theory. Copyright © 2010 John Wiley & Sons, Ltd.     

Does subnational region matter? Foreign affiliate performance in the United states and China

This study examines the extent to which subnational regions can explain foreign affiliate performance in two host country settings, the United States and China, the world's two largest economies at polar ends of the economic spectrum (i.e., an advanced versus an emerging economy). Our results suggest that the subnational region is significant in explaining foreign affiliate performance, thus confirming its importance as an additional unit of analysis for firm performance. This study also shows that the effects of subnational region are far stronger in China than they are in the United States, thus suggesting that regional differences are more critical in their explanatory power for firm performance in emerging economies than they are in advanced economies. Copyright © 2010 John Wiley & Sons, Ltd.