The Financial ReviewAbstracts of Volume 37, 2002Tip: Hit Ctrl-f to search for the author, title or keyword you need Initial Margin Requirements, Volatility, and the Individual Investor: Insights from Japan Kenneth A. Kim, Henry R. Oppenheimer Volume 37, No. 1, February 2002, pp. 1-15 Initial margin requirements represent: (1) a cost impediment to the wealth constrained investor and (2) a potential way of mitigating excessive volatility. However, prior empirical research finds that margins are not an effective tool in reducing volatility. We consider the possibility that margins primarily affect certain stocks and investors. Specifically, we test whether margins affect individuals who, as a group, we believe to be the investors most affected when margin requirements change. Our initial empirical tests, however, do not support this contention. Keywords: margin requirements; volatility; individual investor; Japan Full article (requires subscription) Contagion Effects from the 1994 Mexican Peso Crisis: Evidence from Chilean Stocks Ike Mathur, Kimberly C. Gleason, Selahattin Dibooglu, Manohar Singh Volume 37, No. 1, February 2002, pp. 17-33 The contagion, or informational spillover, effects of the 1994 peso crisis from the Mexican market to the Chilean market, and to the Chilean American Depository Receipts (ADRs) trading in the U.S., are examined. Significant excess returns are observed for Chilean stocks for the event dates of the Mexican Peso crisis, providing evidence of contagion effects. Significant excess returns on the Chilean ADRs are also observed for each of the five event dates associated with the Peso crisis, suggesting that the contagion effects spilled over to the ADRs. A multiple regression model shows that the spillover contagion effects were very efficiently transmitted from the Mexican market to the Chilean market to the Chilean ADRs. Multifactor regressions show that the most significant influence on the pricing of Chilean ADRs is the raw Chilean Index, rather than the Chilean Index expressed in U.S. dollars. Keywords: contagion; Mexican Peso crisis; transmission of volatility Full article (requires subscription) Permanent and Transitory Driving Forces in the Asian-Pacific Stock Markets Ali F. Darrat, Maosen Zhong Volume 37, No. 1, February 2002, pp. 35-51 This paper uses weekly data from November 1987 through May 1999 to examine whether U.S. or the Japan stock market (or both) is the main driving force behind major movements in eleven emerging Asian-Pacific stock markets. We find a robust cointegrating relation linking each of the emerging market with the two matured markets of the U.S. and Japan. The results also show that the U.S., rather than Japan, is the main permanent force driving the equilibrium relations across all Asian-Pacific markets. In contrast, the effect of the Japanese market on the Asian-Pacific region is only transitory. Therefore, strategic asset portfolios in the Asian-Pacific region should include Japanese stocks to diversify any country specific risks. As to U.S. investors, the persistent influence of the U.S. market may limit long-run diversification gains from Asian-Pacific stocks. Keywords: Asian-Pacific stock markets; the U.S. and Japan; cointegration; driving forces; international asset diversification Winners and Losers as Financial Service Providers Converge: Evidence from the Financial Modernization Act of 1999 Robert J. Hendershott, Darrell E. Lee, James G. Tompkins Volume 37, No. 1, February 2002, pp. 53-72 The Financial Modernization Act of 1999 dramatically increased insurers’ and investment banks’ authority to provide an array of financial services and allowed commercial banks to offer investment banking and insurance services. In this paper we examine the market response to this legislation. We find a strong positive response among insurance companies and investment banks, and no significant response among commercial banks. Larger institutions in all three financial sectors earn higher abnormal returns. Additionally, better performing banks earn higher abnormal returns. Our results suggest that allowing financial convergence can add value through synergies and that large players are needed to exploit the scope economies. Keywords: financial services; Glass-Steagall; Gramm-Leach-Bliley, deregulation Interest Rate Surprises and Stock Prices Bento J. Lobo Volume 37, No. 1, February 2002, pp. 73-91 This paper examines the impact of unexpected changes in the federal funds target on stock prices from 1988 to 2001. Measures of interest rate surprises are constructed from survey data and changes in the 3-month T-bill yield. I find that surprises associated with decreases in the target cause stock prices to rise significantly. Surprises associated with increases in the target increase stock market volatility on the announcement day, with volatility reverting to pre-surprise levels on the day after the announcement. This volatility pattern is only evident since 1994. An implication is that concerns about immediate disclosure causing persistent and heightened stock market volatility might be misplaced. Keywords: Monetary policy, Fed funds rate target, interest rate surprises, survey data, stock market volatility, asymmetric reactions, EGARCH model Forecasting Stock Index Futures Price Volatility: Linear vs. Nonlinear Models Mohammad Najand Volume 37, No. 1, February 2002, pp. 93-104 The study examines the relative ability of various models to forecast daily stock index futures volatility. The forecasting models that are employed range from naïve models to the relatively complex ARCH-class models. It is found that among linear models of stock index futures volatility, the autoregressive model ranks first using the RMSE and MAPE criteria. We also examine three nonlinear models. These models are GARCH-M, EGARCH, and ESTAR. We find that nonlinear GARCH models dominate linear models utilizing the RMSE and the MAPE error statistics and EGARCH appears to be the best model for forecasting stock index futures price volatility. Keywords: stock index futures volatility; autoregressive; EGARCH; ESTAR Price Limits and Margin Requirements in Futures Markets Haiwei Chen Volume 37, No. 1, February 2002, pp. 105-121 This paper investigates the hypothesis that futures exchanges could use daily price limits as a substitute for higher margin requirements. The empirical results show that the size of margin is negatively correlated with the presence of price limits. Evidence points to the portfolio adjustment costs theory as an explanation of the benefits from price limits. The empirical results cast doubt on the notion that price limits should be abolished. The results also confirm that exchanges have set margin requirements according to economic theories. Keywords: margin; price limits; futures markets Payment For Risk: Constant Beta vs. Dual-Beta Models Glenn Pettengill, Sridhar Sundaram, Ike Mathur Volume 37, No. 2, May 2002, pp. 123-135 Fama and French's (1992) assertion that investors receive premium payments for risk associated with the book value to market price (BE/ME) and size and not for holding beta risk has sparked a lively debate concerning risk factors that are priced in the market. Howton and Peterson (HP, 1998) use a dual-beta model to test the Fama and French conclusions. They conclude that the significant relationship between beta and returns depends on the use of the dual-beta model. This work, however, ignores the results reported by Pettengill, Sundaram, and Mathur (PSM, 1995). PSM find a significant relation between a constant risk beta and returns when data are segmented between up and down markets but do not consider the impact of size and BE/ME. In this paper we show that the PSM (1995) market segmentation procedure alone provides a sufficient condition to identify a significant relation between beta and returns in the presence of size and BE/ME. Dual market betas may be relevant in explaining risk and return. However, the market segmentation procedure of PSM (1995) is the critical condition for finding a significant relationship between returns and betas. Keywords: constant beta; risk and return; systematic risk Mean and Variance Causality between the Official and Parallel Currency Markets: Evidence from Four Latin American Countries Angelos Kanas, Georgios P. Kouretas Volume 37, No. 2, May 2002, pp. 137-163 This paper examines the issue of mean and variance causality across four Latin American official and black markets for foreign currency using monthly data for the period 1976-1993. We apply a recent test developed by Cheung and Ng (1996) in order to test for mean and variance spillovers. The main findings are: (i) In contrast to the findings of previous studies, EGARCH-M processes characterize each bilateral exchange rate series in both markets; (ii) There is substantial evidence of causality in both mean and variance with the causality in mean largely being driven by the causality in variance; and (iii) The results indicate that the major exporter of causality is the Mexican black market with the black market of Argentina and the black and official markets of Brazil being the smallest contributors. Keywords: Causality; cross-correlation function; EGARCH-M; black market; exchange rates; volatility spillovers Wealth Effects of Private Equity Placements: Evidence from Singapore Sheng-Syan Chen, Kim Wai Ho, Cheng-few Lee, Gillian H.H. Yeo Volume 37, No. 2, May 2002, pp. 165-183 We examine institutional characteristics and the wealth effects of private equity placements in Singapore. Our findings show that private placements in Singapore generally result in a negative wealth effect and a reduction in ownership concentration. We find that at high levels of ownership concentration, the relation between abnormal returns and changes in ownership concentration is significantly negative. We also show that the market reacts less favorably to placements in which management ownership falls below 50%, but more favorably to issues to single investors. We do not find evidence suggesting that our results are due to an information effect. Keywords: equity offerings; private placements; ownership structure Conflict of Interest in Commercial Bank Equity Underwriting Gregory M. Hebb Volume 37, No. 2, May 2002, pp. 185-205 This paper examines the pricing characteristics of initial public offerings underwritten by commercial banks. Assuming IPO underpricing is directly related to ex ante uncertainty, if the market rationally perceives these commercial banks to have a conflict of interest, these securities should have more underpricing than non-commercial bank underwritten initial public offerings (all else equal). On the other hand, if the market believes that commercial bank involvement signals firm quality, less underpricing should be observed. This topic has recently gained in importance with the passage of the Financial Services Reform Act in November, 1999. We find that the underpricing of commercial bank underwritten initial public offerings in which the firm had a previous banking relationship with the underwriter is significantly less than those underwritten by investment banks. Keywords: commercial banks; conflict of interest; initial public offerings; underwriters A Simple Option-Pricing Formula Robert Savickas Volume 37, No. 2, May 2002, pp. 207-226 A simple option-pricing formula based on the Weibull distribution is introduced. The simplicity of the algebraic form and ease of implementation are comparable to those of Black-Scholes. Application to S&P500 options shows that the pricing biases present in the Black-Scholes model are eliminated. Prices produced by the presented model generally lie within or close to the bid-ask spread. For long term options (over one year), the Weibull formula exhibits significantly higher precision than the Black-Scholes formula does. While a rigorous comparison of all available models is necessary, the simplicity and precision of the proposed model are its main advantages over the existing models. Keywords: option-pricing; S&P 500; Weibull distribution; Black-Scholes; skewness Crises, Cronyism, and Credit Michael S. Pagano Volume 37, No. 2, May 2002, pp. 227-256 This paper examines the effects of several potential explanatory factors related to the 1997-1998 East Asian crisis. We find that a crisis can improve a poorly functioning credit system by making domestic lending rates more responsive to market-based returns. We report that the responsiveness of short-term lending rates is directly related to the level of transparency in the economy. Thus, countries with greater transparency (less corruption) are more likely to make credit decisions based on market-wide forces rather than succumb to the influence of special interest groups. Nations with greater transparency also experienced significantly shorter and less severe economic downturns. Keywords: international finance; credit allocation; commercial banks; corruption; financial markets; empirical analysis Cost and Profit Efficiency of the Turkish Banking Industry: An Empirical Investigation Ihsan Isik, M. Kabir Hassan Volume 37, No. 2, May 2002, pp. 257-279 By employing a stochastic frontier approach, we examine the effect of bank size, corporate control and governance as well as ownership on the cost (input) and alternative profit (input-output) efficiencies of Turkish banks. We found that the average profit efficiency is 84% for Turkish banks. The oligopolistic nature of the Turkish banking industry has contributed to less than optimal competition in the loan market and deposit markets. Our results indicate that the degree of linkage between cost and profit efficiency is significantly low. This suggests that high profit efficiency does not require greater cost efficiency in Turkey and cost inefficient banks can continue to survive in this imperfect market where profit opportunities are abundant for all types and sizes of banks. Accordingly, our results indicate that the different sizes of banks have capitalized these opportunities equivalently. Keywords: efficiency; Turkish banks; governance and control; stochastic frontier approach Does Price Discreteness Affect the Increase in Return Volatility Following Stock Splits? Dan W. French, Taylor W. Foster, III Volume 37, No. 2, May 2002, pp. 281-293 Stock return volatility tends to increase significantly following stock splits. One potential cause of this is the trading of stocks in discrete price intervals called ticks. This study provides a direct test of price discreteness as a determinant of this phenomenon by examining variance increases before and after the 1997 date when the exchanges reduced the tick size from 1/8 to 1/16. Results generally show that the post-split variance increase was unaffected by the reduction in tick size even after controlling for other factors. AMEX stocks provided the exception with slightly lower variance increases following the tick size reduction. Keywords: stock splits; price discreteness; tick size; return variance; price clustering Information, Trading Demand, and Futures Price Volatility Changyun Wang Volume 37, No. 2, May 2002, pp. 295-315 We examined the relation between futures price volatility and trading demand by type of trader in the Standard & Poor’s (S&P) 500-stock index futures market. We found that volatility covaries negatively with signed speculative demand shocks but is positively related to signed hedging demand shocks. No significant relation between volatility and demand shocks for small traders was found. Our results suggest that changes in positions of large hedgers destabilize the market, whereas changes in positions of large speculators stabilize volatility. Consistent with models with asymmetrically informed traders, we found that large speculators are likely to possess superior forecasting ability, large hedgers behave like positive feedback traders, and small traders are liquidity traders. Keywords: index futures; trading demand; information; volatility Debt vs. Equity and Asymmetric Information: A Review Linda Schmid Klein, Thomas J. O'Brien, and Stephen R. Peters Volume 37, No. 3, August 2002, pp. 317-349 Recent Nobel Prizes to Akerlof, Spence, and Stiglitz motivate this review of basic concepts and empirical evidence on information asymmetry and the choice of debt vs. equity. We first review the literature that holds investment fixed. Then we review capital structure issues related to the adverse investment selection problem of Myers-Majluf. Finally, we discuss the timing hypothesis of capital structure. Empirical studies do not consistently support one theory of capital structure under asymmetry over the others. Thus, the review suggests that additional theoretical contributions are needed to help understand and explain findings in the empirical literature. Keywords: capital structure, asymmetric information, pecking order hypothesis, timing hypothesis Sources of Bank Interest Rate Risk Donald R. Fraser, Jeff Madura, and Robert A. Weigand Volume 37, No. 3, August 2002, pp. 351-367 We investigate bank stocks’ sensitivity to changes in interest rates and the factors affecting this sensitivity. We focus on whether the exposure of commercial banks to interest rate risk is conditioned on certain balance sheet and income statement ratios. We find a significantly negative relation between bank stock returns and changes in interest rates over the period 1991–1996. We also find that bank characteristics measured from basic financial statement information explain bank stocks’ sensitivity to interest rate changes. These results suggest that bank managers, analysts, and regulators can use this information to assess the relative risk exposure of banks. Keywords: banks, interest rate risk, financial statements Determinants of Institutional Responses to Self-Tender Offers Judith Swisher Volume 37, No. 3, August 2002, pp. 369-383 I examine how institutional investors respond to self-tender offers for common shares. I find that institutions sell more shares in larger offers and with higher proration factors. Institutions also sell more shares when officer and director holdings are not at risk in the offers. Banks, investment advisors, and other managers respond similarly, selling more shares in larger offers. Although institutions as a group do not respond differently by offer type, insurance companies and investment advisors sell more shares in fixed-price offers. Mutual funds, which differ from other types of institutions, sell more shares for firms with greater increases in leverage. Keywords: institutional investors, signaling, self-tender offers Is Off-Board Trading Detrimental to Market Liquidity Joanne Hamet Volume 37, No. 3, August 2002, pp. 385-402 Dual trading can have opposite effects: although competition between markets should induce dealers to offer cheaper transactions, market fragmentation could reduce market activity, liquidity, and exchange efficiency. This paper shows that for French stocks traded on the London Stock Exchange’s SEAQ International (SEAQ-I), market activity decreases significantly in the Paris Bourse during UK bank holidays. Thus, SEAQ-I market makers seem to divert a new clientele to the Paris Bourse, which increases both market activity and the breadth of the Bourse’s order book. Also, contrary to the fragmentation hypothesis, dual trading does not seem to increase information asymmetry. Keywords: dual listing, liquidity, information asymmetry, competition, fragmentation The Effect of Market Structure on the Incentives to Quote Aggressively: An Empirical Study of Nasdaq Market Makers Mark Klock, D. Timothy McCormick Volume 37, No. 3, August 2002, pp. 403-419 We use data on Nasdaq stocks to study arguments that preferencing reduces incentives to quote competitively. We examine a market maker’s volume as a function of various measures of quoting aggressiveness. We find that more aggressive quoting does indeed result in more business. We also examine the relation between volume and quote aggressiveness as a function of the competitiveness. We find that in less (more) competitive markets, increased quote aggressiveness has a smaller (larger) impact on market share. We argue that preferencing arrangements could be more harmful to public investors in markets where competition is weak. Keywords: quote aggressiveness, order flow, market structure, preferencing, market regulation Contrarian Investing in a Small Capitalization Market: Evidence from New Zealand Jim Y.F. Chin, Andrew K. Prevost, and Aron A. Gottesman Volume 37, No. 3, August 2002, pp. 421-446 This paper investigates the performance of accounting-based contrarian investment strategies in the New Zealand market. The return patterns of these strategies are then related to risk-based and behavioral-based explanations of the contrarian anomaly. Based on our analysis of the risk-return characteristics of the various strategies, we attribute the first year underperformance and second year outperformance of the value portfolios to expectational errors caused by noise trading in the relatively illiquid NZ market. The longer two-year correction process is in contrast to the much larger and more developed US and Japanese markets, where value stock price corrections have been found to occur more rapidly. This provides support for the conjecture that longer horizons are required for value strategies to pay off in imperfectly competitive markets than in competitive markets. Keywords: portfolio analysis, contrarian investment strategies An Examination of Conditional Asset Pricing in UK Stock Returns Jonathan Fletcher Volume 37, No. 3, August 2002, pp. 447-468 I examine the empirical performance of various specifications of the capital asset pricing model (CAPM) in UK stock returns, using the stochastic discount framework. When the proxy for the market portfolio includes a proxy for labor income growth in addition to the stock market index, the performance of the CAPM improves. The improvement in performance shows in the magnitude and significance of the pricing errors and in the reduced impact of asset characteristics and other factors in the pricing of assets. There is further improvement when I use conditional versions of the models. Keywords: CAPM, stochastic discount factor Testing the Random Walk Behavior and Efficiency of the Gulf Stock Markets Abraham Abraham, Fazal J. Seyyed, and Sulaiman A. Alsakran Volume 37, No. 3, August 2002, pp. 469-480 Inferences drawn from tests of market efficiency are rendered imprecise in the presence of infrequent trading. As the observed index in thinly traded markets may not represent the true underlying index value, there is a systematic bias toward rejecting the efficient market hypothesis. For the three emerging Gulf markets examined in this paper, correction for infrequent trading significantly alter the results of market efficiency and random walk tests. The Beveridge-Nelson (1981) decomposition of index returns is done to estimate the underlying index. Keywords: infrequent trading, random walk, market efficiency, emerging markets, Gulf equity markets Spreads, Depths, and Quote Clustering on the NYSE and Nasdaq: Evidence After the 1997 Securities and Exchange Commission Rule Changes Kee H. Chung, Bonnie F. Van Ness, Robert A. Van Ness Volume 37, No. 4, November 2002, pp. 481-505 This paper examines liquidity and quote clustering on the NYSE and Nasdaq using data after the two market reforms—the 1997 order-handling rule and minimum tick size changes. We find that Nasdaq-listed stocks exhibit wider spreads and smaller depths than NYSE-listed stocks and stocks with higher proportions of even-eighth and even-sixteenth quotes have wider quoted, effective, and realized spreads on both the NYSE and Nasdaq. This result differs from the findings by Bessembinder (1999, p. 404) that “trade execution costs on Nasdaq in late 1997 are no longer significantly explained by a tendency for liquidity providers to avoid odd-eighth quotations,” and “odd-sixteenth avoidance has little relevance for explaining post-reform Nasdaq trading costs." Keywords: liquidity, spreads, depths, quote clustering, collusion An Intraday Examination of the Components of the Bid-Ask Spread Thomas H. McInish, Bonnie F. Van Ness Volume 37, No. 4, November 2002, pp. 507-524 Using transactions data for a sample of NYSE stocks, we decompose the bid-ask spread (BAS) into order-processing (OP) and asymmetric information (AI) components using the techniques of George, Kaul, and Nimalendran (1991) and Madhavan, Richardson, and Roomans (1997). McInish and Wood (1992) demonstrate that the intraday behavior of BASs can be explained by variables measuring activity, competition, risk, and information. We investigate whether these variables explain the behavior of the OP and AI components of the spread over the trading day. We conclude that, on balance, the variables that determine the aggregate BAS also determine its intraday components. Keywords: microstructure, bid-ask spread, spread components The Performance of Internet Firms Following Their Initial Public Offering Jarrod Johnston, Jeff Madura Volume 37, No. 4, November 2002, pp. 525-550 We find that initial returns were more favorable for Internet initial public offerings (IPOs) than non-Internet firm IPOs. Since the demise of the Internet sector, the underpricing of Internet-firm IPOs is not significantly different from other IPOs. Initial returns of Internet firms are positively and significantly related to underwriter prestige and to pre-IPO market conditions. However, initial returns after the demise of the Internet sector are not significantly related to these characteristics. The aftermarket performance of Internet firms is initially favorable but weakens over time. Firms that experienced higher initial returns during the strong Internet cycle experience weaker aftermarket performance. Keywords: IPO, initial public offering, underpricing, internet firms, cycles Information Transfers Across Same-Sector Funds When Closed-End Funds Issue Equity Eric J. Higgins, Shawn Howton, Shelly Howton Volume 37, No. 4, November 2002, pp. 551-561 This study examines the reaction of non-issuing, same-sector funds when a closed-end fund announces a seasoned equity offering. The non-issuing, same-sector funds have a significant, negative announcement-day abnormal return. The abnormal returns for U.S. debt funds are less negative than U.S. equity and international debt funds. The abnormal returns for international debt funds are more negative than international equity funds. Announcement-day abnormal returns are directly related to the announcement-day abnormal return of the issuing fund and the premium/discount of the issuing fund. Announcement-day abnormal returns are inversely related to the premium/discount of the non-issuing, same-sector funds. Keywords: seasoned offerings, closed-end funds intraindustry Information Flows Across Markets: Evidence From China-Backed Stocks Dual-Listed in Hong Kong and New York Xiaoqing Eleanor Xu and Hung-Gay Fung Volume 37, No. 4, November 2002, pp. 563-588 Using a bivariate generalized autoregressive conditional heteroskedasticity (GARCH) model, we examine patterns of information flows for China-backed stocks that are cross-listed on exchanges in Hong Kong and New York. Results analyzing the dual-listed stocks indicate significant mutual feedback of information between domestic (Hong Kong) and offshore (New York) markets in terms of pricing and volatility. Stocks listed on the domestic market appear to play a more significant role of information transmission in the pricing process, whereas stocks listed on the offshore market play a bigger role in volatility spillover. Keywords: information transmission, bivariate GARCH, China-backed ADRs Market Structure and Return Volatility: Evidence from the Hong Kong Stock Market Wilson H.S. Tong, K.S. Maurice Tse Volume 37, No. 4, November 2002, pp. 589-612 There is no consensus about the cause for higher volatility at the market open than at the market close in the U.S. market. As an order-driven, non-specialist market, the Hong Kong stock market provides a useful setting for the examination. If halt of trade were the major cause of higher open-to-open volatility, the open-to-open volatility in the Hong Kong market would be higher. However, this is not observed. The autocorrelation of the open-to-open return series also indicates that the temporary price deviation at the market opening is not significant. We view these findings as consistent with the specialist argument. Keywords: interdaily return volatility, volume, Hong Kong stock market, market microstructure, cross trading The Effect of the Common Bond and Membership Expansion on Credit Union Risk W. Scott Frame, Gordon V. Karels, Christine McClatchey Volume 37, No. 4, November 2002, pp. 613-636 This paper empirically examines differences in credit union risk profiles based on membership type and membership expansion via select employee groups (SEGs). We find that (1) occupational credit unions have a greater exposure to concentration risk, which they hedge by holding greater proportions of capital, (2) the presence of SEGs is negatively related to credit union capital ratios and positively related to loan-to-share ratios, and (3) the number of SEGs and the proportion of loan delinquencies are positively related. We conclude that credit union membership expansion results in reduced concentration risk and expanded investment opportunities, but also dilutes the informational advantages associated with tight common bonds. Keywords: credit unions, common bond, concentration risk Eastern Finance Association members and institutional subscribers have free access to the full text of articles published in The Financial Review (now starting from the first quarterly issue in 1969) at our Blackwell site. Join now at http://www.blackwellpublishing.com/memb.asp?ref=0732-8516). 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