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(2009)Journal ArticleWe investigate the Bank of Japan's (BOJ) Yen interventions for the period 13 May 1991 to 16 March 2004. The previous literature has been hampered by the coarse daily data and has been unable to identify intervention determinants beyond some embodiment of the first moment of Yen returns. We consider both lagged overnight off-shore (London and New York) and intradaily on-shore (Tokyo) market developments for their heterogeneous influences on the BOJ's intervention decisions. Using a friction model to estimate the reaction function, we find that the interventions were leaning against the wind during the Tokyo hours, in general. Prior to June 1995, there were significant responses to previous day's intradaily Yen returns and volatility. Post 1995, we report a broadening in the BOJ's monitoring to include overnight off-shore Yen returns until Dec 2002 and a broader measure of market disorderliness measured as a transactions cost band in one-month covered interest rate parity condition since Jan 2003. Moreover, there is some evidence that the BOJ secretly leaned into the wind in response to Yen depreciations during the recent period of 2003-2004.
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(2009)ThesisThe focus of this dissertation is the European Credit Default Swaps (CDSs) market. CDSs are the most popular credit derivative products. Three issues are discussed, the first, which is covered in chapter 2, is the investigation of non-diversifiable jump risk in iTraxx sector indices based on a multivariate model that explicitly admits discrete common jumps for an index and its components. Our empirical research shows that both the iTraxx Non-Financials and their components experience jumps during the sample period, which means that the jump risks in the iTraxx sector index are not diversifiable. The second issue, which is covered in chapter 3 is the component structure of credit default swap spreads and their determinants. We firstly extract a transitory component and a persistent component from two different maturities of the Markit iTraxx index and then regress these components against proxies for several commonly used explanatory variables. Our results show that these explanatory variables have significant but differing impacts on the extracted components, which indicates that a two-factor formulation may be needed to model CDS options. The last issue, which is covered in chapters 4, 5 and 6 is the investigation of the linkage between the credit default swap market and the equity market within the European area. We innovatively calibrate the CDS option with the Heston Model to get the implied volatility in the CDS market, which allows us to investigate both the characteristic of implied volatility in the CDS market and the relationship of the two markets not only on the level of daily changes but also with regard to its second moment. Our analysis shows that the stock market weakly leads the CDS market on daily changes but for implied volatility, the stock market leads the CDS market. A VECM analysis shows that only the stock market contributes to price discovery. For sub-investment grade entities, the interactivities between the implied volatility of the CDS market and the implied volatility of the stock market are stronger, especially during the recent credit crunch period. All these results have important implications for the construction of portfolios with credit-sensitive instruments.
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(2009)ThesisThis thesis is the first study that provides comprehensive empirical evidence on both the impacts of the target interest rate news from the Reserve Bank of Australia (RBA) on the Australian financial markets, and the spillover effects of the target interest rate news from the US Federal Reserves (Fed) and the European Central Bank (ECB) on the Asia Pacific's equity and currency markets. This thesis contributes to the current literature in several ways. First, while there is ample evidence in the literature suggesting that the markets would not react to what is already expected but will react to the news, the current literature on the RBA's target rate effects is still limited to the investigation of the overall announcement impact on the first moment of the Australian market return only. Therefore, this thesis firstly comprehensively investigates the impacts of the unexpected components of the RBA's target rate announcements (or news) on the first two moments of various segments of the Australian financial markets including interest rate changes, the Australian dollar and stock market returns. In so doing, this thesis contributes to the current literature on the impacts of domestic target interest rate news. Second, while the established literature seems to be missing a thorough investigation of the spillover effects of the Fed's and the ECB's news on the Asia Pacific markets, this thesis provides comprehensive evidence on the spillover effects of the Fed's and the ECB's target rate news on both the mean and volatility of the Asia Pacific's stock and currency returns. Furthermore, we not only document the presence of the news spillover effects but also highlight the incremental explanatory power of the target interest rate news in the presence of the indirect effects from the US's and euro area's markets to the Asia-Pacific markets. To this end, this thesis contributes to the literature on spillover effects of foreign target interest rate news. Third, while the literature is silent on how quickly the target interest rate news is absorbed in foreign markets, this thesis takes a step forward and breaks down the daily horizon into the overnight and the intraday horizons. In so doing, the thesis examines the absorption speed of target rate news in the Asia-Pacific markets. This is an important issue because there might be potential for a diverse array of response dynamics across countries due to heterogeneous market developments, nature of monetary policy synchronization, and financial and real integration with the U.S. and the euro area. Specifically, this thesis presents three independent empirical inquiries that contribute to the literature on domestic and spillover effects of the target interest rate news. Chapter 4 provides comprehensive empirical evidence for the impacts of the RBA's target rate news on various segments of the Australian financial markets during the period from 1998 to 2006. We also investigate the spillover effects of the US Fed's news on the Australian financial markets. We show that the RBA's and the Fed's news significantly affect the Australian financial markets in line with a priori expectations. However, while the RBA's news raises volatility in the Australian financial markets, the volatility was significantly lower in all market segments following the Fed's news. The spillover effects of the US Fed's and the ECB's target interest rate news on the mean and the volatility of twelve Asia Pacific's stock markets' returns are examined in Chapter 5, and seven Asia Pacific exchange rates against the US dollar and the euro over the period 1999-2006 are carried out in Chapter 6. The spillover effects on the conditional mean are generally consistent with the literature where a majority of Asia Pacific stock markets shows significant negative returns and a majority of currencies depreciates against the US dollar and the euro in response to the Fed's and the ECB's unexpected rate rises. Furthermore, in response to the two target rate news, the conditional volatility of the Asia Pacific stock markets was higher while the market calming effects have been observed for the currency markets and both the Fed and the ECB news elicit persisting volatility responses. We conjecture that as the ECB's news tends to confirm the Fed's earlier decision, this relationship might help reduce uncertainties in the Asia Pacific currency markets upon the future path of target interest rates from both the Central Banks, which ultimately results in into a lower volatility level. These findings are important not only to the Asia Pacific’s policy makers to help them improve the conduct of monetary policy but also to market participants in designing trading mechanisms as well as risk management strategies in response to both domestic and external interest rate shocks. Furthermore, these findings also shed light on the lead-lag relationship between the Fed and the ECB in making policy decisions. The notion that the ECB follows the Fed in setting its policy is so strong amongst market participants that empirical evidence seems to be crucial. Despite the fact that the ECB's news arrives after the Fed's news, this study provides evidence that the ECB's news has its own merits in the Asia Pacific markets and helps resolve differences in beliefs among market participants.
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(2009)ThesisSocially Responsible Investing (SRI) has experienced substantial growth over the last decade, although there is still a lack of consensus on whether this form of investing leads to competitive investment returns. This paper considers the case for SRI by examining the relationship between a range of Environmental Social Governance (ESG) rating factors and financial performance of US listed companies. Previous research in this area has largely been at the portfolio level and focussed on return as a performance measure. This study makes an important contribution to the literature by utilising stock level data to consider the relationship between ESG ratings and not only stock return but also wider measures of financial performance, namely valuation and operating performance. Using a multifactor framework, this study provides evidence of a significant positive relationship between a range of ESG rating criteria and market to book value and return on assets measures, whilst a positive although inconsistent relationship between ratings and stock return is apparent. I argue that the relationship with valuation and operating performance is more clearly identified due to these measures being based on annual data, hence being consistent with rating data and also more stable than stock return (which is impacted by shorter term factors). In comparison to Brammer et al. (2006), the analysis shows that higher stakeholder ratings on the whole are more positively related to stock return. The results are broadly consistent with findings of Galema et al. (2008), although additionally highlight the significance of higher ratings for both valuation and operating performance and that employee conditions are more relevant than other stakeholder rating criteria.
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(2009)ThesisThis thesis investigates key issues concerning how active equity fund managers add value: measuring alpha (Chapter 3), generating alpha (Chapters 4, 5 and 6) and transaction cost minimisation (Chapter 7). Chapter 3 proposes important methodological adjustments to the widely adopted benchmarking methodology of Daniel, Grinblatt, Titman and Wermers (1997). Applying this modified benchmark to a sample of active funds and simulated passive portfolios that mimic fund manager style characteristics, statistically lower tracking error is documented, compared with using the standard methodology. These findings suggest that improved specifications of characteristic benchmarks represent better methods in accurately quantifying fund manager skill. Chapter 4 examines a portfolio strategy which selects stocks using the undisclosed monthly holdings of Australian active funds. When considering a large range of strategies incorporating portfolio holdings information, the top performing strategies are robust to data-snooping and are economically and statistically significant when incorporating transaction costs. Accounting for look-ahead bias in the formation of a strategy, statistically significant alpha of at least 6.88 percent per year is found when following the best performing strategy holding 20 stocks or more in the previous month. Chapter 5 examines the relation of active equity fund managers location proximity to a stock's corporate headquarter using portfolio holdings data. Contrary to much international research, this study reveals evidence inconsistent with a location advantage for Melbourne and Sydney-based funds. Chapter 6 examines retail investor trading on the Australian Stock Exchange. The performance of retail investors is highly heterogeneous: discount (non-discount) retail brokerage investors lose -0.59 (-0.05) percent intraday and experience negative (positive) returns over the subsequent year. These findings are inconsistent with retail investors exerting price pressure or providing liquidity to institutions. Chapter 7 examines whether equity fund managers use multiple brokers in a trade package in order to lower their price impact and brokerage costs. Using the daily trades of funds, multiple broker trades are not found to have lower costs compared to a single broker, even when controlling for the informativeness of the trade package and potential endogeneity. These findings suggest that fund managers do not lower their costs when using multiple brokers.
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(2009)ThesisThis dissertation consists of three stand-alone essays on fundamental uncertainty, stock return volatility and earnings management. The first study investigates the role of information about firms’ fundamentals contained in analysts’ forecasts (which I label “non-accounting information”) in understanding stock return volatility. When combined with Ohlson’s (1995) linear information dynamics, the accounting version of the Campbell-Shiller model (Campbell and Shiller 1988a, 1988b; Vuolteenaho 2002) implies that if current non-accounting information is more uncertain, then future stock returns are expected to be more volatile. The empirical evidence supports the theoretical predictions, and the results are valid for measures of both systematic and idiosyncratic volatility. Additional analysis yields some evidence that both favourable and unfavourable news from non-accounting information increases future stock return volatility. Overall, the results highlight the value relevance of information in analysts’ forecasts beyond what is contained in the current financial statements. The second essay extends the theoretical framework of Callen and Segal (2004) and Vuolteenaho (2002) to investigate the association between the uncertainty of accrual information and stock return volatility. The empirical evidence supports the theoretical prediction that the extent of uncertainty in accounting accruals is increasing with the volatility of future stock returns, and the results are valid for measures of both systematic and idiosyncratic volatility. However, when accrual variability is decomposed into fundamental and unexpected portions, I find that the positive relationship between accrual variability and future stock return volatility is dominated by the fundamental component of accrual variability. The findings therefore suggest that the market places little weight on information conveyed by that component of accounting accruals that is most likely to reflect accounting choices, implementation decisions and managerial opportunism. The final essay argues that the presumed articulation among accruals, cash flows and revenues does not capture decisions on expected accruals when large external financing activities are present. The analysis provides evidence that managers’ “normal” operating decisions associated with net external financing activities are likely to lead to measurement errors in unexpected accruals that are part of expected accruals, and erroneous conclusions that significant earnings management exists when in fact there is none. This is especially pertinent in cases where the partitioning variable used to identify instances of earnings management is supposed to be uncorrelated with external financing, when in fact it is correlated. The results underscore the importance of additional specification tests being conducted to control for estimation biases in unexpected accruals associated with external financing. I suggest the use of matched-firm approach using industry and external financing matches in order that reliable and warranted inferences are made.
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(2009)ThesisThe expected yield to maturity on a defaultable obligation equals the nominal yield less expected default losses. However, in a mark-to-market world, one doesn't have the luxury of reporting one's performance on the basis of yield to maturity. Total return is calculated for an arbitrary holding period, and must reflect any mark-to-market gains or losses as at the close of the period-gains or losses that can be triggered by the bond's upgrade or downgrade. Thus to estimate expected total return, one must estimate not only expected default losses, but also the impact on capital price of expected ratings transitions. This paper begins with the observation that a bond which is blessed by more favourable transition characteristics is likely to produce a higher total return, and poses the question of how that benefit can be quantified. How much is it worth? To answer the question, I start by specifying a formal bond-pricing model reflective of ratings transitions. I survey various statistical methods and past research efforts to identify the ratings-transition matrix which best parametrises the model, and propose a novel test for selecting between competing matrices. Using this approach, I replicate several important studies of ratings transitions. I also use it to examine new published and unpublished data, testing for (and finding) ratings path-dependency, and otherwise exploring the effect of ratings changes on different bond sectors. I then turn to the question of whether it is possible to estimate bond-specific transition probabilities, and propose a way to do so. I combine these efforts into the specifications for a pricing model capable of answering the question: How much is it worth?
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(2009)ThesisIn this thesis we search for optimal hedging strategy in stock index futures markets by providing a comprehensive comparison of variety types of models in the related literature. We concentrate on the strategy that minimizes portfolio risk, i.e., minimum variance hedge ratio (MVHR) estimated from a range of time series models with different assumptions of market volatility. There are linear regression models assuming time-invariant volatility; GARCH-type models capturing time-varying volatility, Markov regime switching (MRS) regression models assuming state-varying volatility, and MRS-GARCH models capturing both time-varying and state-varying volatility. We use both Maximum Likelihood Estimation (MLE) and Bayesian Gibbs-Sampling approach to estimate the models with four commonly used index futures contracts: S&P 500, FTSE 100, Nikkei 225 and Hang Seng index futures. We apply risk reduction and utility maximization criterions to evaluate hedging performance of MVHRs estimated from these models. The in-sample results show that the optimal hedging strategy for the S&P 500 and the Hang Seng index futures contracts is the MVHR estimated using the MRS-OLS model, while the optimal hedging strategy for the Nikkei 225 and the FTSE 100 futures contracts is the MVHR estimated using the Asymmetric-Diagonal-BEKK-GARCH and the Asymmetric-DCC-GARCH model, respectively. As in the out-of sample investigation, the time-varying models such as the BEKK-GARCH models especially the Scalar-BEKK model outperform those state-varying MRS models in majority of futures contracts in both one-step- and multiple-step-ahead forecast cases. Overall the evidence suggests that there is no single model that can consistently produce the best strategy across different index futures contracts. Moreover, using more sophisticated models such as MRS-GARCH models provide some benefits compared with their corresponding single-state GARCH models in the in-sample case but not in the out-of-sample case. While comparing with other types of models MRS-GARCH models do not necessarily improve hedging efficiency. Furthermore, there is evidence that using Bayesian Gibbs-sampling approach to estimate the MRS models provides investors more efficient hedging strategy compared with the MLE method.
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(2009)ThesisThis dissertation consists of three stand-alone but interrelated empirical studies investigating various aspects of the well-documented “home bias anomaly” in international investment. The findings help to understand the international investment allocation behaviour of mutual funds as well as their implications for asset pricing and mutual fund evaluation. The first study investigates the roles of various firm attributes that encapsulate the deadweight costs in determining firm level investment bias. The main findings suggest that firm characteristics related to transaction costs, corporate governance and information asymmetry create significant barriers for fund managers. In addition, foreign funds are more constrained than domestic funds by information asymmetry, even in developed and liberalized markets. Moreover, this study stylises the international investment allocation model in Cooper and Kaplanis (1986) with a quadratic cost function, which reveals the marginal influence of market level deadweight costs on the relationship between firm characteristics and investment bias. It is found that when market level cross-border barriers are exacerbated, as in the case of emerging and restricted financial markets, foreign fund managers become more sensitive to market level deadweight costs and ignore firm characteristics. In general, these findings imply that the market level “home bias anomaly” is an outcome of the complementary effects of investment barriers at both firm and market levels. The second study examines the role of firm level investment bias in predicting future stock returns. It is found that both firm level foreign and domestic biases contain valuable information with respect to firm prospects. However, domestic bias is more informative than foreign bias in terms of subsequent stock returns, partially because of information asymmetry. The third study explores the determinants of fund level investment bias and its ability to predict fund performance. It is found that fund portfolio attributes determine fund level investment biases after controlling for market and fund investment objective specific effects, and fund level investment bias is positively related to fund performance due to lower deadweight costs. Moreover, good macroeconomic environments foster the development of the mutual fund industry.
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(2009)ThesisAll venture capital investments exhibit some form of asymmetric information. The seminal paper on the structure of venture investments, Kaplan and Stromberg (2004), investigates how venture capitalists use deal construction to control agency conflicts within funded deals and their associated internal, external and execution risks. Another key strand of the academic literature has reviewed the contractual arrangements venture capital firms reach, the process of venture capital selection and determinants of their success from a post-investment perspective (Fried and Hisrich (1994), Manigart, Vermeir and Sapienza (1996), Gompers and Lerner (2004), Wright and Robbie (1998)). This thesis also explores venture capital investment, albeit from a pre-investment standpoint. In contrast to Kaplan and Stromberg’s (2004) demonstration of the use of venture capital mechanisms to control agency issues, this research addresses how agency issues influence the final selection of potential investments by venture capitalists. Kaplan and Stromberg (2004) use post-funding metrics to capture risks, which influence post-contract design. From a pre-funding perspective, internal, external and execution risks are subjective, rare and difficult to measure. Nevertheless, this thesis uses pre-funding proxies to replicate these risks, some of which have direct empirical academic support. Information for sixty-two deals, thirty-four funded and twenty-eight unfunded, was hand collected through a combination of surveys, interviews and consultation with five of Australia’s leading venture capital firms, and individuals from the Australian Private Equity and Venture Capital Association (AVCAL) board and executive. The key results indicate that once past initial screening stages, investment proposals that have a higher likelihood of receiving venture investment are those that had prior government investment, and/or, where the entrepreneur has proposed the investment be through milestone tranches and where revenue is already being generated (for early stage ventures). The results suggest that venture capitalists tend to allocate capital to investments perceived as ‘safer’ with respect to agency conflicts. More specifically, venture capitalists are more reliant on signals of quality and lower risk, such as government grants, restriction of capital outlay and prior revenue generation – all of which reduce associated levels of internal and execution risk in new ventures.