School Of Business Administration: Financial Review

We analyze bank governance, share ownership, CEO compensation, and bank risk taking in the period leading to the current banking crisis. Using a sample of large U.S. bank holding companies (BHCs), we find that BHCs with greater managerial control, achieved through various corporate governance mechanisms, take less risk. BHCs that pay CEOs high base salaries also take less risk, while BHCs that grant CEOs more in stock options or that pay CEOs higher bonuses take more risk. The evidence is generally consistent with BHC managers exhibiting greater risk aversion than outside shareholders, but with several factors affecting managers’ risk-taking incentives.

Keywords:

corporate governance; CEO compensation; agency theory; banks; risk taking

G21; G32

Procyclicality, Bank Lending, and the Macroeconomic Implications of a Revised Basel Accord

Kevin T. Jacques

Abstract

Bank regulators are in the process of implementing revised regulatory capital standards. However, the macroeconomic effects of a revised Basel Accord are uncertain. Examining the various channels through which the revised Accord may influence economic output suggests that making the buffer stock of capital positively related to the business cycle is necessary to reduce procycliclity. This can be accomplished by bank regulators using either enhanced supervisory powers or increased financial disclosure.

Keywords:

revised Basel Accord; risk-based capital standards; procyclicality

G21; G28

The Effect of Labor Market Demand on U.S. CEO Pay Since 1980

Gregory L. Nagel

Abstract

This paper shows that the rise in U.S. chief executive officer (CEO) pay from 1980 to 2003 is only partially explained by competition for profit-producing talent in the labor market. This conclusion is obtained by removing unintended data biases from tests of the only theoretical model in the literature that relates labor market competition (measured by large firm size) to CEO pay level. When the biases are removed or minimized, no more than 33% of the 600+ percentage rise in large-firm CEO pay since 1980 is explained by a corresponding increase in large firm size.

Keywords:

executive compensation; CEO wages; labor market demand; extreme value theory; superstars

D2; D3; G34; J3

The Impact on Interest Rates of Unemployment Announcements and Their Revisions

James E. Gunderson and Frederic P. Sterbenz

Abstract

The announced changes in monthly employment reports and in weekly new unemployment claim reports are based on new levels and on revisions to previous levels. We analyze the effect on interest rates of surprises to these two separate components of the changes. We find that for weekly reports the effect on interest rates of the new level is greater than the effect of the revisions. For monthly employment reports, the two components’ effects have similar strength.

Keywords:

interest rates; announcement effects

G12

Exchange-Traded Fund Introductions and Closed-End Fund Discounts and Volume

Scott W. Barnhart and Stuart Rosenstein

Abstract

Exchange-traded funds (ETFs), like closed-end funds (CEFs), are managed portfolios traded like individual stocks. We hypothesize that the introduction of an ETF in an asset class similar to an existing CEF results in a substitution effect that reduces the value of the CEF's shares relative to that of its underlying assets. Our event studies show that upon the introduction of a similar ETF, CEF discounts widen significantly and relative volume declines significantly. Single-equation and systems estimation models show that the widening in discounts and reduction in volume are related to returns-based measures of the substitutability of ETFs for CEFs.

Keywords:

closed-end funds; exchange-traded funds; substitution effect; discounts; trading volume

G11; G12; G14

Oil and the Stock Market: An Industry Level Analysis

Sridhar Gogineni

Abstract

I investigate the impact of daily oil price changes on the stock returns of a wide array of industries. I find that in addition to the stock returns of industries that depend heavily on oil, stock returns of some industries that use little oil also are sensitive to oil prices perhaps because their main customers are impacted by oil price changes. In addition, I present robust estimates of industries’ cost-side and demand-side dependence on oil. These measures can serve as reliable benchmarks when classifying industries into oil-intensive and non–oil-intensive groups, a distinction widely used in studies and media without any quantitative justification so far. Further, I find that the sensitivity of industries’ returns to oil price changes depends on both the cost-side and demand-side dependence on oil and that the relative effects of these factors vary across industries.

Keywords:

oil prices; stock price reaction; commodities; clientele

G10; G14

Estimating Volatility Persistence in Oil Prices Under Structural Breaks

Bradley T. Ewingand Farooq Malik

Abstract

Policy makers and financial market participants are interested in knowing how shocks affect the volatility of oil prices over time. We accurately compute the volatility persistence by incorporating endogenously determined structural breaks into a GARCH model. Contrary to previous findings, we find that oil shocks dissipate very quickly but have a strong initial impact. Understanding this behavior is not only important for derivative valuation and hedging decisions but for broader financial markets and the overall economy, for which there are significant consequences.

Keywords:

oil; volatility; structural breaks; GARCH; ICSS algorithm

Empirical Evidence of the Existence of Investable Premiums in Emerging Market Investable Stocks

Eric C. Girard

Abstract

This paper shows that portfolios of more investable securities bear a premium when compared to portfolios of less investable stocks, reflecting compensation for local risk factors. The investable premium is overwhelmingly priced across 3,782 companies traded in 29 emerging markets from 1988 to 2006. The investable premium impacts stock returns at least as much as other fundamental premiums such as size, value, momentum, and loads on political, economic, and financial risk factors. The impact of the investable premium on emerging stocks returns has increased in strength, implying that foreign ownership has greater influence on local markets in recent years.

Keywords:

multifactor model; investable premium; emerging markets

F3; G1; N2

Idiosyncratic Risk in Emerging Markets

Timotheos Angelidis

Abstract

In this study, I examine the properties and portfolio management implications of value-weighted idiosyncratic volatility in 24 emerging markets. This paper provides evidence against the view that the rise of idiosyncratic risk is a global phenomenon. Furthermore, specific and market risks jointly predict market returns as there is a negative (positive) relation between idiosyncratic (market) risk and subsequent stock returns. Idiosyncratic volatility is the most important component of tracking error volatility, and it does not exhibit either an upward or a downward trend. Thus, investors do not have to increase, on average, the number of stocks they hold to keep the active risk constant.

Keywords:

emerging markets; idiosyncratic risk; tracking error volatility

C13; G10; G11

Volatility Risk Premium, Risk Aversion, and the Cross-Section of Stock Returns

Peter Nyberg and Anders Wilhelmsson

Abstract

We test if innovations in investor risk aversion are a priced factor in the stock market. Using 25 portfolios sorted on book-to-market and size as test assets, our new factor together with the market factor explains 64% of the variation in average returns compared to 60% for the Fama-French model. The new factor is generally significant with an estimated risk premium close to its time series mean also when industry portfolios and portfolios sorted on previous returns are augmented to the test assets.

Keywords:

asset pricing; volatility risk premium; risk aversion; habit formation; momentum

G12

Using Four-Moment Tail Risk to Examine Financial and Commodity Instrument Diversification

Leyuan Youand Robert T. Daigler

Abstract

We consider the effect of higher moments on diversification, since most assets possess a potential for tail losses. In particular, we examine higher-moment Value-at-Risk measures for individual instruments and diversified portfolios. We find that a naïve futures portfolio is consistently superior to common stock indexes. As few as ten randomly chosen instruments diversify away 85% of the unsystematic four-moment tail risk. We also compare the two- and four-moment tail risks for different size portfolios. Finally, the tail risk for naïve portfolios varies much less over time than other portfolios.

Keywords:

four-moment Value-at-Risk; diversification; skewness; kurtosis; commodity futures

G150

The University of Mississippi: School of Business Administration