Essays in Financial Economics: Volume 35

This chapter develops a no-arbitrage, futures equilibrium cost-of-carry model to demonstrate that the existence of cointegration between spot and futures prices in the New York Mercantile Exchange (NYMEX) crude oil market depends crucially on the time-series properties of the underlying model. In marked contrast to previous studies, the futures equilibrium model utilizes information contained in both the quality delivery option and convenience yield as a timing delivery option in the NYMEX contract. Econometric tests of the speculative efficiency hypothesis (also termed the “unbiasedness hypothesis”) are developed and common tests of this hypothesis examined. The empirical results overwhelming support the hypotheses that the NYMEX future price is an unbiased predictor of future spot prices and that no-arbitrage opportunities are available. The results also demonstrate why common tests of the speculative efficiency hypothesis and simple arbitrage models often reject one or both of these hypotheses.

Purpose: In reality, financial decisions are made under conditions of asymmetric information that results in either favorable or adverse selection. As far as financial decisions affect growth of the firm, the latter must also be affected by either favorable or adverse selection. Therefore, the core objective of this chapter is to examine the determinants of each financial decision and the effects on growth of the firm under conditions of information asymmetry.

Design/Methodology/Approach: This chapter uses data for the non-financial firms listed in S&P 500. The data cover quarterly periods from 1989 to 2014. The statistical tests include linearity, fixed, and random effects and normality. The generalized method of moments estimation method is employed in order to examine the relative significance and contribution of each financial decision on growth of the firm, respectively. Standard and proposed proxies of information asymmetry are discussed.

Findings: The results conclude that there is a variation in the impact of financial variables on growth of the firm at high and low levels of information asymmetry especially regarding investment and financing decisions. A similar picture emerges in the cases of firm size and industry effects. In addition, corporate dividen d policy has a similar effect on firm growth across all asymmetric levels. These findings prove that information asymmetry plays a vital role in the relationship between corporate financial decisions and growth of the firm. Finally, the results contribute to the vast literature on the estimation of information asymmetry by demonstrating that the classical and standard proxies for information asymmetry are not consistent in terms of the ability to differentiate between favorable or adverse selection (which corresponds to low and high level of information asymmetry).

Originality/Value: This chapter contributes to the related literature in two ways. First, this chapter offers updated empirical evidence on the way that financing, investment, and dividends decisions are made under conditions of favorable and adverse selection. Other related studies deal with each decision separately. Second, the study offers new proxies for measuring information asymmetry in order to reach robust estimates of the effects of financial decisions on growth of the firm under conditions of agency problems.

Today, firm performance must be measured not only on traditional metrics but also on those that reflect the changing imperatives and new metric knowledge. Thus, the focus of managers, investors, and researchers is shifting from rubrics like sales and profitability to growth as a more appropriate measure of firm performance. We aim to highlight the effects that growth of a firm can have on the level of its systematic risk. Using a sample of 203 firms across nine industries taken from the Indian manufacturing sector for a period of 17 years (1998–2014), we develop and test a panel vector autoregressive (VAR) model to analyze the causal relationship between growth aspects and systematic risk of firms. Results depict that a growth option available to firms increase their level of systematic risk and the risk decreases when firms start chasing this growth by increasing their assets in place. Sustainable growth rate, which depicts the growth potential of firms, plays an important role in reducing the level of systematic risk. The findings of this chapter are relevant to managers who think that growth is always beneficial.

This study examines the five-factor model of Fama and French (2015) on the French stock market by comparing it to the Fama and French (1993)’s base model. The new Fama and French five-factor model directed at capturing two new factors, profitability and investment in addition to the market, size and book to market premiums. The pricing models are tested using a time-series regression and the Fama and Macbeth (1973) methodology. The regularities in the factor’s behavior related to market conditions and to the sovereign debt crisis in Europe are also examined. The findings of Fama and French (2015) for the US market are confirmed on the Paris Bourse. The results show that both models help to explain some of the stock returns. However, the five-factor model is better since it has a marginal improvement over the widely used three-factor model of Fama and French (1993). In addition, the investment risk premium seems to be better priced in the French stock market than the profitability factor. The results are robust to the Fama and Macbeth (1973) methodology. Moreover, profitability and investment premiums are not affected by market conditions and the European sovereign debt crisis.

This study is intended to investigate the volatility patterns in Bombay Stock Exchange Limited Sensitivity Index (BSE Sensex) based on time series data collected for 10 years period of time. To reach out the predefined objectives of the study, the authors have employed generalized autoregressive conditional heteroscedastic models. The study revealed that the presence of heteroscedasticiy is found in BSE Sensex. Further, the model produced highly accurate results when the researchers compared the estimated results from actual. Furthermore, the volatility of BSE Sensex has shown the features of clustering and significant time varying. Moreover, the model has indicated that there is a positive correlation between daily stock returns and the BSE Sensex volatility.

The collapse of Italian economy has coincided with the global financial crisis to which derivatives are suspected to be responsible of its propagation. For this reason, this study aims to examine whether the use of derivatives affects the profitability of Italian banks during both the global financial crisis period and the recession period of Italian economy. To reach this goal an appropriate econometric procedure namely the dynamic Generalized Method of Moments system is applied using data from 22 Italian banks over the long period 2005–2017. A series of bank-specific indicators are used to explain the effect of overall derivatives and each derivative instrument separately on Italian banks’ profitability. The results of regressions panels indicate that in general derivatives as well as measured in the whole or splitting up in instruments specifically in forwards, options, and, in particular, swaps affect positively the profitability of Italian banks. The main conclusion is that – despite the episode of economic recession in Italy – Italian banks boost their profitability by using derivatives.

As practical contribution, policy-makers in Italy should throw out the assumption of the implication of derivatives in the fragility of the banking system. On the contrary, they should pave the way easily for Italian banks’ managers to deal with derivatives and look out for the real problems of the recent collapse of the Italian economy.

Since the famous tapering talk of Bernanke, US Dollar (USD) made a significant appreciation on emerging market local currencies. When the stock indices are adjusted to USD, a negative relationship is usually the case. USD index is a natural candidate for measurement of these effects. It is seen that some emerging stock indices exhibit negative causality with USD index in Granger sense. Moreover, the authors take into account rolling correlations of USD index and the relevant stock indices and examine them on the investment horizon beginning from tapering talk. The authors deduce that Granger causality test and correlation results are coherent with each other which sheds light to the famous discussion whether causality implies correlation or vice versa.