Wednesday, November 30, 2005
A Thanksgiving video is up. VERY good!!!
So many familiar faces!
But since I have you attention, why not consider coming down with us when we go back? Check out our plans here. It will be a GREAT trip!
"For the roughly one-third which said they could quantify the cost of the fraud, the total losses exceeded $2 billion, or an average of $1.7 million per company.
"Economic crime remains difficult to detect, despite everybody's best efforts to invest in internal controls," said Steven Skalak, Global Investigations Leader at PWC.
The survey showed that the most common methods of finding out about financial fraud were still accidental, like calls to hotlines or tips from whistle-blower employees."
Why am I not surprised? Because if people want to hide their dishonesty, it is often easy to do. In class I occassionally use the Adelphia case where I hand out the footnotes that let to the Rigas' downfall.
Knowing that there was a problem, most people (myself included)could not tell for sure which footnote was the "smoking gun."
Tuesday, November 29, 2005
Short version: Bhattacharya and Galpin examine the relative use of indexing vs. stock picking in various equity markets around the world. They find that indexing is increasing pretty much everywhere but especially in more developed markets. They also estimate that the "long run steady state" fraction of stock picking in US markets is 11% (it is now 24% down from 60% in the 1960s."
Bhattacharya and Galpin use an innovative method to measure the degree to which stock picking is used in an equity market. Based on this model, they then compare the relative percentage of stock picking (vs. Indexing) both using a cross sectional analysis as well as time series analysis.
The key idea behind the paper model is that if everyone indexes, then volume should be proportional to size of firm. In their words:
"The idea behind this measure is inspired by a theoretical insight in Lo and Wang (2000). They proved that, if the two-fund separation theorem holds, dollar turnover of a stock, which is defined as the dollar volume of shares traded divided by the dollar market capitalization of the stock, should be identical for all stocks.Given this, the authors the essentially regress actual volume on capitalization (more technically they run the
An empirical implication of the above theoretical insight is that if every person in the world indexes between a risk-free portfolio and the market portfolio (or a value-weighted portfolio that is a proxy for the market portfolio), trading volume in stock i should be explained completely by the market capitalization of stock i."
"regression of log monthly stock volume (measured by number of shares traded in that month for stock i in a country) against the log of monthly shares outstanding (measured by number of shares outstanding in the beginning of the month for stock i). We run this regression for 43 countries, of which 21 are classified as developed markets and 22 are classified as emerging markets."Most of the analysis begins in 1995, but for US stocks they go back into the early 1960s to yield valuable insights as to how markets have changed.
* "The first big result.... is that there is more stock picking in emerging markets than in developed markets." This is shown in figure 1 and table 1.
* "The second big result that Figure 1(a) illustrates is that, on an average, stock picking is declining around the world. The declines in stock picking are quite dramatic, especially in the emerging markets."
In their examination of US stocks, they find that there has been a dramatic decrease in stock picking:
"In the United States, the maximum fraction of volume explained by stock picking has secularly declined from a high of 60% in the 1960s to a low of 24% in the 2000s"Additionally, stock picking is relatively more popular where theory would predict--
namely where information asymmetries are highest. Thus stock picking is more common in young firms, in industries where there is lower asymmetries, and (only somewhat surprisingly) where there are fewer analysts.
VERY cool!! I^3. Indeed their finding that stock picking is negatively related to analyst coverage is worth the price of admission!
Bhattacharya , Utpal and Galpin, Neal E., "Is Stock Picking Declining Around the World?" (November 2005). http://ssrn.com/abstract=849627
By the way, Neal is a SBU grad, so I could be a tad biased ;) I tried not to be, but you can be the judge.
Class Classification: Investments
Please, Sir, I Want Some More - How Goldman Sachs is Carving Up its $11 Billion Money Pie: "The standard portion of net revenue (total revenue minus interest expense) earmarked for compensation at Wall Street firms stands at an astonishing 50 percent. That?s because talent is the most precious commodity on Wall Street; it?s what they sell, so it?s also what they have to pay for."
"With all senior managers of Goldman taking home a $600,000 salary, an equal split of 30 percent of $1.65 billion would be worth almost $2 million, pushing their pay into the neighborhood of $2.6 million."
I always hate these articles as they always remind me how little I make. Oh well. LOL
Monday, November 28, 2005
I mentioned that many people had requested an emailed newsletter since they could not access blogspot from work. Jeff from MBA Depot suggested Feedblitz. It is great. It allows you sign up and receive emails of the most recent blog entries.
In their words:
"It's easy too! No gurus required. The basic service is free to all - no restrictions, no ads. Plus, you can subscribe to any blog or RSS feed by email with FeedBlitz, even if that blog does not use FeedBlitz itself."
You should notice a sign-up box on the right of the blog (at least in Firefox, it sometimes is near the bottom in Internet Explorer). All you have to do is to enter your email address and click on the link they provide for you in email! So easy!
here, I will replicate the box here as well:
Sunday, November 27, 2005
Short version of the book: many traders are just lucky and they take way too many chances because they think they are good.
moneyscience.org : SmartMoney Interview: Nassim Taleb: "Good call TaylorTree for spotting this interview in SmartMoney and alerting me to a recent addition to Taleb's website, Quick Notes and Comments in the Old Style (not quite a blog). You might also be interested in this article from Fortune Magazine teaming Taleb with Mandelbrot. Quite a combination: How the Finance Gurus Get Risk All Wrong. "
Thursday, November 24, 2005
I checked it out and wow! It is so cool. It is an online word processor that multiple people can use at the same time. It will be perfect for co-authoring papers etc. Indeed, you can pretty much make it a "wiki" world.
I have several uses (in and outside of finance) already ready to go.
Check it out. I bet you will be as excited as I am about it!!!
Tuesday, November 22, 2005
just some quick updates on various topics:
1. Due to several requests (especially on the NYC trip) I will somehow be bringing back the newsletter yet again. It is such a pain to do, but there does seem to be a demand for it, so I will figure out a way. Look for it soon.
2. I am sure you will hear about it again from me, but if you can, get down and help out in the Gulf Coast region. It really was devastated and they can use our help. If you want, come with us. Bonaventure Responds is the name of our group that is going down over spring's midterm break (March 4-12, 2006). Even if you can only be there for a portion of the time, you will not regret it!
3. The Southern Finance Association meetings were ok. The resort was not ready for us and many people did stay away in the wake of Wilma, but there were several good papers presented.
more after class...
Wednesday, November 16, 2005
Monday, November 14, 2005
Latest News and Financial Information | Reuters.com:
"From Jan. 31, 2007 it will be able to support one-, two- and three-character stock symbols for Nasdaq-listed and NYSE-listed stocks, in addition to the four-character symbols it currently uses.
The single-character stock symbol carries a degree of prestige. It is held by NYSE-listed companies such as Ford Motor Co. (F.N: Quote, Profile, Research) and Citigroup Inc. (C.N: Quote, Profile, Research) .
Nasdaq, which competes agressively against the NYSE for listings, said the symbol that a market assigns to an issuer 'should be transferable to a competing market if that issuer chooses to switch...'"
Want to hear a class? Here is my finance 401 class lecture on capital structure. Some studnets actually asked me to put them online :)
This is a senior level course.
Take a listen ;)
Thursday, November 10, 2005
Tuesday, November 08, 2005
In much of the
In the first of two blog entries dealing with politics, we will begin off with a seemingly simple question:
In the first of two blog entries dealing with politics, we will begin off with a seemingly simple question:Why vote?
It is a question that has pained economists for years. Why? The odds are very very high that you will not be the marginal voter (i.e. the election results would thus be the same whether or not you voted) and yet the cost of voting falls on the shoulders of the voter (no benefit, high cost).
So why vote? Writing in the NY Times, Stephen Dubner and Steven Levitt (who show good spelling diversification of their first names) examine the question and come to the conclusion that people vote so that they can be seen voting. I would take it a step further and suggest that this is only a portion of it. They also vote so they can feel good about what they did (or else why would so many absentee ballots be cast?), so while they may not feel AS good if no one sees them, they still feel better (to think of it in the form of a regression, it has a positive coefficient).
A couple of “look-ins” from their article:
“Why would an economist be embarrassed to be seen at the voting booth? Because voting exacts a cost - in time, effort, lost productivity - with no discernible payoff except perhaps some vague sense of having done your "civic duty." As the economist Patricia Funk wrote in a recent paper, "A rational individual should abstain from voting."”
They then examine a study of voting habits in
“Every eligible Swiss citizen began to automatically receive a ballot in the mail, which could then be completed and returned by mail…..Never again would any Swiss voter have to tromp to the polls during a rainstorm; the cost of casting a ballot had been lowered significantly. An economic model would therefore predict voter turnout to increase substantially….In fact, voter turnout often decreased….”
“It may be that the most valuable payoff of voting is simply being seen at the polling place by your friends or co-workers.”
Which is interesting in and of itself, but I think may have finance implications as well. Voting is a good example of how what we (if I can allow myself to be called an financial economist for a moment) often deem irrational behavior. But when viewed from a total utility point of view (“I feel better when I vote, so I vote”), It may be perfectly rational to vote.
This is not unlike my views of some behavioral finance hypotheses. From a strict risk and return perspective, investor behavior does often appear irrational, but investors, like voters, may gain some psychic satisfaction from their behavior. Thus from a perspective of utility maximization, the investor may still be acting perfectly rationally. Unfortuntely, this is MUCH more difficult to measure than risk and return.
Monday, November 07, 2005
How 1 1 1 1 Can Equal Less Than 4 - New York Times:
"over the long haul, conglomerates, on average, perform worse in the stock market than the typical focused company. One likely cause is that they tend to do a poor job of allocating capital among their various divisions. Of course, if those units were separate publicly traded companies, the market itself would be making the allocation decisions. And it stands to reason that the overall market is a better administrator in this regard than the average corporate manager."
A study conducted by David S. Scharfstein, a finance professor at the Harvard Business School, offers evidence of inefficient capital allocation among widely diversified companies. Professor Scharfstein found that managers of conglomerates generally felt compelled to invest something in all of their divisions, regardless of the divisions' growth potential - a phenomenon that he calls intrafirm "socialism." Because of it, conglomerates tend to invest too much in divisions with low growth potential and too little in those with high potential."
"Professor Scharfstein's research was conducted for the National Bureau of Economic Research; a copy of his study is at [ssrn]."
Yet another example of a perfectly timed article. Just today in class we were speaking of the problems with internal capital markets!
Salimi, Wang, Yakovlev, and Roychoudhury provide further evidence that the January and December effects. The authors describe these effects as:
"When investors do not sell winner stocks in December but postpone their sale to January so that capital gains will not be realized in the current fiscal year, the "winners" appreciate in December. This is called the December effect.While this has been exained before, this paper brings some more sophisticated mathmatical tools into play. And their findings?
The January effect is the tendency of the stock market to rise between December 31 and the end of the first week in January. The January Effect occurs because many investors choose to sell some of their stock right before the end of the year in order to claim a capital loss for tax purposes."
"The general conclusions that can be drawn from our estimates are that there exist significant December and January effects, and the momentum (represented by cumulative returns), liquidity, and tax incentives are among significant factors affecting monthly returns in the US stock market."Which supports the previous understanding perfectly.
Salimi, Wang, Yakovlev, and Roychoudhury. December and January Effects around the Globe: Evidence from US and International Panel Data. 2005, Working paper:
WSJ.com - Getting Going: "Yet the widespread acceptance of indexing has come only in the past few years. Indeed, as recently as five years ago, I would be inundated with scornful phone calls, letters and emails whenever I recommended index funds. Today, I don't get that reaction"
Why? In his words:
"I think the acceptance of indexing has been driven by two key developments: The proliferation of exchange-traded index funds, often known as ETFs, and the emergence of fee-only financial advisers."
Brilliant! Read the article! In fact, if you are in my class, definitely read the article! But be forewarmed, the article will not stay online for long.
Friday, November 04, 2005
I will start this one with my standard discalaimer whenever I review a paper that is based on a survey data: be forewarned, survey data is often notoroiously inaccurate and biased. Thus, view the folloiwng with a good deal of skepticism.
The warning given, the paper itself is intersting. Peng, Dukes, and Bremer survey 1,312 CFOs who were in the Financial Executives International (FEI) database as of May 24th, 2005. Of course, the vast majority did not reply, but they did get 83 responses (6%).
So remembering the above disclaimer, How did the CFOs respond? Prett much as expected, they hate it! (which is exactly what I hear every time I speak with any of the CFOs I know.)
From the paper:
"...the approximate annual average cost of compliance to a company in our sample is estimated to be $1.77 million....More than 50% of the CFOs in our sample report that the cost estimate of compliance with the Act is between $500,000 and $3 million."About 60% say that the costs of complainace outweigh the benefits.
Other interesting findings:
* "unlike Linck, Netter, and Yang (2005), we find that there is not any significant change in the following aspects of corporate governance practices due to the enactment of the Act since July 2002:"There were some before/after differences however.
The paper reports that more firms are using independent audit committees and have more financial experts on the committee since teh adoption of the law. Moreover, more firms have adopted a code of ethics (80 of 83 repsonders said they do now, where only 57 did prior to SOX).
* The act has created jobs for accounting professionals: "The average number of staff that companies in our sample have to hire to deal with Section 404 compliance is 3.61 with the median value of five. The extreme cases are that two firms have to hire an additional 25 employees for Section 404 compliance."
What may be the most interesting however are the comments the authors received from CFOs. I will quote one to whet your appetite:
"“This Act was horribly overreaching. It is costly, and there is very little/absolutely no cost benefit relationship. The Act and, specifically, the Section 404 requirements, will do little, if anything, to deter the "crimes"/"irregularities" it was intended to deter/preclude. Management override is the biggest issue, and the Section 404 requirements hardly address that issue. It is a complete waste of time and money. PCAOB is ineffective, at best. Their "investigations" of the Big 4 firms is a joke, and the Big 4 firms don't know what to do or how to do it in complying with the Section 404 audits. They (the Big 4 firms) gouged "corporate America" in the purported "audits" of the control environments, using no/very little professional judgment in the conduct of their examinations. And I spent over 30 years with a Big 4 firm, including over 20 as a Partner.”"uh, could you tell us what you really think?
Interesting article. It is still being revised and the authors have asked for comments, so if you have a few minutes, whay not send them your thoughts. And tell them you first saw the article here ;)
Looking for an unsung hero of the US Civil War? You could do much worse than picking Jay Cooke.
Jay Cooke was what we would now call an investment banker.. He had made quite the name for himself selling all types of securities but especially state bonds---his
Cooke did things differently than most bankers at the time. Whether by necessity or plan, he marketed his securities directly to the people. Additionally he played on not only their desire for a good deal, but their patriotism.
For instance, a typical advertisement that he ran in newspapers:
“…independent of any motives of patriotism, there is considerations of self-interest which may be considers in reference to this Loan. It is a six percent loan free of any taxation”
While his pre-war career had been successful, he should be most remembered for his work during the Civil War. Starting in 1862 (after the
The details of his sales are fascinating. His place in history is guaranteed for his paving the way for future generations of “war bonds” and helping to open the world of finance to a much broader audience—a fact that during the later 1800s the railroads would use to their advantage). To help make these bonds available to the general public, he made bonds available in with par values as low as $50 and instructed his network of offices to remain open well into the evening so that the “working man” could invest after work.
It should be noted that these were not just “plain vanilla” bonds. He was selling debt that was callable and had a longer maturity (up to 20 years) than most debt of the day.
But that is not all; he also ran what some consider to be the first “wire house” whereby his firm used telegraphs to sell securities throughout the North from their office in
And even after the actual fighting ended (a time when the Union needed millions of dollars to help rebuild) he kept at his original ways (which angered the more traditional bankers) and now gets credit for initiating price stabilization (a practice whereby the investment banking syndicate enters the secondary market and helps to stabilize the price of the security they just helped to sell to the public).
There is today a middle school named after Cooke in Philadelphia.
Source: Wall Street: a History From Its Beginnings to the Fall of Enron, by Charles R. Geisst, pp. 49-58.
Thursday, November 03, 2005
FRB: Speech, Ferguson--Monetary Credibility, Inflation, and Economic Growth--November 3, 2005:
"By now it must be universally agreed that low and stable inflation is a primary and essential goal for monetary policy, in large part because we believe it brings stability to financial systems and fosters sustainable economic growth over the longer run. In pursuit of this goal, central banks can report some success. According to the latest World Economic Outlook from the International Monetary Fund (IMF), consumer price inflation in the advanced economies over the decade beginning in 1997 and ending next year looks set to come in at an average annual rate of less than 2 percent, down from 3-1/2 percent for the previous ten years. The IMF figures for the United States show a smaller but still substantial decline in headline inflation, from about 3-3/4 percent to 2-1/2 percent. The drop in inflation for the non-industrial economies has been more striking, with average inflation falling from double to single digits over the same time periods"
Showing that leverage leads to underinvestment is standard fare for any corporate finance class. Indeed, I had planned on doing it today. However, as Lyandres and Zhdanov point out, it might be better to say that leverage influences investment, but that the direction of the bias is firm-dependent (which once pointed out is very obvious, but I for one have not considered it!).
Super short version: The option to delay investment is only valuable for firms that will be around. Excessive leverage increases the likelihood of bankruptcy (where shareholders are likely to lose their claim) so levered firms will be biased to invest in projects earlier than a similar all-equity firm.
Longer version: Myers (1977) made an important contribution by showing that leverage can lead to underinvestment because shareholders will opt to not invest in projects if the firm is near bankruptcy and the results of the investment would accrue to debt holders. This idea was widely picked up on in the field and is now widely used to explain why growth firms have less debt than firms with "assets-in-place."
Lyandres and Zhdanov show that this underinvestment is only part of the story. Leverage can also lead to an "overinvestment" problem whereby firms speed-up their investment to realize teh gains prior to a potential bankruptcy.
In the authors' words:
"a firm may optimally delay an investment in a positive NPV project, if by waiting and making the investment at a future date, it is able to increase the value of the investment opportunity. In other words, the value of the option to wait must be taken into account when accessing the profitability of a project. However, when a firm is financially levered, its shareholders face the threat of bankruptcy. Upon bankruptcy, the control of the firm passes over to the debtholders. Hence, if bankruptcy happens, the shareholders lose the option to realize their investment opportunities. This is true regardless of whether bankruptcy is exogenous or endogenous. Thus, the presence of debt makes the option to wait less valuable, and forces the equityholders to speed up the investment, leading to a positive relation between the firm’s financial leverage and its investment intensity. Therefore, this overinvestment effect works in exactly the opposite direction from Myers’ (1977) underinvestment effect."Which once pointed out is obvious. However, we owe the authors a debt for pointing this out to us! So from all of us, THANK-YOU!
Cite: Zhdanov, Alexi and Evgeny Lyandres, Underinvestment or Overinvestment? The effect of Debt Maturity on Investment, Southern Finance Meeting paper (Upload date: Nov 02, 2005).
Topic: Corporate, Leverage, Real Options
Oh boy, here we go! Hold on tight and let's tag along for the ride. This could change some things!
Virtually everything we do with respect to risk and return centers on the assumption of normality (that is that the normal distribution correclt explains returns, or minimally the log of returns).
The problem is nearly perfectly laid out in the opening paragraph of the paper:
"There is ample empirical evidence that the distribution of short-term security returns, e.g., daily, weekly or monthly, is non-normal (Mandelbrot, 1963; Fama, 1965; Campbell, Lo and MacKinlay, 1997). Such data are inadequately described by linear models commonly used in financial economics that assume a normal data-generating process (DGP). For example, return outliers occur with much greater frequency than would be expected assuming normality, resulting in fat-tailed distributions described as leptokurtotic in the fourth moment. Additionally, returns may exhibit asymmetry, having the tendency for either positive or negative returns to persist for any number of reasons (Campbell, Lo and MacKinlay, 1997). This phenomenon of return “clustering” results in skewness in the third moment and has been studied by Conine and Tamarkin (1981) and Harvey and Siddique (2000)."While I will leave the more rigorous math to the paper itself, but the basic idea is that author uses a Markov Chain Monte Carlo simulation to account for the higher moments needed to describe a non normal distribution. Using a simulation also allows for tests of whether these high moments matter.
The answer, in a word, is 'yes'.
In the paper's words:
"Bayesian sampling-based Markov chain Monte Carlo (MCMC) methods are used in this paper to estimate an extension of the normal model by using a modification of the normal likelihood function presented by Fernandez and Steele (1998), henceforth known as FS, that incorporates all four moments of the underlying return DGP."Building on a great deal of past work in the field that examines higher moments, the author looks specifically at CAPM and equity risk premums.
The findings? I will allow Sfridis conclude:
"In this paper Bayesian-based Markov chain Monte Carlo (MCMC) analysis is used to estimate a non-normal likelihood function that effectively specifies the return DGP by the explicit incorporation of higher moments. The significant effect of higher moments on testing of the [Sharp-Lintner] CAPM has been illustrated. Results show that model testing requires incorporation of more complete return information as summarized by the higher statistical moments, leading to possibly contrary conclusions from those obtained under an assumption of normality. A second exercise considers specification of the non-normally distributed market risk premium. Incorporation of additional information contained in the higher moments can yield nearly equivalent point estimation to that from re-specification of the first two moments that implicitly account for excess skewness and kurtosis. However, a major advantage of accurately re-specifying the model is the greater precision of resulting parameter estimates."Which definitely deserves a wow! While the temptation might be to overlook such a finding because of its complexity, it could be why so many of our theortcial models do not stand up to empirical tests. Which is obviously VERY important!
James Sfiridis, "Incorporating Higher Moments into Financial Data Analysis"
(Upload date: Aug 16, 2005)
Tuesday, November 01, 2005
by Francis, Hasan, John, and Waisman.
First the answer: Yes.
Bonds rarely spark the interest of stocks, but this one is sort of cool.
Francis, Hasan, John, and Waisman examine the interest rates spreads of corporate issues based on where companies are incorporated. They find that firms that are incorporated in Delaware pay a penalty (in the form of higher rates) for being under Delaware's corporate rules.
In their words:
"We find that Delaware incorporated firms are associated with higher yield spreads in comparison to non-Delaware firms. Specifically, on average, the difference between bond yields due to Delaware incorporation can be as high as 25 basis points when we compare Delaware to Ohio, Pennsylvania or Massachusetts incorporated companies, which are well known for antitakeover laws that protect managers"This is consistent with the idea that takeovers can reduce bondholders' wealth and reiterates the view that how contracts are structured (and where!) does influence firm value.
The authors also examine equity returns around debt issues across different states of incorporation. They find that the state of incorporation also may be a factor in determining equity returns around debt issues. This response is attributed to lower costs of debt capital stemming from the reduced agancy cost of debt in these states. Again in their own words:
"stockholder wealth enhancement hypothesis contends that state antitakeover laws would benefit stockholders and increase the value of the firm by lowering the firm’s agency costs of debt. In general, the conflicting interests of bondholders and stockholders may cause two types of agency problems. First, a risk incentive (asset substitution) problem.....If bondholders anticipate this action on the part of stockholders, they demand a higher interest rate to account for the greater risk they encounter, and are willing to pay less for the bonds at the time of issuance, which leads to a reduced value of the firm (Kahan and Klausner, 1993). Second, an underinvestment problem occurs if the value of the firm’s investment opportunities is revealed to be less than the face value of the maturing debt plus the costs of undertaking the investment project (Myers, 1977).Which is pretty standard for any corporate finance class, but the finding is then surprising.
"we find that, on average, firms incorporated in states with stronger takeover laws, such as Ohio, Pennsylvania and Massachusetts, experience positive abnormal stock returns around the announcement of bond issuance, whereas firms incorporated in states which offer relatively milder takeover restrictions, such as Delaware, experience significantly negative abnormal returns around the bond issuance event, consistent with the stockholder wealth enhancement hypothesis."Their overall conclusion however:
"...although as far as shareholders are concerned, it is yet unclear whether Delaware wins a race to the top by addressing their rights or a race to the bottom by addressing the needs of management, as far as bondholders are concerned, Delaware ultimately wins a race to the bottom. These findings strongly suggest that it is important to look at the total effect of governance terms, including state laws, before drawing conclusions on regulatory and security design policies, and that it is important to evaluate these laws considering all majorcorporate stakeholders.Interesting!
Bill Francis, Iftekhar Hasan, Kose John, and Maya Waisman.
"Does Delaware Incorporation Affect Bondholder Wealth?"
(Upload date: Aug 17, 2005).