Friday, March 31, 2006

Shocks Seen in New Math for Pensions - New York Times

Shocks Seen in New Math for Pensions - New York Times:
"The board that writes accounting rules for American business is proposing a new method of reporting pension obligations that is likely to show that many companies have a lot more debt than was obvious before.

In some cases, particularly at old industrial companies like automakers, the newly disclosed obligations are likely to be so large that they will wipe out the net worth of the company"
"Congress is trying to tighten the rules that govern how much money companies are to set aside in advance to pay for benefits. The accounting board is working with a different set of rules that govern what companies tell investors about their retirement plans"
A long overdue change!

U.S. exchanges still eye foreign expansion: analysts - MarketWatch

That US exchanges are looking to expand globally has been a story since I was in college, but given NASDAQ's 72% premium (and even then the deal fell apart), maybe they are getting serious now?

From MarketWatch: U.S. exchanges still eye foreign expansion: analysts - MarketWatch:
"U.S. exchanges are still interested in global expansion, including a potential acquisition of the London Stock Exchange, despite the Nasdaq Stock Market's decision to drop its bid, market analysts say."

"The all-electronic LSE might be a better fit technologically for Nasdaq, but the bigger NYSE, which is gearing up to launch an electronic trading platform, could break the bank in pursuit of Europe's biggest exchange."

Thursday, March 30, 2006

Does Investment Skill Decline Due to Cognitive Aging or Improve with Experience? by George Korniotis, Alok Kumar

Gee, another "why hadn't I thought of that?" one. (uh no comment!)

SSRN-Does Investment Skill Decline Due to Cognitive Aging or Improve with Experience? by George Korniotis, Alok Kumar:
"The economic costs of aging are considerable - older investors earn roughly 2% lower annual returns on a risk-adjusted basis. Collectively, our results are consistent with the hypothesis that older investors' portfolio choices reflect greater knowledge about investing but their investment skill deteriorates with age...."
While I am a tad unwilling to chalk up the lower returns totally to "declining congnitive abilities" (it could be that they are "out of the loop" and hence more uninformed), it is an interesting look at how aging affects investing.

Actually I am surprised this one hasn't had more play in the popular press! I just googled it and it did appear on MoneyScience, but no where else appeared. Weird.

Korniotis, George M. and Kumar, Alok, "Does Investment Skill Decline Due to Cognitive Aging or Improve with Experience?" (January 2006). Available at SSRN:

Wednesday, March 29, 2006

Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders by Sang-Gyung Jun, Mookwon Jung, Ralph Walkling

Ready for another cool paper on share repurchases? Here you go!

SSRN-Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders by Sang-Gyung Jun, Mookwon Jung, Ralph Walkling

Short version: This paper attempts to disentangle the signaling story ("we are buying back stock because we are undervalued") and the wealth transfer ("we are buying back stock because we can screw over bondholders") stories.

The findings are
"generally consistent with the positive signaling effect of stock repurchases, but also provide some support for wealth transfer. In the subset...where signaling effects are less likely, the positive correlation of wealth changes between stockholders and bondholders is completely eliminated. Finally, bond ratings are much more likely to be upgraded in samples without executive options which is precisely where the signaling effects are expected to be concentrated."
Besides updating previous literature (and looking at data in the post 1997 Lehman Brother Bond Database world), the authors find that the reason for the buyback is important. Not surprisingly (and confirming Kahle's 2002 findings), if the repurchase is being done to fund option plans, then there is less of a stock price reaction.

Again in the authors' own words:
"In general, our results on equity alone or bonds alone indicate positive wealth changes to equity holders and negative wealth changes to bondholders surrounding repurchase announcements. For bondholders, however, the wealth losses are only significant in the subset of firms associated with options. These are precisely the cases where any off-setting effects of positive signaling are less likely to occur....."

"...results show that bond ratings for [repurchasing] firms with options are less likely to be upgraded after stock repurchases." [Thus, the] ...results are generally consistent with positive signaling but also provide some support for wealth transfer."

VERY COOL! An I^3 paper! (Interesting, Important, and Informative!)

Jun, Sang-Gyung, Jung, Mookwon and Walkling, Ralph A., "Share Repurchase, Executive Options and Wealth Changes to Stockholders and Bondholders" (March 14, 2006). Available at SSRN:

The Influence of Audit Committee Financial Expertise on Earnings Quality: US Evidence by Bo Qin

SSRN-The Influence of Audit Committee Financial Expertise on Earnings Quality: US Evidence by Bo Qin

More evidence that board make-up matters. In this peice, Qin finds that, having an
"..accounting-literate professional as SEC initially proposed serving on the audit committee are more likely to have high quality of reported earnings than others without such an expert.
Interestingly the final definition of financial expert that was adopted by the SEC yielded a MUCH weaker finding so it appears that not only board make-up matters, but also definitions!

Qin, Bo, "The Influence of Audit Committee Financial Expertise on Earnings Quality: US Evidence" (March 2006). Available at SSRN:

Financial Rounds: Insider Trading By Lawmakers (via WSJ)

The Unknown Professor reports on the WSJ piece that has legislators actually including themselves in a new law that would strengthen insider trading laws!

Financial Rounds: Insider Trading By Lawmakers (via WSJ):
"Lawmakers are once again considering strengthening insider trading laws. However, in a twist, this time the laws wouldn't apply to corporate executives or securities brokers, but to the legislators themselves! According to Tuesday's Wall Street Journal:"
If you remember, this topic spurred some controversy in the past so I may just not mention any of the literature that finds Senators (and maybe other legislatures) beating the market. ;)

FRB: Speech, Bies--Sound Capital and Risk Management--March 29, 2006

If you are in a Money and Banking class, this one should not be missed! Today's speech by Fed Governor Susan Schmidt Bies.

FRB: Speech, Bies--Sound Capital and Risk Management--March 29, 2006

A few look-ins:
"...with the advent of very large banking organizations that engage in a wide variety of business activities--some of them quite complex--the Federal Reserve has become even more interested in ensuring that banking organizations understand the risks of these activities."
"To conduct a credible internal analysis of relevant risks, institutions should identify which risks can generally be quantified and which ones cannot. When risk measurements are based on scarce or incomplete data, or on unproven quantitative tools, institutions might need to use sensitivity analyses, stress tests, or scenario analyses to a greater extent in order to develop meaningful risk measures."
Why Basel II matters:
"One of the most important sound practices for a banking organization is the tying of risk exposures to capital. Banks that use similar risk models can have very different risk exposures. That is why the Basel II approach to capital is so important. Basel II provides a framework in which the risk level banks choose to accept is reflected in their capital."
It is not just interest rate exposure!
"Focusing now on operational risk, one of the most substantial changes in the U.S. banking industry in recent years is the movement of the largest organizations toward fee-based revenue streams. These new activities include securitizing loan portfolios, with the bank retaining responsibility for loan servicing; buying and selling financial instruments for customers; and other business lines that generate revenue by charging customers transaction and account processing fees. These activities generate little balance-sheet exposure, but they present the potential for large losses if the complex systems and financial deals associated with them are not managed in a sound manner"
And finally, what is the current status:
"Now I would like to give a brief update on where we stand with implementing Basel II in the United States, as well as with amending the current Basel I regime. First of all, you may have heard that tomorrow the Federal Reserve Board plans to review a draft of the interagency Basel II notice of proposed rulemaking (NPR) at a public meeting, meaning that a draft NPR will also be made available to the public at that time. The final NPR is expected to be issued in the Federal Register after all of the U.S. banking agencies complete their review and approval processes, meaning it will then be "officially" out for comment."
It's almost like being there ;)

Monday, March 27, 2006

Bank Deal Starts Debate on Polish Role in United Europe - New York Times

Yet another international takeover blocked on political grounds. The NY Times suggests that this hints at an underlying uneasiness in the EU.

Bank Deal Starts Debate on Polish Role in United Europe - New York Times:
"The Polish government, alarmed at the idea of foreigners owning what would be Poland's largest bank, has blocked the deal, precipitating a bitter clash with the European Union and stirring a broader debate about economic nationalism and Poland's place in a united Europe.
Nearly two years after it joined the union, Poland seems no more at ease with its membership than do the French and Dutch voters who rejected the proposed European Constitution last year — driven, in part, by their fear of low-cost labor from the east"

Tim Hortons rises more than 20% in debut - MarketWatch

An update on the Tim Horton's IPO

Tim Hortons rises more than 20% in debut - MarketWatch:

The IPO price was $23.16 but the first trade in teh secondary markets (NYSE) was much higher, again showing that you have to be in early to make money on IPOs.
"After opening at $31.95, the stock fell in the open market, making it hard for retail investor to net a gain as it traded under $30 a share for most of the day.

Tipping the scales at $672 million, Tim Hortons ranks as the richest IPO in North America this year."
As of 10:50 AM on 3/27/06 the stock is trading at $27.39.

Mimicking Repurchases by Massimo Massa, Zahid Rehman, Theo Vermaelen

SSRN-Mimicking Repurchases by Massimo Massa, Zahid Rehman, Theo Vermaelen


Most examinations of stock buybacks find that the management is conveying information to the market about the relative valuation of the firm. Thus, buybacks are seen as good signals and the price tends to increase atthe time of the announcement and (at least according to some authors) continue to outperform in the months following the buyback announcement.

Massa, Rehman, and Vermaelen extend this research by looking at the other firms in the industry. In the authors' words:
"The central idea of this paper is that an open-market share repurchase announcement may provide information not only about the repurchasing firm but also about its competitors. The competitors, aware of the information externality of their rival’s repurchase decision, react accordingly....We argue that a stock repurchase affects positively the stock price of the repurchasing firm but affects negatively the price of the other competing firms in the same industry. Indeed, as a firm repurchases, it generates expectations that the other firms within the same industry will also repurchase. If they do not, the market will interpret this negatively, attributing it to worse economic prospects or higher agency costs. This induces the other firms in the industry to repurchase, not because they want to take advantage of a significantly undervalued stock price (as predicted by the market timing hypothesis), but simply to correct the negative market perception by mimicking the behavior of their competitors. "
The authors hypothesize that the negative impact on competitors of a stock buyback will be most pronounced in a concentrated industry. And sure enough, they find this to be the case:
" the unconcentrated industries, a repurchase of a firm does not significantly affect the other firms, in the concentrated ones, the impact is significant and negative."

The implication of this is that "The more concentrated the industry, the more likely it is that a firmrepurchases shares if other firms are repurchasing shares. " When coupled with the finding that in concentrated industries, there is less of a positive response to these subsequent announcements, this is taken as evidence that the firms in concentrated industries are expected to do buybacks after the initial firm does a buyback.

If this is true, then it implies that firms in concentrated industries are doing buybacks not because of market timing but because of peer pressure, should not have as strong of signal nor should they experience a positive long term drift. Again in the authors' words:
"Stocks of high concentration firms initiating a repurchase do not experience any significant long run abnormal returns (over the 36 months following the announcements). This contrasts with repurchases in competitive industries that deliver an average long run abnormal return equivalent to 25% over the 36 months following the announcement.
See, I told you it was interesting. So maybe there is more to a simple stock buyback than meets the eye!

Massa, Massimo, Rehman, Zahid and Vermaelen, Theo, "Mimicking Repurchases" (February 26, 2005). EFA 2005 Moscow Meetings Paper. Available at SSRN:

Sunday, March 26, 2006

Google enters the index / All eyes are on the Internet firm as it joins the S&P 500

Google enters the index / All eyes are on the Internet firm as it joins the S&P 500:
"Google shares jumped 7 percent Friday in response to an announcement late Thursday that the Internet company will be added to the Standard & Poor's 500 index, effective next Friday."
This "Index effect" has been well studied. Some argue it is liquidity, while others suggest it is an information story (more analysts, while others suggest it is merely supply and demand. (for a more complete review see Maxam's working paper.

Saturday, March 25, 2006

The Ad-Free Personal Finance Blogs Aggregator

This is really cool. A listing of virtually every finance blog plus if you click through, you get the stories from that blog. For instance, FinanceProfessor is blog #29 (it's alphabetical). Click through and see what you get:

The Ad-Free Personal Finance Blogs Aggregator

What I am reading

Back in the day when I put out a regular newsletter, one of the favorite sections was always the "what I am reading" section. Since I have a few minutes, I will revive it.

I am about 3/4's done with The End of Poverty by Jeffrey Sachs. The book is simultaneously looks at 1. what makes developing economies (now and in the past) tick, 2. Sach's personal experiences with economies and governments around the globe, and 3. and his prescriptions to end extreme poverty by the end of this generation.

It is surprisingly good: at once both interesting and informative and even has an introduction by Bono. Definitely a positive NPV!

I am also ristening to Bona grad Neil Cavuto's Your Money or Your Life. It is a series of his editorials. They are OK. Not great, but well done none-the-less. I agree with his tax position, not necessarily on some of his other topics.

Also reading Team of Rivals which is really really good. It is about Lincoln and his cabinet. Finally I just finished ristening to 1491. Which was excellent!

Wednesday, March 22, 2006

J.P. Morgan Plans Massive Buyback

What great timing! Just yesterday we spoke of stock buybacks in our MBA 610 class.

J.P. Morgan Plans Massive Buyback: "J.P. Morgan Chase said its board authorized the repurchase of up to $8 billion of the company's common stock."

A few quotes (which happily enough fit exactly with what we discussed in class :) )
"We believe the new stock repurchase program provides additional flexibility"

"J.P. Morgan said it will buy back stock at management's discretion. The timing of any repurchases and the exact number of shares bought back will depend on market conditions and alternative investment opportunities.

The repurchase program doesn't include specific price targets or timetables, and stock can be bought through open market purchases or in privately negotiated transactions."

A look at derivative trading before Black and Scholes.

In a forthcoming Journal of Finance piece, Moore and Juh examine how options were priced 60 years BEFORE the Black-Scholes formula. They find that when markets were competitive, the pricing errors were about the same that we find today!

Summary: Previous research on the efficiency of option pricing is mixed. This may be because of poor data (example monthly data) or actual mispricing.

In this paper, Moore and Juh use option data from South African markets (the article contains an interesting history of these gold-dominated markets as well!), and find that while investors sort of "got it" they did misprice some and that this mispricing seems tied to the degree of competition in the market.

Specifically it appears that investors overestimated volatilty somewhat. For instance from the section on option pricing:
"Of the 112 stocks in our data set, 84 had more than half of the options quoted on them overpriced relative to Black-Scholes model prices (including 18 stocks forwhich all options written were overpriced)...."
As a percentage, this mispricing seems to be tied to market competitivenes:
"Our results suggest that findings of option mispricing that rely on a broker’s quotes are quite sensitive to the competitiveness of the market in which the broker operated. It is possible that differing levels of competition in the option writing market can explain the divergent findings of Boness (1964), Kruizenga (1964), Black and Scholes (1972), and Kairys and Valerio (1997)."
Of course in today's market we do not always get things correctly either and the authors compare the pricing errors of today with those of the earlier period. The finding? The errors are quite comparable. In the words of Moore and Juh:
"Comparing these warrants to derivatives trading between 2001 and 2003 on the same exchange and using the same methods to compute volatility, we find that early twentieth century investors mispriced in a comparable way using a historical measure of volatility and outperformed modern JSE investors using a perfect-foresight measure of volatility. Development of the modern theory does not appear to have improved the performance of South African investors."
and equally important (maybe more so) after showing that the mispricing was a function of the degree of competitiveness in the market:
"...these results suggest that a competitive market, whether through trading of derivatives on an exchange or competition among rival brokers, has been more important in driving derivativeprices to fair values than the development of a formal derivative pricing model...."
Cool paper!


Derivative Pricing 60 Years before Black-Scholes: Evidence
from the Johannesburg Stock Exchange by LYNDON MOORE and STEVE JUH. This review was based on a Northwestern University working paper. The version that is forthcoming in the JF is temporarily available here.

Tuesday, March 21, 2006

Google introduces its finance page

You had to know it was coming, and today Google released its new finance page.

At first glance, I like the graphing tool (will be great for class presentations), but still like Yahoo's finance page better since you can download historical prices. But check it out for yourself:

Google Finance

Here is an article on Google's finance page from the San Francisco Chronicle.

Tim Horton's Carveout

This is a text book quality example of an IPO. Not only is a well known company, it has altered its price range, offered its investment bankers a Green Shoe Option, but the parent Wendy's is only carving out a portion of the firm and then plans on spinning off the rest later. : Tim Hortons boosts IPO price:
"Tim Hortons Inc. is boosting the price of its stock and granting its underwriters the option to buy more shares when the company goes public this week"
"It would still leave Wendy's with most of Tim Hortons' outstanding shares, but the fast food chain announced earlier this month it would spin off its remaining shares by the end of the year."
Wow, they don't make any better examples than that!

FRB: Speech, Bernanke--Reflections on the Yield Curve and Monetary Policy--March 20, 2006

Interesting speech. Will make for great discussions in Institutions or Money and Banking classes!

FRB: Speech, Bernanke--Reflections on the Yield Curve and Monetary Policy--March 20, 2006:
"Current and near-term forward rates are particularly sensitive to monetary policy actions, which directly affect spot short-term interest rates and strongly influence market expectations of where spot rates are likely to stand in the next year or two.....For example, since June 2004, the one-year forward rate for the period two to three years in the future has risen almost 1-1/2 percentage points. As the ten-year yield is about unchanged even as its near-term components have risen appreciably, it follows as a matter of arithmetic that its components representing returns that are more distant in time must have fallen. In fact, the one-year forward rate nine years ahead has declined 1-1/2 percentage points over this tightening cycle. Incidentally, by comparing forward rates implied by yields on nominal Treasuries with those implied by Treasury securities that are indexed for inflation, we can infer that about two-thirds of the overall decline in far-distant nominal forward rates over this tightening cycle has been associated with a drop in real yields, with the remainder reflecting a drop in inflation compensation."

Tuesday, March 14, 2006

I'm back!

Hi everyone, I'm back. The service trip (with about 288 people to MS and Louisiana) went very well. Much good work got done, but wow is there a long long ways to go. The destruction, even after 6 months, is beyond belief.

For more on our trip check out:

1. Our main hurricane relief page
2. Our blog--which used to be my randomtopics2 blog. At some point it will revert to it, but not yet.
3. Our yahoo group

When I was gone, I noticed this news item:

The Net's New Age: "In a small deal that signals big changes on the Internet, Google announced Mar. 9 that it has acquired a Silicon Valley sensation called Writely."

As you may remember I have been touting Writely for a while and it proved useful in trip planning. Now there needs to be a better online spreadsheet for sharing. (If anyone knows of a good one, please let me know.)

anyways, I really just wanted to let you know that you expect more regular finance postings again :)

thanks for the patience.