ACRN Journal of Finance and Risk Perspectives
Volume 8, Issue 1 (2019)
ISSN 2305-7394


Volume 8 / Ongoing Publication


pdf Economic and Financial Transactions Govern Business Cycles

Victor Olkhov
TVEL, Moscow, Russia


Problem/Relevance - This paper presents new description of the business cycles that for decades remain as relevant and important economic problem.
Research Objective/Questions - We propose that econometrics can provide sufficient data for assessments of risk ratings for almost all economic agents. We use risk ratings as coordinates of agents and show that the business cycles are consequences of collective change of risk coordinates of agents and their financial variables.
Methodology - We aggregate similar financial variables of agents and define macro variables as functions on economic space. Economic and financial transactions between agents are the only tools that change their extensive variables. We aggregate similar transactions between agents with risk coordinates x and y and define macro transactions as functions of x and y. We derive economic equations that describe evolution of macro transactions and hence describe evolution of macro variables.
Major Findings - As example we study simple model that describes interactions between Credits transactions from Creditors at x to Borrowers at y and Loan-Repayment transactions that describe refunds from Borrowers at y to Creditors at x. We show that collective motions of Creditors and Borrowers from safer to risky area and back on economic space induce frequencies of macroeconomic Credit cycles.
Implications – Our model can improve forecasting of the business cycles and help increase economic sustainability and financial policy-making. That requires development of risk ratings methodologies and corporate accounting procedures that should correspond each other to enable risk assessments of economic agents.

Keywords: business cycle, economic transactions, risk assessment, economic space

pdf Is Human Capital the Sixth Factor? Evidence from US Data

1,2 Pondicherry University, India


Problem/Relevance: Measuring the risk of an asset and the economic forces driving the price of the risk is a challenging task that preoccupied the asset pricing literature for decades. However, there exists no consensus on the integrated asset pricing framework among the financial economists in the contemporaneous asset pricing literature. Thus, we consider and study this research problem that has greater relevance in pricing the risks of an asset. In this backdrop, we develop an integrated equilibrium asset pricing model in an intertemporal (ICAPM) framework.
Research Objective/Questions:
Broadly we have two research objectives. First, we examine the joint dynamics of the human capital component and common factors in approximating the variation in asset return predictability. Second, we test whether the human capital component is the unaccounted and the sixth pricing factor of FF five-factor asset pricing model. Additionally, we assess the economic and statistical significance of the equilibrium six-factor asset pricing model.
Methodology: The human capital component, market portfolio, size, value, profitability, and investment are the pricing factors of the equilibrium six-factor asset pricing model. We use Fama-French (FF) portfolios of 2 3, 5 5, 10 10 sorts, 2 4 4 sorts, and the Industry portfolios to examine the equilibrium six-factor asset pricing model. The Generalized method of moments (GMM) estimation is used to estimate the parameters of variant asset pricing models and Gibbons-Ross-Shanken test is employed to evaluate the performance of the variant asset pricing frameworks.
Major Findings: Our approaches led to three conclusions. First, the GMM estimation result infers that the human capital component of the six-factor asset pricing model significantly priced the variation in excess return on FF portfolios of variant sorts and the Industry portfolios. Further, the sensitivity to human capital component priced separately in the presence of the market portfolios and the common factors. Second, the six-factor asset pricing model outperforms the CAPM, FF three-factor model, and FF five-factor model, which indicates that the human capital component is a significant pricing factor in asset return predictability. Third, we argue that the human capital component is the unaccounted asset pricing factor and equally the sixth-factor of the FF five-factor asset pricing model. The additional robustness test result confirms that the parameter estimation of the six-factor asset pricing model is robust to the alternative definitions of the human capital component.
The empirical results and findings equally pose the more significant effects for the decision-making process of the rational investor, institutional managers, portfolio managers, and fund managers in formulating the better investment strategies, which can help in diversifying the aggregate risks.

Keywords: Asset pricing; FF five-factor model; human capital; return predictability; six-factor asset pricing model; sixth factor.

pdf Sports Sentiment and Stock Returns: The Bombay Stock Exchange

Francisca M. Beer1, Frank Lin2
1,2 California State University, San Bernardino, USA


Problem/Relevance: This study is motivated by psychological evidence of a strong connection between sporting event outcomes and mood. To evaluate this connection, we analyze the Indian stock market reaction to sudden changes in investors’ mood captured by India’s cricket results. By focusing on a rarely studied mood variable and a very infrequently studied stock exchange, this study adds to our understanding of the association between sporting event outcomes and mood.
Research Objective/Questions: In this study, we investigate the impact of cricket wins and losses on the Bombay Stock Exchange. We hypothesize that cricket wins or losses will drive investors’ mood substantially and unambiguously so that the game outcomes will be powerful enough to impact asset prices. We also evaluate the hypothesis that losses are psychologically more powerful than wins.
Methodology: We analyze the daily data from the Bombay Stock Exchange using the methodology of Edmonds et al. (2007). This methodology has the advantages of capturing the Bombay Stock Exchange stock returns time-varying volatility through a GARCH model.
Major Fundings: Our findings show that cricket wins and losses do not impact the Bombay Stock Exchange. On the exchange, stock prices reflect relevant information. Our results are thus consistent with the Efficient Market Hypothesis.
Implication(s): Our results imply that on the Bombay Stock Exchange, cricket wins and losses cannot be reliably used by investors and portfolio managers to achieve returns in excess of the average market returns on a risk-adjusted basis.
Keywords: Sentiment, Sports Sentiment, Investor mood, ARCH, GARCH, Bombay Stock Exchange

pdf Internal Control Weakness and Managerial Myopia: Evidence from SOX Section 404 Disclosures

Amy E. Ji
Saint Joseph’s University

Problem/ Relevance: Managerial myopia is an important issue of interests to academics, practitioners, and regulators as managers have been condemned for their obsession with short-term earnings and myopic investment decisions that sacrifice firms’ long-term value for shareholders. This article contributes by examining whether the quality of firms’ internal controls over financial reporting (ICFR) is associated with managerial myopia.
Research Objective/ Questions:
The purpose of this study is to examine whether managers in firms reporting material internal control weaknesses (ICW) under Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 engage in myopic behaviors more than those in firms without reporting ICW.
The study uses the logit regression model to investigate a sample obtained from Compustat for the period of 2005-2013.
Major Findings: The study finds a positive association between internal control weaknesses reported by auditors under Section 404 of the SOX and managerial short-termism which is measured by the probability of cutting R&D expenses in the current year from the previous year.
Implications: Whereas prior studies mostly examine the impact of internal controls on accounting quality, this study demonstrates the implication of internal controls beyond financial reporting quality by showing an association between internal control quality and managerial myopia. Future research may further investigate the association between firms’ financial reporting quality and managerial investment decisions.
Keywords: internal control; internal control over financial reporting; internal control weakness; Sarbanes-Oxley Act (SOX) Section 404; managerial myopia; managerial short-termism

pdf Determinants of the Real Equilibrium Exchange Rate in Albania: An Estimation Based on the Co-integration Approach

Natasha Ahmetaj, Merita Bejtja
Bank of Albania

Problem/Relevance: Investigation of exchange rate behaviour has been an important topic in international monetary economics because of the impact of exchange rates on economies. One strand of the literature has focused on explaining the observed movement of the nominal or real exchange rate in terms of macroeconomic variables. Another strand of the literature has evaluated the behaviour of the real exchange rates in relation to the equilibrium exchange rate, which is the real exchange rate that is consistent with macroeconomic balances. Albania implements a free floating exchange rate regime; therefore, evaluating whether the actual real exchange rate is too strong or too weak compared with the real equilibrium exchanges rate has great relevance for the Albanian economy.
Research Objective/Questions: Generally, the real exchange rate is defined as the nominal exchange rate adjusted for the relative price differential between domestic and foreign goods and services. So, an appreciation of the nominal exchange rate or higher inflation at home relative to other countries may lead to an appreciation of the real exchange rate. Such appreciation weakens the competitiveness of a country, widens the current account deficit and increases vulnerability to financial crises. The opposite holds true when the real exchange rate depreciates. The aim of this paper is, first, to estimate the equilibrium real exchange rate for the Albanian currency against the euro and, second, to assess the total exchange rate misalignment during the period of 2001Q1-2017Q1. Thus, the equilibrium real exchange rate is used as a benchmark for evaluating the misalignment of the actual real exchange rate.
Methodology: This paper explores the determinants of the real exchange rate for Albania, during the period of 2001Q1-2017Q1, based on the stock-flow approach, the so-called Behavioural Equilibrium Exchange Rate (BEER), which effectively employs reduced-form modelling of the exchange rate based on standard co-integration techniques. The stock of net foreign assets and productivity changes has been considered fundamental for the real exchange rate. We have used the Johansen co-integration technique to test the existence of long-run relationships between our main variables and to evaluate the path of the equilibrium real exchange rate based on vector error correction model (VECM) results. Then the analysis is completed by calculating the degree of misalignment as the difference between the actual real exchange rate and the equilibrium real exchange rate.
Major Findings: Based on the Johansen co-integration approach, we find one long-run relationship between the real exchange rate of the Albanian lek against the euro, relative productivity and net foreign assets during the period of 2001Q1 to 2017Q1. The model implies that the real exchange rate is affected, as we expected, by relative productivity and net foreign assets, confirming that an increase in both variables leads to an appreciation of the real exchange rate in the long run. Our results show that the behaviour of the actual real exchange rate is similar to the path of the equilibrium exchange rate and that the degree of misalignment throughout the period is estimated to be moderate.
Implications: Our empirical results confirm that the degree of misalignment is reasonable, suggesting a consistency between macroeconomic (especially monetary) policies and the free floating exchange rate regime. Assessing real exchange rate misalignment is a very important issue for policy makers because of the severe welfare and efficiency costs that such misalignment can have for an economy.
Jel Classification: C22, F31, F32
Key words: Equilibrium exchange rate, Co-integration analysis, BEER

pdf Dividend Yields, Stock Returns and Reputation

Eun Kang1,Ryumi Kim*,2, Sekyung Oh3

1California State University San Marcos University
2Chungbuk National

3Konkuk University

Problem/ Relevance – The relationship between dividend yields and stock returns is an unresolved issue in finance. Previous papers show mixed results on the relationship. To clarify the relationship, we consider dividend reputation. We investigate whether dividend reputation plays a role in explaining the relationship between dividend yields and stock returns.
Research Objective/ Questions – We hypothesize that firms with dividend reputation tend to have less risk compared to firms without dividend reputation, and the expected return of firms with dividend reputation will be lower given the dividend yield, which is called the “reputation effect.” A mix of firms with and without dividend reputation in a sample could distort the relationship between stock returns and dividend yields. We group stocks according to reputation and analyze the relationship between dividend yields and stock returns.
Methodology – We construct our sample from all firms listed on the NYSE, AMEX, and NASDAQ stock exchanges. In our analysis, reputation effects are included to analyze the relationship between dividend yields and stock returns. We divide our sample firms into three groups according to the track record of dividend payments to control for reputation effects: (1) reputation-established firms, (2) reputation-building initiation, and (3) no reputation firms. To test the hypotheses, we run the panel regression with reputation variables and the control variables.
Major Findings – We find that the reputation effect is strongest for reputation-established firms and a weaker reputation effect for reputation-building younger firms. After controlling the reputation effect and other relevant variables, we find that there does exist a significantly positive relationship between dividend yields and stock returns.
Implications – The empirical results show that the reputation effect is higher for established firms with a good track record of dividend payments than for firms with a short history of dividend payments or for firms with an unreliable history of dividend payments. After controlling the reputation effect and other relevant variables, we find there exists a significantly positive relationship between dividend yields and stock returns. We also find that one year is not enough time for firms to build a dividend reputation.
Keywords: dividend yield, stock return, reputation effect, reputation building

pdf Abnormal accounting accrual Management by internal and external Market Discipline: The case of Tunisian banks in the context of the ‘Arab Spring’

Mohamed Sadok Gassouma*
Institute of Finance and Taxation of Sousse, Tunisia

Problem/Relevance: This paper deals with such market disciplinary factors as shareholder ownership, audit committee composition and Basel III prudential regulation affecting accounting manipulation measured by abnormal accruals in Tunisian banks in the event of managerial deviation from regulatory requirements
Research Objective/Questions : The aim of this study is to estimate the abnormal accruals that measure the accounting manipulation, and to test the effect of disciplinary and regulatory factors accordingly to The spring Arab revolution, on accounting Manipulation.
Methodology: We propose to construct abnormal accruals as an endogenous variable, using the classic Kothari model (2005), in order to explain them by means of the “difference-in-difference” estimation approach (DID), understand the significance of the evolution of the manipulation, and explain these accruals using internal and external disciplinary factors. On the other hand, we use the credit risk portfolio manipulation theory advocated by Nessim (2003) and Repullo (2007), to understand the concept of actual venture capital of Tunisian banks after the Arab Revolution.
Major Findings : The results show that the situation of Tunisian banks has dramatically worsened since the Tunisian Revolution. The DID approach showed an exacerbation of abnormal accruals and a manipulation transfer from net income smoothing to credit portfolio value smoothing in order to reach a healthy financial situation. This aggravation is linked to the market discipline deterioration, the shareholders, the external auditors and the supervisory board.
Implications : Before the Revolution, accounting manipulation was mainly caused by banking undercapitalization that led managers to offer more risky credit in a diluted ownership market and in an informational asymmetry situation characterized by the absence of the audit committee. After the Revolution, accounting manipulation resulted from an overcapitalization situation, which led managers to grant more risky credit. To circumvent the shareholders’ supervisory power, managers manipulated credit portfolio values, offering a low level of credit risk, and circulating false beliefs for shareholders and depositors. This was done when prudential supervision was weak, leading to an information asymmetry and long-term conflict of interest between external auditors and managers through abnormal remuneration and a long relationship.

pdf Saving and Investment Pattern: Assessment and Prospects

Deepika Dhawan*, Sushil Kumar Mehta

School of Business, Shri Mata Vaishno Devi University

Relevance: This study is conducted to look into the investor rationality by examining the pattern of saving and investment in the city of Jammu situated in Jammu and Kashmir, India.
Research Objective: The objective of this study is to see the association of saving and income; reasons for saving; and preferences of investors for different investment instruments through administering the structured questionnaire.
Methodology: Respondents are conveniently selected based on judgment. One -Way ANOVA, ANCOVA, and MANOVA are used to identify and understand the patterns of saving and investment and underlying triggers for the same.
Findings: A relationship between saving and income is found, after controlling for the effects of variables, namely, age, gender, and occupation. Likewise, the impact of gender on financial literacy and awareness is found. This study also finds that people prefer safe and liquid investments with tax benefits, higher returns, and fewer lock-in-periods.
Implications: The outcome will help financial consultants and investment managers to know more about the psyche and the level of financial literacy of people, and thus to help them in their objective of garnering funds and invest at a significant level and, finally helping in the capital formation.
Keywords: Investor Rationality, Annual Savings, Investment, Annual Income, Underlying Triggers