JOFRP_Title_201908


2019, Volume 8, Issue 1



pdf TABLE OF CONTENTS



pdf Economic and Financial Transactions Govern Business Cycles

Victor Olkhov
TVEL, Moscow, Russia

Abstract
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

RAHUL ROY, SANTHAKUMAR SHIJIN
Pondicherry University, India

Abstract
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.
Implications: 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. Beer,Frank Lin
California State University, San Bernardino, USA

Abstract
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

Abstract
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.
Methodology: 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

Abstract
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.
Key words: Equilibrium exchange rate, Co-integration analysis, BEER


pdf Dividend Yields, Stock Returns and Reputation


Eun Kang 1, Ryumi Kim 2, Sekyung Oh 3

1 California State University San Marcos University, 2 Chungbuk National, 3 Konkuk University


Abstract
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



Abstract
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

Abstract
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


pdf Governing Board Attributes as Profitability Influencers under Endogeneity: An Econometric Analysis in South Africa

Navitha Singh Sewpersadh
University of KwaZulu-Natal

Abstract

Presently, the oversight role performed by the governing board has been interrogated due to the demise of several corporate giants. The governing board is responsible for advancing the strategic direction of the company by ensuring superior performance whilst managing risks. Accordingly, this study investigated whether the governing board has any influence on a firm’s profitability by using OLS and GMM estimation on an unbalanced panel of 130 firms over a six-year period. ROA served as a proxy for firm performance and several board-level governance variables were selected namely board size, board independence, CEO duality, director qualifications, and board interlocks. From an econometric contribution, this study found that the addition of instrument variables in the GMM estimation model has proven to be robust in examining corporate governance variables. GMM is also robust in controlling endogeneity and a possible bi-directional causality between board and profitability. From a theoretical contribution, agency, resource dependence and management hegemony theories are highly prevalent in the governing boards of the JSE. The results of this study are as envisaged in the SCP paradigm. All hypotheses were supported, showing overall that profitability is significantly influenced by the board attributes. This study provides a useful analysis of the theoretical framework used by academic writers as a foundation for model specification as well as contributes to the econometric methodology of corporate governance. These findings will also advise future researchers, stakeholders and regulators in better understanding the role of board composition from a profit maximisation and sustainability outlook.

Keywords: board interlocks, ROA, corporate governance, IV, GMM, JSE, managerial opportunism, profitability



pdf Corporate Social Responsibility (CSR) and Risk Taking: Evidence from Indonesia

Joni Joni, Rezki Ananda Mulia
Maranatha Christian University

Abstract

In this paper, we investigate the effect of Corporate Social Responsibility (CSR) on risk taking in Indonesia. We hand collect CSR and other corporate governance data from 2016-2017 for publicly listed firms on the Indonesian Stock Exchange (IDX). The results, based on 820 firm-year observations, suggest that CSR activity is negatively related to corporate’s risk. This means the presence of CSR activity is positively perceived by stakeholders. Therefore, it reduces operating and market risks of the company. Also, we test for endogeneity and the main findings remain similar.

Keywords: CSR, Risk taking, Endogeneity



pdf Early Stage Investing in Green SMEs: The Case of the UK

Robyn Owen, Othmar Lehner, Fergus Lyon, Geraldine Brennan
Centre for Enterprise and Economic Development, Middlesex University Business School

Abstract

How might a Green New Deal be applied to the early stage financing of Cleantechs? Amidst rising interest and adoption of Green New Deals in the US, the paper explores the need for more focused policy to address early stage long horizon financing of Cleantechs. We argue that insufficient focus has been applied to early stage investing into these types of innovative SMEs that could lower CO2 emissions across a range of sectors (including renewable energy, recycling, advanced manufacturing, transport and bio-science). Adopting a resource complementarity lens and borrowing from transaction cost theory, we illustrate and build theory through longitudinal UK case studies. These demonstrate how government policy can scale-up through international collaboration public-private, principally venture capital, co-finance to facilitate cleantech innovation with potentially game changing impacts on reducing CO2 emissions in order to meet the Paris 2015 Climate Change targets.

Keywords: Green New Deal, Early Stage Cleantech, Low Carbon, SME Finance


pdf The Problem of Heterogeneity within Risk Weights: Does Basel IV contain the Solution?

Christina Binder 1, Othmar Manfred Lehner 2
1 University of Applied Sciences Upper Austria
2 Hanken School of Economics, Helsinki, Finland

Abstract

The article uses a bank’s credit data to study the impact of the Basel IV regulations on risk weight density (RWD). The analysis of the simulated data shows mixed results, as the improvement of risk weight heterogeneity is restricted to optimistically valued portfolios. Conservatively valued portfolios are likely to be confronted with an RWD decrease. However, within these portfolios, risk weight heterogeneity usually does not play an important role. Out of all the analysed Basel IV rules, the output floor clearly has the biggest influence on risk weight density, while the effect of the input floors is very limited within optimistically valued portfolios and is even eliminated by the removal of the scaling factor within conservatively valued portfolios. The change in RWD will also lead to a concurrent change in risk-weighted assets and therefore also in the level of eligible capital. The findings within the retail portfolio confirm those of the EBA study, which already suggested that Basel IV and especially the output floor will lead to a significant increase of risk capital (European Banking Authority, 2018).

Keywords: Bank regulation, Credit risk, Risk weights, Risk weighted assets, Basel IV, Internal ratings based approach



pdf Factoring transition risks into regulatory stress-tests: The case for a standardized framework for climate stress testing and measuring impact tolerance to abrupt late and sudden economic decarbonization

Michael Hayne 1, Soline Ralite 2, Jakob Thomä 1, Daan Koopman 1
1 2°Investing Initiative, Berlin, Germany
2 2°Investing Initiative, Paris, France

Abstract

A debate has recently emerged as to whether climate risks may be material for financial stability, driven by a solid body of evidence that climate risks may create value destruction for key industrial sectors that are prominently represented in financial markets. As a result, financial supervisory authorities are starting to explore how these risks can be integrated into existing stress-testing frameworks. This paper proposes a methodology that financial supervisors could follow to build ‘late & sudden’ transition scenarios that could be used as input into either traditional or climate-specific stress-tests of regulated entities. It also proses that supervisors run multiple simulations of these scenarios across regulated entities to inform on systemic and idiosyncratic ‘impact tolerance’ and creation of ‘reverse stress-tests’ enable the setting of minimum capital thresholds. An illustrative application of the process is shown, focusing on listed equity and corporate bonds tied to climate sensitive sectors (fossil fuels, power, steel, cement, automotive and aviation).

Keywords: Climate stress-test, Climate transition risks, Scenario analysis, Reverse stress-testing, Minsky moment


pdf Value at looking back: Towards an empirical validation of the role of reflexivity in econo-historic backtesting: Economic market prediction corrections correlate with future market performance

Julia M. Puaschunder
The New School, NY, USA; Columbia University, NY, USA

Abstract

The following article innovatively paints a novel picture of the mass psychological underpinnings of business cycles based on information flows in order to recommend how certain communication strategies could counterweight and alleviate information failing market performance expectations that could potentially build disastrous financial market mass movements of booms and busts. An introduction to the history of economic cycles will lead to George Soros’ Theory of Reflexivity in order to draw inferences for the analysis of the role of information in creating economic booms and busts in the age of globalization. Empirically, based on a central European central bank’s GNP projections and backtesting corrections, a pattern of central bank corrections communication and economic market performance will be unraveled for the first time to outline that central bank market prediction corrections are positively correlated with near future market performances and negatively correlated with distant future market performances. The collective reality of prices and the irrationality of the crowds perturbating markets will be discussed. Business cycles are argued to obey some kind of natural complexity, as for being influenced by econo-historic communication trends. Recommendations how to create more stable economic systems by avoiding emergent risks in communicating market prospects more cautiously will be given in the discussion followed by a prospective future research outlook and conclusion.


Keywords: Backtesting, BIP, Business cycles, Central bank communication, Corrections, Errors, Expectations, Forecasting corrections, Gross National Product (GDP), Globalization, Long boom, Long downturn, Market performance, Price, Reflexivity



pdf Audit committee structure and bank stability in Vietnam

Quang Khai Nguyen, Van Cuong Dang
University of Economics Ho Chi Minh City

Abstract

The role of the audit committee in maintaining banking stability is becoming increasingly important. However, there are not many studies have examined the relationship between the audit committee structure and bank stability in developing countries. This paper examines the relation of the audit committee structure and the bank stability in the difference level of bank stability and the role of external audit quality in this relation by employing empirical techniques like 2SLS, S-GMM or quantile regression analysis with panel data, and using a sample of 37 commercial banks in Vietnam from 2002 to 2018. Our empirical results show that bank stability varies negatively with audit committee size, but this relationship is mitigated in banks that use good external audit services. Moreover, we also find that the relation of the audit committee structure and bank stability is heterogeneous, and that it is stronger in banks with higher stability levels. Based on these results, banks that have a large audit committee should consider a high quality external audit service and should increase the proportion of financial and accounting expertise in the audit committee in order to ensure bank stability.

Keywords: Audit committee structure, Bank stability, External audit