Geoffrey Loudon

Foreign exchange exposure and the pricing of currency risk in equity returns: Some Australian evidence

Abstract Having regard to the importance of knowing whether equity returns are sensitive to exchange rate changes and if currency risk is priced when making international financial management decisions, the following evidence is provided in this paper. Although equity returns of Australian industries display differential ex post sensitivity to exchange rate movements, evidence from a two factor asset pricing model suggests that equity returns do not include any premium for currency risk borne. One implication of these findings is that corporate hedging of currency exposure may not add value.

Financial Risk Exposures in the Airline Industry: Evidence from Australia and New Zealand

Important financial risks facing the airline industry include interest-rate, currency and fuel-price risk. This paper estimates the exposure to these risks within the airline industry of Australia and New Zealand, using both linear and non-linear specifications, for a variety of horizon lengths. Evidence for exposure, both symmetric and asymmetric, tends to strengthen as the return horizon is lengthened. Exposure to these financial risks is largely unchanged by the terrorist attacks and the collapse of a major competitor in September 2001.

Linkages between international REITs: the role of economic factors

Purpose – The purpose of this paper is to study correlations between the national real estate investment trusts (REIT) markets in the USA and the four Asia‐Pacific countries of Australia, Hong Kong, Japan and Singapore, and document the extent to which the time variation present in these correlations can be explained from a set of 11 economic and financial factors. Both US dollar and local currency returns are used.Design/methodology/approach – Time‐varying correlations are estimated using a DCC‐GARCH model that allows for asymmetries in both the correlations and volatilities. The correlations are then regressed on a set of four economic and seven financial factors, and tests of statistical significance are conducted in order to discriminate between relevant and irrelevant explanatory variables. The authors estimate a fixed‐effects panel regression as well as individual regressions for each dynamic correlation.Findings – Significant time variation is found in the four REIT correlation series. Panel regres...

Put Call Parity Theory: Evidence From The Big Australian

This paper provides Australian evidence, obtained during unusual trading conditions, on put call parity theory. The empirical results show that observed violations of the theory are insufficient to indicate that economic profits can be derived therefrom after allowing for normal transaction costs. Observed violations cannot be explained by the presence of nonsimultaneous price data. The impact of certain institutional restrictions is considered and the existence of transaction costs appears to have the most significant influence.

Is the risk–return relation positive? Further evidence from a stochastic volatility in mean approach

Existing evidence on the relation between risk and return is conflicting. This evidence is extended by estimating a stochastic volatility in mean model using equity returns from a mix of ten emerging and five developed markets. Results suggest that while the relation is significantly positive for China and significantly negative for Australia, it is insignificant for the remaining markets studied. Findings also vary across subperiods related to the Asian financial crisis of 1997 to 1998. Model estimates identify some important differences across these markets in the nature of volatility in terms of its own volatility, persistence and predictability.

Is volatility risk priced after all?: Some disconfirming evidence

Recent theory and evidence from US studies suggest that aggregate market volatility risk is a strong candidate for inclusion in the list of risk factors that earn a risk premium in equilibrium. We re-examine the sensitivity of stock returns to volatility risk using delta-neutral index option straddles to proxy for innovations in aggregate volatility. Contrary to existing US evidence, our analysis finds little evidence that volatility risk is priced in Australian equities. This finding is robust across a variety of methods for characterizing the underlying volatility factor.

Evidence on the issuer effect in warrant overpricing

Prior literature offers evidence that warrant prices tend to be higher than the prices of matched options. Explanations for warrant overpricing include a liquidity premium, hedging costs, market power and investor perceptions. Each of these explanations suggest that overpricing is likely to be related to the identity of the issuer. Any such issuer effect may also be affected by differences in credit risk. This study reconfirms the existence of a large excess warrant premium and provides evidence that it is significantly related to the identity of the warrant issuer, even after taking into account important liquidity and hedging factors.

An Early Warning Tool for Measuring the Build-Up of Systemic Risks in Banks and Financial Systems

This paper develops, analyses and implements an early warning tool for systemic risk in banks and financial entities. The tool is based on a refined approach to stress testing. Calculations performed on Australian bank data are shown to predict past distress. Risk is measured as a function of expected capital shortfall in individual firms. A simple model of regulatory capital is assumed. Systemic risk is shown to be driven by the size and leverage of balance sheets and interdependence between firms. Firm balance sheets are modelled using publicly available information and assumed to depend on market returns. Model refinements using more comprehensive information and practical implementation are also discussed.

Monitoring Risk in the Financial System Using Time Series Methods

SRISK methodology recently proposed in the literature is refined and extended. The refinement is to define systemic risk using a formalised stress testing framework including a stress function. Baseline risk and the stress risk are in terms of the ordinary and stressed expectation. Stressed expectation is expectation computed under a hypothetical stress, modelled with the stress function and scenarios. Systemic stress is defined in terms of a stress function and systemic scenarios impacting on a number of firms or financial entities. Stress functions are chosen by the practitioner and typically exaggerate undesirable extreme outcomes. Properties and characterisations of stress and stress related quantities are displayed and explored. Application is made to the study of the stability of Australian banks using daily time series data.

Linkages between the U.S. and Asia-Pacific REITs: The Role of Economic and Financial Factors

We study correlations between the national REIT markets in the US and the four Asia-Pacific countries of Australia, Hong Kong, Japan and Singapore, and document the extent to which the time variation present in these correlations can be explained from a set of economic and financial factors. Time-varying correlations are estimated using a DCC-GARCH model that allows for asymmetries in both the correlations and volatilities. Financial factors are more dominant and have greater explanatory power than economic factors. We find that REIT correlations tend to rise with increases in the interaction of national inflation rates, the US default risk premium and global equity market uncertainty. We also find that REIT correlations tend to fall with increases in the interaction of national short term interest rates and the term spread.