Ghassem Homaifar

Variance and lower partial moment betas as bases for costing equity capital among regulated utilities

An important question in the setting of public utility rates is, ‘What constitutes a fair rate of return or cost of equity capital for a regulated utility?’ Recent debates over this issue have centred on the CAPMs ability to produce realistic equity cost figures for use in the rate-setting process. Several researchers recommend modified or expanded versions of the market model as a means of improving its predictive capabilities. One such approach is the lower partial moment model. The purpose of the present paper is to assess the robustness of the lower partial moment model relative to the conventional CAPM as a basis for estimating the cost of a utility companys equity capital. The hypothesis that empirical estimates of the LPM beta tend to overestimate the true systematic risk of utility companies was corroborated by our test results.

Exchange rate uncertainty and the efficiency of the forward market for foreign exchange

Exchange Rate Uncertainty and the Efficiency of the Forward Market for Foreign Exchange. — The paper investigates to what extent exchange rate uncertainty can account for the observed deviations from the forward market efficiency hypothesis (FMEH). The empirical analysis employs a simple varying parameter regression to allow uncertainty to modify the central parameters of the FMEH in a direct way. Uncertainty is proxied by significant exchange rate changes. The results indicate that there is considerable support for the FMEH if one allows the intercept term to vary over time.ZusammenfassungUnsicherheit über Wechselkurse und Effizienz von Terminmärkten. — Die Verfasser untersuchen, in welchem Ausmaß die Unsicherheit über Wechselkurse für die beobachteten Abweichungen von der Hypothese der Effizienz von Terminmärkten verantwortlich ist. Bei der empirischen Analyse verwenden sie eine einfache Regression mit variierenden Parametern, um unmittelbar berücksichtigen zu können, daß Unsicherheit die zentralen Parameter der Hypothese verändern kann. Unsicherheit wird durch signifikante Wechselkursänderungen approximiert. Die Ergebnisse deuten darauf hin, daß die Hypothese der Effizienz von Terminmärkten dann beachtlich gestützt wird, wenn man zuläßt, daß sich das absolute Glied der Regressionsgleichung im Zeitablauf verändern kann.

Intertemporal Test of Beta Stationarity Performance of Islamic Sector Structured Mutual Funds

The purpose of this research paper is to examine social Islamic mutual funds’ financial performance. Since Islamic mutual funds have only been around for the past two decades, most of the research on this topic is fairly new. In this study we apply the single factor model of Schwert and Seguin (1990) to a sample of Islamic mutual funds. The Islamic mutual funds market is one of the fastest growing sectors within the Islamic financial system. Several studies have investigated the characteristics of individual Islamic mutual funds (see Elfakhani, et al (2006), Elfakhani ,et al (2005), and Hassan, et al (2005). We are not aware of any studies that have applied the Schwert and Seguin methodology to Islamic mutual funds. Such an application is important because it allows for studying the impact of market volatility on the time variation of monthly betas and the corresponding returns. Using the S&P 500 and the FTSE Global Islamic indices on sector structured Islamic mutual funds, our results suggest that the volatility of the market and that of the Islamic mutual funds portfolio behave differently with inter and intra market proxies. There is also evidence that the volatility persistence of each Islamic mutual fund portfolio and its systematic risk are significantly related. Hence, the systematic risks of different portfolios tend to move in a different direction during periods of increased market volatility. As a result, we gain an insight into the return dynamics and the process by which Islamic mutual funds prices are determined.

A generalized algorithm for duration and convexity of option embedded bonds

ABSTRACT This article derives a generalized algorithm for duration and convexity of option embedded bonds that provides a convenient way of estimating the dollar value of 1 basis point change in yield known as DV01, an important metric in the bond market. As delta approaches 1, duration of callable bonds approaches zero once the bond is called. However, when the delta is zero, the short call is worthless and duration of callable will be equal to that of a straight bond. On the other hand, the convexity of a callable bond follows the same behaviour when the delta is 1 as shown in Dunetz and Mahoney (1988) as well as in Mehran and Homaifar’s (1993) derivations. However, in the case when delta is zero, the convexity of a callable bond approaches zero as well, which is in stark contrast to the non-zero convexity derived in Dunetz and Mahoney’s paper. Our generalized algorithm shows that duration and convexity nearly symmetrically underestimate (overestimate) the actual price change by 11/10 basis points for ± 100 basis points change in yield. Furthermore, our algorithm reduces to that of MH for convertible bonds assuming the convertible bond is not callable.

The long-run relationship between stock return dispersion and output

Based on the rational that some industry groups are more closely linked to the business cycle than others, we re-examined a previous analysis on the long-term relationship between stock return dispersion by industry and Gross Domestic Product (GDP), which evaluated data until 1987 by extending it to 2008. Using Mean Square Forecast Errors (MSFE) statistics, we find that incorporating the return dispersion in Vector Autoregressive (VAR) models enhances their forecasting power for output (GDP) in the long run. This article also determines that the relationship between stock return dispersion by industry and GDP is tenuous in the recent decade from 1999.

The duration and convexity of convertible preferred stock: an extension

The purpose of this paper is to provide mathematical expressions for the duration and convexity of a convertible preferred stock. In general, the duration of a convertible preferred stock is the product of the Macaulay duration for a pure preferred stock and an elasticity measure that relates the convertibles price to the price of its straight preferred component. Convexity has two parts. The first is based on the convexity of the pure preferred element, while the second is predicated on the gamma coefficient of the embedded call option.