Ian A. Cooper

Costs to Crossborder Investment and International Equity Market Equilibrium

In this paper we first proposed a way of measuring home bias based on portfolio holdings of investors compared with global market weights that would hold under the ICAPM. We inferred the costs to cross-border investment and compared them to actual costs and restrictions, thus identifying the home bias puzzle. Since the collection of articles in which the paper appeared is no longer available, we are making the paper available on SSRN.

Asset Values, Interest-Rate Changes, and Duration

Much effort has been recently devoted to investigating and expounding the properties of the measure called “duration.†Two properties claimed for duration are (1) that it is a good indicator of the average life of a payments stream and (2) that it measures the elasticity of the present value of such a stream with respect to the discount rate. Unfortunately the theoretical justifications of the second, more important, property have been based upon the analysis of either a change in a discount rate constant for all future time periods, or, more generally, a parallel shift in the term structure of interest rates.

The Equity Home Bias Puzzle: A Survey

Home bias - the empirical phenomenon that investors assign anomalously high weights to their own domestic assets - has puzzled academics for decades. Financial theory predicts that an internationally well diversified portfolio of stocks and short-term bonds can reduce risk significantly without affecting expected return. Although the globalization of international equity markets has increased international investments, equity portfolios remain severely home biased today, and no single explanation seems to solve the puzzle completely. In this paper, we first provide a thorough description of the equity home bias phenomenon by defining, discussing, and applying the competing measures and presenting some estimates of the costs of under-diversification. Second, we evaluate the explanations for the equity home bias proposed in the literature such as information asymmetries, behavioral aspects, barriers to foreign investment, and governance issues, and conclude that each explanation on its own falls short, suggesting that the equity home bias probably reflects a combination of factors. Lastly, we review the implications of international under-diversification for portfolio formation and the cost of capital of companies.

Consistent Methods of Valuing Companies By Dcf: Methods and Assumptions

In this note we discuss four common methods of valuing firms: 1.Discounting operating free cash flow at the weighted average cost of capital. 2.Discounting equity free cash flow at the cost of equity. 3.Valuing the firm using adjusted present value. 4.Discounting the capital cash flow at the unlevered cost of capital. We examine four alternative assumptions about leverage policy and how they affect three things: discount rates, the present value of tax savings, and how to use the above methods. We describe alternative ways of implementing the valuation methods consistently, and how to choose between them. Finally, we show how inconsistent application can lead to errors that are subtle but large. The use of incorrect formulas can result in an estimate of the present value of the tax saving that is double its correct value.

International Propagation of the Credit Crisis

We use a large sample of non-US banks to examine the propagation of the 2007-2009 crisis. Using both stock market and structural variables we test whether the relative incidence of the crisis was better explained by crisis models or by the VaR-type analysis of the Basel system. Consistent with crisis models, we find that comovement, interbank linkages, leverage, and fragility of funding structure are related to crisis impact. Contrary to the assumptions of the Basel system, we find that asset risk, measured by the risk weightings of the Basel, has a perverse relationship with crisis impact when considered alone and no relationship when other variables are included. We provide evidence of both a direct linkage between banks and an indirect linkage which could either represent linkages in the real economy or common demands by investors for liquidity. We also investigate whether the relative impact of the crisis on banks was related to a shift in correlations and find that it was not. We discuss the implications of our findings for regulation.

Which Measure of Aggregate Implied Cost of Capital Predicts Equity Market Returns

We investigate the relative ability of two measures of the market implied cost of capital to predict aggregate equity market returns. One is Aggregate ICC, which is a weighted average of individual firms’ ICC’s. The other is ICC calculated using index information (Index ICC). Index ICC predicts market returns more robustly than Aggregate ICC. Using 11 countries we show that predictability occurs only at longer horizons. The characteristics of Index ICC are consistent with it capturing the time-series variation of the long-run expected return.

A Pure Measure of Home Bias

The literature on international equity holdings distinguishes between home bias (overweighting of home stocks) and foreign bias (relative underweighting for more ‘distant’ countries). The two biases can be integrated into one distance-based model. We define pure home bias as the excess of home bias relative to this model, and find pure home bias only in emerging markets. Countries with high tax rates and low credit standing have higher pure home bias, and more development comes with lower distance aversion. Methodologically, the choice of portfolio bias measure matters. We find the best measure to be a covariance-based measure relative to the world average. JEL classification: G15, G18, G30, G38, F3

The Behaviour of Sentiment-Induced Share Returns: Measurement When Fundamentals are Observable

We test the effect of sentiment on returns using a sample of upstream oil stocks where we have a good proxy for fundamental value. For this sample, the influence of sentiment is highly time-varying, appearing only after the post-2000 increased interest in oil-related assets. Contrary to the hard-to-arbitrage hypothesis, sentiment affects returns on these stocks principally through their fundamentals rather than through deviations from fundamentals. Retail investor sentiment predicts short-term momentum of fundamentals and Baker–Wurgler sentiment predicts mean reversion of fundamental factors. These effects appear in a portfolio that is long hard-to-arbitrage stocks and short easy-to-arbitrage stocks, but only because this portfolio has net exposure to fundamentals.

A Test of International Equity Market Integration using Evidence from Cross-border Mergers

We examine the changes in betas resulting from international mergers. We find that the beta with respect to the acquirers home market rises and that with respect to the targets home market falls. This effect is robust with respect to controls for changes in the operations of the companies involved and other robustness tests. It is consistent with the location of primary affecting betas with respect to different international equity markets. Such an effect can occur only if international equity markets are not fully integrated, and the risk that is generated by the stochastic discount factor in each country depends on the location of the primary listing of a company.

Consistent Valuation of Project Finance and LBO's Using the Flows-to-Equity Method

A common method of valuing the equity in highly leveraged transactions is the flows-to-equity method. When applying this method various formulas can be used to calculate the time-varying cost of equity. In this paper we show that some commonly used formulas are inconsistent with the assumptions about the debt plan. We show that the error resulting from using the wrong formula can be large at the currently low levels of interest rates. We derive an equity releveraging formula which captures the effects of a time-varying fixed debt plan, expensive debt, and costs of financial distress, and discuss the relative merits of using the flows-to-equity method or APV.