Mao-Wei Hung

Can the Gains from International Diversification Be Achieved without Trading Abroad

We examine whether portfolios of domestically traded securities can mimic foreign indices so that investment in assets that trade only abroad is not necessary to exhaust the gains from international diversification. We use monthly data from 1976 to 1993 for seven developed and nine emerging markets. Return correlations, mean-variance spanning, and Sharpe ratio test results provide strong evidence that gains beyond those attainable through home-made diversification have become statistically and economically insignificant. Finally, we show that the incremental gains from international diversification beyond home-made diversification portfolios have diminished over time in a way consistent with changes in investment barriers. Copyright The American Finance Association 1999.

Pricing Convertible Bonds Subject to Default Risk

Convertible bonds are commonplace securities, but valuing them properly is tricky. In addition to being exposed to interest rate risk like any bond in a stochastic interest rate environment, they contain both an option to convert them into shares of the issuing firm, and also exposure to the risk of default. In this article, Hung and Wang present a lattice technique that allows relatively straightforward valuation, even in the presence of these three sources of risk. After describing their technique in general, they put it to use to evaluate a convertible bond issued by Lucent.

Volatility and maturity effects in the Nikkei index futures

Many financial data series are found to exhibit stochastic volatility. Some of these time series are constructed from contracts with time‐varying maturities. In this paper, we focus on index futures, an important subclass of such time series. We propose a bivariate GARCH model with the maturity effect to describe the joint dynamics of the spot index and the futures‐spot basis. The setup makes it possible to examine the Samuelson effect as well as to compare the hedge ratios under scenarios with and without the maturity effect. The Nikkei‐225 index and its futures are used in our empirical analysis. Contrary to the Samuelson effect, we find that the volatility of the futures price decreases when the contract is closer to its maturity. We also apply our model to futures hedging, and find that both the optimal hedge ratio and the hedging effectiveness critically depend on both the maturity and GARCH effects.

Regulations, lender identity and bank loan pricing

Abstract Earlier empirical studies indicate that contract costs associated with loan monitoring influence bank loan pricing and that all lenders may not be equally efficient monitors. We examine whether differential monitoring costs lead foreign banks to price loans to U.S. firms differently from their U.S. counterparts. In particular, we hypothesize that due to relatively lax regulations governing the operations of foreign banks in the U.S. prior to the passage of the FDIC Improvement Act (FDICIA) of 1991, such banks were required to invest less resources in loan monitoring and were thus less efficient, or more costly, monitors. If the regulations introduced through FDICIA were effective then these foreign banks would be forced to improve their monitoring functions which would, in turn, reduce the rates charged on foreign loans. We test these hypotheses regarding the influence of regulations and lender identity by examining the differential lending behavior of American and Japanese banks to U.S. companies, since Japanese banks comprise the major foreign banking presence in the U.S.

Valuation of intellectual property

Purpose – This paper aims to provide a new approach to evaluate intellectual property (IP) and uses a cautious view of how volatility impacts the economic value of IPs.Design/methodology/approach – Real option is a useful tool for valuing investments under uncertainty and if it is applied to the valuation of IP with some modifications, it is also widely accepted. However, it is still debatable whether there is a constant rate‐of‐return. This paper incorporates a sensitivity variable to account for the volatility of the expected rate of return. Thus, rate‐of‐return can be a constant or increase with volatility.Findings – First, it was found in the simple model that Vega may be negative when the option is deep in the money. Second, in the general model, the option can be seen as a sequence of options and under the constant rate‐of‐return shortfall setting, it resembles traditional financial options with positive Vega.Originality/value – The scenario set‐up allows the authors to explain why uncertainties of ...

Short-Run and Long-Run Persistence in Mutual Funds

This empirical examination of a strategy that picks equity mutual funds on the basis of past short- and long-run performance provides some interesting results. The premise is that short-run mutual fund performance is likely to persist in the long run. A division of the funds in the CRSP Survivor-Bias-Free U.S. Mutual Fund Database according to past performance?funds with strong past short-run and long-run performance rated as best?reveals that in the subsequent year the best funds significantly outperformed the worst funds. Mutual fund investors can likely benefit from selecting funds on the basis of not only past short-run performance but also past long-run performance.

Credit Rating Change Modeling Using News and Financial Ratios

Credit ratings convey credit risk information to participants in financial markets, including investors, issuers, intermediaries, and regulators. Accurate credit rating information plays a crucial role in supporting sound financial decision-making processes. Most previous studies on credit rating modeling are based on accounting and market information. Text data are largely ignored despite the potential benefit of conveying timely information regarding a firm’s outlook. To leverage the additional information in news full-text for credit rating prediction, we designed and implemented a news full-text analysis system that provides firm-level coverage, topic, and sentiment variables. The novel topic-specific sentiment variables contain a large fraction of missing values because of uneven news coverage. The missing value problem creates a new challenge for credit rating prediction approaches. We address this issue by developing a missing-tolerant multinomial probit (MT-MNP) model, which imputes missing values based on the Bayesian theoretical framework. Our experiments using seven and a half years of real-world credit ratings and news full-text data show that (1) the overall news coverage can explain future credit rating changes while the aggregated news sentiment cannot; (2) topic-specific news coverage and sentiment have statistically significant impact on future credit rating changes; (3) topic-specific negative sentiment has a more salient impact on future credit rating changes compared to topic-specific positive sentiment; (4) MT-MNP performs better in predicting future credit rating changes compared to support vector machines (SVM). The performance gap as measured by macroaveraging F-measure is small but consistent.

Effect of wind on stock market returns: evidence from European markets

Environmental psychology studies have found evidence that wind speed has a strong influence on mood and comfort. This study investigated the relationship between wind speed and daily stock market returns across 18 European countries from 1994 to 2004. A significant and pervasive wind effect was found on stock returns. This finding was supported by psychological literature claiming that mood affects judgement and decision-making in situations involving uncertainty and risk, and coincides with the argument of misattribution. This investigation also found strong seasonality effect and temperature effect in European stock markets. Specifically, the influence of wind on stock returns is demonstrated to be more significant than that of sunlight, indicating that wind might exert a stronger impact on mood than sunshine and hence be a better proxy for mood than sunshine. Above all, our findings contradict the rational asset-pricing hypothesis and contribute to the behavioural finance literature.

A heterogeneous model of disposition effect

A portfolio choice model is provided to illustrate the disposition effect under irrational belief in mean reversion assumption. Higher cognitive reference, stronger irrational belief in mean reversion magnitude and less risk aversion all strengthen the disposition effect in the model. The equilibrium market interest rate is priced after the market clearing condition is employed. The grater disposition effect reduces the capital mobility from the stock market to the bond market and thus mitigates the dropping of the market interest rate.

Impact of foreign-listed single stock futures on the domestic underlying stock markets

The purpose of this article is to investigate whether foreign-listed single stock futures (SSFs) would have any impact on their domestic underlying stock markets. GARCH (1,1) and GJR-GARCH (1,1) are used to analyse the data from the London International Financial Future and Options Exchange (LIFFE) in this research. Results show that the introduction of the foreign listed SSF contracts seems to have more explanatory power with respect to the higher volatility of their domestic spot markets than the announcement of the SSF contracts. Also, for two of the nine securities, the daily activity shocks of the foreign-listed SSFs are responsible for the higher conditional volatility of their home underlying stocks, while the activity that is forecastable but highly variable across days diminishes the conditional volatility of the underlying stocks.