Massimiliano Barbi

On the risk-neutral value of debt tax shields

The recent interest in the valuation of the benefits from debt financing arises from the disagreement in the financial literature about the meaning of ‘value of tax shields’. Although it is accepted that the tax deductibility of interest increases the value of the firm, the correct valuation of this extra-value is controversial. We adopt a risk-neutral approach to derive a general formula for the value of tax shields. This framework clearly shows that this value equals the summation of the discounted future tax savings. Once we specify a leverage policy and a cash flow dynamics, some well-known formulas are obtained.

Optimal hedge ratio under a subjective re-weighting of the original measure

In this article we study a risk-minimizing hedge ratio with futures contracts, where the risk of the hedged portfolio is measured through a spectral risk measure (SRM), thus incorporating the degree of agent’s risk aversion. We empirically estimate the optimal hedge ratio (OHR) using a long time series of UK and US equity indices, the EURUSD and EURGBP exchange rates and four liquid commodities (Brent crude oil, corn, gold and copper), to represent different asset classes. Comparing the results with common OHRs (such as the minimum variance and the minimum expected shortfall), we find that the agent’s risk aversion has a material impact, and should not be ignored in risk management.

A generalized approach to optimal hedging with option contracts

In this paper, we develop a theoretical model in which a firm hedges a spot position using options in the presence of both quantity (production) and basis risks. Our optimal hedge ratio is fairly general, in that the dependence structure is modeled through a copula function representing the quantiles of the hedged position, and hence any quantile risk measure can be employed. We study the sensitivity of the exercise price which minimizes the risk of the hedged portfolio to the relevant parameters, and we find that the subjective risk aversion of the firm does not play any role. The only trade-off is between the effectiveness and cost of the hedging strategy.

Optimal Corporate Hedging Using Options with Basis and Production Risk

In this paper we investigate the optimal hedging strategy for a firm using option contracts, where both the role of production (quantity) and basis (proxy) risk are considered. Contrary to the existing literature, we find that the exercise price which minimizes the shortfall of the hedged portfolio is primarily affected by the amount of cash spent on the hedging program. Also, we decompose the effect of quantity and proxy risk showing that the latter greatly affects hedging effectiveness while the former drives the choice of the optimal option contract. Finally, fitting the model parameters to match a financial turmoil scenario confirms that choosing a suboptimal option moneyness leads to a non-negligible economic loss.

Interest Rate Risk Estimation: A New Duration-Based Approach

Duration is widely used by fixed income managers to proxy the interest rate risk of their assets and liabilities. However, it is well known that the convexity of the price-yield relationship introduces approximation errors that grow with changes in yield. In this paper we suggest a new approach, discrete duration, which significantly improves upon the accuracy of traditional duration methods and achieves a level of accuracy close to the more complex duration plus convexity. In particular, discrete duration performs particularly well for long dated and low coupon rate bonds, where the estimation error is impressively close to zero.

Crowdfunding Practices In and Outside the US

We analyze all Kickstarter projects till December 2013. Their success is driven by the presence of a video, a higher number of rewards, a shorter campaign, and a lower goal. A more extensive description signals higher quality and helps the funding, unless it becomes too prolix. We study the distribution of non-US projects. Categories have different concentrations across countries, but the funding determinants are comparable, as Kickstarter taps the same world crowd. UK and Canada openings increase the number of projects and reduce the probability of success, due to a diminished quality and a lower “collective attention�? from worldwide backers.

Out of Sight, Out of Mind: Financial Illiteracy, Inattention, and Sluggish Mortgage Refinancing

We analyze the effect of an exogenous shock to the Italian mortgage market. A new reform passed in 2007 has abolished prepayment fees and simplified mortgage refinancing, making it akin to a cost-free decision to households. This law — along with the almost simultaneous drop in market interest rates — has generated important gains for fixed rate borrowers, which we quantify at up to 8 percent of the principal balance. Nevertheless, only 4.2 percent of borrowers have locked in this opportunity. We establish a causal relationship between this sluggish behavior, investors’ inattention, and their level of financial illiteracy.

Financial Literacy, Households' Investment Behavior, and Risk Propensity

We investigate the role of socio-demographic characteristics of households on their level of self-declared financial literacy and investment experience, and the effect of financial literacy on household risk aversion, leveraging on about 38,000 MiFID questionnaires provided to us by an Italian primary bank. We find that the level of financial literacy is lower for the young and the old, women, less wealthy and financial fragile, lesseducated individuals living in the Southern part of Italy, and in less densely populated areas. Past professional expertise in a finance-related field helps increasing the level of financial literacy. Risk aversion of households is significantly affected by financial literacy, as the less financially knowledgeable tend to be more risk averse.

Time Value vs. Cost of Forcing Call: New Evidence on Convertible Bond Call Policy

Since the seminal work of Ingersoll (1977b) the puzzle concerning the delay of convertible bond calls has seemingly been solved. Several studies have put forward a number of possible reasons to explain the apparent delay: dividend dilution, the risk of financial distress following a failed conversion, agency costs and tax shield, to cite the most unanimously agreed ones. However, we argue that an important advantage of convertible bond calls has been almost neglected: the time value-extraction from conversion option. By proposing a new measure for the effective convenience of calling — which we define as net time value advantage — we give a more comprehensive explanation of firms’ convertible bonds call policy.