Yaz Gulnur Muradoglu

What can behavioural finance teach us about finance

Purpose - The paper draws on the key themes raised at a Round Table discussion on behavioural finance attended by academics and practitioners. The paper provides a background to the key aims of behavioural finance research and the development of the discipline over time. The purpose of this paper is to indicate some future research issues on behavioural finance that emanate from the financial crisis and highlight areas of mutual benefit to both behavioural finance academics and the finance industry so as to encourage a creative cross-fertilisation. Design/methodology/approach - The paper draws on a Round Table discussion on behavioural finance that was organized by the Behavioural Finance Working Group, the Centre for the Study of Financial Innovation and Financial Services Knowledge Transfer Network. Findings - The paper highlights numerous benefits that behavioural finance research can contribute to the financial industry, but at the same time there is an evident discrepancy between the academic and the professional world when it comes to utilising behavioural finance research. Practical implications - The paper highlights several areas where behavioural finance can contribute significant benefits to a wide array of aspects of the finance industry. Social implications - The paper seeks to inform behavioural finance issues so as to encourage collaboration between the academic world and finance practitioners. In so doing, the paper aims to encourage a greater awareness of individual decision-making frames and heuristics and how industry can apply these concepts to improve the allocation of finance products to society. Originality/value - The paper brings together a wide array of finance professionals and academics to encourage greater collaboration and mutual respect of each others interest in and uses for behavioural finance.

The banking and financial crisis in the UK: what is real and what is behavioural?

Purpose - The purpose of this paper is to reflect on the recent banking and financial crisis in the UK. It discusses the triggers of the crisis from a UK perspective and then examines the immediate reactions in the form of short-term policies and concludes with a discussion on longer-term policies. Design/methodology/approach - This is a conceptual paper that argues that some of the triggers of the crisis are real and some are behavioural. Findings - The crisis has its roots in the sub-prime crisis of the USA with spillover effects for the UK due to its well-developed and international financial sector. The systemic environment of high leverage in the financial, corporate and household sectors, the international nature of finance, and the opacity in banks balance sheets are real triggers. In contrast, the underestimation of risks by almost all agents in the economy is behavioural. Practical implications - The paper argues that some of the conditions that led to the crisis will not change and should now be incorporated in new banking regulations. This is particularly true in the case of behavioural factors. Optimism, greed, herding and underestimation of low-probability high-impact events, are all parts of human nature. Human nature will not change. Thus, it need better regulations. Social implications - Less privileged groups, such as the poor, the uneducated, and the elderly, need better regulation to make them less vulnerable not only to others biases but also to their own biases. Originality/value - The paper is original in discussing behavioural side of the crisis along with the real side of it.

The Leverage Effect on Stock Returns

This paper examines the relation between abnormal stock returns and leverage. Expanding on Modigliani and Miller’s (1958) Proposition II, abnormal returns are estimated using the asset pricing models of Sharpe and Lintner (the traditional Capital Asset Pricing Model, CAPM), of Fama and French and of Carhart. The findings indicate that returns are decreasing in firm leverage. This paper tests this relation empirically with other risk factors and finds that the results remain robust. The results show that leverage is a firm characteristic that loads on a risk factor. This evidence suggests that leverage should be priced as a risk factor and requires adequate incorporation into common asset pricing models.

Financial Distress Resolution in China - Two Case Studies

Purpose - The purpose of this paper is to examine two contrasting financially distressed companies in China and their restructuring strategies. Chinese firms are selected as providing a context where bankruptcy law is in its infancy and where the state is still heavily involved as a shareholder. As a result, the process of distressed company restructuring is likely to differ markedly from that observed in developed economies. Design/methodology/approach - The paper adopts a case study methodology to explore on an in-depth basis the features of the distress resolution process in the Chinese institutional context and to investigate how it differs from the process in more developed economies. The paper analyses the firms accounting-based performance to understand the nature of their difficulties. It then examines the complex restructuring procedures initiated and uses an event study approach to evaluate the stock markets reaction to these strategies. Findings - The distinguishing features of the Chinese restructuring process are as follows. First, the assets of distressed firms are sometimes transferred without payment being made in return. Second, social considerations play a role, in particular the states need to maintain employment levels or ensure the funding of redundancy payments. Finally, firms can remain in severe financial distress for extended periods of time; possible reasons for this are explored in the paper. Originality/value - The existing distress literature focuses on developed economies such as the USA and the UK. The paper provides an in-depth understanding of the special features of the Chinese situation, including the role of government and other more commercially driven shareholders; the subsequent importance of social policy issues; the protracted and complex nature of the restructurings; and the frequent use of mergers, share transfers, asset swaps and asset sales.

Estimating analyst's forecast accuracy using behavioural measures (Herding) in the United Kingdom

Purpose - The purpose of this paper is to identify herding behaviour on financial markets and measure the herding behaviour impact on the accuracy of analysts earnings forecasts. Design/methodology/approach - Two alternative measures of herding behaviour, on analysts earnings forecasts are proposed. The first measure identifies herding as the tendency of analysts to forecast near the consensus. The second measure identifies herding as the tendency of analysts to follow the most accurate forecaster. This paper employs the method of The Generalised Method of Moments in order to relax any possible biases. Findings - In both measures employed, a positive and significant relation is found between the accuracy of analysts earnings forecasts and herding behaviour. According to the first measure analysts exhibit herding behaviour by forecasting close to the consensus estimates. According the second herding measure, it is found that analysts tend to herd towards the best forecaster at the time. Finally, it is concluded that the accuracy of analysts forecasts increases as herding increases. Research limitations/implications - The present study triggers concerns for further research in the modelling of analysts forecasting behaviour. Originality/value - This paper proposes that a measure based on human biases is the best way to estimate and predict the analysts earnings forecast future accuracy.

The Characteristics of Corporate Distress in an Emerging Market: The Case of China

This paper is one of the first studies to empirically examine the nature and cause of financial distress in an emerging market context. This is important given the impact of the recent global privatization phenomenon. These privatized firms have since been subject to a new competitive environment, redefined objectives and management incentives. In this context, we investigate the characteristics of a sample of 100 distressed firms in China between 1999 and 2003. Existing bankruptcy and distress literature cites two main causes of financial distress: debt overhang and economic distress. By comparing the distressed firms financial and operating performance with that of their respective industries, we conclude that corporate distress in China is caused predominantly by firm level poor operating performance, not by leverage. Our evidence indirectly speaks to the debate that financial renegotiations between distressed firms and their creditors are inefficient. In addition, our sample provides a unique opportunity to study how (partial) government ownership affects firm performance and efficiency in the context of financial distress and soft budget constraints.

Do International Institutions Affect Financial Markets?: Evidence from the Greek Sovereign Debt Crisis

ABSTRACT This paper investigates the effects of the policy announcements from the International Monetary Fund, and European Union (EU) offices including the European Commission, the European Central Bank, the Euro Area ministers on financial and real sectors during the recent Greek Sovereign Debt Crisis. We also include the reactions of financial and real sectors to Rating Agencies, Greek government and Greek public that were actively involved. We find that financial sectors have stronger reactions to international institutions and Greek government policy action announcements than the real sectors. Banking and financial sectors react predominantly negatively to unfavorable announcements, while real sector responses are mixed. The immediate reaction to EU offices and troika policy announcements are the highest in banking with negative abnormal returns of more than 1.5% per day. Public riots following unfavorable EU announcements also generate high falls in banking and financial sectors. The results show that favorable effects of an announcement from an international organization can be offset by negative effects arising from protests from the public and negative responses of the local government to announcements from international organizations.

Worldwide impact of IMF policies during the Asian crisis: who does the IMF help, creditors or crisis countries?

This paper examines the effects of International Monetary Fund (IMF) policy announcements on financial markets worldwide. We investigate reactions from stock, bond, foreign exchange and futures markets and banking and financial companies during the Asian crisis. We explore the impact of IMF bailouts not only on crisis countries, but also on main creditor countries. We study the impact of local governments’ and public responses in crisis countries to account for interaction between the IMF and local parties. We show IMF involvement and local governments’ co-operation actually helps crisis countries but not creditors. We show that in crisis countries, financial markets generally react unfavourably to their governments’ initial demands for IMF assistance, while compliance of the crisis countries with the IMF policy action is commonly perceived as good news. Financial markets in crisis countries react negatively to prolonged negotiations and government actions against IMF policy. Creditor countries’ financial markets are not responsive to IMF actions in crisis countries. We discuss policy implications of findings.

The effect of leverage mimicking portfolios in explaining stock returns variations

Purpose - The purpose of this paper is to explore the effect of leverage mimicking factor portfolios in explaining stock return variations. This paper broadens the focus of the current asset pricing literature by forming portfolios mimicking the leverage factor. Design/methodology/approach - Following Fama and Frenchs and Carharts procedure in forming size, book-to-market and momentum mimicking portfolios, the authors of this paper form leverage mimicking factor portfolios to explain stock returns. A five factor model is constructed that explains the variations in stock returns better relative to the other asset pricing models including the Fama-French-Carhart four factor model. Findings - The findings indicate that the leverage mimicking portfolio helps to explain stock return variations better relative to the other asset pricing models including the Fama-French-Carhart four factor model. Results are robust to other risk factors. Research limitations/implications - The results lead us to explore further avenues in using other risk factors in asset pricing such as future work to consider other cross-sectional attributes such as the stochastic behaviour of earnings or profitability that might also produce common variation in stock returns. There may be other risk factors that carry a premium and thus can be used for asset pricing. Practical implications - The papers findings are important in fund management when selecting or evaluating portfolio performance. The authors introduce an additional factor that has a sound theoretical appeal and show that leverage mimicking factor portfolios provide additional information in pricing assets, both in the cross section of all shares and in different sectors. Originality/value - To the best of the authors knowledge this is the first study of the effect of leverage mimicking factor portfolios in explaining stock return variations.

The UK Crisis of 2008: What is Real and What is Behavioural?

This paper is about the crisis of 2008 in the UK. I first discuss the triggers of the crisis in the UK, then go over the immediate reactions to it in the form of short term policies and conclude with a discussion of long term policies. The crisis of 2008 has its roots in the sub-prime crisis of the US. UK imported it due to its well developed and international financial sector. Some of the triggers of the crisis of 2008 are real and some are behavioural. Systemic nature of high leverage in all sectors including financial, corporate and household, international nature of financial sector, and opacity of balance sheets are the real triggers. The underestimation of risks by almost all agents in the economy is behavioural. I argue that some of the conditions that led to the Crisis of 2008 will not change and should be regulated. Behavioural factors should now be considered carefully in designing the new regulation.