Search

For fixed income investment, the preponderant risk is the clustering of defaults in the portfolio. Accurate prediction of such clustering depends on the knowledge of default correlation. We develop...

We examine the relation between capital structure decision and the incentive power of executive compensation that contains both cash and equity components. Our analytical model shows that executive...

For a well-diversified bond portfolio, default risk over the investment horizon is known as the major risk and the risk is largely from correlated defaults. While plenty of theoretical work about d...

Stigma has negative consequences for quality of life and HIV care outcomes. PositiveLinks is a mobile health intervention that includes a secure anonymous community message board (CMB). We investigated discussion of stigma and changes in stigma scores. Of 77 participants in our pilot, 63% were male, 49% Black, and 72% had incomes below the federal poverty level. Twenty-one percent of CMB posts (394/1834) contained stigma-related content including negative (experiencing stigma) and positive (overcoming stigma) posts addressing intrapersonal and interpersonal stigma. Higher baseline stigma was positively correlated with stress and negatively correlated with HIV care self-efficacy. 12-month data showed a trend toward more improved stigma scores for posters on the CMB versus non-posters (− 4.5 vs − 0.63) and for posters of stigma-related content versus other content (− 5.1 vs − 3.3). Preliminary evidence suggests that a supportive virtual community, accessed through a clinic-affiliated smartphone app, can help people living with HIV to address stigma.

In this study, we intend to reveal some problems with the classic valuation method – the weighted average cost of capital (WACC) method. We first address a fundamental question about WACC, that is, should WACC be interpreted as a spot rate, a forward rate or any kind of average of either of them? We show that the nature of WACC is the expected forward rate. We next demonstrate that without understanding this nature, we may misinterpret the famous MM formula and MM Proposition II, as well as develop incorrect valuation framework. Our findings provide insightful implications to academia and practitioners for the proper interpretation and implementation of the WACC method.

This paper puts forward a capital structure model that incorporates the impacts of dividend policy and personal taxes that are commonly ignored by the existing capital structure models. The results show that paying dividends can reduce the tax benefits from issuing debts, which explains why existing capital structure models commonly overestimate leverage ratios. The results further show that as dividend payout increases, leverage ratios and credit spreads increase too. By incorporating the impacts of dividend policy and personal taxes, the capital structure model established in this paper can generate wide range of leverage ratios and credit spreads, which are consistent with what are observed in the real world.

The equivalent annual cost (EAC) method is a useful tool in asset pricing, lease financing and corporate investment. It deals with projects with different economic lives and has wide applications in many fields outside the finance or even business. However, the important EAC concept and its applications are not always very well understood even within the finance academia. There are a few misunderstandings surrounding 1this widely taught and practiced methodology as evidenced by our experience with finance professionals over the past decades and the lack of clarity in all the mainstream textbooks we have surveyed. One of them is the misconception that the EAC method requires infinite time horizon and infinite repetitions of the identical project or equipment. Given its importance and wide application, the finance profession has an obligation to serve well its gatekeeper role by not overlooking these misconceptions. Thus far, no one has raised and addressed these misconceptions. We fill in this void by explicitly revealing, explaining and addressing these misconceptions. Specifically, we argue that infinite horizon is a convenience but not a necessity by showing how the method can be used for projects or assets with finite horizons and what cautions one has to take. We also provide threads for future studies along this line. Our work makes a marginal contribution the finance theory, pedagogy and practice.

We examined the effects of sovereign risk on bond duration in European and Latin American sovereign bond markets over the period 1996 to 2011. We compared the sovereign risk-adjusted duration with the Macaulay duration for both investment- and speculative-grade US dollar-denominated sovereign bonds. We found that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for all ratings, and the ‘shortening’ effect is stronger for lower rated bonds, which generally intensified during the recent financial crisis. Results are robust when credit default swap (CDS) prices are used as a proxy for changes in sovereign risk. This study provides evidence for advocating the importance of adjusting the bond duration for sovereign risk. More important, this study provides a practical methodology for estimating a sovereign risk-adjusted duration measure for managing international bond portfolios.

This paper presents a new approach for estimating default correlation by linking default correlation to equity return correlation while preserving the fundamental relation between default and asset correlations in the structural framework. Our hybrid model thus overcomes a long-standing empirical difficulty that default correlation estimation relies on the unobservable asset process. The empirical analysis shows that our hybrid model demonstrates a considerable improvement over the existing structural model of Zhou (2001) for the sample periods of 1970-1993 and 1990-2010. We also illustrate the difference between the two models in predicting default correlations over the period of the 2008 financial crisis.

This paper examines the effect of sovereign risk on bond duration. We compare the sovereign risk-adjusted duration for U.S. dollar-denominated Asian sovereign bonds with their Macaulay duration for both investment grade bonds and speculative grade bonds. We find that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for all bonds, regardless of their bond rating and their maturity. Further, the “shortening” effect of sovereign risk on duration gets stronger as bond rating deteriorates and in recessionary conditions. Our findings provide strong support for the importance of adjusting for sovereign risk when bond portfolio managers apply the popular duration measure to hedge interest rate risk.

This paper examines one of the major problems in credit risk models widely used in the financial industry to forecast future defaults and bankruptcies. We find that even after proper calibration, a representative credit risk model can severely underestimate default correlation. We further find that a likely reason for the underestimation of default correlation is the problematic common practice in the financial industry of using observable equity correlation as a proxy for unobservable asset correlation when the model is applied to predict default correlation. However, our results show that this proxy in common practice is not valid.

This paper incorporates human capital into the well-established portfolio theory by allowing for job security in personal portfolio choice. Our model predicts that young people hold more cash to hedge against risk associated with human capital (layoff risk). As people age, layoff risk decreases, and consequently, they invest in more risky assets – stocks in their portfolios. However, as people approach retirement, their human capital diminishes, and they become more risk averse. Hence, they hold more cash again. Our model provides a plausible explanation for the observed investment behavior of people who reveal humped shape stock holdings over the life cycle. Our results suggest that financial advisors should take into account different levels of job security when giving financial advice to different individuals.

This paper examines the effects of default risk, call risk, and their interactions on bond duration. We find that call risk decreases durations of default-free bonds, while default risk alone generally decreases durations for risky bonds with only a few exceptions. The joint effect of default and call risk always results in shorter durations for corporate bonds. Controlling for the effect of default risk, call risk has a negative effect on duration, which diminishes as bond ratings decline. Finally, the effect of call risk on duration depends on bond characteristics. Empirical evidence shows that the effect of call risk is smaller for discount bonds and for deep-discount fallen angels.

In this paper, we argue that accounting curricula should be expanded to cover the topic of real options. Our argument relies on reference to the [American Institute of Certified Public Accountants (AICPA) (1999) ( Core Competency Framework , New York, NY: AICPA Accessed 21.08.08], the framework for curriculum change espoused by [Arya, A., Fellingham, J. C., & Schroeder, D. A. (2003). An academic curriculum proposal. Issues in Accounting Education , 18 (1) 29–35], a global study of core competencies for management accountants [International Federation of Accountants (IFAC), (2002). Competency profiles for management accounting practice and practitioners. New York, NY: International Federation of Accountants], a global capital-budgeting “best practices statement” [International Federation of Accountants (IFAC), (2008). International good practice guidance: Project appraisal using discounted cash flow . New York, NY: International Federation of Accountants], current specifications of the CMA exam [Institute of Management Accountants (IMA), (2008). Certified management accountant (CMA) learning outcome statements (effective 07/01/04), updated 07/2008 . Accessed 29.10.08.], and elements of the Albrecht and Sack report [Albrecht, W. S., & Sack, R. J. (2000). Accounting education: Charting the course through a perilous future . Accounting education series, Vol. 16. Sarasota, FL: American Accounting Association]. We make special reference to the linkage of the topic of real options to two broad educational goals: decision-modeling and risk analysis. Existing resources that accounting faculty can use to incorporate real options into the curriculum are limited. As a response, we provide an extended example that accounting educators can use to cover the topic of real options. This example uses a set of binomial trees (one for cash inflows and another for cash outflows). The step-by-step approach presented in this paper allows students without a technical/mathematical background to extend discounted-cash-flow (DCF) decision models (e.g., NPV) to incorporate real options that are embedded in proposed investment projects.

Using a popular three-factor term structure model that accounts for the correlation between default and interest rates to fit corporate bond yields, we uncover missing factors in the model. The principal component analysis indicates that the model residuals of bonds across different ratings and maturities are driven by some common factors. Further analysis shows that residuals exhibit significant negative correlation with the concurrent and lagged monthly returns of S&P 500. Our results suggest that the term structure model of corporate bonds should incorporate aggregate economic factors in order to better explain the term structure of corporate bond yields.

We examine the interactive effect of default and interest rate risk on duration of defaultable bonds. We show that duration for defaultable bonds can be longer or shorter than default-free bonds depending on the relation between default intensity and interest rates. Empirical evidence indicates that in most cases duration for defaultable bonds is much shorter than for their default-free counterparts because of the negative relation between default risk and interest rates. Results suggest that the duration measure must be adjusted for the effects of default risk and stochastic interest rates to achieve an effective bond portfolio immunization.

The study examines the joint effect of sovereign and call risks on the duration of callable sovereign bonds over the period 1996–2011. The results indicate that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for U.S. dollar-denominated investment-grade callable sovereign bonds. Further, the “shortening” effect of sovereign and call risks on duration is generally stronger among bonds of lower ratings. Similar results are obtained when CDS prices are used as a proxy for changes in sovereign risk. Results from this study emphasize the importance of considering the joint effect of sovereign and call risks in managing the interest rate risk exposure in fixed income investments.

Default correlation is a critical concept in risk management for fixed income investment, bank management, and insurance industry, working capital management, among many. We extend the Leland-Toft term structure model into a two-firm environment and predict the default correlation between two firms by directly simulating the calibrate model based on the observed equity data (1990-2010) for various ratings. Using our empirical default correlation estimation as the benchmark, our investigation sheds more light on the structural approach in predicting default correlation. The results show that our approach outperforms the previous Zhou’s model, thereby our approach is not only theoretical improvement, but also has an empirical advantage.

We examine effects of sovereign risk on bond duration in European and Latin American sovereign bond markets over the period 1996-2011. We compare the sovereign risk-adjusted duration for U.S. dollar-denominated sovereign bonds with their Macaulay duration for both investment- and speculative-grade bonds. We find that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for all bonds, regardless of the bond rating and maturity. Further, the “shortening” effect of sovereign risk on duration is generally stronger among bonds of lower ratings. During the recent global financial crisis, the “shortening” effect was dampened for quality sovereign bonds. But the sovereign risk effect on duration was intensified for BBB and BB rated bonds, reflecting investors’ perception of increasing likelihood of default by issuing nations. Results are robust when CDS prices are used as a proxy for changes in sovereign risk. Moreover, the regional analysis shows that sovereign risk shortens duration much less for sovereign bonds issued by the EU and Latin American countries than for non-EU member counterparts. Our study demonstrates the importance of, and provides a practical guide for, bond portfolio managers to account for sovereign risk in managing interest rate risk exposure in their investments.

We investigate the relationship between underwriter reputation and earnings management of IPO firms over the period of 1991-2005. We find that IPO firms engage in less earnings management if they are underwritten by prestigious investment bankers. Furthermore, the role of prestigious underwriters in restraining earnings management of IPO issuers do not change during the Internet Bubble period or after the passage of the Sarbanes-Oxley Act (SOX). The findings support the certification role of underwriters in the IPO process. We also document that firms going public in the post-SOX period engage in less earnings management compared to firms going public in the pre-SOX period. Further findings suggest that the changing objectives of venture capitalists may explain the reduction in the level of earnings management of IPO firms following the passage of SOX.