Review of Pacific Basin Financial Markets and Policies

We examine co-movements of nine Asian equity markets with both the US and Japan with special interest in distinguishing co-movements during periods of positive returns from those during periods of negative returns. A discrete asymmetric piecewise linear conditional mean returns specification is adopted to generate asymmetric co-movement parameters for periods of positive and negative returns. Conditional heteroskedasticity is modeled using GARCH and EGARCH specifications. Predicted conditional volatilities are used to generate alternative estimates of asymmetric and time-varying co-movement parameters. Conditional mean returns from asymmetric and symmetric conditional mean return models along with GARCH and EGARCH volatilities are used to generate estimates of asymmetric and symmetric conditional (ex-ante) Sharpe ratios. Asian markets returns and volatilities show a clear tendency to move more with the US than with Japan; and their co-movements with negative US returns far exceed their co-movements with positive US returns, thereby suggesting that any diversification benefits into Asian equities are likely to manifest themselves more during periods of positive than negative US returns. Conditional asymmetric Sharpe ratios exceed conditional symmetric Sharpe ratios; however, and more importantly, performance-ranking differs depending on whether asymmetric versus symmetric conditional Sharpe ratios are used. Asymmetric conditional Sharpe ratios suggest that India (followed by Malaysia) offers the best return/risk tradeoff, with the least favorable market is South Korea (using GARCH) and Philippines (using EGARCH).

This paper investigates the monthly initial return and its conditional return volatility for Chinese IPOs. We find that the mean initial return (IR) and cross-sectional return volatility are highly auto- and cross-correlated, and time-varying. We propose a system of two simultaneous equations: a GARCH-in-mean (GARCH-M) process with an ARMA(1,1) adjustment in the residuals for the IR and an EGARCH process for the conditional return volatility, assuming that the IR and its conditional return volatility are linear functions of the same market, firm- and offer-specific characteristics. We find that the model captures both time-series and cross-sectional correlations at the mean and variance levels. Our findings suggest that the conditional return volatility affects the IR positively and significantly, in addition to the traditional market, firm- and offer-specific characteristics. IPOs with higher conditional return volatility, as a proxy for information asymmetry, tend to be underpriced more. The paper demonstrates the merit of using a conditional variance model, along with time series and cross-sectional analysis to price Chinese IPOs.

China has taken important steps to reform its economy and capital markets in the past 20 years. Despite these efforts there is a lack of quantitative evidence on how these measures have impacted price returns in the stock exchanges. The purpose of this research was to determine the randomness of Chinese equity returns and to measure the scaling property of volatility over time. The main assumption of the Efficient Market Hypothesis is that security returns follow the path of a random walk and that volatility scales with the square root of time. This notion was tested by analyzing daily stock returns of the Shanghai- and Shenzhen Composite Indexes between 1990 and 2013. The Kolmogorov–Smirnov (KS) test rejected the log-normal distribution and random walk hypothesis. The measured Hurst exponents revealed a multiscaling property of fractal Brownian motion and indicated the presence of long-range dependence. The findings also showed that the degree of persistence and cycle length has reduced over time.

In practice, it is observable that firms tend to smooth periodical earnings because periodical earnings are considered by capital markets as a proxy for firms' success, and therefore, are often operationalized by the respective compensation plans for managers. Considering financial hedging strategies such as purchasing financial derivatives, income smoothing can lead to a restricted use of financial derivatives even if it decreases firm value because the periodical changes of the value of financial derivatives possibly cause undesired volatilities in periodical earnings. In this paper, a deductive multi-period analytical decision model based on the capital market theory is presented to explain the influence of income smoothing on firms' hedging strategy. Thereby, principal-agent relations between a firm's investors and managers (decision makers) are assumed. Moreover, the decision model is applied to a real data set by conducting a sensitivity analysis. To our knowledge, this is the first paper to operationalize accounting constraints to determine how much a firm should hedge its risk exposure.

This study attempts to address two research questions on the idiosyncratic return volatility and stock price informativeness. First, whether idiosyncratic return volatility is a valid proxy for stock price informativeness in emerging markets, and if it is, whether there exists a monotonic relationship between the idiosyncratic return volatility and stock price informativeness throughout the whole sample. We find that the idiosyncratic return volatility reflects the stock price informativeness in China. However, such a relationship does not exist in a monotonic fashion. These results indicate that idiosyncratic return volatility serves as an information measure, but must be used with caution.

On 1 July, 2002, the Taiwan Stock Exchange changed its closing mechanism to a five-minute call auction to limit market manipulation at day's end and enhance the fairness of the closing price. This paper examines the effect of the new closing mechanism on the behavior of attention securities and analyzes the role of each trader type in attention securities' behavior. After the new mechanism, market volatility improved, trading activity and order aggressiveness reduced, while liquidity deteriorated. The closing prices of attention securities are mainly influenced by large individual investors and by domestic institutions, with the large individual investors showing the most intention to influence prices upward during the closing interval both before and after implementation of the five-minute call auction. However, introduction of the five-minute call auction made it more difficult and costly to influence closing prices.

Prior research has shown that credit downgrades affect firm's capital structure decision. However, after adjusting for biases associated with the use of market debt ratio and after controlling for simultaneity between credit ratings and leverage, we find that rating upgrades also play a role in firms' leverage. Contrary to previously reported findings, our evidence also indicates that the effect of rating downgrades on capital structure lasts for more than just one year.