Review of Pacific Basin Financial Markets and Policies

The interdependence of options is common among compound options. Moreover, this interconnectedness is synonymous with probability theory-how a set of axioms are treated. The conditionality, where one option value is dependent on another option, has spilled over to option pricing, especially exchange options. However, it seems that no study has explored whether that simultaneous occurrence of two options is conditional or not. This study uses conditional approaches (Radon–Nikodým derivative and probability theory) to illustrate conditionality in an exchange option. Furthermore, hedging strategy is derived based on straddles. The results show that due to conditionality another exotic option, tri-conditional option (also known as triple option) is derived. The hedging of a triple option encompasses both dynamic and static techniques.

The paper investigates the impact of fair value accounting for illiquid assets (so-called ‘Level 2’ and ‘Level 3’ assets by accounting rules) on banks’ valuation and focuses on the change in relative weight of Level 3 (the most opaque and illiquid assets) with respect to Level 2 assets. The boundary between Level 3 and Level 2 assets is blurred and less clear than the one between Level 1 and Level 2 assets. Such unclear borderline entails corporate governance issues and provides room for opportunistic behavior by managers to opt for less transparent instruments. The paper proposes the change in Level 3-to-Level 2 assets ratio as a new measure to capture deviations in the opacity of bank assets and suggests a negative relationship between this ratio and bank’s price-to-book value. The rationale behind this relationship is that market participants interpret growth in Level 3-to-Level 2 assets ratio as an increase in bank’s opacity, since Level 3 assets might be as illiquid as Level 2 assets with the benefit of a less transparent model-based valuation technique. Based on a sample of 33 European banks from 2009 to 2018, I find that an increase of 100bps in Level 3-to-Level 2 assets ratio is linked to a decrease of about 74bps in the price-to-book value. Results are robust for different measures of firm relative valuation and using a different measure of illiquidity in fair value assets holdings (Level 2-to-Level 1 assets ratio).

This study investigates the impact of diversification between traditional margin income and nontraditional income (noninterest-based income) on bank risk-taking and bank lending spread for banks operating in Pakistan. Bank risk is measured with the nonperforming loan ratio and bank $Z$-score. Data of this study is obtained from financial statements, which are an annual publication of State Bank of Pakistan, for the period 2006–2016 for 52 banks in Pakistan. Panel regression with the generalized method of moments (GMM) estimator is employed. The study reveals that an increase in noninterest income increases bank risk-taking (spending on highly risky assets), as noninterest income is riskier than interest income. It is also revealed that banks with greater dependence on noninterest income may grant a loan with lower lending spread. These results have implications for the betterment of the banking system, regulatory authority, and stakeholders as well. From a regulatory perspective, the study provides guidelines for making rules and regulations to control and monitor the dependence on noninterest income as well as on interest income. Pakistan banks regulatory authority should focus on the increase in disclosure of the composition of noninterest income and this disclosure would increase understanding of changing environment of banking in Pakistan.

This paper considers the response of the equity and oil markets to the onset of crisis conditions after February 15, 2020. Based on derivative markets for equities and WTI (West Texas Intermediate) crude-oil futures contracts, implied equity and oil volatilities quantify the depth of the crisis and contrast it with the previous ones. The estimated Black [(1976) Journal of Financial Economics, 3, 167–179] vol skew and Merton [(1976) Journal of Financial Economics, 3, 125–144] option model parameters are able to discern between demand- and supply-side facets. The time when the futures curve is in contango identifies the beginning and, to date, conclusion of the crisis. Using the CAPM, co-movement of oil and equity prices permits computing forecasts of spot oil prices. In considering these events, we recognize the essential role of prices in financial markets: They are conveyors of information, the “Message from Markets,” in which financial theory proves useful, practical and applicable.

Our paper investigates the relationship between corporate governance (internal corporate governance mechanism) and announcement returns of spinoff firms, and examines whether such relationship can be explained by product market competition (external corporate governance mechanism). Using a sample of 269 completed spinoffs between 1983 and 2009, we find a nonlinear U-shaped relationship between corporate governance and the cumulative abnormal return around the announcement period. Moreover, we find that such a nonlinear relationship hinges on the level of competition in the market in which the spinoff firms operate. Specifically, we find that weak governance firms experience higher announcement period return only in highly competitive industries, while strong governance firms exhibit higher announcement period return, but only in moderately competitive industries. Our findings reconcile the mixed results in the literature regarding the relationship between corporate governance and firm value by examining the effect of product market competition on this relationship. Our results highlight the importance of product market competition as a moderator between corporate governance and the announcement period return of the spinoff firms.

Previous research indicates that analysts’ forecasts are superior to time series models as measures of investors’ earnings expectations. Nevertheless, research also documents predictable patterns in analysts’ forecasts and forecast errors. If investors are aware of these patterns, analysts’ forecast revisions measured using the random walk expectation are an incomplete representation of changes in investors’ earnings expectations. Investors can use knowledge of errors and biases in forecasts to improve upon the simple random walk expectation by incorporating conditioning information. Using data from 2005 to 2015, we compare associations between market-adjusted stock returns and alternative specifications of forecast revisions to determine which best represents changes in investors’ earnings expectations. We find forecast revisions measured using a ‘bandwagon expectations’ specification, which includes two prior analysts’ forecast signals and provides the most improvement over random-walk-based revision measures. Our findings demonstrate benefits to considering information beyond the previously issued analyst forecast when representing investors’ expectations of analysts’ forecasts.

Duration and convexity are important measures in fixed-income portfolio management. In this paper, we analyze this measure of the bonds by applying the beta model. The general usefulness of the beta probability distribution enhances its applicability in a wide range of reliability analyses, especially in the theory and practice of reliability management. We estimate the beta density function of the duration/convexity. This estimate is based on two important and simple models of short rates, namely, Vasicek and CIR (Cox, Ingersoll, and Ross CIR). The models are described and then their sensitivity of the models with respect to changes in the parameters is studied. We generate the stochastic interest rate on the duration and convexity model. The main results show that the beta probability distribution can be applied to model each phase of the risk function. This distribution approved its effectiveness, simplicity and flexibility. In this paper, we are interested in providing a decision-making tool for the manager in order to minimize the portfolio risk. It is helpful to have a model that is reasonably simple and suitable to different maturity of bonds. Also, it is widely used by investors for choosing bond portfolio immunization through the investment strategy. The finding also shows that the probability of risk measured by the reliability function is to highlight the relationship between duration/convexity and different risk levels. With these new results, this paper offers several implications for investors and risk management purposes.