Advances in Quantitative Analysis of Finance and Accounting

The following sections are included:

• Preface to Volume 6

• Contents

• List of Contributors

• Advances in Quantitative Analysis of Finance and Accounting Editorial Board

This chapter analyses the hedging decisions of an emerging economy which is exposed to market risks and whose debt contract is subject to collateral constraints. Within a sovereign debt model with default risk and endogenous collateral, the optimal choice of hedging instruments are studied when both futures and nonlinear derivatives are available. It is examined in which way the hedging policy is affected by the cost of default and the financial constraints of the economy and some implications are provided in terms of resource allocation.

As a more general approach, the authors formulate a concave quadratic programming model of the marketing strategy (QPMS) problem. Due to some built-in limitations of its corresponding linear programming version, the development of the QPMS model is necessary to further improve the research effort of evaluating the profit and sales impact of alternative marketing strategies. It is the desire of the authors that this study will increase the utilization of programming models in marketing strategy decisions by removing artificially restrictive limitations necessary for linear programming solutions, which preclude the study of interaction effects of quantity and price in the objective function. The simulation analysis of the QPMS and its linear counterpart LPMS indicates that the solutions of the QPMS model are considerably more consistent with a priori expectations of theory and real world conditions.

This study investigates two ways that sample selection can impact inferences about market efficiency: (1) unintentional, nonrandom exclusion of observations because of lack of available data for some firm-years (“passive deletion”); and (2) the effects of extreme return observations. The analysis proposes and illustrates a set of simple diagnostic tests designed to assess the sensitivity of estimated hedge portfolio returns to sample composition. These diagnostics are applied to the accrual anomaly and the forecast-to-price anomaly and the results indicate that the forecast-to-price anomaly is not robust to the effects of passive deletion. Moreover, extreme returns — as few as 100 firm-year observations — appear to generate the observed abnormal returns to both strategies.

This chapter examines the value relevance of earnings in high- and low-technology industries, a topic about which unresolved questions remain. The focus is on high-tech firms, given assertions that financial reporting is least effective for their industries. It is found that adjusting for expense mismatching is more effective in low-tech industries, while diversifying noise in high-tech industries substantially increases the association of earnings and stock returns. The value relevance of earnings for either type is indistinguishable when noise and expense mismatching are jointly controlled. It is thus concluded that noise arising from uncertainty of realizing future R&D benefits is the main factor explaining the weaker association of earnings and stock returns for high-tech firms.

Thirty years of Canadian evidence has been used to shed light on the motivation and implications of stock splits, stock dividends, and reverse splits. The maximum 5-year period before and after the “event” month was focused and the changes in stock return, earnings per share (EPS), beta, trading volume, number of transactions, price to earning ratio (P/E), valuation, and corporate governance characteristics were examined. Strong information signaling effect of stock splits was found, as well as persistent superior performance and a favorable change in relative valuation are observed in the post-stock split period. The total trading volume increases after stock split ex-date while the trading volume per transaction decreases considerably, signifying a possible change in investor composition. However, no accompanying change was found in the governance environment. The overall evidence supports the signaling hypothesis as well as the optimum price and the relative valuation hypotheses. Stock dividend and reverse stock split firms have significantly weaker stock performance and operating performance than stock split firms. The negative trend does not improve in a long-term after the ex-date.

In a recent article, Darrat et al. (2003) report results for the DJIA in which higher volume causes higher volatility without significant feedback. These empirical results have interesting behavioral interpretations. It is argued that the observed positive causality from volume to volatility supports overconfidence hypothesis over other alternatives, including Andreassen's (1990) salience hypothesis. The evidence suggests that investors suffer from a psychological error (overconfidence), inciting them to trade too aggressively and drive prices away from their fundamental values.

This chapter proposes a theoretical model of initial public offering by taking into account the uncertainty in security pricing and the underwriting process. Three major factors are shown to affect the IPO pricing: (1) the uncertainty of stock price, (2) the legal requirement that restricts underwriters from selling any part of the issue above the fixed offering price, and (3) the underwriters' risk tolerance. It is shown that underpricing is negatively related to the underwriter's risk tolerance, and positively related to the length of premarket period and market price volatility.

In this study, the determinants of profits to momentum/contrarian strategies were examined when applied to national stock market indexes. Using monthly stock market index data of 16 countries from December 1969 to December 2000, it is found that momentum strategies are profitable over horizons from 3 to 12 months, while contrarian strategies are profitable for long horizons such as 2 years or longer. However, the profit is statistically significant for only the 6-month horizon. The present decomposition analysis indicates that international momentum/contrarian profits are mainly due to the autocorrelations in these national market index returns, not to cross-serial correlations or to cross-sectional variation in their mean returns. Consistent with the trading strategy results, it is also found that most of the stock market indexes follow a mean-reverting process, implying positive autocorrelations in short-horizon returns and negative autocorrelations in long lags.

Earnings management is examined around the time of proposals of antitakeover charter amendments. Overall, weak but statistically significant, negative abnormal accruals are found in the proposal year. The overall result appears to be driven by firms proposing restrictive charter amendments, which have strong negative abnormal accruals in the proposal year. The present interpretation is that executives of firms proposing restrictive amendments manage earnings opportunistically in that they defer income-decreasing accruals in the year prior to the amendment proposal to after the shareholders have voted on the amendment.

Portfolio selection models are programmed by their respective efficiency criteria to fall into a state of first-order condition love with the right sort of outliers. Nothing is changed, unfortunately, when, in general, a deterministic portfolio optimization model's inputs are stochastic rather than parametric. Distributional properties of the input estimator functions employed by four common portfolio selection models are reviewed and their solution algorithms studied in search of unique interactive effects that may mitigate the estimation error problem. Empirical and analytic support is provided for the conclusion that there is one model, an unlikely hero, that is least susceptible.

This chapter examines the empirical effects of financial leverage (FL) (corporate capital structure) on the market value of a selection of firms listed on the Australian Stock Exchange, developing a direct value-leverage model. Employing a least square dummy variable method to a pooled time-series and cross-sectional data set, the results suggest that the value of a firm rises significantly with FL. More specifically, there is a statistically significant positive effect of total, total interest bearing, and long-term FL on the market value of a firm, suggesting that leverage matters even under the Australia's (full) dividend imputation tax system.

This chapter finds that the intraday Nikkei futures returns exhibit different patterns of momentum or mean reversion when changing observation intervals. Using a Markov chains methodology, a significant return momentum was found at 1-min observation interval. However, a significant return mean reversion was found at 10-min observation interval. This switching pattern of momentum to mean reversion is robust to intraday seasonality. Further, the sources that contribute to the high-frequency momentum and mean reversion are explored and it is concluded that large limit orders and the bid-ask effect can play the role.

The following sections are included:

• Index