Quarterly publication of the Multinational Finance Society     ISSN 1096-1879

The Equivalence of Causality Detection in VAR and VECM Modeling with Applications to Exchange Rates
(Multinational Finance Journal, 2006, vol. 10, no. 3/4, pp. 153–177)

T.J. Brailsford
UQ Business School, University of Queensland, Australia
J. H.W. Penm
The Australian National University, Australia
R.D. Terrell
The Australian National University, Australia

Vector error-correction models (VECM) are increasingly being used to capture dynamic relationships between financial variables. Estimation and interpretation of such models can be enhanced if zero restrictions are allowed in the coefficient matrices. Specifically, in tests of indirect causality and/or Granger non-causality in a VECM, the efficiency of the causality detection is crucially dependent upon finding zero coefficient entries where the true structure does indeed include zero entries. Such a VECM is referred to as a zero-non-zero (ZNZ) patterned VECM and includes full-order models. Recent advances have shown how ZNZ patterns can be explicitly recognized in a VECM and used to provide an effective means of detecting Granger-causality, Granger non-causality and indirect causality. This paper develops a general approach and framework for I(d) integrated systems. We show that causality detection in an I(d) system can be discovered identically from the ZNZ patterned VECM’s or the equivalent VAR models (JEL: C10, C63, F30, G10).

Keywords: error correction models, VAR, granger causality, purchasing power parity.

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Risk Management in Emerging Markets: Practical Methodologies and Empirical Tests
(Multinational Finance Journal, 2006, vol. 10, no. 3/4, pp. 179–221)

Marios Nerouppos
Cyprus International Institute of Management, Cyprus
David Saunders
University of Waterloo, Canada
Costas Xiouros
University of Southern California, U.S.A.
Stavros A. Zenios
University of Cyprus, Cyprus

Risk management has undergone a remarkable transformation over the past fifteen years, with most new methods having been designed for the concerns of large institutions operating in well-developed financial markets. This paper addresses a problem faced by smaller institutions operating in emerging markets, namely the significant lack of data. As many risk management techniques are data intensive, this problem may seem insurmountable. This paper introduces a new method, enriched historical simulation, which supplements the data in an emerging market with data from other markets. The principle behind this methodology is that when many markets are considered, the essence of emerging market economies comes to the fore, with local idiosyncrasies being washed out. This principle is illustrated on the problem of estimating Value-at-Risk on the Cyprus and Athens Stock Exchanges. Numerical tests show that standard models underestimate risks, but that estimates are improved significantly with the use of external data (JEL: C10, C80, G10, G15).

Keywords: risk management, historical simulation, value-at-risk, emerging markets.

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The Long-Run Stock Performance of Privatization IPOs
(Multinational Finance Journal, 2006, vol. 10, no. 3/4, pp. 223–250)

Seung-Doo Choi
Dongeui University, Korea
Sang-Koo Nam
Korea University, Korea

This paper compares the long-run buy-and-hold returns of privatization initial public offerings (IPOs) to those of the domestic stock markets of respective countries using a sample of 241 privatization IPOs from 41 countries. The evidence indicates that the privatization IPOs significantly outperform their domestic stock markets if the returns are equally-weighted while value-weighted returns show a sharp reduction in performance. However, there are substantial variations in the long-run performance of privatization IPOs across industries, issuing countries, issue period, and the origin of commercial law of the country. This paper also analyzes the cross-sectional determinants of the long-run buy-and-hold returns of privatization shares. The results indicate that the long-run performance of  privatization IPOs is significantly related to the proxies of policy uncertainty, consistent with the signaling models of Perotti (1995). Such effects appear to be overwhelming in the earlier post-IPO period, while the traditional market factors become more important as the policy uncertainty disappears over time. The institutional features of the country such as accounting standards, origin of commercial law, and corporate governance scheme also affect the return performance of privatization issues (JEL: G32).

Keywords: privatization, IPO, policy uncertainty, CAR, BHAR

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Closed-End Country Funds and International Diversification
(Multinational Finance Journal, 2006, vol. 10, no. 3/4, pp. 251–276)

Andreas Charitou
University of Cyprus, Cyprus
Andreas Makris
University of Cyprus, Cyprus
George P. Nishiotis
University of Cyprus, Cyprus

Using data from 1993 to 2002 for eight developed and fifteen emerging markets, we find that return correlations, mean-variance spanning, and Sharpe ratio tests support that closed-end country funds (CECF) can mimic their corresponding foreign indices, and that they are more heavily influenced by their corresponding local markets instead of the U.S. market. This implies that U.S. investors, by investing in CECF, can achieve similar international diversification benefits to those achieved by investing directly in the foreign indices. We also document increased correlation between the U.S. market and foreign markets during this period and find no compelling evidence of economically and statistically significant international diversification benefits, as opposed to a pre 1993 period. These findings could be associated with the financial market liberalization that was prevalent during the period (JEL: G15).

Keywords: closed-end country funds, international diversification, emerging markets, liberalization, spanning tests.

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The Valuation of Options on Bonds with Default Risk
(Multinational Finance Journal, 2006, vol. 10, no. 3/4, pp. 277–305)

Riadh Belhaj
Conservatoire National des Arts et Métiers, France

In this paper we present a model for valuing European and American options, which incorporates both default and interest rate risks. We develop a framework that permits evaluation of three kinds of options: (i) options issued by default-free counterparties on risky bonds, (ii) options issued by risky counterparties on default-free bonds and (iii) options issued by risky counterparties on risky bonds — a case where default risk enters at both levels. We show that the price of a put option on a risky discount bond is hump shaped for a European put and monotone increasing for an American put. We also find that the price impact of default risk is less for an American put option than for a European one (JEL: G13).

Keywords: option pricing, default risk, defaultable bonds, vulnerable options.

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