Quarterly publication of the Multinational Finance Society, a non-profit corporation     ISSN 1096-1879

An Admissible Macro-Finance Model of the US Treasury Market.
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 1–38)

Peter Spencer
University of York, U.K.

This paper develops a macro-finance model of the yield curve and uses this to explain the behavior of the US Treasury market. Unlike previous macro-finance models which assume a homoscedastic error process and suppose that the one-period return is directly observable, I develop a general affine model which relaxes these assumptions. My empirical specification uses a single conditioning factor and is thus the macro-finance analogue of the EA1(N) specification of the mainstream finance literature. This model provides a decisive rejection of the standard EA0(N) macro-finance specification. The resulting specification provides a flexible 10-factor explanation of the behavior of the US yield curve, keying it in to the behavior of the macroeconomy. (JEL: C13, C32, E30, E44, E52)

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European Put-Call Parity and the Early Exercise Premium for American Currency Options
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 39–54)

Geoffrey Poitras
Simon Fraser University, Canada
Chris Veld
University of Stirling, U.K.
Yuriy Zabolotnyuk
Carleton University, Canada

The European put-call parity condition is used to estimate the early exercise premium for American currency options traded on the Philadelphia Stock Exchange. Using a sample of 331 pairs of call and put options with the same exercise price and time to expiration, evidence is provided for early exercise premiums that average 5.03% for put options and 4.60% for call options. The premiums for both call and put options are strongly related to the interest rate differential and time to expiration. These results have implications for the use of European option pricing models in the valuation of American options. (JEL: G10, G12, G13, G14)

Keywords: European put-call parity; currency options; early exercise premium

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The Risks in CDO-Squared Structures
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 55–74)

Andrew Adams
University of Edinburgh Business School, U.K.
Rajiv Bhatt
Deloitte Touche Tohmatsu India Pvt. Ltd., India
James Clunie
Scottish Widows Investment Partnership, U.K.

The recent sub-prime debacle has brought ‘innovative’ structured credit products such as collateralized debt obligations under severe criticism. The complexity of some structured finance securities and difficulties in understanding their risks has been a common theme. This paper argues that CDO-squared structures can be so complex as to make risk assessment difficult. By modeling a simplified CDO-squared structure using Monte Carlo simulation, two of the risks unique to such structures are examined: default location risk and overlap risk. Failure to take account of these risks during a distressed credit environment will result in greater than anticipated losses among senior CDO-squared tranches.(JEL: G11, G15, G24)

Keywords: collateralized debt obligation; CDO-squared; default location risk; overlap risk; Monte
Carlo simulation

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Merging Activity as a Rational Explanation for the Long-Run Underperformance of IPO
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 75–102)

Patrick Sentis
University Montpellier, France

The phenomena of IPO underpricing and underperformance are examined in the same rational model. In this model, underpricing is caused by the presence of uninformed investors. Low-type firms carry out an IPO under the same conditions as high-type firms. Instead of investing by themselves, the latter prefer to merge with a bidder, which entails their delisting from the market. The behavior of these firms provides a rational explanation for the underperformance phenomenon since only low-type firms remain on the market. Initial preliminary findings are consistent with the basic idea of the model. We show that when mergers occur, the monthly average return of the remaining firms is significantly negative, whereas the monthly average return is not significantly different from zero for the months without mergers. This result suggests that mergers induce a depreciation effect on the remaining firms and could be a source of underperformance.(JEL: G32, G34)

Keywords: initial public offerings, underpricing, underperformance, delisted, takeover, merger.

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Towards Decoding Currency Volatilities
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 103–134)

D. Johannes Jüttner
Macquarie University, Sydney
Wayne Leung
Macquarie University, Sydney

This study examines on the basis of economic theory the determinants of exchange rate volatilities for a large number of currencies. We relate daily changes in GARCH(1,1) volatilities of exchange rates to the volatility changes of several of their presumed fundamental economic determinants in the context of a portfolio balance model. The use of high-frequency data limits the choice of the explanatory economic variables that can be included in empirical estimates. The first differences of GARCH(1,1) volatilities of share and bond price indices reflect portfolio trading decisions in corresponding markets for both assets. In the same vein, first differences of the gold price volatility, as an additional determinant, are related to exchange rate volatilities of two commodity currencies in the sample. The panel data estimates, using the Seemingly Unrelated Regression technique, produce coefficients with the expected signs and statistical significance. The results of our study enhance our understanding of high-frequency currency volatility changes for 19 currencies beyond the purview of announcement effects in the event studies framework (JEL: F31, G154, C22)

Keywords: Exchange rate volatilities, volatility relationships, GARCH modelling

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Taxation, Dividend Payments and Ex-Day Price-Changes
(Multinational Finance Journal, 2009, vol. 13, no. 1/2, pp. 135–154)

Sven-Olov Daunfeldt
The Ratio Institute, Sweden
Carina Selander
Umeå University, Sweden
Magnus Wikström
Umeå University, Sweden

The purpose of the paper is to study the effect of taxation on dividend payments and ex-dividend price-changes in Sweden during 1991-1995. Tax changes in Sweden during the 1990s were implemented in such a way that they provide an opportunity to include direct measures of the tax-treatment of dividends and capital gains in the empirical analysis, in contrast to previous studies. The results indicate that tax-reforms can have large effects on dividend payments, while the effects on ex-dividend price-changes are less conclusive.(JEL: G12, G35)

Keywords: censoring, dividend, ex-dividend, taxation.

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