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

The Effect of Extreme Markets on the Benefits of International Portfolio Diversification
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 155–188)

Daniella Acker
University of Bristol, U.K.
Nigel W. Duck
University of Bristol, U.K.

We investigate the effects of bull and bear markets on correlations between developed and emerging country equity returns, and on the benefits of combining international markets in a portfolio. Contrary to most other studies we find that correlations fall in both bull and bear markets, although far more in the former; that emerging markets provide both additional diversification benefits for investors in developed markets and, especially, some protection during bear markets.(JEL: F3, G1, G10, G11, G15)

Keywords: International equity markets, correlations, portfolio choice.

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Modeling Volatility in Foreign Currency Option Pricing
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 189–208)

Ariful Hoque
Curtin University of Technology, Australia
Felix Chan
Curtin University of Technology, Australia
Meher Manzur
Curtin University of Technology, Australia

This paper presents a general optimization framework to forecast put and call option prices by exploiting the volatility of the options prices. The approach is flexible in that different objective functions for predicting the underlying volatility can be modified and adapted in the proposed framework. The framework is implemented empirically for four major currencies, including Euro. The forecast performance of this framework is compared with those of the Multiplicative Error Model (MEM) of implied volatility and the GARCH(1,1). The results indicate that the proposed framework is capable of producing reasonable accurate forecasts for put and call prices.(JEL: G12, G13)

Keywords: Foreign currency options, implied volatility, optimal volatility, multiplicative error model, GARCH model

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Benchmark Concentration: Capitalization Weights Versus Equal Weights in the FTSE 100 Index
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 209–228)

Isaac T. Tabner
University of Stirling, U.K.

Identifying a suitable benchmark is essential when testing asset pricing models, measuring the performance of active investors, or providing market proxy portfolios for passive investors. Concern that increased domination of capitalization weighted stock indices by a few large firms will lead to inefficient portfolio diversification is leading some investors and researchers to argue that index providers should adjust their weighting methods to limit concentration. This study tests and rejects the hypothesis that concentration arising as a result of capitalization weights in the FTSE 100 Index increases risk, either during normal market conditions or during negative tail events in the return distribution. On the contrary, during the left tail of the return distribution, the equally weighted portfolio of FTSE 100 Index constituents exhibits higher risk and lower returns than the capitalization weighted FTSE 100 Index portfolio, a finding consistent with variations of the CAPM that allow for time varying risk premia.(JEL: G11, G12, G14)

Keywords: stock index benchmarks, incremental returns, incremental standard deviation, portfolio diversification, capitalization weights, index concentration, performance measurement.

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A Structural form Default Prediction Model for SMEs, Evidence from the Dutch Market
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 229–264)

Frieda Rikkers
Tilburg University, Netherlands
André E. Thibeault
Vlerick Leuven Gent Management School, Belgium

The objective of this research is to develop a structural form probability of default model for small and medium-sized enterprises, dealing with the methodological issues which arise in the modelling of small commercial loan portfolios, and to test the applicability of the model in practice. Other motivations are to provide an extensive overview of the characteristics of SMEs, and to provide a list of characteristics that a PD model for SMEs should contain, e.g. time and cost efficiency, broad applicability, limited data requirements, and powerful in predicting default. The structural form model is developed and tested on a unique dataset of private firm’s bank loans of a Dutch bank. The results are promising; the model output differs significantly between defaulted and non-defaulted firms. The structural form model can be used on its own, or as an additional variable in a credit risk model. A second PD model is developed using logistic regression with a number of financial ratios, including the structural form measure. This variable is significant in default prediction of SMEs and has some additional predictive power, next to the popular financial ratios. Overall, the results indicate that the structural form model is a good indicator for default of SMEs. (JEL: C51, C52, G21, G28, G33)

Keywords: SME, probability of default, structural form credit risk model, Basel II

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Short-Sellers and Short Covering
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 265–292)

James Clunie
Scottish Widows Investment Partnership, U.K.
Peter Moles
University of Edinburgh Business School, U.K.
Tatiana Pyatigorskaya
Merrill Lynch Wealth Management, U.K.

This study fills an important gap in the literature on loss realization aversion. It shows how a ‘sophisticated’ sub-set of investors, namely short-sellers, react to losses. Using daily data on stock lending, we estimate the average price at which short positions were initiated, thus permitting a study of short-sellers’ responses to their own book losses. We find that short-sellers close their positions in response to losses and not simply in response to rising share prices. This is a key result and a distinction from findings in related research. We conclude that short-sellers do not exhibit an aversion to realizing losses, but instead accept their losses or ‘mistakes’ systematically. Stocks subject to short-covering in this manner do not subsequently under-perform the market, and so there is no evidence of an investment performance cost (other than transaction costs) associated with immediately covering short positions that fall to an accounting loss. As short-sellers are believed to play an important role in the setting of prices, the results of this study have implications for asset pricing and market efficiency.

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Robust Regression Estimation Methods and Intercept Bias: A Capital Asset Pricing Model Application
(Multinational Finance Journal, 2009, vol. 13, no. 3/4, pp. 293–321)

James B. McDonald
Brigham Young University, USA
Richard A. Michelfelder
Rutgers University, USA
Panayiotis Theodossiou
Rutgers University, USA
Cyprus University of Technology, Cyprus

Robust estimation techniques based on symmetric probability distributions are often substituted for OLS to obtain efficient regression parameters with thick-tail distributed data. The empirical, simulation and theoretical results in this paper show that with skewed distributed data, symmetric robust estimation techniques produce biased regression intercepts. This paper evaluates robust methods in estimating the capital asset pricing model and shows skewed stock returns data used with symmetric robust estimation techniques produce biased alphas. The results support the recommendation that robust estimation using the skewed generalized T family of distributions may be used to obtain more efficient and unbiased estimates with skewness. (JEL: G12, C13, C14, C15).

Keywords: CAPM; quasi-maximum likelihood estimator; robust estimator; skewed generalized T

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