Search results
1 – 10 of over 10000This paper examines the implications of standard barter models of market equilibrium for financial security returns in New Zealand. The key question addressed is: does the ‘equity…
Abstract
This paper examines the implications of standard barter models of market equilibrium for financial security returns in New Zealand. The key question addressed is: does the ‘equity premium puzzle’ of Mehra and Prescott (1985) found in the U.S. also hold in ?ew Zealand? To examine the existence of the equity premium puzzle, quarterly financial security returns and consumption data are examined from 1965 to 1997 to calibrate parameters in the Consumption Based Asset Pricing Model. Unlike much of the existing international evidence, this paper corrects for durable goods consumption following the assumptions of the model that all consumption be consumed in a given period. Numerical analyses indicate that the class of models examined are unable to generate equity premia consistent with historical estimates of the equity premium in New Zealand. Due to small sample variability however, while this discrepancy is material in size, the result is not statistically significant.
In this paper, it is argued that previous estimates of the expected cost of equity and the expected arithmetic risk premium in the UK show a degree of upward bias. Given the…
Abstract
In this paper, it is argued that previous estimates of the expected cost of equity and the expected arithmetic risk premium in the UK show a degree of upward bias. Given the importance of the risk premium in regulatory cost of capital in the UK, this has important policy implications. There are three reasons why previous estimates could be upward biased. The first two arise from the comparison of estimates of the realised returns on government bond (‘gilt’) with those of the realised and expected returns on equities. These estimates are frequently used to infer a risk premium relative to either the current yield on index‐linked gilts or an ‘adjusted’ current yield measure. This is incorrect on two counts; first, inconsistent estimates of the risk‐free rate are implied on the right hand side of the capital asset pricing model; second, they compare the realised returns from a bond that carried inflation risk with the realised and expected returns from equities that may be expected to have at least some protection from inflation risk. The third, and most important, source of bias arises from uplifts to expected returns. If markets exhibit ‘excess volatility’, or f part of the historical return arises because of revisions to expected future cash flows, then estimates of variance derived from the historical returns or the price growth must be used with great care when uplifting average expected returns to derive simple discount rates. Adjusting expected returns for the effect of such biases leads to lower expected cost of equity and risk premia than those that are typically quoted.
Details
Keywords
Peter J. Phillips, Michael Baczynski and John Teale
The purpose of this paper is to determine whether self‐managed superannuation fund (SMSF) trustees earn: the equity risk premium or any premium to the riskless rate of interest.
Abstract
Purpose
The purpose of this paper is to determine whether self‐managed superannuation fund (SMSF) trustees earn: the equity risk premium or any premium to the riskless rate of interest.
Design/methodology/approach
Using a sample of 100 SMSFs, the average annual returns since inception of the funds in the sample are compared with: the average annual equity risk premium since that time and the average yield of Commonwealth Government Securities since that time.
Findings
The investigation reveals: the SMSFs in the sample do not earn the equity risk premium and the SMSFs in the sample did not earn a premium to riskless rate of interest. This leads to the conclusion that the SMSFs have borne risk without commensurate reward. Research limitations/implications – The trustees' rationale for making particular investment decisions and the consistency of the portfolio structures with the risk profiles of the trustees are two areas that may be fruitfully explored in future research.
Practical implications
For SMSF trustees, a simple portfolio that divides assets between (unmanaged) index funds and risk‐free securities on the basis of trustees' risk aversion may generate better results than the existing portfolios. For policy makers, the relatively poor performance of SMSFs implies that the superannuation system as currently structured may not be generating returns that will maximize retirement incomes.
Originality/value
The paper provides the first comparison of SMSF returns with the equity risk premium and the riskless rate of interest measured at appropriate horizons.
Details
Keywords
I survey applications of Markov switching models to the asset pricing and portfolio choice literatures. In particular, I discuss the potential that Markov switching models have to…
Abstract
I survey applications of Markov switching models to the asset pricing and portfolio choice literatures. In particular, I discuss the potential that Markov switching models have to fit financial time series and at the same time provide powerful tools to test hypotheses formulated in the light of financial theories, and to generate positive economic value, as measured by risk-adjusted performances, in dynamic asset allocation applications. The chapter also reviews the role of Markov switching dynamics in modern asset pricing models in which the no-arbitrage principle is used to characterize the properties of the fundamental pricing measure in the presence of regimes.
Details
Keywords
Anastasios G. Malliaris and Ramaprasad Bhar
The equity premium of the S&P 500 index is explained in this paper by several variables that can be grouped into fundamental, behavioral, and macroeconomic factors. We hypothesize…
Abstract
The equity premium of the S&P 500 index is explained in this paper by several variables that can be grouped into fundamental, behavioral, and macroeconomic factors. We hypothesize that the statistical significance of these variables changes across economic regimes. The three regimes we consider are the low‐volatility, medium‐volatility, and high‐volatility regimes in contrast to previous studies that do not differentiate across economic regimes. By using the three‐state Markov switching regime econometric methodology, we confirm that the statistical significance of the independent variables representing fundamentals, macroeconomic conditions, and a behavioral variable changes across economic regimes. Our findings offer an improved understanding of what moves the equity premium across economic regimes than what we can learn from single‐equation estimation. Our results also confirm the significance of momentum as a behavioral variable across all economic regimes
Details
Keywords
C. Correia and P. Cramer
This study employs a sample survey to determine and analyse the corporate finance practices of South African listed companies in relation to cost of capital, capital structure and…
Abstract
This study employs a sample survey to determine and analyse the corporate finance practices of South African listed companies in relation to cost of capital, capital structure and capital budgeting decisions.The results of the survey are mostly in line with financial theory and are generally consistent with a number of other studies. This study finds that companies always or almost always employ DCF methods such as NPV and IRR to evaluate projects. Companies almost always use CAPM to determine the cost of equity and most companies employ either a strict or flexible target debt‐equity ratio. Furthermore, most practices of the South African corporate sector are in line with practices employed by US companies. This reflects the relatively highly developed state of the South African economy which belies its status as an emerging market. However, the survey has also brought to the fore a number of puzzling results which may indicate some gaps in the application of finance theory. There is limited use of relatively new developments such as real options, APV, EVA and Monte Carlo simulation. Furthermore, the low target debt‐equity ratios reflected the exceptionally low use of debt by South African companies.
Details
Keywords
Kyriacos Kyriacou, Jakob B. Madsen and Bryan Mase
The aim of this paper is to identify why the historically observed equity risk premium is larger than most researchers believe is reasonable. Whilst equity is undoubtedly riskier…
Abstract
Purpose
The aim of this paper is to identify why the historically observed equity risk premium is larger than most researchers believe is reasonable. Whilst equity is undoubtedly riskier than government issued securities, the extent of the realised premium on equity has been characterised as a “puzzle”.
Design/methodology/approach
This paper measures the equity premium for a number of countries over the past 132 years, and then uses a pooled cross‐section and time‐series analysis to investigate the relationship between the equity premium and inflation.
Findings
This paper shows that the equity premium over the past 132 years has been significantly positively related to the rate of inflation and, therefore, has resulted in an equity premium that is substantially higher in the post 1914 period than before. This effect results from the relative performance of bonds and stocks during inflationary periods. The relatively poor performance of bonds during periods of inflation drives much of the equity premium.
Research limitations/implications
Counterfactual simulations in the paper show that the average equity premium post 1914 would have been 4.61 per cent and not 7.34 per cent had the rate of inflation been zero. This is much closer to theoretically derived estimates.
Practical implications
The size of the equity premium has implications for investors' asset allocation decision. The importance of inflation suggests that in a low inflation environment, the expected equity premium will be considerably lower than the historically realised equity premium.
Originality/value
This paper establishes a clear link between the rate of inflation and the equity premium.
Details
Keywords
Rana Ahmad Baker and Ali Al‐Thuneibat
The purpose of this paper is to investigate the relation between audit firm tenure and the perceived audit quality measured by the client‐specific equity risk premium. The study…
Abstract
Purpose
The purpose of this paper is to investigate the relation between audit firm tenure and the perceived audit quality measured by the client‐specific equity risk premium. The study population consists of all the manufacturing and service firms traded in Amman Bourse during the period 2002‐2005.
Design/methodology/approach
The Boone et al. model – with some modifications – was used for testing the hypotheses.
Findings
The results show that the relation between audit firm tenure and equity risk premium is positive, the equity risk premium increases with tenure as a result of reduced audit quality. These results were consistent with some previous studies, which showed that long relationships between an audit firm and a client are associated with lower perceived audit quality and, as a result, higher equity risk premium.
Practical implications
The audit firm should be rotated in order to enhance auditor independence and audit quality, and increase investors' confidence in reported earnings. Additionally, investors are encouraged to give higher attention to the tenure of the audit firm when evaluating the quality of the financial reports of the companies they are planning to invest in.
Originality/value
This is the first paper to provide evidence from a developing country about an important issue – audit quality – which is expected to support and sustain improvement of audit quality, and therefore, financial reporting quality.
Details
Keywords
Otto Randl, Arne Westerkamp and Josef Zechner
The authors analyze the equilibrium effects of non-tradable assets on optimal policy portfolios. They study how the existence of non-tradable assets impacts optimal…
Abstract
Purpose
The authors analyze the equilibrium effects of non-tradable assets on optimal policy portfolios. They study how the existence of non-tradable assets impacts optimal asset allocation decisions of investors who own such assets and of investors who do not have access to non-tradable assets.
Design/methodology/approach
In this theoretical analysis, the authors analyze a model with tradable and non-tradable asset classes whose cash flows are jointly normally distributed. There are two types of investors, with and without access to non-tradable assets. All investors have constant absolute risk aversion preferences. The authors derive closed form solutions for optimal investor demand and equilibrium asset prices. They calibrated the model using US data for listed equity, bonds and private equity. Further, the authors illustrate the sensitivities of quantities and prices with respect to the main parameters.
Findings
The study finds that the existence of non-tradable assets has a large impact on optimal asset allocation. Investors with (without) access to non-tradable assets tilt their portfolios of tradable assets away from (toward) assets to which non-tradable assets exhibit positive betas.
Practical implications
The model provides important insights not only for investors holding non-tradable assets such as private equity but also for investors who do not have access to non-tradable assets. Investors who ignore the effect of non-tradable assets when reverse-engineering risk premia from asset covariances and market capitalizations might severely underestimate the equity risk premium.
Originality/value
The authors provide the first comprehensive analysis of the equilibrium effects of non-tradability of some assets on optimal policy portfolios. Thus, this paper goes beyond analyzing the effects of market imperfections on individual portfolio choices.
Details
Keywords
Asgar Ali, K.N. Badhani and Ashish Kumar
This study aims to investigate the risk-return trade-off in the Indian equity market at both the aggregate equity market level and in the cross-sections of stock return using…
Abstract
Purpose
This study aims to investigate the risk-return trade-off in the Indian equity market at both the aggregate equity market level and in the cross-sections of stock return using alternative risk measures.
Design/methodology/approach
The study uses weekly and monthly data of 3,085 Bombay Stock Exchange-listed stocks spanning over 20 years from January 2000 to December 2019. The study evaluates the risk-return trade-off at the aggregate equity market level using the value-weighted and the equal-weighted broader portfolios. Eight different risk proxies belonging to the conventional, downside and extreme risk categories are considered to analyse the cross-sectional risk-return relationship.
Findings
The results show a positive equity premium on the value-weighted portfolio; however, the equal-weighted portfolio of these stocks shows an average return lower than the return on the 91-day Treasury Bills. The inverted size premium mainly causes this anomaly in the Indian equity market as the small stocks have lower returns than big stocks. The study presents a strong negative risk-return relationship across different risk proxies. However, under the subsample of more liquid stocks, the low-risk anomaly regarding other risk proxies becomes moderate except the beta-anomaly. This anomalous relationship seems to be caused by small and less liquid stocks having low institutional ownership and higher short-selling constraints.
Practical implications
The findings have important implications for investors, managers and practitioners. Investors can incorporate the effects of different highlighted anomalies in their investment strategies to fetch higher returns. Managers can also use these findings in their capital budgeting decisions, resource allocations and other diverse range of direct and indirect decisions, particularly in emerging markets such as India. The findings provide insights to practitioners while valuing the firms.
Originality/value
The study is among the earlier attempts to examine the risk-return trade-off in an emerging equity market at both the aggregate equity market level and in the cross-sections of stock returns using alternative measures of risk and expected returns.
Details