SSRN Viewer

This study examines whether application of IFRS by non-US firms results in accounting amounts comparable to those resulting from application of US GAAP by US firms. IFRS firms have greater accounting system and value relevance comparability with US firms when IFRS firms apply IFRS than when they applied domestic standards. Comparability is greater for firms that adopt IFRS mandatorily, firms in common law and high enforcement countries, and in more recent years. Earnings smoothing, accrual quality, and timeliness are potential sources of the greater comparability. Although application of IFRS has enhanced financial reporting comparability with US firms, significant differences remain.

Gorton and Rouwenhorst (2006) examined commodity futures returns over the period July 1959 to December 2004 based on an equally-weighted index. They found that fully collateralized commodity futures had historically offered the same return and Sharpe ratio as U.S. equities, but were negatively correlated with the return on stocks and bonds. Reviewing these results ten years later, we find that our conclusions largely hold up out-of-sample. The in- and out-of-sample average commodity risk premiums are not significantly different, nor is the cross-sectional relationship between average returns and the basis. Correlations among commodities and commodity correlations with other assets experienced a temporary increase during the financial crisis which is in line with historical experience of variation of these correlations over the business cycle.

At a time when distrust of corporate management is at an all-time high and the media are increasing their focus on corporate governance, Standard & Poor's has published a study that examines the transparency and disclosure (T&D) practices of major public companies around the globe. This article describes how the Standard & Poor's T&D study was conducted and what the finding reveal, addressing such questions as: Which companies provide the most extensive disclosure in their basic corporate filings? Which companies disclose above and beyond what the law requires? Are there significant differences among the T&D practices of various regions and within regions? What is the significance of the T&D rankings? How can T&D be improved? Standard & Poor's T&D rankings have a wide distribution across countries and regions and reveal some interesting findings about practices within and among the different countries and regions. For U.S. companies, there are significant differences in the amount of disclosure provided in annual reports. T&D rankings based on annual reports for the U.S. companies studies are correlated to the determinants of expected returns, such as market risk, size, and the price-to-book ratio.

We derive a partial differential equation (PDE) representation for the value of financial derivatives with bilateral counterparty risk and funding costs. The model is very general in that the funding rate may be different for lending and borrowing and the mark-to-market value at default can be specified exogenously. The buying back of a party's own bonds is a key part of the delta hedging strategy; we discuss how the cash account of the replication strategy provides sufficient funds for this. First, we assume that the mark-to-market value at default is given by the total value of the derivative, which includes counterparty risk. We find that the resulting pricing PDE becomes non-linear, except in special cases, when the non-linear terms vanish and a Feynman-Kac representation of the total value can be obtained. In these cases, the total value of the derivative can be decomposed into the default-free value plus a bilateral credit valuation and funding adjustment. Second, we assume that the mark-to-market value at default is given by the counterparty-riskless value of the derivative. This time, the resulting PDE is linear and the corresponding Feynman-Kac representation is used to decompose the total value of the derivative into the default-free value plus bilateral credit valuation and funding cost adjustments. A numerical example shows that the effect on the valuation adjustments of a non-zero funding spread can be significant. The Addendum for this paper is available at the following URL: http://ssrn.com/abstract=2109723

The “VERAVAL Valuation” forecasts a great future for ElectraBul with solid customer, sales and FCF growth. Between 2010 and 2019 the customer base is expected to grow by 60%, sales in MWh by 72%, etc. However, the “VERAVAL Valuation” concludes that the value of ElectraBul shares in April 2010 was $4.858 million. Four comparisons below support the conclusion that the “VERAVAL Valuation” falls short even in terms of the most basic common sense.Seven misconceptions in the “VERAVAL Valuation” are outlined and their enormous impact on the valuation is quantified.

All-cash homebuyers account for one-third of U.S. home purchases over 1980-2017. We use multiple datasets and research designs to robustly estimate that mortgaged buyers must pay an 11% premium over all-cash buyers to compensate home sellers for mortgage transaction frictions. A dynamic, representative-seller model implies only a 3% premium, which would suggest an 8% puzzle. Accounting for heterogeneity in selling conditions explains half of this difference, but there is still a puzzle in conditions with high transaction risk. An experimental survey of U.S. homeowners replicates these patterns and suggests that belief distortions can explain the puzzle in these high-risk states.

Current Monte Carlo pricing engines may face computational challenge for the Greeks, because of not only their time consumption but also their poor convergence when using a finite difference estimate with a brute force perturbation. The same story may apply to conditional expectation. In this short paper, following Fournie et al. (1999), we explain how to tackle this issue using Malliavin calculus to smooth the payoff to estimate. We discuss the relationship with the likelihood ratio method of Broadie and Glasserman (1996). We show on numerical results the efficiency of this method and discuss when it is appropriate or not to use it. We see how to apply this method to the Heston model.

We compare the predictive abilities of earnings and cash flows for future cash flows. We base our predictions on a model of the relation between future cash flows and past earnings and its components, including cash flows. As predicted, we find that current and past earnings explain significantly more variation in future cash flows than current and past cash flows, but only after permitting the cash and accrual components of earnings to have different multiples. As predicted, disaggregating the accrual component of earnings significantly further enhances the predictive ability of earnings for future cash flows. Contrary to claims in the popular press, the depreciation and amortization components of earnings have significant predictive ability for future cash flows. Our inferences are robust to controlling for operating cycle and industry membership.

Does the choice of weighting scheme used to form test portfolios influence inferences drawn from empirical tests of asset pricing? To answer this question we first show that, with monthly rebalancing, an equal-weighted portfolio outperforms a value-weighted portfolio in terms of total mean return, four-factor alpha, and Sharpe ratio. We then explain that this outperformance is partly because the equal-weighted portfolio has higher exposure to systematic risk factors; but, a considerable part (42%) of the outperformance comes from the difference in alphas, which is a consequence of the rebalancing to maintain constant weights in the equal-weighted portfolio. Finally, we demonstrate that the inferences drawn from tests of asset-pricing models are substantially different depending on whether one uses equal- or value-weighted test portfolios. We illustrate this by considering four applications: (1) a test of the CAPM, using the methodology of Gibbons, Ross, and Shanken (1989); (2) a test of the spanning properties of the stochastic discount factor, using the approach of Hansen and Jagannathan (1991); (3) a test of the relation between characteristics and returns, using the multivariate weighted two-stage procedure of Fama and MacBeth (1973); and (4) a test of whether expected idiosyncratic volatility is priced or not, using the non-parametric methodology of Patton and Timmermann (2010). For all four tests, we explain how the weighting scheme influences our inferences.

Regulators of many countries try to find the “true” WACC of Electricity, Gas, Water… activities. All their documents have in common a main confusion: they do not differentiate among expected, required, historical, and regulator allowed returns, which are 4 very different concepts. Most of the documents have several conceptual errors (they apply wrongly the CAPM and the WACC), several inconsistencies estimating parameters and multiply the WACC by the depreciated book value of assets. Another two common peculiarities of many regulators are a) their penchant for calculating averages and averages of averages, and b) their argument of doing strange calculations “because many other regulators do so.” We show how a European Regulator arrives to a “WACC before taxes of the electricity regulated activities” of 5,58%. We also show that using the same data and the same method, but criteria of other regulators for the calculation of the parameters you may justify any “WACC before taxes” in the interval 2,4% - 7,4%.After reading the mentioned documents of the regulators a question arises: Are they fiction or science fiction? We show some confusions, errors, inconsistencies and useless arguments of the documents of Regulators and propose solutions. Regulator reports (such as the one in Section 1) are very helpful to discover conceptual mistakes, valuation errors… and to think about the meaning of several concepts widely used in Corporate Finance and Financial Markets.

This article solves a model that links earnings quality to the equity risk premium in an infinite-horizon consumption CAPM economy. In the model, risk-averse traders hold diversified portfolios consisting of a risk-free bond and shares of many risky firms. When constructing their portfolios, traders rely on noisy reported earnings and dividend payments for information about the risky firms. A new element of the model is an explicit representation of earnings quality based on reversing accrual errors that investors cannot observe. The model shows that earnings quality magnifies fundamental risk. Absent fundamental risk, poor earnings quality cannot affect the equity risk premium. Moreover, only the systematic (undiversified) component of earnings quality risk contributes to the equity risk premium. In contrast, all components of earnings quality risk affect earnings capitalization factors. The model ties together consumption-CAPM and accounting-based valuation research into one benchmark formula linking earnings quality to the equity risk premium and earnings capitalization factors.

We demonstrate how a machine learning algorithm can be applied to predict and explain modern market microstructure phenomena. We investigate the efficacy of various microstructure measures and show that they continue to provide insights into price dynamics in current complex markets. Some microstructure features with apparent high explanatory power exhibit low predictive power, and vice versa. We also find that some microstructure-based measures are useful for out-of-sample prediction of various market statistics, leading to questions about the efficiency of markets. Our results are derived using 87 of the most liquid futures contracts across all asset classes.

We construct a new index of uncertainty — the World Uncertainty Index (WUI) — for 143 individual countries on a quarterly basis from 1996 onwards. This is defined using the frequency of the word “uncertainty” in the quarterly Economist Intelligent Unit country reports. Globally, the Index spikes near the 9/11 attack, SARS outbreak, Gulf War II, Euro debt crisis, El Niño, European border crisis, UK Brexit vote and the 2016 US election. Uncertainty spikes tend to be more synchronized within advanced economies and between economies with tighter trade and financial linkages. The level of uncertainty is significantly higher in developing countries and is positively associated with economic policy uncertainty and stock market volatility, and negatively with GDP growth. In a panel vector autoregressive setting, we find that innovations in the WUI foreshadow significant declines in output.

This paper examines the importance of political risk, the financial risk, and economic risk in portfolio and direct investment decisions. In addition, the components (from the International Country Risk Guide) of each of these risk measures are examined. The components of political risk include: Government Stability, Socioeconomic Conditions, Investment Profile, Internal Conflict, External Conflict, Corruption, Military in Politics, Religion in Politics, Law and Order, Ethnic Tensions, Democratic Accountability, and Bureaucracy Quality. The financial risk components include: Foreign Debt as a Percentage of GDP, Foreign Debt Service as a Percentage of Exports of Goods and Services, Current Account as a Percentage of Exports of Goods and Services, Net International Liquidity as Months of Import Cover, and Exchange Rate Stability. The Economic Risk category includes: Per Capita GDP, Real GDP Growth, Annual Inflation Rate, Budget Balance as a Percentage of GDP, and Current Account as a Percentage of GDP. First, I explore whether any of these measures contain information about future expected stock returns by conducting trading simulations. Second, I show the relation between these measures and implied costs of capital based on earnings forecasts. My results suggest that the country risk measures are correlated future equity returns - but only in emerging markets. These results are consistent with emerging markets being to some degree segmented from world capital markets.

Firms with low ratios of fundamentals (such as earnings and book values) to market values are known to have systematically lower future stock returns. We document that short-sellers position themselves in the stock of such firms, and then cover their positions as the ratios revert to normal levels. We also show that short-sellers avoid firms where the transaction costs of short-selling are high and where the low ratios are due to temporarily low fundamentals, rather than temporarily high prices. Our evidence suggest that short-sellers use information in these ratios about either (i) temporary mispricing, or (ii) unknown risk factors, to boost their investment returns.

We do three things in this paper. We first develop a metric to measure the popularity of the value-weighted portfolio in a stock market. We use our metric to document that, though the value-weighted portfolio is less popular in emerging markets than in developed markets, its popularity is increasing everywhere. In the United States, for example, trading in the value-weighted portfolio could only explain 32% of trading volume in the 1920s, but can explain 68% in the 2000s. Finally, as we have better data for the United States, we explore why the value-weighted portfolio is becoming more popular.

We empirically test the prediction of Pastor, Stambaugh, and Taylor (2021) that green firms outperform brown firms when concerns about climate change increase unexpectedly, using data for S&P 500 companies from January 2010 to June 2018. To capture unexpected increases in climate change concerns, we construct a daily Media Climate Change Concerns index using news about climate change published by major U.S. newspapers and newswires. We find that on days with an unexpected increase in climate change concerns, the green firms’ stock prices tend to increase while brown firms’ prices decrease. Further, using topic modeling, we conclude that this effect holds for concerns about both transition and physical climate change risk. Finally, we decompose returns into cash flow and discount rate news components and find that an unexpected increase in climate change concerns is associated with an increase (decrease) in the discount rate of brown (green) firms.

Discussants: PETER BOSSAERTS, California Institute of Technology JOHN COCHRANE, University of Chicago, Graduate School of Business EUGENE FAMA, University of Chicago, Graduate School of Business WILL GOETZMANN, Yale University, School of Management ROBERT S. HARRIS, Darden Graduate School of Business, University of Virginia JOHN HEATON, Northwestern University, Kellogg Graduate School of Management ROGER IBBOTSON, Yale University, School of Management MICHAEL J. MAUBOUSSIN, Chief U.S. Investment Strategist - Credit Suisse First Boston and Adjunct Professor - Finance and Economics - Columbia Business School ANDRE F. PEROLD, Harvard University, Harvard Business School JAY RITTER, University of Florida, Warrington College of Business ROBERT WHITELAW, New York University, Stern School of Business Organized by: PETER TUFANO, Harvard Business School While it is sometimes difficult to teach ideas that we would all agree to be correct, it is infinitely more difficult--and more rewarding--to teach material where the "correct answer" is still very debatable. For these subjects, one challenge as an educator is to know the "state of play" in the academic community about the issue. Another challenge is deciding whether to take one point of view, or whether to try to teach the students more than one point of view. While students will press for THE right answer, if they can understand why reasonable people reach different answers, this can move a class from fixating on one rote answer to a deeper contemplation of the subtleties of the various arguments. This new section of FEN-Educator will attempt to spotlight research areas where there is considerable disagreement in the profession. Our inaugural piece is a discussion of the equity risk premium--the long run return of stocks over riskless bonds--which is the source of much confusion in MBA classrooms and in practice. Ivo Welch has agreed to write a brief summary of the issues surrounding the market risk premium and to assemble a selected bibliography on the topic. We then invited a range of researchers, educators and practitioners to comment on how they treat this topic in the classroom. We would like to thank Ivo and the discussants for their willingness to innovate. In the spirit of innovation, we have set up a discussion board where readers can post their own observations on teaching the market risk premium and continue the conversation begun by Ivo and the discussants. (((This board can be found at http://www.???))) This section was obviously not intended to be the definitive answer on the market risk premium, nor a large scale survey of the numbers we use in class (which can be found in Ivo's forthcoming Journal of Business piece.) Rather it is a modest attempt to move discussions from the halls of our offices (where we ask one another, "What are you going to tell them tomorrow about the risk premium?") to a more public venue, and in so doing, assist finance professors. Please let us know what you think of this concept, how it can be improved, and what other topics you might find interesting.

We examine the equity market reaction to events associated with the passage of a directive in the European Union (EU) mandating increased nonfinancial disclosure. These disclosures relate to firms’ environmental, social, and governance (ESG) performance, and would be applicable to firms listed on EU exchanges or with significant operations in the EU. We predict and find (i) an on average negative market reaction; (ii) a less negative market reaction for firms having higher pre-directive nonfinancial performance; and (iii) a less negative reaction for firms having higher pre-directive nonfinancial disclosure levels. Results are accentuated for firms having the most material ESG issues, as well as investors anticipating proprietary and political costs as a result of the mandated disclosures. Overall, the results are consistent with the equity market perceiving that this disclosure regulation of nonfinancial information would lead to net costs (benefits) for firms with weak (strong) nonfinancial performance and disclosure.

This paper examines the usefulness of International Accounting Standards (IAS) in a transitional economy, the People's Republic of China (PRC). Using a sample of firms that provide financial reports under both IAS and more rigid local PRC standards, we conclude that information produced using IAS is no more useful than that prepared using Chinese standards. First, there is no difference in the explanatory power of IAS and PRC accruals for future cash flows. Second, for stocks that can only be owned by international investors, IAS and PRC earnings and accruals have a similar association with annual stock returns. Finally, for stocks that can be owned only by domestic investors, PRC earnings have a higher relation with annual stock returns than IAS earnings. We argue that one explanation for the failure of IAS data to dominate PRC data is the absence of effective controls and infrastructure in China to monitor the additional reporting judgment available to managers under IAS.

The validity of day trading as a long-term consistent and uncorrelated source of income for traders and investors is a matter of debate. In this paper, we endeavored to answer this question by conducting a thorough analysis of the profitability of Opening Range Breakout (ORB) strategies, with a particular focus on the 5-minute ORB. Using a large dataset that covered more than 7,000 US stocks traded from 2016 to 2023, the research aimed to assess how effective this strategy was in producing consistent and uncorrelated returns. A new aspect of our study was the focus on Stocks in Play, which are stocks that show higher than normal trading activity on a specific day, mostly because of fundamental news about the company. Our results showed a significant benefit in limiting day trading only to those Stocks in Play (even after considering transaction costs). A portfolio that consisted of the top 20 Stocks in Play achieved a total net performance of over 1,600%, with a Sharpe ratio of 2.81, and an annualized alpha of 36%. Passive exposure in the S&P 500 would have achieved a total return of 198% during the same period. Furthermore, this paper expanded the analysis to compare the return profile of the ORB strategy applied to different time frames, such as 15, 30, and 60 minutes. In the last part of the paper, we presented detailed stock-specific statistics for the 25 best and worst performers of an ORB strategy over all the time frames. To the best of our knowledge, this is the first public paper with such intraday granularity and comprehensive stock-level database.

This paper presents an efficient algorithm for computing the allocation weights of the risk parity portfolio (or the more general risk budget portfolio) based on Newton's method. The algorithm is provably convergent, and in dimension < 1000 requires on average less than 5 iterations.

This paper considers the factor tau (τ) in the Black-Litterman model. τ is one of the more confusing aspects of the model, as authors provide contradictory information regarding its use and calibration. We will consider the origin of the mixed-estimation model used in the Black-Litterman Model so that we can develop a richer understanding of τ and its place in the model. We will discuss the various models which use the name Black-Litterman and how they do or do not use τ. Finally, we will show several ways to calibrate τ when using the canonical Black-Litterman model.

There is surprisingly little agreement among academics about the existence of time diversification, which we define as the anomaly where equities become less risky over longer investment periods. This study provides the most thorough analysis of time diversification conducted, using 113 years of historical data from 20 countries (over 2,000 years of total return data). We construct optimal portfolios for 20 different countries based on varying levels of investor risk aversion and time horizons using both overlapping and distinct historical time periods. We find strong historical evidence to support the notion that a higher allocation to equities is optimal for investors with longer time horizons, and that the time diversification effect is relatively consistent across countries and that it persists for different levels of risk aversion. We also note that the time diversification effect increased throughout the 20th century despite evidence of a declining risk premium. Although time diversification has been criticized as inconsistent with market efficiency, our empirical results suggest that the superior performance of equities over longer time horizons exists across global equity markets and time periods.

Factor models of security returns decompose the random return on each of a cross-section of assets into pervasive components, affecting almost all assets, and a diversifiable component. We describe four alternative approaches to factor models of asset returns. We also discuss issues related to estimating factor models and testing for the appropriate number of factors.