Broader Equity Market Research Articles

All Eyes on Asset Quality: Microfinance Global Valuation Survey 2010

The past year held many challenges for microfinance: not since the Asian crisis of the late 1990s has the sector faced a more difficult economic environment. Yet despite these conditions, most micro-finance institutions (MFIs) proved to be up to the challenge. Beginning in January 2009, MFI portfolio delinquency levels began to deteriorate rapidly, with loans past due over 30 days (portfolio at risk [PAR30]) jumping from a median of 2.2 percent to 4.7 percent during the first five months of 2009, while profitability dropped from a median return on equity (ROE) of nearly 18 percent at year-end 2008 to 6 percent by May 2009. However, since June 2009 delinquency has moderated and profitability levels have come back to stabilize at 4 percent for PAR30 and 10 percent for ROE, respectively. Most MFIs continue to maintain solid reserve and capitalization levels, with equity ratios unchanged from the 18-20 percent range established over the past two years. This occasional paper aims to shed new light on equity valuation trends in microfinance, which must necessarily begin with a detailed examination of how MFIs have coped during the recent economic crisis. Accordingly, the first part of the paper is devoted to MFI asset quality and its impact on microfinance profitability. Next, the authors examine trends in valuation benchmarks for microfinance private equity transactions and analyze the key drivers behind these valuations. This section also delves into the recent growth in transaction volume and valuation multiples in India, which had a particularly active market in 2009. Finally, the authors seek to place the microfinance equity market within the context of the broader equity market, using comparisons with publicly listed low-income financial Institutions (LIFIs) in developing countries.

Is angel investing worth the effort? A study of Keiretsu Forum†

This paper provides a case study of Keiretsu Forum, a Silicon Valley-based angel group. Computing an internal rate of return for the group's investments reveals that they generated higher returns than could have been obtained from the broader equity market as measured by popular index funds. Perhaps more important, this study also indicated that the processes developed by and regularly used by the angel group are effective at identifying potential failed deals but are not so restrictive as to bypass potential winners.

Risk-Based Indexation

A capitalization-weighted index is the most common way to gain access to broad equity market performance. These portfolios are generally concentrated in a few stocks and present some lack of diversification. In order to avoid this drawback or to simply diversify market exposure, alternative indexation methods have recently prompted great interest, both from academic researchers and market practitioners. Fundamental indexation computes weights with regard to economic measures, while risk-based indexation focuses on risk and diversification criteria. This paper describes risk-based indexation methodologies, highlights potential practical issues when implemented, and illustrates these issues as it applies to the Euro Stoxx 50 universe.

Do REIT Announcements of Open Market Repurchase Programs Signal Value Changes in Rivals?

Executive Summary. This paper examines the short-and long-run equity returns for REITs that do not announceopen market repurchases when a rival real estateinvestment trust (REIT) announces a repurchase. Priorresearch finds evidence of significant positive returns tothe announcing REITs, on average, but does not examinethe effect of the announcement on rival REITs. We findevidence of a significant negative reaction for nonannouncingrival REITs over the event window. The returnsare directly related to the previous four week returnfor non-announcing REITs and inversely related to thefirm's market-to-book ratio and volatility of returns. Boththe announcing firms and their non-announcing rivalssignificantly outperform the broader equity market on arisk-adjusted basis in the two years following the repurchaseannouncement.

Alpha and Beta of Long/Short Equity Hedge Funds: A Study of Swedish and International Funds

As shown in the literature, delivering alpha over time and in different market environments is very difficult and relatively few managers have the ability to do so. Empirical analysis has shown that the main drivers of return for Long/Short Equity hedge funds are a stock market factor and the spread between small- and large capitalization stocks. We find that Swedish Long/Short Equity hedge funds outperformed their international peers during the financial crisis in June 2007 - December 2008 but underperformed during the previous equity bull market April 2003 - May 2007. The reason for this is found to be a lower beta to the broad equity market for Swedish funds. Funds started during 2004 - 2005 operated with a higher beta to the Swedish stock market during the equity bear market compared to funds started before April 2003. Our regression model can explain 65% of the returns of the funds during the bear market period and the stock market is the only statistically significant factor. The capability to generate alpha is found to be limited and concentrated to the equity bull market.

Global Asset Pricing: Is There a Role for Long-Run Consumption Risk?

We estimate long-run consumption-based asset pricing models using a comprehensive set of international test assets, including broad equity market portfolios, international value/growth portfolios, and international bond portfolios. We find that differences in returns across assets within a country are sometimes (and most prominently for the U.S.) better captured by the assets' exposure to long-run consumption risk as opposed to their exposure to one-period changes in consumption (the canonical consumption CAPM). Across countries, however, exposure to long-run consumption risk does not provide a better fit than the canonical consumption CAPM. Thus, when characterizing the cross-country distribution of returns, long-run consumption risk does not seem to play any particular role, even if long-run risk is important for explaining the cross section of expected returns in the U.S. Furthermore, we show that consumption growth is more predictable over short to medium-run horizons than over longer horizons and that empirical evidence of a declining risk aversion parameter estimate in long-run risk models has to be interpreted with care.

The Greenspan years: an analysis of the magnitude and speed of the equity market response to FOMC announcements

We examine the impact of monetary policy on the SP however, an unexpected change of 25 basis points in the Fed funds target rate results in an approximate 48 basis points decline in the broad equity market’s return. The speed of these market reactions is rapid with the equity market reaching a new equilibrium within 15 minutes.

REIT returns: between the Pacific and the Atlantic

PurposeThe purpose of this paper is twofold in examining the international transmission of REIT returns volatility. The first purpose is to add to the literature on whether the real estate securities market and the broader equity market are integrated. The second objective of the study is to determine whether geographic risk factors can be transmitted beyond their region of influence.Design/methodology/approachThe study uses the GARCH(1, 1), EGARCH, and GARCH‐M models.FindingsThe results show that there are significant international spillovers of REIT returns volatility within the Pacific region. The results also show that there are significant volatility transmissions between the Pacific and the Atlantic regions.Practical implicationsThe results are consistent with the implication that the real estate sector and the general equity market are integrated such that geographic risk can be transmitted across national borders. The result will have major implications for international investment strategies.Originality/valueTo date, there has been no published study on the international transmission of REIT returns volatility. This study therefore examines whether the conditional variance of REIT returns of a country is affected by volatility transmission across markets in the same region using four Pacific markets.

Valuation of Income Trusts: An Exploration of Clienteles and Implicit Taxes

Canadian income trusts are a publicly-traded flow through structure. Their use in Canada has expanded beyond the traditional real estate sector (REITs). We use this alternative business structure to explore the valuation of investor taxes in a broad equity market setting. Adapting a pricing model, we determine that the value of earnings generated by an income trust should be higher than a corporation only if the marginal shareholder has a low tax rate. Empirical evidence shows that the value of earnings is higher for income trusts than for a set of matched businesses operating as corporations, consistent with the marginal investor in income trusts being a low-tax rate individual. A second set of tests explores the implicit taxes borne by common shares. We find that the relation between pre-tax returns and earnings for common stock is significantly lower than for income trusts, consistent with the implications of implicit taxes. This research contributes to our understanding of clienteles and implicit taxes in the common equity market.

An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation

We econometrically estimate a consumption-based model asset pricing model with stochastic habit formation and test it using the generalized method of moments. The model departs from existing models with deterministic internal habit (e.g. Dunn and Singleton (1986), Ferson and Constantinides (1991) and Heaton (1995)) by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently, an additional shock to the marginal rate of substitution. The stochastic shocks to the consumption habit are persistent and provide an additional source of time variation in expected returns. Using Treasury bond returns and broad equity market index returns, we show that stochastic internal habit formation models resolve the dichotomy between the autocorrelation properties of the stochastic discount factor and those of expected returns and provide a better explanation of time variation in expected returns than models with either deterministic habit or stochastic external habit.

The Greenspan Effect on Equity Markets: An Intraday Examination of U.S. Monetary Policy Announcements

In this paper, we provide an intraday analysis of the impact of monetary policy on the equity markets. Specifically, we study changes in prices and changes in volatility for the S&P 500 associated with Federal Open Market Committee announcements as well as real-time changes in market expectations about future policy. The analysis shows an economically and statistically significant inverse relationship between equity market returns and changes in the Fed funds rate target. The magnitude of the response is dependent on whether the change was expected or unexpected. An expected change in the Fed funds rate target of 25 basis points results in approximately a 30 basis point decline in the broad equity market, while an unexpected change of 25 basis points in the Fed funds rate target results in approximately 125 basis point decline in the broad equity market. The speed of these market reactions is rapid with the equity market reaching a new equilibrium within fifteen minutes. In contrast to these results, the analysis also shows a positive relationship exists between equity market returns and changes in expectations about future monetary policy. Taken together, these results regarding price changes (returns) suggest that the price discovery process in the equity markets is dominated by the realization of expectations and not market expectations per se. Meanwhile, the volatility analysis suggests a volatility spike follows both FOMC announcements and real-time changes in expectations, but the duration of these spikes is relatively short-lived and dampens out within one hour.

Calendar Anomalies and Capital Market Efficiency: Listed Property Trust Investment Strategies

This study focuses on the efficient market hypothesis (EMH) and inspects the existence of calendar anomalies in the Australian capital markets. It is the first study that provides a comprehensive examination of calendar anomalies in the Australian capital markets, particularly in the Australian Listed Property Trust (LPT) market. The study reveals that calendar anomalies exist in both the Australian LPT market and the broader equity market, providing evidence of market inefficiency. It is also found that some of these return irregularities are diminishing and dissipating over time, suggesting the move towards a higher level of efficiency.The results from this study provide support to active investing. Moreover, this study quantifies the potential for profiting on the calendar anomalies by active investing in a practical sense and provides significant practical implications for LPT portfolio managers and investors.

Price Predictability and Capital Market Efficiency: Listed Property Trust Investment Strategies

This study focuses on weak form EMH and investigates whether the Australian Listed Property Trust (LPT) market and broader equity market (All Ordinaries) are efficient in the weak form. It examines the daily closing price indices of LPTs and All Ordinaries for the period of 1 June 1992 to 30 May 2003. The results suggest that Australian LPTs and the broader equity markets are efficient in the weak form, and securities prices are not predictable based on historical price movements.The evidence of weak form efficiency has significant implications for investment strategies. It questions the relevance of technical analysis in the process of formulating investment/trading strategies. In the wake of questionable significance of technical analysis, this study provides active managers with suggestions for formulating investment strategies and investment decision making.

The Case for Long/Short Equity in Traditional Asset Class Construction

Having noted that the number and variety of hedge fund strategies is particularly high, the author examines long/short equity strategies and their place in a balanced, diversified portfolio. In particular, the article focuses on the question of whether such strategies should be viewed distinctly from the broader hedge fund categories. The argument in favor of separating these strategies for other hedge funds is in large measure anchored in the fact that long/short equity portfolios tend to be more highly correlated to the broad equity market indices. The author concludes that categorizing these strategies alongside long-only and tracking error constrained equity processes should yield a more efficient asset class experience: lower deviations and higher returns.

Do We Need CAPM for Capital Budgeting?

A key input to the capital budgeting process is the cost of capital. Financial managers most often use the CAPM to estimate the cost of capitalfor which they need to know the market risk premium. Textbooks advocate using the historical value for the US equity premium as the market risk premium. The CAPM as a model has been seriously challenged in the academic literature. In addition, recent research indicates that the true market risk premium might have been as low as half the historical US equity premium during the last two decades. If business finance courses have been teaching the use of the wrong model along with wrong inputs for 20 years, why has no one complained? We provide an answer to this puzzle. The classic rule for making capital budgeting decisions is to take projects with positive Net Present Value (NPV). Consider a project that generates an annual, real cash flow of $100,000 forever, starting one year from now. The initial investment is $1,600,000. To decide whether to invest in this project or not, we discount all future cash flows and subtract the initial investment to get the NPV. The decision rule is then simple: if the NPV is positive, take it; if the NPV is negative, leave it. The current textbooks used in all major MBA courses advise financial managers to calculate the cost of capital based on the Capital Asset Pricing Model (CAPM). The project's cost of capital is the rate investors require to undertake the investment, and we should discount all future cash flows at this rate. The cost of capital in the CAPM equals the riskfree rate plus a risk premium. The CAPM asserts that the only relevant risk measure for a project is its beta. The beta factor times the excess return of the market over the riskfree rate determines the risk premium of the investment. A key input for the CAPM is the excess return of the market over the riskfree rate, the market (equity) risk premium. The common practice has been to use the historical average return over a long period as a measure of what investors expect to earn. As a proxy for the market portfolio, a broad equity market index is applied. For the US the average market risk premium of the S&P 500 was 7.43% during the post-war period, whereas the real riskfree rate (six-month commercial paper) was 2.19%. Assuming that the project beta is 1.0 and the firm is 100% equity financed, the cost of capital is 2.19% + 1 x 7.43% = 9.62% and the NPV of our project is negative: 100,000/ 0.0962 - 1,600,000 = -$560,499. We would decide against investing. However, a new strand of literature starting with Blanchard (1993) takes a forward-looking perspective to determine the market risk premium. Instead of taking an average over a past

The REIT Vehicle: Its Value Today and in the Future

The real estate investment trust (REIT) structure has come under increasing scrutiny given the problems the structure poses for firms wishing to retain earnings in depressed real estate equity and debt markets. We estimate the net benefits of the structure to be no more than 2%-5% of industry equity market capitalization, although the benefits are larger for firms with lower payout ratios. In addition, the value of the format doubles as the share of tax exempt/deferred investment in REITs increases to 40%, the fraction obtaining in the broader equity market. Educating this investor clientele on the benefits of the REIT structure is an important goal for REIT management.

International Real Estate Securities: A Test of Capital Markets Integration

Executive Summary. The investigation into the cross-sectional and time-series differences in correlation coefficients between property stocks and broader equity indices in fourteen countries yields several interesting findings. First, the study found that correlation coefficients in many countries have not been stable over time, and in several of these countries there is a discernable trend toward integration or segmentation of the property sector with the broader equity market. Second, the study explored three hypotheses (Relative Weight, Global and Investment Structure) that would account for these differences and trends. While further quantitative work will be needed, the preliminary findings support two of the three original hypotheses. It appears that both a Global and Investment Structure hypothesis explain a great deal of the variation that is observed in market integration / segmentation across countries. More rigorous statistical tests will be needed to confirm these preliminary observations.