Capital Market Equilibrium Research Articles

QUANTITATIVE FINANCIAL ANALYSIS OF EQUIPMENT RENT OF ENTERPRISES OF URBAN CONSTRUCTION AND ECONOMY

The special case of industrial investment which is the equipment rent by the enterprises of city building and economy is investigated. The necessity in the quantitative financial analysis of the equipment lease arises both for the owner of the equipment and for the lessee. For the owner it is important to correctly determine the amount of rent and financial efficiency of leasing the equipment. The lessee, if there is an alternative, must decide whether to lease the equipment or buy it. These problems can be solved on the basis of purely financial principles, and any method of their solution is based on the concept of the present value of financial flows.
 There are ratios, which allow you to determine the size of payments for the lease of equipment, the effectiveness of leasing equipment for the owner. The problem (to rent or buy equipment?), which is a special case of the problem of measuring efficiency, is solved. Numerical examples of solving the above problems are also given. Particular attention is paid to the analysis of the effect of risk and inflation on the rate of interest on which the discounting of cash flows, rent payments are made. The estimation of the market value of urban construction and economy enterprises with different types of risks taken into account has been carried out. The modification of I. Fisher's formula which allows, in conditions of uncertainty, using appropriate methods to predict the real rate of inflation (as well as using the model of capital market equilibrium - in particular beta coefficient) to determine the expected value of inflation rates, inflation risk premium has been substantiated.

Cost of equity and corporate social responsibility for environmental sensitive industries: Evidence from international pharmaceutical and chemical firms

We analyze the relationship between the cost of equity and corporate social responsibility activities (CSR) of international environment-sensitive industries for the study period from 2008 to 2019. The capital-market equilibrium and affect-as-information theories are applied. Results show chemical firms have lower equity financing costs via CSR performance than pharmaceutical firms. Particularly, social performance has the lowest cost of equity, followed by environmental performance. Although investors judge both industries through similar long-term growth opportunities, chemical firms have greater risks and lower leverage and book-to-market ratios than their counterparts. Size significantly lowers financing costs for pharmaceutical firms in environmental and social categories.

Demography and provisions for retirement: the pension composition, a behavioral approach

AbstractPensions may be provided for in a modern society by a mix of several methods, namely by voluntary individual savings, mandatory fully-funded occupational pension systems, mandatory social security financed by pay-as-you-go, and old-fashioned hoarding in cash. We call a specific mixture of the four systems a pension composition. We assume that individual workers decide on their own individual savings, that the fully-funded occupational system is decided upon by the age cohort of the median worker, and that social security is decided upon by the median voter. We assume that individual and collective pension savings are the only sources of capital supply. When capital supply equals demand from industry, there is equilibrium in the capital market with a corresponding equilibrium interest rate and pension composition. In this paper, we assume a demography with one hundred age brackets and we investigate how changes in the birth rates, survival rates, and the retirement age affect the pension composition and the capital market equilibrium. Our conclusion is that for a given technology, the pension composition and the interest rate are determined by the demography and cannot be modified at will as a long-term political instrument.

Capital Market Equilibrium With Imperfect Competition: The Case of the ECB\u2019s Asset Purchase Programme

We set up a multiperiod, CAPM-type model with imperfect competition between investors in case of an additional price-insensitive market participant. The motivation for this additional actor comes from the ECB’s announcement to buy a substantial amount of securities “whatever it takes” which reflects the willingness to trade in a entirely price-inelastic way. Our model explains the effects on demand functions, equilibrium prices, portfolio holdings and investors’ expected utility. The interaction of price-inelastic additional demand by the ECB, on the one hand, and imperfect competition, on the other hand, causes differentiated results regarding timing strategies, development of prices over time, and utility implications.

Demography and Provisions for Retirement - The Pension Composition, a Behavioral Approach

Pensions may be provided for in a modern society by a mix of several methods, namely by voluntary individual savings, mandatory fully-funded occupational pension systems, mandatory social security financed by pay-as-you-go, and old-fashioned hoarding in cash. Here, we call the specific mixture of the four systems the pension composition. We assume that individual workers decide on their own individual savings, that the fully-funded occupational system is decided upon by the age cohort of the median worker (MW), and that the social security is decided upon by the median voter (MV). In this behavioral approach we distinguish between several social groups, where individuals belong to several groups simultaneously and where the interests of the different groups are only partly coinciding. For a given demography and interest rate, the joint result of the decisions of the different age cohorts is a Pareto equilibrium. For ease of exposition we assume that individual and collective pension savings are the only sources of capital supply. When capital supply equals demand from industry there is equilibrium in the capital market with a corresponding equilibrium interest rate. In this paper we assume a demography with one hundred age brackets and we investigate how changes in the birth rates, survival rates, and the retirement age affect the pension composition and the capital market equilibrium. Our conclusion is that the demographic effects are considerable not only for the resulting pension composition but also for macro-economic variables such as the wage rate, the interest rate, and the capital-income ratio. It follows that the pension composition in general and social security in particular is determined by the demography and cannot be modified at will as a long-term political instrument. We find that this is relevant for the present century, where birth and mortality rates in most western countries are steeply declining.

International capital asset pricing model: the case of asymmetric information and short-sale

We develop an international capital asset pricing model in the presence of shadow costs of incomplete information and short sales. Our model shows the direct effect of exchange rate risk, information costs and short sales costs on asset prices. At equilibrium, this model gives an explicit expression of two systematic risk premium. The first one is linked to the exchange rate. The second one is related to international market risk. Our model explains in part the well-known home bias equity by market segmentation. This model, which is proposed for the first time in the literature, can be seen as an international version of Wu et al. (Rev Quant Finance Account 7:119–136, 1996) and Merton (J Finance 42:483–511, 1987) models of capital market equilibrium in international markets. Our analysis shows that the dispersion in beliefs increases the market inefficiency, and that short sale constraints can reduce the cost of ignorance and the magnitude of the home bias equity. Our model provides an operational approach in asset pricing to take account of previous important costs.

Capital asset market equilibrium with liquidity risk, portfolio constraints, and asset price bubbles

This paper derives an equilibrium asset pricing model with endogenous liquidity risk, portfolio constraints, and asset price bubbles. Liquidity risk is modeled as a stochastic quantity impact on the price from trading, where the size of the impact depends on trade size. Asset price bubbles are generated by the existence of portfolio constraints, e.g. short sale prohibitions and margin requirements. Under a restrictive set of assumptions, we prove a unique equilibrium price process exists for our economy. We characterize the market’s state price density, which enables the derivation of the risk-return relation for the stock’s expected return including both liquidity risk and asset price bubbles. This yields a generalized intertemporal and consumption CAPM for our economy. In contrast to the traditional models without liquidity risk or asset price bubbles, there are additional systematic liquidity risk and asset price bubble factors which are related to the stock return’s covariation with liquidity risk and asset price bubbles.

Life Expectancy and Retirement Age

The extension of life has exerted more and more pressure on the Chinese pension industry. In order to alleviate this pressure, more and more experts and scholars put forward policy recommendations for postponing retirement. At present, the specific reform scheme of the retirement age in China has not yet been introduced, and there are still some disputes on how to carry out the policy of postponing retirement. However, from the perspective of international experience, some countries or regions adjust retirement age directly or indirectly according to the life expectancy of population. This practice is important reference for our country. Whether China should build the adjustment mechanism of life expectancy and retirement age has very high research value. Under this background, this paper investigates the feasibility of establishing the linkage mechanism of life expectancy and retirement age from a perspective of a social planner through mathematical deduction and theoretical research, and further explores the adjustment formula between them. It hopes that this research can enrich and develop the application of overlapping generations model to the pension problem, and give relevant reference to government departments regarding the issue of postponing retirement. This paper, based on two-period overlapping generations model, introduces the retirement factors, and builds a general equilibrium framework in four aspects of individual behavior, enterprise behavior, government behavior and capital market equilibrium under the assumptions of completely competitive market, full employment and government control of the retirement age. With the optimality principle and the comparative static analysis, we find that when the economy is in a stable state, life expectancy with the maximum social welfare is positively related to the retirement age, manifesting a negative inverse proportion function form. Based on this functional relation, we use the parametric estimation method and assignment simulation to solve the adjustment formula of the life expectancy and retirement age of the population, and put forward an adjustment comparison table between them. According to the calculation results and prediction of life expectancy by China Issues National Plan on Population Development（between 2016 to 2030）, we recommend extending the retirement age to 65 years before 2030. In the end, by testing the model, on the premise of keeping the pension balance, we find that if there is no adjustment mechanism between the life expectancy and retirement age, sudden changes in life expectancy will reduce the pension payment, and can lead to the losses of social welfare. Therefore, based on the findings of this paper, and in the context of the extended life expectancy of Chinese population, we suggest that the governments should consider building the adjustment mechanism of life expectancy and retirement age, and increase the retirement age with the extension of life expectancy.

Demography and Provisions for Retirement: The Pension Composition, an Equilibrium Approach

Pensions may be provided for in a modern society by several methods, viz., voluntary individual savings, mandatory fully funded occupational pension systems, and mandatory social security financed by pay-as-you-go. The specific mixture of the three systems we will call the pension composition. We assume that individual workers decide about their own individual savings, that the fully funded occupational system is decided upon by the age cohort of the median worker and that social security is decided upon by the median voter. For a given demography and interest rate the joint result of those decisions is a Pareto- equilibrium. Nowadays most of capital supply stems from individual and institutionalised pension savings. For ease of exposition we will assume that individual and collective pension savings are the only source of capital supply. When capital supply equals demand from industry there is equilibrium on the capital market with a corresponding equilibrium interest rate. In this paper, we assume a demography with hundred age brackets and we investigate how changes in the birth and survival rates affect the pension composition and the capital market equilibrium. Our conclusion is that the demographic effects are considerable not only for the resulting pension composition, but also for macro-economic variables as the wage rate, the interest rate and the capital-income ratio. It follows that the pension composition in general and social security in particular is determined by the demography and cannot be used as long-term political instrument. We find that this is relevant for the present century, where birth and mortality rates in most western countries are steeply declining.

Investor recognition and stock returns: evidence from China

PurposeMerton’s model of capital market equilibrium under incomplete information predicts that contemporaneous stock returns are positively related to investor recognition and that future stock returns are negatively related to investor recognition. The purpose of this paper is to empirically investigate whether Merton’s theory holds true for the Chinese stock market.Design/methodology/approachThis paper proposes the degree of shareholder base growth (SBG) as a proxy for investor recognition and examines the relationship between investor recognition and stock returns through a univariate analysis and Fama-Macbeth cross-sectional regressions based on A-Share listed firms.FindingsThe results show that investor recognition is nonlinearly and positively related to contemporaneous stock returns and is negatively related to future stock returns in contrast to the conclusions of Merton’s theory. A long-short trading strategy that involves buying stocks with the lowest SBG rate and that sells stocks with the highest SBG rate will earn an average monthly return of 3.615 percent.Research limitations/implicationsThough Merton’s theory is not fully reflected in the Chinese stock market, investor recognition is considered an important risk factor in the Chinese stock market.Originality/valueNo works have yet investigated the validity of Merton’s “investor cognition hypothesis” in relation to the Chinese stock market. This paper strives to fill this gap.

When 1 + 1 > 2: How Investors React to New Product Releases Announced Concurrently with Other Corporate News

Firms routinely use press releases to announce the launch of their new products. An examination of these press releases shows that in approximately 7% of cases, firms issue new product announcements concurrently with other corporate announcements. However, the consequences of these actions are unknown because event studies typically eliminate concurrent announcements in an attempt to avoid their confounding effects. The authors use a comprehensive sample of press releases issued by publicly traded U.S. firms to document the consequences of firms announcing the release of a new product concurrently with another corporate announcement that conveys good news. Drawing on Merton's (1987) model of capital market equilibrium with incomplete information, the authors identify three conditions that are conducive to the issuance of concurrent new product announcements. They then verify that under these conditions, the increase in shareholder value associated with concurrent announcements is higher than that associated with issuing two similar announcements separately. This research provides insights into how firms can leverage corporate communications to increase stock prices.

A Single Period Stochastic Model for Maximising Firms Value

This article sets up a single period value maximization model for the firm based on stochastic end-of-period cash inflows, stochastic bankruptcy costs and taxes based on income rather than wealth. The risk-return trade-off is captured in the Capital Asset Pricing Model. Thus, the model also assumes a perfect capital market and market equilibrium. The model establishes the existence of a unique optimal financial leverage at which the firm value is maximized, this leverage being less than the maximum debt capacity of the firm.

Pricing derivatives in the presence of shadow costs of incomplete information and short sales

Financial models are based on the standard assumptions of frictionless markets, complete information, no transaction costs and no taxes and borrowing and short selling without restrictions. Merton’s (J Finance 42:483–510, 1987) develops a simple model of capital market equilibrium with incomplete information. Wu et al. (Rev Quant Finance Account 7:119–136, 1996) extend Merton’s (J Finance 42:483–510, 1987) model by proposing an incomplete information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. The shadow costs include two components. The first component is the product of pure information cost due to imperfect knowledge and heterogeneous expectations. The second component represents the additional cost caused by the short-selling constraint. Short-selling bans around the world after the global financial crisis become more and more important. Nezafat and Wang (Short-sale constraints, information acquisition, and asset prices, Scheller College of Business, Georgia Institute of Technology, Atlanta, p 30308, 2013) develop a model of information acquisition and portfolio choice under short-sale constraints. Bellalah (J Futures Mark, 1999) and Bellalah and Wu (Ann Oper Res 165:123–143, 2009) include information costs the valuation of assets and derivatives. This is the first study to our knowledge devoted to the pricing of derivatives that accounts simultaneously for information costs and short sales constraints for the option market and its underlying asset market. We extend the classic models by Black and Scholes (J Polit Econ 81:637–659, 1973), Black (J Financ Econ 79(3):167–179, 1976), and Barone-Adesi and Whaley (J Finance 2(81):303–320, 1987) among others to account for shadow costs of incomplete information and short sales. We present a general method and provide the general differential equation for the pricing of derivatives within incomplete information and short selling costs.

Characterisation of Economic Growth in Developing Economies with Informal Sector

The paper presents a general equilibrium model of a developing economy with a capital intensive formal sector and a large informal sector with sector‐specific capital to analyse the effects of investments on the sectoral returns to capital, sectoral wage rates, and composition of output and employment. Beginning with capital market disequilibrium (unequal sectoral rates of return) and labour market distortion (formal‐informal wage gap), the model traces the evolution of the economy till capital market equilibrium is attained. The investments in the formal sector equalise the wages (a “turning point” in growth à la Lewis) and reduces the size of the informal sector. The sectoral rates of returns equalise only if there is no factor intensity reversal, otherwise the economy specialises in the production of formal goods. The investments in the informal sector equalise the rates of return, do not affect the size of the formal sector and finally, a formal‐informal wage gap persists provided factor intensities are not reversed.

Shadow costs of incomplete information and short sales in the valuation of the firm and its assets

This paper presents a simple framework for the valuation of compound options within shadow costs of incomplete information and short sales. The shadow cost includes two components. The first component is the product of pure information cost due to imperfect knowledge and heterogeneous expectations. The second component represents the additional cost caused by the short-selling constraint. Information costs are linked to Merton's (1987. Journal of Finance 42, 510) model of capital market equilibrium with incomplete information, CAPMI. This model is extended by Wu et al. (1996. Review of Quantitative Finance and Accounting, 7, 136) who propose an incomplete-information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. This model is used in our paper to provide for the first time in the literature analytic solutions for derivatives in the presence of both shadow costs of incomplete information and short sales.When deriving the compound call option formula, we consider a call option on a stock, which is itself an option on the assets of the firm. Our methodology incorporates shadow costs of incomplete information and short sales on the firm's assets as well as the effects of leverage in the capital structure. The formula can be useful in the valuation of several corporate liabilities in the presence of information uncertainty and short sales constraints about the firm and its cash flows. Our analysis can be used for the valuation of several real options.

Investment and growth in a developing economy with vast informal sector

In developing economies like India, ‘informal’ sector occupies a large portion of GDP and employment. In the wake of slowdown in investments across countries and ensuing fall in the GDP growth rates, the question that arises is the following. If an economy suffers from growth slowdown, and since investment is often believed to be a driver of growth, should more investments go to the formal sector or to the informal sector? In what ways outcomes are different in terms of composition of output, employment, and wages? The issue may be a particular interest to India where slowdown in investments is believed to be the primary reason behind the recent sluggish growth of the economy. This paper theoretically evaluates the effects of investments on sectoral wage rates, output and employment composition, and growth in a developing economy consisting of a vast informal sector in a general equilibrium framework with endogenous demand and sector specific capital. The model traces, beginning with capital market disequilibrium and labour market distortion, whether investments into the sectors lead to equilibrium in capital and labour markets over time. This approach is distinctly different from the existing literature that is primarily engaged with finding out comparative statics results of a change in policy variables such as tariff rate and subsidy/tax. This paper also brings in endogenous demand that is mostly missing thus far. The model highlights the following results. Investments in the formal sector increase the size of the sector and cause the informal sector to shrink. The labour market distortion goes away as wages are eventually equalized across the sectors, after which the capital market equilibrium is achieved. Equalisation of wages is similar to the ‘turning point’ of the Lewis model of development. On the other hand, investments in the informal sector increase its own size but do not alter the size of the formal sector. Much contrary to the previous case, capital market equilibrium is achieved first, so the labour market distortion stays, leading to the existence of a persistent wage gap in the long run. One way of avoiding the possibility of the informal sector becoming large in size would be to subsidize the short-run capital return in the formal sector. This of course is a ‘second-best’ policy to counteracting the distortion in the labour market.

A Single Period Stochastic Model for Maximising Firms Value

This article sets up a single period value maximization model for the firm based on stochastic end-of-period cash inflows, stochastic bankruptcy costs and taxes based on income rather than wealth. The risk-return trade-off is captured in the Capital Asset Pricing Model. Thus, the model also assumes a perfect capital market and market equilibrium. The model establishes the existence of a unique optimal financial leverage at which the firm value is maximized, this leverage being less than the maximum debt capacity of the firm.

Issues in real options with shadow costs of incomplete information and short sales

This paper presents the valuation of real options and the capital budgeting models within shadow costs of incomplete Information and short sales. Shadow costs are sunk costs in the spirit of Merton's (1987) model of capital market equilibrium with incomplete information.The shadow cost includes two components. The first component is the product of pure information cost due to imperfect knowledge and heterogeneous expectations. The second component represents the additional cost caused by the short-selling constraint. Information costs are linked to Merton's (1987) model of capital market equilibrium with incomplete information, CAPMI. This model is extended by Wu, Li and Wei (1996) who propose an incomplete-information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. This model is used in our paper to provide for the first time in the literature analytic solutions for derivatives in the presence of both shadow costs of incomplete information and short sales.Shadow costs are used in standard discounted cash flow techniques and real options. The justification of shadow costs in real projects is based on the observation that R&D needs to be done before investment decisions. The main results regarding real options and shadow costs of incomplete information and short sales are proposed by extending the analysis in Bellalah (1999, 2000) and Bellalah and Wu (2009).Our results have important implications in terms of pricing derivative assets and different types of real options. In particular, this framework can be easily implemented in investment decisions and the valuation of flexibility embedded in real projects. In fact, several investment decisions under uncertainty can be reformulated and their results can be implemented in the presence of incomplete information and investment constraints.

On information costs, short sales and the pricing of extendible options, steps and Parisian options

This paper provides a simple framework for the valuation of exotic derivatives within shadow costs of incomplete information and short sales. The specific features of the OTC markets with comparison to the organized markets require an additional investment to obtain information about the financial products, to process data, to elaborate models, etc. The shadow cost includes two components. The first component is the product of pure information cost due to imperfect knowledge. The second component represents the additional cost caused by the short-selling constraint. Information costs are linked to Merton’s (J Fianance 42:483–510, 1987) model of capital market equilibrium with incomplete information, CAPMI. This model is extended by Wu et al. (Rev Quant Finance Account 7:119–136, 1996) who propose incomplete-information capital market equilibrium with heterogeneous expectations and short sale restrictions, GCAPM. This model is used in our paper to provide for the first time in the literature analytic solutions for derivatives in the presence of both shadow costs of incomplete information and short sales. Our methodology incorporates shadow costs of incomplete information and short sales in the options and their underlying securities. We provide formulas using the standard Black and Scholes method or the martingale method. Since shadow costs are important in the presence of illiquidity, the formulas are useful for the valuation of OTC derivatives.

The Impact of High-Speed Rail Investment on Economic and Environmental Change in China: A Dynamic CGE Analysis

This study investigates the impact of high-speed rail investment on the economy and environment in China using a computable general equilibrium (CGE) model with a focus on the period 2002-2013. The analysis is implemented in a dynamic recursive framework capturing long-run capital accumulation and labor market equilibrium. A national level impact was simulated through direct impact drivers including land use conversion, output expansion, cost reduction, productivity increase, transport demand substitution and induced demand. The results suggest that rail investment in China over the past two decades has been a positive stimulus to both the economy and social welfare, while the effect on CO2 emissions generation has been large. Overall, the economic and welfare contributions of rail investment are achieved primarily through induced demand and output expansion, whereas the contribution from a reduction of rail transportation costs and rail productivity increases were modest. In addition, negligible negative impacts from land use for rail development and the substitution effect among other modes were found. Emissions reduction from substitution of rail for other modes was small and overwhelmed by output expansion due to lowered rail transport costs and induced demand.