Five-year Horizon Research Articles

Exchange-Rate Dark Matter

Dark matter is believed to account for 83 percent of the matter in the universe and plays a central role in cosmology modeling. This paper argues that an analogous form of dark matter plays a similarly important role in international macroeconomics. Like its cosmological counterpart, exchange-rate dark matter cannot be directly observed, but its existence can be inferred from observations on the real exchange rates and interest rates. In the first part of this paper I show that dark matter is the dominant driver of short- and medium-term changes in real exchange rates for the G-7 countries; accounting for more than 90 percent of the variance at the five-year horizon. Although standard models stress the role of real interest differentials as the proximate drivers of real exchange-rate variations, my findings indicate that they are empirically unimportant.To understand the nature of exchange-rate dark matter, the second part of the paper develops an open-economy DSGE model in which the risk shocks driving households’ habits interact with collateral constraints and incomplete markets. The model not only shows that risk shocks can account for the role of dark matter as a driver of real exchange-rate dynamics, but also that these same shocks have significant macroeconomic implications. My analysis suggests that exchange rates appear disconnected from traditional macroeconomic fundamentals because they are particularly susceptible to risk shocks that play an important role in international macroeconomics.

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Exchange-Rate Dark Matter

Dark matter accounts for 83 percent of the matter in the universe and plays a central role in cosmology modeling. This paper argues that an analogous form of dark matter plays a similarly important role in international macroeconomics. Exchange-rate dark matter is invisible, but its existence can be inferred from observations on real exchange rates and interest rates. I first show that dark matter is the dominant driver of short- and medium-term changes in real exchange rates for the G-7 countries; accounting for more than 90 percent of the variance at the five-year horizon. I then develop a model in which risk shocks account for dark matter's role as a driver of exchange-rate dynamics and other macro variables.

Orphan Versus Non-Orphan IPOs: The Difference Analyst Coverage Makes

This paper addresses the question of the importance of analyst coverage for the long-run returns of IPO firms over the period from 1991 to 2010. In US IPOs, during the one- to five-year horizon, we find a significant long-run abnormal performance by orphans (IPOs without analyst coverage) compared to non-orphans (IPOs with analyst coverage). Further analysis reveals that this outperformance by non-orphans stems from high analyst coverage. Our results are robust after accounting for venture capital backing, underwriting syndicates, underpricing, institutional investor ownership, or operating performance variables.

Covered interest rate parity in emerging markets

This paper finds that while covered interest rate parity holds for large and small triple A rated economies, it holds for emerging markets only for a three-month maturity. For a five-year horizon the size and frequency of violations lead to the conclusion that covered interest rate parity does not hold for longer maturities for Brazil, Chile, Russia and South Korea. Overall this paper finds that aspects of credit risk are the source of violations in CIRP in the long-term capital markets rather than transactions costs or the size of the economy.

Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth

A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton et al. (J Account Res, 40, 657–676, 2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon.

Orphan versus Non Orphan IPOs: What Value Stems from the Coverage of Financial Analysts?

This paper examines the long run performance of IPOs carried out between 1991 and 2005. By using various methodologies, we find that IPOs in our sample performed negatively relative to comparison portfolios over the 1991-2005 horizon. This abnormal long run performance is much severe for orphans’ IPOs (without financial recommendation) than non orphans’ IPOs from three to five-year horizon (statistically significant). The evidence suggests that analyst coverage is indeed important to issuing firm but the market do not fully incorporate the perceived value of this coverage. Further analysis reveals that this outperformance by non orphan stems from high coverage.Investors pay more attention for non orphan when IPOs are non venture capital backed, with a small underwriting syndicate and low underpriced. Over the 1991-2005 period, analyst’s affiliation does not appear to matter. This result is inconsistent with the conflict of interest hypothesis (Michaely and Womack, 1999). We establish that analyst recommendations are significantly related to long run performance of IPOs. Hence, we corroborate the crucial role of financial analysts in producing and interpreting IPOs’ financial releases.

US planetary sciences to focus on smaller missions, research, and technology development

Heeding community advice, NASA’s planetary science division seeks to scale back its flagship missions while retaining strong international partnerships.

Does Income Smoothing Really Create Value?

Extant literature suggests that income smoothing, as measured by unit-free measures such as the correlation between pre-managed earnings and discretionary accruals, creates value. We recognize that income smoothing also drives up the volatility of discretionary accruals due to larger dollar amounts of smoothing efforts. We find that although the unit-free aspect of income smoothing is associated with higher future returns, the volatility aspect is associated with lower future returns. Taken together, high levels of future returns associated with the correlation measure are completely offset by negative future returns associated with the volatility measure over one-month to five-year horizons. These findings are robust to a battery of control variables and to different measures of income smoothing, and robust for industry groupings and firms adopting similar income-smoothing practices. Our results cast doubts on the ability of income smoothing to create value for shareholders over time. In particular, although the literature suggests that investors value smooth firm performance, artificially dampening the variabilities of reported earnings over time does not fool investors. Instead, income smoothing destroys value because investors are more sensitive to the increase in information asymmetry brought about by the volatility measure than to the decrease in information asymmetry brought about by the correlation measure.

Predictability of stock returns and asset allocation under structural breaks

This paper adopts a new approach that accounts for breaks to the parameters of return prediction models both in the historical estimation period and at future points. Empirically, we find evidence of multiple breaks in return prediction models based on the dividend yield or a short interest rate. Our analysis suggests that model instability is a very important source of investment risk for buy-and-hold investors with long horizons and that breaks can lead to a negative slope in the relationship between the investment horizon and the proportion of wealth that investors allocate to stocks. Once past and future breaks are considered, an investor with medium risk aversion reduces the allocation to stocks from close to 100% at short horizons to 10% at the five-year horizon. Welfare losses from ignoring breaks can amount to several hundred basis points per year for investors with long horizons.

Bank Risk Taking and Liquidity Creation Following Regulatory Interventions and Capital Support

During times of bank distress, authorities often engage in regulatory interventions and capital support in order to reduce bank risk and calm financial markets. A potential unintended effect of such actions is that they may also reduce the liquidity created by banks, with possible adverse consequences for the economy as a whole. This paper investigates the effects of regulatory interventions and capital support on bank risk taking and liquidity creation over both the short run (one-year horizon) and long run (five-year horizon) using a unique dataset of German universal banks over the period 1999-2009. Our main findings are that regulatory interventions and capital support are associated with reductions in both risk taking and liquidity creation in the short term and long term. Thus, both types of actions have both intended and unintended consequences.

Finding Fair Value in Global Equities: Part II—Forecasting Returns

This article is the second of a two-part series that develops a framework for comparative valuation of major equity markets around the world. In this article, the authors invert the dividend discount model (DDM) discussed in “Fair Value in Global Equities:Part I,” published in the preceding issue of this journal, in order to extract a time series of the implied equity risk premium (ERP) and the real required return (RRR).They estimate regression equations to find the macroeconomic drivers of these series. The ERP increases with the output gap at home and abroad, as well as with high past values of the ERP. This relationship allows for benchmarking the ERP and the RRR to the current economic environment and to forecasts of the future economic environment. The authors compare the use of these tools with other ways to forecast returns. At a five-year horizon, valuation alone is a good predictor of future returns, and the current value of the RRR works particularly well in this regard. At a one-year horizon, forecasts based on the benchmarking of the RRR to the future economic environment work significantly better than traditional valuation metrics, if the economic outlook is correct. <b>TOPICS:</b>Global, analysis of individual factors/risk premia, theory

Cost-effectiveness of rivaroxaban versus enoxaparin for the prevention of postsurgical venous thromboembolism in Canada

This study aimed to evaluate the cost-effectiveness of prophylaxis with rivaroxaban vs. enoxaparin in the prevention of venous thromboembolism (VTE) after total hip replacement (THR) and total knee replacement (TKR) from the perspective of the Canadian healthcare system. A model was developed that included both acute VTE (represented as a decision tree) and long-term complications (represented as a Markov process with one-year cycles). Transition probabilities were derived from phase III clinical trials comparing rivaroxaban with enoxaparin and published literature. Costs were derived from the Ontario Case Costing Initiative and publicly available sources. Utilities were derived from published literature. The model reported VTE event rates, quality-adjusted life expectancy and direct medical costs over a five-year horizon. Costs are reported in 2007 Canadian Dollars (C$). When rivaroxaban and enoxaparin are compared in patients undergoing THR, rivaroxaban dominates enoxaparin. That is, rivaroxaban is associated with improved health outcomes as measured by increased quality-adjusted life years (QALYs; 0.0006) and fewer symptomatic VTE events (0.0061), and also with lower cost (savings of C$300) per patient. Similarly, rivaroxaban dominates enoxaparin in patients undergoing TKR, achieving a gain of 0.0018 QALYs, a reduction of 0.0192 symptomatic venous thromboembolic events and savings of C$129 per patient. Rivaroxaban is a cost-effective alternative to enoxaparin for VTE prophylaxis in patients undergoing THR and TKR. Over a five-year horizon, rivaroxaban dominated enoxaparin in the prevention of VTE events in patients undergoing THR and TKR, providing more quality-of-life benefit at a lower cost.

A Competing Risk Dynamic Hazard Approach to Investigate the Impairment Outcomes of Property-Casualty Insurers

This study applies a competing risk approach and develops dynamic type-specific Cox’s hazard models to investigate the underlying risk factors associated with the incidence and the timing of impairment events occurring to property-casualty insurers in the U.S. during January 1998 - June 2010. The models treat impairment events of different manners as distinct, and accounts for the changes in the financial characteristics of insurers as well as the development of macro-economic conditions over time. It is found that the hazards of impairment events of different manners are neither equal nor proportionate. The hazards for a supervision, a conservation, and a rehabilitation event increase more rapidly with time than the hazard for a liquidation event. The model for a generic impairment event and the models for manner-specific impairment events feature different significant underlying risk factors. The differences across estimated models are not due to random variations, which strengthen the evidence that impairment events of different manners are distinct phenomenon, and emphasize the need to develop separate models for separate impairment event types. The validation results over a five-year forecast horizon show that the models for manner-specific impairment events exhibit better predictive accuracy in forming time-varying survival estimates than does the model for a generic event. The proposed approach aids insurance regulators in the early identification of troubled insurers, in the choice of optimal means of regulatory interventions, and in the preparation of appropriate preventative/remedial plans with sufficient lead time.

The Value of Long-Term Accrual Management

In this paper, we examine both value-enhancing and value-detrimental effects of smooth earnings on forward-looking value proxies of future returns from one-month to five-year horizons. Some prior studies, on one hand, find that smoothed earnings signal superior performance, enhancing thereby firm value; some others, on the other hand, argue that smooth earnings achieved through managerial intervention are noisy. We capture the potentially harmful long-term managerial intervention aspects of earnings smoothing by multi-period accruals volatility that increases with smooth earnings. Consistent with previous literature, we treat the correlation (“correlation”) between cash flows and accrual as the value enhancing aspect of earnings smoothing. In multivariate regressions that control for a battery of risk factors, future returns are positively related to earnings smoothing of the correlation variable but negatively associated with accrual volatility. Moreover, economic significance tests performed in this paper show that the value detrimental effects of accrual volatility completely wipe out future returns increases associated with any increase in correlations. These results are particularly pronounced in discretionary accruals and in firms with high information asymmetry and underlying operating uncertainty. The evidence suggests that due to its large accrual volatility effect, excessive long-term accrual management, whether voluntary or involuntary, is valuedetrimental.

Standard &amp; Poor's Indices Versus Active Funds Scorecard, Year End 2008

The S&P Indices Versus Active Funds (SPIVA) Scorecard report performance comparisons corrected for survivorship bias, shows equal- and asset-weighted peer averages, and provides measures of style consistency covering actively managed U.S. equity, international equity and fixed income mutual funds. Underlying data is from the CRSP Survivor-Bias-Free U.S. Mutual Fund Database. To accommodate CRSP release schedules, SPIVA is published semi-annually with a fourteen week lag. Over the five year market cycle from 2004 to 2008, S&P 500 outperformed 71.9% of actively managed large cap funds, S&P MidCap 400 outperformed 79.1% of mid cap funds and S&P SmallCap 600 outperformed 85.5% of small cap funds. These results are similar to that of the previous five year cycle from 1999 to 2003. The belief that bear markets favor active management is a myth. A majority of active funds in eight of the nine domestic equity style boxes were outperformed by indices in the negative markets of 2008. The bear market of 2000 to 2002 showed similar outcomes. Benchmark indices outperformed a majority of actively managed fixed income funds in all categories over a five-year horizon. Five year benchmark shortfall ranges from 2-3% per annum for municipal bond funds to 1-5% per annum for investment grade bond funds. The script was similar for non-U.S. equity funds, with indices outperforming a majority of actively managed non-U.S. equity funds over the past five years.

Standard &amp; Poor's Indices Versus Active Funds Scorecard, Mid Year 2008

The S&P Indices Versus Active Funds (SPIVA) Scorecard report performance comparisons corrected for survivorship bias, shows equal- and asset-weighted peer averages, and provides measures of style consistency covering actively managed U.S. equity, international equity and fixed income mutual funds. Starting with this report, we reintroduce an enhanced SPIVA with broader asset class coverage. Data for enhanced SPIVA is from the CRSP Survivor-Bias-Free U.S. Mutual Fund Database. To accommodate CRSP release schedules, the new SPIVA will be published semi-annually with a fourteen week lag. Over five years ending June 2008, S&P 500 outperformed 68.6% of actively managed large cap funds, S&P MidCap 400 outperformed 75.9% of mid cap funds and S&P SmallCap 600 outperformed 77.8% of small cap funds. Among global equity funds, five-year results show S&P Global 1200 outperforming 70.1% of global equity funds, S&P 700 outperforming 86.5% of international equity funds, and S&P IFCI Composite outperforming 73.9% of emerging market funds. Among fixed income funds, indices outperformed twelve of thirteen categories over a five-year horizon. Only emerging market bond funds outperformed their benchmark index. Funds disappear at a meaningful rate. Over five years, 26.8% of U.S. equity funds, 22.5% of global equity funds and 24.7% of fixed income funds have been merged or liquidated. This highlights the importance of addressing survivorship bias in mutual fund analysis.

A Model for Enhancing Evidence-Based Capacity to Make Informed Policy Decisions on the Introduction of New Vaccines in the Americas: Paho's Provac Initiative

New and underutilized vaccines are becoming available to combat important public health challenges. Each year, rotavirus is estimated to cause approximately 111 million episodes of gastroenteritis, which requires home care, 25 million clinic visits, 2 million hospitalizations, and approximately 440,000 deaths in children younger than 5 years of age worldwide. Children in the poorest countries account for 82% of rotavirus deaths. An estimated 16,000 deaths by rotavirus-induced diarEditor’s note: The thoughtful article by Dr. Andrus and his colleagues in describing the utility of the Pan American Health Organization’s (PAHO’s) ProVac model1 reminds us of the startling childhood and adult disease statistics. Whether it is the 440,000 gastroenteritis annual deaths in children younger than age 5 or the 32,000 annual deaths from papillomavirus—with more than 80% in poor and developing countries—these numbers are staggering. Examples such as the experience in Mexico that was described by Santos et al.2 show the ProVac model can work very well. The authors suggest that three essential factors need to be addressed if agencies and governments are to attain a sustainable impact: decisions should be nationally based; evidence used to support the decisions must be broad-based; and infrastructure must be in place to support a nationally based process. The ProVac program objectives are rather aggressive, with just a five-year horizon to achieve a series of ambitious goals. At the same time, PAHO is honest: the organization recognizes it has little choice but to move in this direction. PAHO can serve as a model for the rest of the developing world. Lessons learned in the ProVac experience will serve many others well as they attempt a similar, if not more aggressive approach.

Winning by Losing: Evidence on Overbidding in Mergers

Do acquiring companies profit from acquisitions? Or do acquiring CEOs overbid and destroy shareholder value? Answering this question empirically is difficult since the hypothetical counterfactual is hard to determine. While negative stock reactions to the announcement of mergers are consistent with value-destroying mergers, they are also consistent with overvaluation of the acquiror at the time of the announcement. Similarly, studies of long-term returns to acquirors are affected by slow adjustments in valuation. This paper studies bidding contests to address this identification issue. We construct a novel data set on all mergers with overlapping bids of at least two potential acquirors between 1983 and 2004. We then compare adjusted abnormal returns of all candidates both before and after a merger fight. The key identifying assumption is that the returns and other corporate outcomes of losing bidders are a valid counterfactual for the winner, after employing the standard controls and matching criteria. We find that stock returns of bidders are not significantly different before the merger fight, but diverge significantly after one bidder has completed the merger. Winners significantly underperform losers over a five-year horizon. These results are robust to various sample selection criteria and controls including firm and case fixed effects. Our findings suggest that CEOs significantly overbid, at least in the context of merger fights.

TRADEOFFS OF AUSTRIAN BUDGETARY POLICIES: AN OPTIMUM CONTROL ANALYSIS

In this paper, we use optimum control methods to determine optimal budgetary policies for Austria over a five-year horizon. Optimal fiscal policies are calculated using the algorithm OPTCON. Optimal policies are compared to a simulation using extrapolated values of budgetary policy variables in terms of their performance with respect to Austrian macroeconomic targets. Policy tradeoffs between these variables are quantified.