Dividends and Corporate Governance: Canadian Evidence

-- Bin Chang and Shantanu Dutta

This paper examines the role of corporate governance as a determinant of dividend policy with Canadian data over the period 1997-2004. It finds that firms with large board favor higher dividend payments. Further, the ratio of option over cash in CEO’s compensation negatively affects dividend payments. Findings generally show support for the ‘substitution model’ (La Porta et al., 2000). As per the ‘substitution model’, firms with weaker governance characteristics (such as large board size, lower alignment of CEO pay, lower percentage of unrelated director, CEO duality, lower CEO ownership, prevalence of dual-class share structure) are likely to pay higher dividends. It also finds that firms which pay higher dividends are those with less investment opportunities, larger size, and less market risk. These findings are robust even after controlling for endogeneity, external monitoring by equity analysts, joint effect of investment opportunity and corporate governance variables, stock repurchases, or dividend premium.

© 2012 IUP. All Rights Reserved.

Profitability of Option-Based Merger Arbitrage

-- Xuewu Wang and Lei Wedge

This paper examines the profitability of option-based merger arbitrage. A simple arbitrage strategy using stock options is designed to examine the merger arbitrage profitability from 1996 to 2008. This strategy takes long position on call options of target firms and put options of acquirer firms simultaneously. The results show that the option-based arbitrage strategy is far more profitable than the stock-based arbitrage strategy. Option arbitrage grows one dollar invested in merger deals in January 1996 into more than seventeen dollars by December 2008. In contrast, stock arbitrage grows one dollar into approximately seven dollars over the same period. It is also observed that both the strategies generate significant arbitrage portfolio returns that are robust to controls of traditional asset pricing factors.

© 2012 IUP. All Rights Reserved.

Exchange Rate Dynamics in Indian Foreign Exchange Market: An Empirical Investigation on the Movement of USD/INR

--Maram Srikanth and Braj Kishor

In the present study, an attempt has been made to explain the dynamics of exchange rate in Indian foreign exchange market. The empirical study is based on ‘Multiple Regression Analysis’ to identify the factors that drove the exchange rate of USD/INR during the period January 1999 through March 2011. Apart from the secondary data, the primary data on exchange rate of USD/INR was collected through a questionnaire from 175 professionals across the world. The results suggest that lagged value of the dependent variable (USD/INR), current account balance, relative money supply, index of industrial production and interest rate differential are the most significant variables in determining the USD/INR exchange rate. It is also observed that forward premia, capital account and RBI’s net intervention do affect exchange rates (significant at 10% level), but their impact is found to be marginal. The survey results, based on primary data, suggest that Indian foreign exchange market has become deep, liquid and efficient over a period of time. A majority of the respondents agreed that forward premia influence future exchange rates. There is a near unanimous view that RBI played a proactive role during the financial crises in the past. The results have policy implications since exchange rates affect all the sectors of the economy.

© 2012 IUP. All Rights Reserved.

The German Exchange Traded Funds

-- Gerasimos G Rompotis

This paper investigates the performance and trading characteristics of 43 German Exchange Traded Funds (ETFs) traded on XTRA market during the period 2003-05. The findings show that these ETFs perform similar to the underlying indexes but are riskier than indexes. German ETFs do not adopt full replication strategies, a fact that results in a substantial tracking error. Return is positively related to risk and negatively related to tracking error. Furthermore, the volatility of German ETF returns is found to be positively correlated to tracking error, premium and intraday volatility, which means that the higher the magnitude of these variables, the higher the risk of ETFs. On the other hand, the risk of investing in German ETFs is negatively related to bid-ask spread. Tracking error is positively related to risk, premium and spread, while the expense ratio decreases when the size of ETFs increases due to economies of scale. Going further, the magnitude of bid-ask spread and the corresponding cost of investing in German ETFs increase when the premium and intraday volatility increase too. Finally, turnover is negatively related to intraday volatility.

© 2012 IUP. All Rights Reserved.

Predicting the Bond Ratings of S&P 500 Firms

--Murat Körs, Ramazan Aktaişe and M Mete Do öğüanay

In this paper, we have developed models to find out as to what factors are important in determining the bond ratings of the non-financial firms which are included in S&P 500 index. Our analysis is different from other analyses in the literature because we have used the more recent data, i.e., the ratings belong to the years 2008, 2009 and 2010. We have performed two types of analyses. In the first analysis, all the variables are used as explanatory variables after eliminating some variables to avoid multicollinearity. In the second analysis, factor analysis is performed to group the variables into factors, and variables whose correlations with the factors are the highest are used as explanatory variables. In both the analyses, multiple discriminant analysis, ordered logit, and ordered probit models are estimated. The best model is the ordered logit model that used all the variables. The important factors that determine the bond ratings are long-term liabilities/total assets ratio, return on equity, net profit margin, trade payables, and operating income. The firms that need to improve their bond ratings must pay attention to these factors. Also, by using the models presented in the paper, investors can have an idea about the credibility of the issuers.

© 2012 IUP. All Rights Reserved.

The Impact of Derivative Trading on the Liquidity Beta of Underlying Stocks in India

-- M S Narasimhan and Shalu Kalra

This paper examines the impact of changes in aggregate market liquidity on stocks in which derivative trading is allowed. Though the liquidity of the market declines after the introduction of derivative trading, the impact of changes in market liquidity on stocks is critical in asset pricing. We find that the negative value of liquidity beta has increased after the introduction of derivative trading, thus increasing the sensitivity of liquidity shocks on asset prices.

© 2012 IUP. All Rights Reserved.