The relationship between fund performance and cash flows is very important to fund investors, fund managers, and management companies alike. As is the case in the U. S., many studies have shown that better-performing funds have larger cash flows. This study investigates the relationship between fund performance and cash flows in Korean equity fund markets, and shows the behavior of investors in response to fund performance. Very few studies have considered Korean fund market's unique features. In 2005, the Korean fund markets and industry have faced structural changes that affected the behavior of investors. Based on the structural changes, we show the relationship between fund performance and cash flows. Since 2000, Korea has witnessed great capital influx due to great market expansion. Investors began to be aware of the risk and reward relation of equity funds, and are able to distinguish equity funds from bond funds and bank savings. At the same time, nominal interest rates have drastically declined. As a consequence, the equity fund market has started to attract investors seeking higher returns on their investments. In line with the changing climate of financial markets, the Korean government has allowed commercial banks to conduct fund sales business using their extensive retail networks. As expected, sales businesses by commercial banks have helped accelerate the rapid growth of equity funds. To meet growing investors’ demands, investment management companies have devised dollar cost averaging techniques for equity mutual fund investments. They could succeed in launching a host of new equity funds that were designed specifically for dollar cost averaging investments. As a result of these adjustments, by the end of 2004, the demand base of equity funds was further strengthened with much larger market share. Moreover, the assets under management of equity funds following the preponderant dollar cost averaging investments have also begun to grow rapidly, which has provoked structural changes in the Korean mutual fund market. By fully taking into account such unique features and developments in the Korean fund markets, we investigate the relationship between fund performance and cash flows. For this study, fund data are generously provided by Zeroin and FN Guide, Korean financial data providers. The period for empirical analysis runs from January 2001 through December 2007. A total of 223 equity funds are selected among 1,117 public equity funds which have total net assets over 50 billion Korean won on average. One thing that should be noted here is ways in which class funds are handled to make sure to prevent the problems of fund replication. Nowadays, like in the U. S., most funds in Korea are established as class funds which can be included in the same portfolio but with different fee structures. For the purpose of empirical analysis, hence, just a fund should be selected among the same class funds. In this study, in order to prevent the replication bias, only the largest class fund is selected. To investigate the effect of equity fund performance on fund flows, we regress fund flows on equity fund performance and other control variables. According to the previous literature, control variables include standard deviation of past fund returns, past fund flows, market flows, log of total net assets, fund age, and some related dummy variables. Additionally, we employ a switching regression model to reflect the effect of structural changes of fund markets on the relationship between fund performance and flows. The overall results are as follows. First, as expected from the previous U.S. studies, better-performing funds have larger monthly cash flows than the other worse-performing funds. That is to say, investors base their fund investment decisions on the performance. Second, we find that fund performance and cash flows are positively related only for the period of 2005∼2007, based on which we conclude that the structural changes of the fund market affect the performance-flow relationship. Third, we observe the effect of start- up funds caused by enormous cash flows into start-up funds, but it does not affect the conclusion of this study. Also, we do not find any survivorship bias in the Korean fund market. To empirically prove the absence of start-up fund and survivorship biases, we employ both the direct and indirect approaches. Fourth, the best-performing funds in general induce greater cash inflows than do the worst-performing funds. As is the case in the U. S., therefore, we conclude that there exists an asymmetric relationship between fund performance and cash flows for the Korean equity fund markets. We also find evidence supporting the effect of structural changes on the relationship between fund performance and cash flows. Unfortunately in Korea, due to its relatively short history of fund markets and lack of data availability thereof, sufficient studies have not been conducted to fully understand the behavior of fund investors. The increasing number of behavioral finance analyses underlines the importance of understanding the behavior of fund investors for both protecting fund investors and further advancing fund industry. Therefore, we believe that this study could effectively stimulate further research.

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The previous literature on the effect of corporate governance on firm values raises a question on the efficiency of the stock market. One line of research involves many papers supporting that good corporate governance leads to higher firm values as measured by the Tobin’s Q. Papers by Ashbaugh et al. (2004), and Byun et al. (2008) among others belong to this group claiming that reduction in agency costs helps to increase firm value by reducing the cost of capital. On the other hand, there are papers showing that the information on corporate governance is not fully reflected in the stock prices; therefore, investors may still realize abnormal returns by investing in firms with good corporate governance (Gompers et al., 2003; Bebchuk et al., 2009). These two results are not consistent in terms of market efficiency since the first group of papers implies that information on corporate governance is already reflected on the stock price of the firms while the second group of papers implies that the information is not fully reflected on the stock prices. In this paper, we attempt to reconcile these two contradictory findings by providing evidence that the realization of the effect of good corporate governance is contingent on the level of firms’ information asymmetry. We empirically show that good corporate governance of a firm reduces the cost of equity capital only when the information asymmetry of the firm is relatively at a low level. Practically, the information on corporate governance such as ownership structure, board of directors, shareholder right protection, and audit committee is abstruse as well as hard to access. In Korea for example, the Corporate Governance Service evaluates the governance level of the firms listed on the Korea Exchange, but does not disclose corporate governance scores to investors except for the best and second-best firms. Because of the incomprehensibility of corporate governance level, stock investors may not fully reflect the information on the corporate governance of a firm on its stock price, so that reduction in the cost of equity capital of the firm may not be attained. Investors’ perception of corporate governance, therefore, is an important issue for the efficiency of a stock market and the financing costs of related firms. We hypothesize that the level of information asymmetry of a firm affects the level of the investors’ understanding of the corporate governance of the firm and, accordingly, the value of the firm. To the authors’ knowledge, this is the first study ever conducted to show that the effect of good corporate governance on the firm value depends on the level of information asymmetry of a firm. Previous studies have investigated the relation between corporate governance and firm value without taking into account investors’ perception of corporate governance. This paper, however, complements the existing results by considering the impact of investors’ understanding of their firms’ corporate governance. For the analysis, we divide the sample firms into two groups based on their level of information asymmetry. The number of analyst coverage is used as a proxy for information asymmetry. Then, we construct a hedge portfolio which is long in good governance firms and short in weak governance firms by each group, and estimate the abnormal return of the hedge portfolio of each group using CAPM and Fama-French (1993) three-factor model. The results show that the abnormal return of the hedge portfolio is statistically not different from zero for the low information asymmetry group, which implies that information on corporate governance is efficiently reflected on stock prices for the group. On the other hand, the abnormal return is significantly positive for the high information asymmetry group, which suggests that information on corporate governance of those firms is not fully understood by the investors and, therefore, is not fully reflected on the stock prices. We also regress Tobin’s q on corporate governance scores and find that corporate governance has significantly positive effect on Tobin’s q only for the low information asymmetry group. The effect of corporate governance on Tobin’s q is insignificant for the high information asymmetry group. In summary, we find that investors do not really reflect the information on the corporate governance of firms on their stock prices and their financing costs in case of higher information asymmetry. On the contrary, we show that good corporate governance positively affects firm values with lower level of information asymmetry.

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This paper investigates the spill-over effects of the U.S.’s and the euro area’s macroeconomic news on the Asia-Pacific interest rates. We find that higher than expected news from these two economies raises the conditional mean, and most news, regardless of signs, elicits the associated volatility of daily returns of the Asia-Pacific interest rates. We also find supporting evidence for the two possible channels of the spillover effects of macroeconomic news, namely the policy reaction expectation and the integration mechanisms. More importantly, we reveal that the U.S.’s unemployment rate news and the euro area’s inflation news have the strongest impact on the first two moments of the Asia-Pacific interest rates daily returns. These findings are consistent with the relative size of these two economies and the monetary policy frameworks conducted at the U.S.’s Federal Reserve and the European Central Bank.

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The smart money hypothesis states that investor money is “smart” enough to flow into the funds that will outperform in the future; that is, the investors have an ability to identify superior managers and invest accordingly. The first studies to address this issue (Gruber, 1996; Zheng, 1999) find that, indeed, funds that receive greater net money flows subsequently outperform their less popular peers. This pattern was termed the “smart money effect.” Also, more recent research (Keswani and Stolin, 2008) finds a robust smart money effect in the United Kingdom and the U.S. The effect is caused by buying (but not selling) decisions of both individuals and institutions. On the other hand, Sapp and Tiwari (2004) could not detect the smart money effect when they applied a more appropriate performance evaluation procedure that takes the stock returns momentum effect into account. To understand better how different types of investors make their fund buying and selling decisions, we briefly present evidence on the determinants of mutual fund money flows in Korea. Our dependent variables are net flows and their components that are expressed as proportions of fund value at the end of the month. We would expect lagged fund cash flows and fund returns to be the primary determinants of the fund cash flows. Control variables are logarithms of fund total net assets (TNA) and fund age, as well as fund total expenses (Chevalier and Ellison, 1997; Sirri and Tufano, 1998). Our results, based on the time series of cross-sectional regression coefficient estimates, indicate that our flow variables are persistent. Coefficient estimates for lagged flows and TNA are always positive and significant. But those for past performance, fund age, and fund expenses are negative and significant. In this paper, we examine the smart money issue with Korean daily data (January 2002 to May 2008). Owing to data constraints, all of the above studies work with the aggregate money flows to funds. All investors are aggregated, and sales are offset by repurchases. Furthermore, not having access to exact net flows, these papers approximate such flows using fund TNA and fund returns. But our data allow us to conduct a stronger test for the smart money effect by using daily data on exact fund flows, and to gain greater insight into investors’ decisions by considering separately the sales and purchases of individual and institutional investors in the Korean fund market. So we observe exact flows rather than approximations based on fund values and fund returns. To examine the smart money controversy, a simple way is to evaluate the performance of all “new money” put into mutual funds by investors. A natural benchmark against which to measure the success of these new investments is the performance of “old money”, that is, of assets already in place before the latest round of investments. We characterize our fund portfolios using what Zheng (1999) calls “the portfolio-level approach.” Specifically, each month we conduct a Carhart (1997) four-factor regression for every fund portfolio to obtain our four estimated factor loadings. Our new money portfolios don’t deliver higher alphas than old money fund portfolios. In other words, new money is not, in fact, smart. We also use a different methodology above, which involves sorting funds into positive and negative flow groups. The results are similar. On the other hand, in order to examine the pervasiveness of Korean investors’ ability to select superior funds, we compare equally weighted groups of popular and unpopular funds. This approach curtails the influence of funds with extreme flow observations. To understand which flow components drive this result, it is desirable to apply the same methodology to all the flow variables comprising net flows. Specifically, each month we sort funds using our measures of normalized money flows into high flow portfolios and low flow portfolios. We then compare the risk-adjusted performance of equally weighted high and low flow portfolios. The results show that the average alphas of the high flow portfolios are not larger than those of the low flow portfolios. This means that we no longer find this smart money effects. Only the result from the trading strategies confirms adverse Zheng (1999)’s information effect, that is, relatively investors can beat the market by investing in negative money flow, low money flow funds. To verify that the smart money effect holds throughout the empirical period and appraising methodology, we use alternatives approach. First, we repeat our analysis separately for the first and last halves of our Jan. 2002 to May 2008 study full period. Indeed, the contributions of the two subperiods are of similar results. Second, we show portfolio-level approach results using Ferson and Schadt’s (1996) conditional performance evaluation. Specifically, we follow Wermers (2003) and Kacperczyk et al. (2005) in implementing the conditional version of the Carhart (1997) model with the risk-free rate and term structure premium and credit spread representing the conditioning set of publicly available information. The results are qualitatively similar to those under the unconditional portfolio approach. There is no smart money effect on the basis of net flows, inflows and outflows. The results once again confirm that inflows and outflows don’t give rise to the smart money effect in the Korean fund market.

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The financing market accessibility is an important factor to consider when investigating firms’ financing choices. However, many studies on the capital structure adjustment speed, derived from traditional capital structure theories, have largely ignored the importance of financing market accessibility especially when they investigate the speed toward the target debt ratio. Thus, this paper investigates the role of financing market accessibility in the process for a firm to adjust their debt ratio to its target debt ratio. Since Modigliani and Miller suggested irrelevance proposition regarding the relationship between leverage and firm value in 1958 (Modigliani and Miller, 1958), many researchers have raised the question about the validity of the argument. Initially, they questioned whether the Modigliani and Miller’s irrelevance proposition is well supported by the available firms’ data and whether the imperfections of capital market make firm value links to debt ratio. A trade off theory was created on the basis of the latter case, claiming that a firm would select a target debt ratio by taking into consideration both costs and benefits of the debts. While Modigliani and Miller (1963) suggested a correction theory about irrelevance proposition, Baxter (1967) presented the bankruptcy cost theory arguing that the increase of the expected bankruptcy costs could countervail the tax shield of debt as the debt ratio increases. Jensen and Meckling (1976) showed the optimal debt ratio could be influenced by the agency cost occurring because stockholders entrust managers with the firm’s management. Since Modigliani nd Miller’s correction theory (Modigliani and Miller, 1963), the trade off theory developed by many researchers suggest that the optimal capital structural is determined by the relationship (trade off) between cost and benefit of using of debts. Survey result suggested by Graham and Harvey (2001) shows that 81% of 392 firms indeed consider a target debt ratio (or range) an important factor when they make their financing decisions. However, Myers (1984) refutes this trade off theory of capital structure with an updated version of Donaldson’s (1961) pecking order theory, according to which asymmetric information leads managers to believe that the market generally underprices their shares (Flannery and Rangan, 2006). As a result, a firm’s investment is financed first with internal funds before the firm gets into debt if internally generated funds are not sufficient, and equity financing is used only as a last choice of financing instrument. In a pecking order theory, the observed firm’s leverage shows primarily the result of a firm’s historical profitability and investment opportunities. Firms have no strong preferences about their debt ratios and no obvious propensity toward adjusting leverage alteration caused by financing needs or operating profit (loss). Other theories about capital structure also do not support the view of timely convergence toward a target debt ratio. Baker and Wurgler (2002) argue that a firm’s observed debt ratio shows its cumulative ability to catch the opportunity which equity shares are highly evaluated; that is, stock prices fluctuate around their true values, and managers tend to issue shares when the firm’s market-to-book ratio is high (Flannery and Rangan, 2006). This market timing theory, on the other hand, argues that a firm’s manager continuously takes the advantage of information asymmetries to benefit current shareholders. Thus, this theory suggests, like the pecking order hypothesis, that there is no reversion to a target debt ratio if market timing is the dominant determinant on firm’s leverage. The pecking order and market timing theories suggest that firms’ managers, generally not aware of any leverage effect on firm value, do not endeavor to modify changes in leverage. On the other hand, the tradeoff theory of capital structure implies that the factors of market imperfection can damage both leverage and firm value, thereby forcing firms to take management initiatives to offset deviations from their optimal debt ratios (Flannery and Rangan, 2006). Thus, estimating the adjustment speed of capital structure could be an important first step in verifying conflicting theories of capital structure. Using manufacturing firms listed on Korean security markets from Jan. 1, 2001 to Dec. 31, 2008, this study analyses the relationship between financing market accessibility and capital structure adjustment speed toward target debt ratio. This paper shows that the capital structure adjustment speed overall increases when the debt and equity financing market accessibility is good. This result holds regardless of the use of book and market debt ratio as dependent variable. Furthermore, firms can adjust their leverage toward the target faster when they have good equity financing market accessibility than debt financing market accessibility. These results suggest that financing market accessibility is the crucial determinant of capital structure adjustment speed, and this finding should shed important light into ways for policy makers to support firms’ smooth debt and equity financing.

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The protection of environment in parallel with firms’ sustainable growth has never been such an important issue as it has become today when the environmental damages have begun to threaten the global ecosystem and the survival of many plants and animals including human beings. Evidently, increasing consumption and mass production of goods to satisfy incessant consumption needs are the most significant culprit of environmental damages. Therefore, companies must take responsibilities by changing their production processes and establish procedures to control the pollution created by their production processes. But firms would not initiate such environmental management activities unless they are certain of the positive effects of incorporating environmental elements in the company management since the major goal of firms is to maximize the profit. With this issue in mind, we attempt to provide a scientific evidence that is related to the environmental management of companies. Specifically, we investigate the effect of environmental management on firm value based on the sample of firms that received the National Environmental Management Award. This award was initiated by the Korean government in 1999 and is now the most prestigious prize in the environmental management area. It has been given to firms that invest a significant portion of their resources on the environmental activities. In order to win the Grand Prize the firm must have the records of continuous environmental management activities for at least three years. As such, these firms can serve as a good proxy for the better environmental management. The environmental management could have both positive and negative impacts on firm value. Typically, firms must spend a substantial amount of capital to install and implement the pollutant control, and it is definitely a cost factor in the short-run. However, the environmental management enables firms to upgrade their corporate image as a good global citizen, which can contribute to a sales increase. It also makes firms reduce the unnecessary or marginal inputs in the manufacturing process which can lead to a decrease in production costs. Or under the circumstances wherein many countries and regions strengthen the regulation on environmental protection, the environmental management could be especially effective in preventing costly environmental lawsuits that may occur when a company ignores the environmental factors. These long-term effects will have a positive influence on firm value. Therefore, the overall impact of the environmental management must be measured by an empirical investigation. In this regard, our OLS regression results indicate that firms with significant environmental management activities have a higher Tobin’s q value. Thus, we conclude that the environmental management activities by firms are not a waste of resources but actually contribute to the improvement of firm value. However, the positive relationship between environmental activities and the firm value could be spurious, since there could exist the endogeneity problem in the underlying process. In other words, it is possible that the firms with a higher value could engage in environmental management since they have resources to invest in such activities, not the other way around. In order to control the confounding effects caused by endogeneity among variables, we employ three different methods when analyzing the impact of environmental management on firm value. First, we control the firm fixed effects in panel data analysis to eliminate the possibility that the unobserved firm characteristics may generate spurious results. Second, we estimate the simultaneous equation model with two dependent variables where one of the endogenous dependent variables is a dummy variable that is also an independent variable employed to explain the other continuous dependent variable. Third, we examine the difference in firm value increase between environmental management firms and control firms by the difference-in-difference test. The difference-in-difference method allows us to observe the increase of firm value caused purely by the environmental management after controlling for the firm value changes over time and the firm value difference without environmental management. Even after controlling the endogeneity problem we obtain the results that environmental management has a strong positive relationship with firm value and the increase in firm value is economically significant. We also examine the characteristics of the firms engaging in environmental management. The results indicate that the environmental management firms are bigger in terms of total assets and sales. Most of them are also members of the 10 biggest chaebol groups and other remaining business groups that are subject to the regulation on shareholdings in other domestic companies. Since the environmental management often requires a huge amount of capital expenditure, these companies can reap the benefit of economies of scale in this regard. Then, it is understandable that bigger firms can more easily employ environmental management while, in fact, most of bigger firms are chaebol firms. Further, they should have an additional incentive to engage in environmental management, which is to countervail the negative publicity of chaebol as a whole. In addition, we find that environmental management firms spend more on advertisement and R&D and have a higher profitability and a larger cash flow from operating activities compared to the firms in control group. We conjecture that profitable firms with high cash flows are better positioned to perform environmental management since they have more resources to allocate on environmental activities. However, environmental management firms in general have shorter business histories and higher fixed debt ratios.

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This paper explores the impact of multidimensional uncertainty on people’s incentives to acquire information using the Kyle model of informed trading. In a single period Kyle model, the informed trader is worse off if he acquires information (called non-fundamental information) about the level of noise trading. This is due to the fact that the informed trader, by betting against noise traders, reduces the variance of the total noise related trading; he gains from such a bet, but loses part of profits from fundamental trading. If there is a speculator who trades only on non-fundamental information, the informed trader is better off acquiring information that is dominated by the speculator’s whereas acquiring non-fundamental information that is not dominated could make the informed trader worse off than without such information. Moreover, the informed trader is much better off sharing such dominated information with the speculator after acquiring it. When there are two traders who have fundamental information, the less informed trader has stronger incentives to acquire non-fundamental information. We also show that non-fundamental information provides a better return if the noise trading has a bigger variance than the asset value. The overall picture emerging from this exercise is that traders who focus on fundamentals do not have strong incentives to acquire non-fundamental information.

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This paper examines the efficiency of intraday price discovery in the Seoul won/dollar FX market. More specifically, we investigate three aspects of the efficiency of price discovery: the speed of price discovery, the degree of price discovery per trade, and the accuracy of price discovery in the market. The speed and degree of intraday price discovery are measured by WPC (weighted price contribution) and WPCT (WPC per trade), which are devised by Barclay and Warner (1993) and Barclay and Hendershott (2003), respectively. The accuracy of intraday price discovery is measured by VR (variance ratio) proposed by Lo and MacKinlay (1988). We use the real- time transaction data and two-minute-interval quotes data of inter-dealer trades, brokered through Seoul Money Brokerage Services Ltd. from April 1 to May 30, 2003. Price discovery is defined as the dynamic process by which prices incorporate new information in financial markets including FX market. Since price discovery is generally the most important function in financial markets, its efficiency has become a very valuable public good. Despite the importance of its economic implications, the studies on the efficiency of intraday price discovery on FX market are very limited. Previous studies can be generally classified into two categories: those that belong to the first category indirectly analyze the efficiency of intraday price discovery by comparing it with that of other FX markets, while those of the second category directly analyze an aspect of the efficiency of intraday price discovery on an FX market. Rosenberg and Traub (2006) and D’Souza (2007) fall into the first category. Rosenberg and Traub (2006) examines the relative information shares of spot and futures FX markets using the methodology of Hasbrouck (1995) for two sample periods: May-August 1996 and March-May 2006. D’Souza (2007) investigates information content of order flows in inter-dealer brokered markets during two years from October 2000 to September 2002 using real-time transaction data. He reports that trades are more informative when they are initiated in a local country rather than in major foreign exchange centers like London and New York. Kaul and Sapp (2009) is the only existing study that falls into the second category. The study analyzes the accuracy of inter-dealer Euro-USD and CAD-USD FX markets for the year of 2000 through the VR test and GARCH analysis, and reports that the relative accuracy of price discovery is the greatest when trading activity is high and dealer concentration reaches its peak. The distinct features of our paper from the previous domestic and international studies on the efficiency of intraday price discovery are summarized as follows. First, this is domestically the first paper to directly examine the efficiency of intraday price discovery. Our paper provides another angle for the second category in the field, which currently includes the only paper by Kaul and Sapp (2009). Second, as far as we know, this is domestically and internationally the first paper to study all the dimensions of the efficiency of price discovery. Kaul and Sapp (2009), the only existing study of the second category, on the other hand, has a limitation of examining only accuracy out of three dimensions of efficiency of price discovery. Third, this paper provides an answer to the following question: “To what degree is the efficiency of intraday price discovery in the Seoul FX market attained during a trading day?” The answer is yet to be provided by the existing domestic literature. Eom et al. (2008) finds that the autocorrelation of daily won-dollar exchange rates disappeared after January 2001. This result indicates that the efficiency of price discovery has been achieved in the market at least in the frequency of daily since then. There has not been any further study which investigates the degree of intraday efficiency of price discovery is attained. The overall results of this study can be summarized as follows. First, the intraday pattern of price discovery exhibits an inverse J-shape. In addition, most of intraday price discovery is attained during the first 90 minutes just after the market opening. To be more specific, during the close-to-close (open-to-close) time span, about 75.3% (44.5%) of price discovery occurs during the first 90 minutes just after the market opening. After that, the speed and degree of price discovery decrease up to the last 60 minutes before the market closing, from which they increase again. Second, the efficiency of intraday exchange rates, after the market opening, is attained up to lunch break. During the period from the market opening to lunch break, there exists the autocorrelation in won/dollar exchange rates. When the short horizon is expanded from 30 minute to 120 minute with the long horizon fixed at a trading day, the computed VRs are significantly greater than 1. This result indicates that won/dollar exchange rates under-react to information in the short horizon, and thus there exists a positive autocorrelation in exchange rate returns. Meanwhile, if the short horizon is expanded to 150 minute i.e. the entire morning session, then the computed VR is not significantly greater than 1, indicating that positive autocorrelation does not exist. Overall, our findings imply that the efficiency of price discovery in the Seoul won/dollar FX market is very high; the process of price discovery occurs very quickly with great accuracy.

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A financial crisis is often triggered by negative external factors in the credit market. In case of the recent global financial crisis, the trigger was the sudden collapse of Lehman Brothers. Hence, it can be a reasonable notion to reflect the cost of externality on a fair deposit insurance premium in order to absorb consequential market distortion. This is akin to correcting the market distortion by taxing air pollution. Pedersen and Roubini (2008) is the first paper to address this issue by proposing the idea as a viable way to restore financial stability. In this paper, we reframe Merton’s (1974) credit risk model based on a general equilibrium context and price the systematic risk for deposit insurance which is considered to be the cost of the negative externality. For that purpose, we make use of the general equilibrium models such as Cox, Ingersoll and Ross (1985), Ahn and Thompson (1988) and Bates (1991). The model assumes that the return dynamics on the firm value process follows a geometric Brownian motion. This kind of stochastic dynamics is made possible by an economy’s random technological change over time. Park, Ahn and Kim (2009) has derived the risk-neutral dynamics for the firm value process using the Ahn and Thompson’s model (1988). The risk-neutral dynamics allows us to price a risky debt in a general equilibrium setting. Applying Ito’s lemma to the equilibrium relationship between the firm (asset) value and its debt value, we derive an equilibrium return dynamics on the debt. From this equilibrium return dynamics, we obtain an equilibrium relationship between the asset risk premium and the debt risk premium for a firm. Particularly, we show that the systematic risk premium depends upon the following variables: 1) the relative riskiness of debt (deposit) to asset, 2) asset beta, and 3) the investor’s relative risk aversion. The relative riskiness of debt to asset is largely associated with the bank’s financial risk represented by the leverage (debt to asset) ratio. The asset beta is determined by the asset return covariance with the economy’s total wealth. According to Merton (1977), the fair deposit insurance premium per dollar is defined as a present value of the expected default loss (per dollar deposited) under Martingale (Q) measure. Deposit insurance premium is, henceforth, computed as a sum of the present value of the expected loss to depositors from their bank default and its systematic risk premium; the risk-neutral default probability under Q measure accounts for the risk premium beyond its expected default loss. The expected default loss is, in turn, estimated using the classical logit model. In order to estimate the debt premium, we impute the firm asset return (unobservable) from its stock return (observable) by employing the iterative procedure used by Vassalou and Xing (2004). This procedure is similar to the KMV’s procedure outlined in Crosbie (1999). The procedure is based on the Merton’s notion (1974) that a firm’s stock is, as a matter of fact, a call option on the firm’s asset with the book value of the firm’s liability being the strike price. We first estimate the stock return volatility from the daily stock prices and use it as an initial value for the asset return volatility. Using the Merton’s relationship, we compute daily asset values for each trading days. We then compute the asset return volatility for the next iteration. The procedure is repeated until it converges. A striking difference of our model from the traditional option based model such as Merton (1977) and Marcus and Shaked (1984) is that our model allows us to estimate the expected default loss and the systematic risk premium explicitly and separately. Our model also differs markedly from that of Cooper and Davydenko (2004),which derives a relationship between the equity risk premium and the debt risk premium, in that ours is, in nature, a general equilibrium model while theirs is not. An empirical analysis is done for the Korean commercial banks and the mutual savings banks and is compared to the results obtained by the prior studies such as Marcus and Shaked (1984), and Duffie, Jarrow, Purnanandam and Yang (2003). Our model generally produces a higher premium than what one would obtain from the Marcus and Shaked’s (1984), which tends to underestimate it. We, furthermore, find that the expected default losses are higher for the mutual savings banks than the commercial banks, but the systematic risk premia are the opposite. We think that the commercial banks tend to be more procyclical as evidenced by their higher beta coefficients. The systematic risk premia varied over the business cycle, and reached the peak in the year of 2008. They are negatively related to the degree of financial stability. We recommend that the deposit insurance premia should be charged at the rates reflecting the differences in the systematic risk premia.

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The Korean fund market has experienced a tremendous growth in the past several years. Especially, the growth in the equity type fund has been phenomenal; for instance, its balance grew from 6.5 trillion won in March 2005 to 127.7 trillion won as of November 2008. While low interest rate and steady growth trend in the world stock market have driven the increase in the market size, the introduction of systematic monthly fund investment method, which is virtually the dollar cost averaging investment, has also played a significant role. In fact, since its introduction, fund distributors often advise individual investors in favor of the dollar cost averaging method, asserting that it generates higher returns with lower risks compared to the lump sum investment strategy; accordingly, many individual investors have participated in equity-type fund investment. This study aims to compare the performance of the lump sum (LS) investment strategy and dollar cost averaging (DCA) investment strategy in the Korean mutual fund market to check whether the DCA method really outperforms the LS method. Thus far numerous debates have followed over which of these two investment strategies is better since Constantinides (1979) which suggests that the LS investment strategy outperforms the DCA investment strategy. Prior to his paper, it was generally accepted that DCA is better than LS due to the dollar cost averaging effect. However, many theoretical and empirical researches since Constantinides (1979) have suggested that LS actually outperforms DCA. Most of the literature on this issue, regretfully, has been solely based on theoretical analysis or simulation methods only. Even empirical analysis has relied on hypothetical accounts rather than actual investment accounts. In this regard, this paper is different from the past literature in that we used not only the conventional simulation methodologies, but also individual investors’ actual account data to effectively compare the performance of LS and DCA investment strategies. The data for this paper are comprised of: i) KOSPI stock index and bond yields from January 1988 to December 2008 for the historic simulation; ii) KOSPI stock index and bond yield from January 2001 to December 2008 for Monte Carlo simulation; and iii) 36,890 individual accounts (of which 22,449 using DCA strategy and 14,441 using LS strategy) from December 2004 to November 2008 for the real investor data analysis. Our major findings are as follow. First, the historic simulation shows that LS investment strategy provides better return for short-term investment horizon (1 year) while DCA investment strategy outperforms for the long-term investment horizon (3 year and 5 year). This result holds robust whether we use simple return, Sharp measure, or Jensen’s alpha to measure the fund account performance. The Monte Carlo simulation shows similar results: the LS investment strategy gives better return for the 1 year investment horizon. For the 2 year investment horizon both strategies are comparable while DCA starts to outperform LS when the investment horizon is longer than 3 years. Second, we use individual fund investment account data to compare DCA and LS strategies and find that DCA outperforms LS during our study period which is divided into bullish period and bearish period. We find that the marginal effect of DCA on the risk adjusted return (Jensen’s alpha) is positive even after controlling for the market conditions. It is also found that DCA becomes a better investment strategy than LS when the investment term is longer and the investment capital is larger. Third, we compared two different methods to close down DCA investment account. Fund investors with DCA account can either choose automatic sell-off when their monthly saving contract matures or wait to select the better time to sell-off his or her fund even after the contract term expires. We find that investors who choose different sell-off time other than automatic contract expiration time do not perform better, and this indicates that investors as a group do not have ability to choose better investment exit time. Finally, we conduct the sensitivity analysis for the fund investment in response to the changes in the stock prices. We find that both fund purchase and fund sell-off are sensitive to stock price movements. Both purchase and sales of fund increase when the stock price (KOSPI index) rises, and they decrease when the stock price falls. Between the purchase and sales, fund purchase activity is more sensitive to the stock price movements than fund sales activity is while LS investors are more sensitive than DCA investors are. Our study result suggests that individual equity type fund investors are better off when they invest with DCA strategy and for a longer time horizon. This paper makes a meaningful contribution to the fund and investment literature as it is the first paper to examine the actual investors’ account to compare the DCA and LS fund investment methods. Nonetheless, we acknowledge that some part of the result may be sensitive to the study period.

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