This paper derives no arbitrage moment bounds from Fama and French 25 portfolios(FF25) and tests stochastic discount factor models through them. We compare the result of moment diagnosis test with that of generalized method of moment(GMM) test and Hansen and Jagannathan(1997)’s minimum distance(H-J distance) test. The result is the following. The greatest lower bound of moment for FF25 is marginally increasing with the order of moment. This phenomenon is inferred to be occurred from fat-tail property in security market data including FF25. But most of constant parameter models in our research do not satisfy these moment conditions from the second to the fourth and therefore cannot be among no arbitrage stochastic discount factor set for FF25. But some of time-varying parameter models in our research satisfy these conditions and some of them are not rejected at given significance level in H-J distance test. This implies that instrumental variables in conjunction with models are effective to price FF25.

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In this paper, we explore the historical equity premiums in Korean stock market, and examine whether there is equity premium puzzle in Korean market, which is, as noted in Siegel(1998) and Campbell(2001), universally observed in major financial markets. We, however, find that equity premiums in Korean market are very small, and conclude that there is no equity premium puzzle in Korean market. There may be several reasons that equity premium puzzle is not observed in Korean market: short sample period, errors in estimating risk free rates, very low risk aversion, and/or undervaluation of Korean stock market. Among these factors, we argue that undervaluation is the most responsible factor for low equity premiums. We estimate equity returns with fundamentals such as dividends and earnings, then calculate equity premiums. We find that equity premiums estimated with fundamentals are much large than historical equity premiums. This implies that Korean stock market may not be free from equity premium puzzle.

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This paper examines the effects of an option to wait to invest on a firm's financing and investment decisions when capital markets suffer from asymmetric information regarding the profitability of the firm's investment project. We focus on the role of such an option available to the firm as a means to avoid mis-pricing in the spot capital markets. Under symmetric information, financing becomes irrelevant as the firm makes its investment decision efficiently. Here, the option to wait functions only as a means of minimizing its burden of capital cost at the expense of the first mover's advantage. Under asymmetric information, we show that relatively undervalued firms prefer debt financing whereas relatively overvalued ones prefer equity financing. This holds because an undervalued firm can minimize loss from undervaluation by issuing debt whereas an overvalued firm can maximize benefit from overvaluation by issuing equity. As a result, the equity market is always populated by overvalued firms and hence is bound to fail. In equilibrium, therefore, only debt market may open. In equilibrium, firms' behavior goes as follows. A firm with a superior project defers investment in order to avoid mis-pricing applicable in the debt market, anticipating that informational asymmetry will disappear in the next period so that it can finance at a fair market price based on its true profitability. A firm with an inferior project gives up investment because even the maximum payoff from investment is no greater than the debt obligation. All the remaining firms with medium quality projects make investments by raising funds in the debt market.

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This study empirically examines the price effect of abnormal order imbalances for Korea stocks from January 2003 to January 2005 according to classifications by trade initiators (buyer-initiated or seller-initiated), investor type(domestic individual, domestic institution, and foreigner) and firm size. First of all, in vector autoregression analysis by using all daily returns and order imbalances, both information effect and liquidity effect are shown. However, in VAR analysis with daily returns and order imbalances when large order imbalance occurs, this liquidity effect is inferred to be caused by domestic individual investors. This is supported by the results in event study; an event is defined as a day when a particular investor group forces order imbalance higher or lower than standard deviation of all daily order imbalances on a particular firm around its mean. In events by domestic institutions and foreigners, changes of prices along to the directions of large order imbalances are not reversed for 4 or 5 days after the events. Additionally, net trading volumes also are similar to order imbalances in magnitude and direction. However, for events done by domestic individual investors, around the event day, cumulative excess returns are widely reversed. Furthermore, order imbalances of domestic individual group are ten times as big as net trading volume of the investor group. This may be because of big heterogeneity in opinion about future price movement in a domestic individual group. Finally, as size of firm increases, the impact of information effect of all investor groups order imbalances seems to increase.

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This article investigated the relevance of the skewed Student-t distribution innovation in analyzing volatility stylized facts, namely, volatility clustering, volatility asymmetry, and volatility persistence, in three individual Korean shares. For this purpose, we assessed the performance of RiskMetrics and two long memory Value-at-Risk (VaR) models (FIGARCH and FIAPARCH) with the normal, Student-t, and skewed Student-t distribution innovations. From the results of the empirical VaR analysis, the skewed Student-t distribution innovation provided more accurate VaR calculations, in capturing stylized facts in the volatility of three sample returns. Thus, the correct assumption of return distribution might improve the estimated performance of VaR models in the Korean stock market.

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This paper examines the effect of analyst stock recommendations on equity option market activity in US over the 1996 to 2002 period. I find that the implied volatilities of recommended stocks gradually increase up to the recommendation revision date and stay at the increased level after the revision, especially following downgrades. This pattern, however, seems to reflect changes in the past realized volatilities more than ex post future realized volatilities, indicating that option market may be overreacting to recommendation revisions. A delta hedged trading strategy that shorts call options on recommendation revision date yields significant positive profits before transaction costs, supporting the overreaction hypothesis. Analysis of cumulative returns and abnormal trading volume prior to the revision further suggests that there is more information trading in option market than in stock market.

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We examine if analysts can add value beyond what stock characteristics can provide in Korean market using their stock recommendations. The stock characteristics included in this study are price momentum, contrarian variables such as turnover ratio, earnings -to-price ratio and book-to-market ratio, and size. Given that these characteristics and their return predictabilities are already known to analysts, if analysts can provide added value, the investment strategy following their stock recommendations should generate higher returns than the investment strategies formed by stock characteristics do. In addition, we examine how the information asymmetry can affect the investment value analysts provide through their stock recommendations. We first show that three month buy-and-hold abnormal returns on zero investment portfolio using consensus recommendation and changes in consensus recommendation earn 12.89% and 9.61%, respectively, confirming the previous findings that analyst recommendations have investment value. Then we examine if analyst recommendations add value, using a model following Jegadeesh et al. (2004). The results show that the level of consensus recommendations does not add value, whereas, the changes in consensus recommendations do add value up to 2 month holding period. We also show that analysts can add more value when the information asymmetry is higher in the market. When the information asymmetry is high, the three month zero investment portfolio returns on the level and the changes in consensus recommendations are statistically significant 3.45% and 3.50% respectively. It indicates that the analysts’ private information contributes more to the investment value added by analysts when the information asymmetry is high.

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We investigated the relationship between return volatility and trading volume using 20 individual Korean stocks. Employing trading volume as a proxy for information arrival, the implications of volatility persistence and asymmetry were tested using the GARCH(1,1) and EGARCH(1,1) models. The empirical analysis shows that, although including trading volume in the GARCH and EGARCH models explains the persistence and asymmetry of conditional variances, the remaining ARCH effects are still present in the residuals of those models. These results do not support the implications of the volatility–volume relationship of the mixture of distribution hypothesis in the Korean stock market.

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Similar to the derivative warrant or covered warrant, the equity linked warrant (ELW) market has been rapidly growing since its first appearance on December 2005 in Korea. The Korean ELW market is now ranked fourth in the world with 1,300 listed ELWs and 300 billion dollars of daily dollar trading volume within one year upon debut. A rich variety of hybrid derivative linked securities (DLS) has been witnessed and the importance of DLS more stressed for the developed and increased capital market. One of the most interesting topics is to examine the effect of several types of DLS issuance or repurchase on its underling assets. Out of the various DLS, this paper investigates on the price, volume, and volatility effects of underlying stocks around the introduction and expiration date of ELW, very popular DLS in Korea. The study finds the delta hedge effect that the price and volume of underlying stocks increase on or prior to the date when the term and conditions of ELW issuance is determined, and the short-term signaling effect that the price and volume of underlying stocks increase a day after ELW introduction. With respect to the expiration of ELW, it is shown that the price of underlying stocks goes down before the expiration date and goes up after the date of out-of-the money ELW, and that the price of underlying stocks decreases a little bit around the expiration date for in-the-money ELW. In addition, the price of underlying stocks shows higher volatility during ELW list periods rather than before the introduction or after the expiration date. The results of this paper demonstrate somewhat different pictures, compared to those of the previous literatures. The reasons may be explained that the Korean ELW market has not been settled down yet. Therefore, the paper is short of perfection on the ELW trading system, which should be improved. The current system does not allow physical settlement on the expiration of ELW and bid-ask quota for a liquidity provider within 30 days before expiration date. Also, most issuers play a role of the liquidity provider and the time gap is only 2 or 3 days between the announcement and introduction dates. The paper makes some contribution in the sense that it is the first study of ELW in Korea. The paper reveals some imperfection through comparison of the results of this paper to those of the previous literatures. This will help the ELW market to completely settle down in Korea. The paper also could trigger the various studies with respect to ELW, for instance on the development of ELW price determination model or the factor analysis of price.

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Based on the theorem 1 of Bakshi and Madan(2006) that the difference between the historical volatility and the risk-neutral volatility is determined by the risk aversion and the higher moments of return distribution, this paper investigates the risk aversion implied on KOSPI 200 index options. In addition, we explore relative importance between skewness and kurtosis by using the change of the parameter value estimated when imposing upon restrictions on higher moments. We find out that the risk aversion implied on KOSPI 200 option is smaller than that implied on S&P index options, and the kurtosis of return distribution is relatively more important than the skewness. The importance of kurtosis is consistent to the result of S&P options market. To test a reliability of the methodology used in Bakshi and Madan (2006), finally, we compare our results to the results using the methodology of Bliss and Panigirtzoglou (2004). The method of Bakshi and Madan (2006) gives the risk aversion similar to those of extant methodologies, albeit a small quantity of computational load.

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