To determine the appropriate tick size for the Korean Exchange (KRX), we analyze the effect of changing the minimum tick size (hereafter “tick size”) on, first, the liquidity, measured by relative spread, market depth, and volume and secondly, on the overall market quality. The results from these analyses shed light on the optimal tick size for the KRX. Our finding shows an ambiguous effect of changing the tick size on market quality: reducing the tick size increases relative spread and volume but decreases market depth. Also, compared to the U.S. exchanges whose tick size is one cent regardless of the stock price, the tick size of the KRX is a step function of the stock price. This characteristic allows us to study the effect of changing the tick size by comparing stocks with prices just above and just below the level at which the tick size changes. Unlike previous studies, our analyses focus on the effect of changing the tick size on market depth among liquidity variables, by, among others, addressing the endogeneity problem among the variables. Other specific methods used in our analyses are as follows. First, as a preliminary study, we examine whether our results regarding the effects of changing tick size on three variables of liquidity--relative spread, market depth, and volume--in the KRX are the same as those from previous studies on domestic and overseas exchanges. Second, we investigate the effects of changing tick size on investors’ order submission patterns to find the reasons and implications of the adverse effects of reducing tick size on market depth. For both analyses, we conduct panel-data analyses, which are robust even with the endogeneity problem. Rogers’ (1993) standard errors are incorporated in order to adjust for the clustering effect. Third, we test dynamic relations between tick size and market depth in order to obtain detailed results indicating the effects of reducing tick size on market depth. This test is designed to measure the extent to which the KRX tick size could be reduced. For this test, we use the sample stocks whose tick sizes change during the sample period. We, first, sort them into 9 categories based on their upper and lower price limits and, then, conduct “endogeneous” event studies. Using all 689 common stocks listed on the KRX during our sample period of 122 trading days from January 3 to June 30 in 2005, we apply both TAQ (Trades and Quotes) and daily data to each stock. The data are provided by the KRX. The test results for our seven null hypotheses are as follows. •Results from Analyses for the Effects of Changing Tick Size on Liquidity: Reducing tick size has a favorable effect on relative spread and volume, but an unfavorable effect on market depth. This finding of trade-off among the liquidity variables confirms similar results from previous studies; however our finding is more robust, since the endogeneity problem among the variables is taken into account in the regression analyses. Our study also has the practical implication that policy makers must heed unfavorable effect on market depth when considering reducing the tick size as a way to reduce transaction costs. •Results from Analyses Using Investors’ Order Submission Patterns: As tick size is reduced, order size decreases and the ratio of cancellation and correction orders increases. Market depth, in turn, is decreased and market quality deteriorates. As tick size is reduced, the ratio of “order-more-improved to best-order” also increases. This increase leads market depth and relative spread to decrease; as a result, it can either improve or deteriorate market quality due to the trade-off between them. As tick size is reduced, the market-order ratio slightly increases, decreasing liquidity and, in turn, resulting in a slight deterioration of market quality. All together, a decrease in order size and an increase in the ratio of cancellation and correction orders are, at least, principal causes for decreasing market depth as tick size reduces. •Results from Dynamic Relation between Tick Size and Market Depth: Reducing tick size does not decrease the market depths of the stocks whose prices are around the points at which the tick size jumps, except at 10,000 won. This implies that the tick size can be reduced at most price levels without deterioration of market depth. The price range jumping around 10,000 won is the only exception at which market depth decreases with statistical significance as the tick size decreases. This phenomenon is closely related to the large change in the relative tick size (from 0.1% to 0.5%) at this price range, which is a very abrupt change compared to that at other price ranges (from 0.1% to 0.2%, in particular for 5,000 won and 50,000 won price ranges). Therefore, if we set our argument to stocks under 100,000 won, the KRX can reduce the relative tick size 0.2 percent without having significant adverse effects on market depth.

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This paper is an empirical investigation of the determinants of the cross- section of stock returns in Korea. While Fama and French’s (1993) three-factor asset pricing model is known to perform reasonably well in explaining the cross-section of stock returns in the U.S. and many other stock markets in developed countries, the model’s performance in explaining the cross-section of stock returns in Korea has been less than satisfactory. More specifically, there is mixed evidence for the existence of the book-to-market effect in the Korean stock market. Because Fama and French’s three-factor model is empirically motivated without firm theoretical grounds, it is difficult to argue that the book-to-market factor (HML) is a priced risk factor in the Korean stock market without clear empirical evidence for the book-to-market effect in the cross- section of stock returns in Korea. Consequently, an alternative asset pricing model is necessary to be used widely in Korea for the purpose of risk adjustment in estimating the cost of capital or performance evaluation. Using monthly stock returns and accounting information for the sample of non-financial firms belonging to the KOSPI index over the 1991~ 2007 period, we first investigate the cross-sectional relationship between stock returns and firm characteristics in the Fama-MacBeth regression framework. We find no evidence for the book-to-market or momentum effect. Firm characteristics which show significant relationship with the cross-section of stock returns in Korea are firm size measured by market capitalization and liquidity measured by turnover. Given the evidence for the size and turnover effects, we construct portfolios by sorting firms into four size groups and four turnover groups independently, similar to the way in which Fama and French (1993) construct their size and book-to-market portfolios. The sixteen size-turnover portfolios show clear patterns in average returns, decreasing in both firm size and turnover. Moreover, these size-turnover portfolios exhibit much bigger spread in average returns than the portfolios constructed using firm size and book-to-market (size-BM portfolios), which suggests that the size-turnover portfolios may be more useful and relevant test assets than the size-BM portfolios in the Korean stock market. The clear pattern of average returns in the size-turnover portfolios suggests that liquidity measured by turnover may be a priced risk factor in Korea. In order to estimate the magnitude of the risk premium associated with the size and turnover effects, we construct mimicking portfolios which are designed to capture the effects of firm size and turnover in the cross-section of stock returns, similar to the way in which Fama and French (1993) construct their mimicking portfolios, SMB and HML. Consistent with the results from the Fama-MacBeth regressions, the size factor (SMB) and the turnover factor (NMP) show significantly positive average returns while the average return of the book-to-market factor (HML) is positive but statistically insignificant. The magnitudes of the average returns for SMB and NMP are also economically significant at 0.99% per month for SMB and 1.19% per month for NMP. We then perform standard time-series and cross-sectional tests of asset pricing models using the size- turnover and size-BM portfolios as test assets. The asset pricing models we consider are the Fama-French three-factor model and our alternative three-factor model which replaces the book-to-market factor HML with the liquidity factor NMP. The main findings are as follows. When the size-turnover portfolios are used as test assets, the GRS F-test rejects the Fama- French three-factor model while it does not reject our alternative three-factor model. Moreover, the estimated risk premium for the liquidity factor NMP is both economically and statistically significant at 1.3% per month, which is also similar in magnitude to its average return of 1.19% per month. When the size-BM portfolios are used as test assets, the two models show broadly comparable performance. These main findings remain unchanged when we test the models using the first half or the second half of the sample period. In particular, we find that the liquidity factor NMP shows significant explanatory power for the cross-section of stock returns in each of the sub-sample periods. The Fama-French three-factor model is widely used in research and practice for risk adjustment and performance evaluation in both the U.S. and Korea. But the lack of clear empirical evidence for the book- to-market effect in Korea raises a question about the relevance of the book-to-market factor HML and the Fama-French three-factor model in understanding the determinants of stock returns in Korea. The findings in this paper suggest that our alternative three-factor model which incorporates a liquidity factor may be more useful and relevant for understanding the systematic variation of stock returns in Korea.

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This paper analyzes the behavior of return and volatility using the opening and closing prices of Korea Exchange (KRX) stocks and examines the impact of global trading of cross-listed Korean stocks on the volatility. For the analysis, this paper specifically examines ratios of variances of open-to-open relative to close-to-close returns as well as correlation of returns for adjacent trading and non-trading periods for the KRX stocks, and the impact of global trading on variance ratios and return correlations. Through the analysis, this paper finds evidence from the Korean market that supports the explanation offered by Amihud and Mendelson (1991) attributing greater volatility in opening prices to the preceding overnight non-trading period. This paper also documents that opening prices reflect temporary pricing deviation while such deviations are less likely to occur at closing, and thus these deviations are likely a main source of pricing errors causing the greater volatility at the opening of the market. Moreover, by examining the price behavior of cross-listed KRX stocks and comparing the results with those of non-cross-listed stocks, this paper provides additional evidence that the high volatility at the daily opening may be attributed to the overnight non-trading period that precedes it and that globalization of stock trading can reduce pricing errors and improve value discovery.

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Recent research on corporate acquisitions suggests that misvaluation in the stock market affects the M&A activities. The management of an overvalued firm may be tempted to maximize its shareholder value by exchanging its overvalued stocks with those of less overvalued firms (Shleifer and Vishny, 2003; Rhodes- Kropf et al., 2005). Consequently, using stocks as a medium of payment in a merger can be interpreted as a signal that the acquiror may have been overvalued; thus, the market response could be less favorable (Dong et al., 2006). In order to prevent such a negative effect of using stocks, an acquiror whose firm is not overvalued prefers to make a cash offer (Shleifer and Vishny, 2003). Another important implication of the misvaluation hypothesis is that corporate acquisitions by an overvalued firm tend to reduce the stock price volatility as long as non-overvalued target firms are found in different industries from the overvalued firm (Cai and Vijh, 2007). This hypothesis contrasts with the agency view that a decrease in the stock price volatility after a merger results from the managerial incentives, seeking the insurance effects on its career by diversifying firms under its control. This paper examines changes in the shareholder value and the stock price volatility following merger announcements and tests whether the corporate acquisition in the absence of strategic choice of a medium of payment incurs a signaling effect of overvaluation. To do so, we introduce a simple model of a merger in which the merger announcement can be considered a signal of overvaluation. In the model, the management of an acquiring firm has private information on the synergy of acquisition and the value of the firm. We show that the management chooses acquisitions regardless of the synergy if the firm is overvalued, while, otherwise, it chooses acquisitions only when the acquisition synergy is large enough. As a result, a corporate acquisition by a firm that is potentially overvalued may raise a concern on the possibility of adverse selection. In general, the adverse selection can be avoided if the management can strategically choose the medium of the payment. In this paper, however, we insist that due to the unique feature of Korean M&A market in which cash offers are not allowed in M&A transactions, the valuation effects of the merger announcement in Korea reflect both synergy expectation and the concerns about adverse selection. We provide empirical analyses on whether the stock market reactions to the merger announcement are less favorable as the acquiror is more likely to be overvalued. We choose the value of the stock options that the management of the acquiror is endowed as a proxy variable to determine whether the firm is overvalued. More specifically, we classify sample firms whose stock options for the management are in-the-money (ITM firms, hereafter) to be more likely to be overvalued and those whose stock options are out-of-the-money (OTM firms, hereafter) to be less likely. Empirical results show that first, ITM firms exhibit a lower cumulative abnormal return than OTM firms do following the merger announcement. Furthermore, ITM firms exhibit a large decrease in the stock price after the completion of the merger while OTM firms do not. This result is consistent with the misvaluation hypothesis that overvalued firms attempt to use the overvalued shares of stock to acquire other firms to maximize the shareholder value. For ITM firms, an increase in the stock price due to the expectation of merger synergy is at least partially countervailed by concerns on adverse selection. On the other hand, OTM firms experience a greater increase in the stock price since adverse selection is less severe. Second, we find that the cumulative abnormal returns to the merger announcement are positively related with changes in the stock price volatility after the completion of the merger. In other words, firms with a greater decrease in the stock price volatility exhibit less increase in the stock price. This result supports that a decrease in stock price volatility may be a consequence of the managerial attempt to utilize the overvalued stocks to acquire firms at a lower price than the target company deserves, not necessarily an outcome of agency problems. Lastly, we find that firms whose management has stock options do not exhibit a decrease in the volatility of their stock prices, while those whose management does not have stock options do. This result is consistent with the notion that firms whose management has stock options are less likely to pursue diversification than firms whose management does not. In addition, our empirical results turned out to be robust to the use of pre-merger stock performance as another proxy variable of overvaluation.

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We hypothesize that investor relations(IR) as voluntary disclosures lead to long-term reductions in information asymmetry among investors. The results show that firms which held IR experience a significant decline in the subsequent level of information asymmetry, in contrast to firms which did not. This decline in information asymmetry results from less trading by privately informed investors relative to uninformed investors. After the potential endogenous relation between disclosure and information asymmetry is controlled, the results are robust. Additionally, we find that IRs held consecutively over two quarters do not contribute to the further decline in information asymmetry. The results imply that IR activities are effective in reducing information asymmetry and therefore, might contribute to a decline in the cost of capital.

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This paper investigates the effects of infrequent trading and overnight trading halts on the overnight and daytime returns behavior. Previous empirical studies of market microstructure document the variance and covariance structure of intra- and inter-day stock returns. Many of them try to explain their findings by bid- ask spread. This study, however, explains it by the effects of infrequent trading and overnight trading halts. A model is developed for explaining various returns behavior based on the existence of infrequent trading and overnight trading halts. Empirical evidence is presented for KOSPI All Share, Large Cap, Small Cap indices. The empirical results confirm the validity of the model proposed in this study.

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The beneficiary regard public pension fund as risk free asset. It is reason why the government guarantee the pension members pension benefit with no relation of fund investment result. But the pension members predict changing of pension scheme when the pension liability exceed pension asset plus government pension support ability. When pension liability is bigger than government payment due to poor pension fund performance, the members think that pension scheme must be changed. They consider that pension contribution rate will be raised or beneficiary will be reduced. They regard pension benefit right as risk asset including possibility of changing in consequence of pension fund result. In this paper, I try to estimate discount rate of pension liability including pension scheme risk; the probability of reducing beneficiary or raising contribution.

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This paper estimates the empirical pricing kernels (EPK) implied by the KOSPI 200 options using the reverse engineering technique suggested by Rosenberg and Engle (2002). The empirical pricing kernels are estimated as a power function as well as a polynomial function of the returns of the underlying index. The empirical results documented in this paper are as follows： First, the empirical performance of the power pricing kernel is worse than that of the polynomial pricing kernel that contains more parameters and so is more flexible than the power pricing kernel. This contrasts to the results of Rosenberg and Engle (2002), which investigate the S&P 500 options market. Second, the pricing and forecasting ability of the EPK deteriorate if we estimate the EPK by imposing the restriction that the EPK prices the short term bond exactly. While the amount of the deterioration is large in the case of the power pricing kernel, it is relatively small in the case of the polynomial pricing kernel. The hedging performance with the restriction is almost the same as or sometimes better than the one without the restriction, depending on the hedging method. Third, the empirical performance of time-invariant EPKs is generally poor. The difference in the empirical performance between the time-invariant EPK and the time varying EPK is more prominent in the case of polynomial EPK. The hedging performance of time-invariant EPKs is sometimes better than that of the time-varying EPKs in the case of power EPK. Fourth, the polynomial EPK is more sensitive to the underlying return state compared to the power EPK. The shape of the polynomial EPK that is a function of the underlying return state fluctuates more and reflects the non-linearity of the pricing kernel better than the power EPK. The estimated power EPKs tend to decrease as the underlying return increase. This implies the marginal utilities of investors decrease with the underlying return. Fifth, the risk aversion implied by the EPK is time varying and it has a statistically significant relation with the KOSPI 200 index return and the lag value of the risk aversion.

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It is believed that the value of common stock is the sum of the values of cash flow and voting rights. According to Zingales(1994), the value of voting rights is increasing as the private benefits of control is getting greater. We show that the stock price reflects the value of voting rights when two party is fighting to get the control power of the firm. This paper also shows the existence of the voting right capture strategy, which is a profit seeking strategy that consists of buying stocks before the date of record and selling those stocks right after the date of record. In addition, we find some supporting empirical evidences of the existence of the voting right capture strategy from a sample of 17 domestic companies which experienced keen control power conflicts between 2000 and 2006.

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This paper presents existence and sources of long-term reversal in the Korean stock market. During the past 15 years, return reversals from the past performances of individual stocks, which are listed in the Korean Stock Exchange, existed significantly, in terms of buy-and-hold abnormal returns. We found that cross-sectional contrarian premiums over 1- to 36-month holding periods were significantly positive during the period of Aril, 1987 to April, 2002. The sources of these premiums, however, were differently analyzed according to the past portfolio formation periods. In the 12 months formation period, the contrarian premiums were found to result mainly from the systematic risk factors of Fama-French 3 factor model, but the premiums in the 24 and 36 months formation periods were not due to the systematic risk factors, but to the hypothesis of behavioral finance that the overreaction increases with the length of formation period. Additionally, we analyzed the sources of contrarian premiums in the two sub-sample periods, up- and down-market periods. In the down market period, co-skewness factor premiums were found to play an important role for explaining the contrarian premiums, but in the up market period, contrarian premiums were found to be an evidence of weak-form market inefficiency which could not be explained from any asset pricing model.

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