Infroduction and Expiration Impacts of Equity Linked Warrant(ELW) on Underlying Assets
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.
Infroduction and Expiration Impacts of Equity Linked Warrant(ELW) on Underlying Assets
Keyword : Volatility Spread,Skewness,Kurtosis,Risk Aversion,KOSPI 200,KOSPI 200 option,Generalized Method of Moment(GMM),Likelihood Ratio Test(LR test),KOSPI 200
Volatility Spread on KOSPI 200 Index Options and Risk Aversion
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.
Volatility Spread on KOSPI 200 Index Options and Risk Aversion
Keyword : Conflicts of Interest,Underwriting,Asset Management,IPO,Underpricing
Conflicts of Interest Among Securities Firms Running Asset Management Businesses
Many securities firms are running asset management businesses as well as underwriting businesses. However, when securities firms run these two businesses at the same time, a conflict of interest may arise between customers of underwriting business and those of asset management business. For example, securities firms want to favor customers of asset management businesses at the expense of those of the underwriting businesses because they can get more profit from the former business which is growing much faster than the latter one. We test for conflict of interest by comparing the underwritten prices of IPOs from 1999 through 2006 in Korea by securities firms both with and without asset management businesses. We find that IPOs are more deeply underpriced when they are underwritten by securities firms running asset management businesses. This shows that there may be conflicts of interest among them which favor customers of the asset management business by channeling deeply underpriced IPO stocks into their running funds. In addition, conflicts of interest turn out to be more conspicuous among securities firms having larger fund market shares or those that have begun with the asset management business first before running the underwriting business. Our results imply that the combination of underwriting and asset management businesses may cause conflicts of interest and the degree of conflicts of interest may vary in accordance with how deeply they are engaged in the asset management business.
Conflicts of Interest Among Securities Firms Running Asset Management Businesses
Do corporate managers manipulate the stock price to have a lower exercise price for their stock options? : Some evidence from the U.S. stock market
We investigate a unique period of at least six months and one day, at the beginning of which a group of American companies cancel their employee stock options that are voluntarily tendered in return for replacement options to be granted at the end of the period (the stock option exchange program). As the exercise price of the replacement options is determined by the stock price on the re-grant date, a decrease in the stock price during the period benefits participating employees. We examine the hypothesis that management, when its options are tendered in exchange for replacement options, manipulates the stock price during the period to have a lower exercise price for the replacement options. We find some evidence supportive of this hypothesis. Furthermore, participation of management in the exchange program appears to be costly to shareholders who have to sell before the end of the period.
Do corporate managers manipulate the stock price to have a lower exercise price for their stock options? : Some evidence from the U.S. stock market
Keyword : Mergers and Acquisitions,Size effect,Acquirer,Event study,Market reaction
Acquire's Firm Size and Stock Market Response to M&A Announcement
We examined a sample of 264 acquisitions by firms listed in KRX (Korea Exchange) from 1998 to 2005. We found the size effect in acquisition announcem ent returns, which is consistent with the study of Moeler, Schlingemann, and Stulz (2004). The announcement abnormal return for small acquirers averages 6.53% compared to 4.84% of large a cquirers. After finding that small firms are better acquirers than large firms, we examined possible explanations for the size effect as folows; First, we investig ated that the small firms' gains might be from the economies of s cales. Second, poor performance may lead to prudent decisions. Third, managements with large free cash flows would make poor acquisitions rather than increase payouts to shareholders. Fourth, firms make acqui sitions when they exhaust their growth oportunities. For these hypotheses to explain the size effect, we test whethe r or not small and large acquirers have different characteristics. The size effect is robust to firm, and it will not
Acquire's Firm Size and Stock Market Response to M&A Announcement
Keyword : credit ratings,capital structure,Credit Ratings-Capital Structure Hypothesis (CR-CS),tradeoff theory
Credit ratings and capital structure
We test the Credit Ratings-Capital Structure Hypothesis (CR-CS) that credit ratings afect capital structure decisions of firms, using 695 firms listed on the Korea Stock Exchange. We also examine whether CR-CS is efective in the empirical models of the tradeof capital structure theory. Korea underwent structural changes since the currency crisis of 197. Our sample period is divided into the pre-crisis term of 1995 to 19 97 and the post-crisis term of 1998 to 2005. Our empiric al results are as follows.First, the CR-CS is not supported in the former term but suppor ted in the latter term. Second, while the variable turns out to be not significant, the variable has a significantly negative efect on the debt ratio, reflecti ng an upward bias in the Korean ratings. Third, variables of credit ratings are also significan tly negative in the tradeoff models.
Keyword : within-firm diversification,across-firm diversification,related and unrelated diversification,firm value,financial crisis
Valuation Effect of Across-firm and Within-firm Diversification
This study examines the valuation effect of across-firm diversification as well as within-firm diversification using data of Korean firms listed on KRX during the period over 1994~2003. Although many Korean firms diversify their business through the ownership of other firms, current literature has paid little attention to the valuation effect of across-firm diversification. This study, by considering ownership relations across firms, attempts to examine the valuation effect of across-firm and within-firm diversification. Specifically, the degree of related and unrelated diversification is separatedly measured, employing the Caves' method. The sample period is divided into pre-crisis, crisis, and post-crisis periods in order to reflect the impact of financial crisis in late 1990's. Our results show that the negative valuation effect of within-firm diversification presented by prior studies hold only for unrelated diversification and for pre-crisis period. The valuation effect of within-firm diversification have disappeared since crisis period. However, although there were no valuation effect during pre-crisis and crisis period, across-firm diversification have a significant negative effect on firm value for both related and unrelated diversification during post-crisis period. These results indicate that corporate restructuring enforced and regulations and systems established following financial crisis have a significant impact on corporate strategy and market perception of diversification activities.
Valuation Effect of Across-firm and Within-firm Diversification
Critical Assessment of BTO(Build-Transfer-Operate)
‘Build-Transfer-Operate(BTO)', one variation of project financing, has been widely used to finance the infrastructure projects. To induce private participation in the infrastructure projects with low (or even negative) rate of returns, BTO arrangements were supplemented with ‘minimum rate of return guarantee' by the government. This ‘BTO with minimum rate of return guarantee' caused much economic inefficiencies-overestimation of the demands and resulting waste of tax money-due to the perverse incentives inherent in the arrangements. This paper analyzes the BTO arrangement using simple economic models and suggests some measures to mitigates the inefficiencies.
Critical Assessment of BTO(Build-Transfer-Operate)
A Study on Determining the Spreads of Won-Denominated Credit Default Swaps
Determining the spread (or the premium) of CDS (Credit Default Swap)s properly is the first step for making the domestic credit derivatives market work. However, as far as we know, there is no literature dealing with won-denominated CDS. We suggest two methods for determining a won-denominated CDS spread and then we analyse the spreads obtained by each method. One method uses the market quotes of dollar-denominated CDS, whose reference entities are dollar-denominated bonds issued by domestic firms. The other method uses the credit spreads of won-denominated risky bonds. In addition, unobservable asset correlation is a critical factor in determining the spreads of basket default swap or a single CDS with counterparty default risk. Hence, we also suggest calculation methods for both implied correlation and historical correlation, and analyse the derived correlation results. Our results are remarkable. First, we can't find any evidence of a long-term equilibrium relationship and price-discovery phenomenon between won-denominated CDS spreads obtained by the two different methods. Second, won-denominated CDS spreads calculated by the first method are shown to be subject to the implied volatility of KOSPI200 options and KOSPI200 returns. However, the spreads calculated by the second method are shown to be subject to the treasury bond yields and the spreads between long-term bond yields and short-term bond yields. Third, the correlation implied by the dollar-denominated basket CDS is quite different from the historical correlation. In fact, the implied correlation is much higher than the historical correlation for basket CDS whose protection seller is a domestic financial institution and protection buyer is a foreign investment bank. Fourth, the historical correlation calculated by using CDS spread data is higher than that calculated by stock return data. The spreads of basket CDSs or a single CDS with counterparty default risk has a negative relationship with asset correlation. Therefore, the CDS spreads using stock returns correlation are higher than those using default swap spread correlation.
A Study on Determining the Spreads of Won-Denominated Credit Default Swaps
An Empirical Study on the Pricing Model of Equity Linked Deposit
The market for Equity Linked Deposits (ELD) has been rapidly growing in Korea. Most ELDs can be decomposed into two components；straight bond and equity option. The latter is the more important part of the two because it primarily determines the characteristics of an ELD, which are quite different from those of a plain deposit product. The diversity of equity options in ELDs make it difficult for investors to evaluate the value of ELDs. This paper examines pricing models for ELDs based on data on ELDs issued from Mar. 2003 to Dec. 2005. The option features in ELDs covered in this study include exotic options like Barrier and Digital options as well as plain vanilla European options. We restrict our attention to products of which underlying assets are Korean equities or equity index. We calculate theoretical prices of ELDs in the primary market and compare them with issue prices to determine which pricing model is suitable for pricing ELDs. For the valuation of options embedded in ELDs, we use both historical and implied volatility estimates and assume stochastic or constant interest rates to see the influence of interest rate assumptions. Under each option pricing assumption, theoretical prices of ELDs are on average below issue prices. The interest rate assumptions have little effect on the price while the implied volatility model is better than the historical one in explaining issue price of ELDs. Also some factors driving the discrepancies between theoretic and issue price are identified. They include type of implicit derivatives, underlying asset, and so on.
An Empirical Study on the Pricing Model of Equity Linked Deposit
