Asian Review of Financial Research

pISSN: 1229-0351
eISSN: 2713-6531

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Asian Review of Financial Research / August 2020 Vol. 33 No. 3

Momentum in Korean Corporate Bond Market

Minyeon Han;Jemoon Woo;Hyounggoo Kang

Asian Review of Financial Research :: Vol.33 No.3 pp.301-338

Abstract
Momentum in Korean Corporate Bond Market ×

The momentum effect is the phenomenon whereby the higher the past return on an asset, the more persistent this return will be in the future. The momentum effect can be found not only in equity, but also in several other asset classes. For example, recent studies show that momentum occurs in the corporate bond market (Pospisil and Zhang, 2010; Jostova et al., 2013; Israel et al. 2017; Houweling and Zundert, 2017, Ho and Wang, 2018). This phenomenon has been documented in the U.S. and various other regions, where various strategies for promoting momentum are appearing. However, empirical studies on the momentum effect in Korea are mostly limited to stocks. AAlthough bonds represent a large proportion of Korea's financial market, studies of the existence of momentum in this market are still rare. Therefore, we attempt to determine whether the momentum effect exists in the Korean corporate bond market, and if so, what drives this effect. We focus on the corporate bond market, not the government (treasury) bond market, for the following reasons. Depending on the characteristics of the firm that issues a corporate bond, the speed at which investors respond to this information may vary. Given the characteristics of corporate bond issuers, the momentum effect is more likely to occur if there are differences in the speed at which information is reflected. In contrast, in the government bond market, issuers are not diverse. Therefore, the information asymmetry among market participants is smaller for government than corporate bonds, so investors have less influence in the government bond market. Participants in the corporate bond market are more likely to interpret private or public information differently from each other than their counterparts in the government bond market are. Our main results are as follows. First, the higher the past return of a bond, the higher its future return. In other words, we verify the momentum effect. A momentum strategy comprising a six month formation period and a six month holding period shows an average return of 0.17% per month (2.02% per year). The momentum in the corporate bond market is not explained by previously observed systematic risk factors for bonds and stocks (Fama and French, 1993, Carhart 1997). Thus, we cannot conclude that the observed momentum of corporate bonds is associated with compensation for systematic risk. The profitability of the abovementioned corporate bond momentum strategy remains robust even when we control for various characteristics, such as the duration and age of the bond. Second, the profitability of the bond momentum strategy is strong when the formation period and holding period are the short-term periods of three to six months each. The corporate bond momentum is mostly sustained in the short term. Third, the bond momentum strategy is profitable during the period excluding financial crisis and economic expansion, but not during the period including financial crisis and contraction. Fourth, the corporate bond momentum is strong in the low credit rating group. In other words, the higher the past return, the higher the future return in the group of firms with low credit ratings. Fifth, we find that most of the firms in the low credit rating group, which shows a significant momentum effect, are small and have low liquidity. Accordingly, we suggest that the momentum effect occurs at the lower credit level due to the gradual information diffusion phenomenon reported by Hong and Stein (1999). For example, momentum is high under small market capitalization, when private information is difficult to spread. In addition, it is difficult to interpret information from firms with low credit ratings. Sixth, we do not find evidence of the spillover between stock momentum and bond momentum reported in previous studies (Gerbhart, Hvidkjaer, and Swaminathan, 2005). For example, we do not observe a significant relationship between high stock returns in the past and high future bond returns. Finally, after controlling for the effect of bond rating changes on bond returns, the performance of the momentum strategy remains statistically and economically significant. Our study has the following academic and practical implications. First, it reveals a momentum phenomenon in non-stock assets, namely corporate bonds, in the Korean market. Many studies focus on the momentum phenomenon in stock markets. Our results suggest that we also need to research the momentum phenomenon that can occur in various asset classes in Korea. Second, portfolio managers can use our findings to develop an effective bond investment strategy. In the overall asset management industry in Korea, investments in corporate bonds are increasing, especially among institutional investors such as pension funds and insurance companies. Therefore, based on the results of this study, the abovementioned momentum strategy can be used to obtain excess returns in the Korean bond market.

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A Study on the Effect of Credit Ratings on M&A Activity

Seonhyeon Kim;Changki kim

Asian Review of Financial Research :: Vol.33 No.3 pp.339-375

Abstract
A Study on the Effect of Credit Ratings on M&A Activity ×

Credit rating agencies give firms credit ratings to indicate their creditworthiness. As these agencies have sophisticated methodologies for evaluating managerial, affiliate, industry, business, and financial risks, they play an important role in the financial market. In addition, credit rating agencies play the monitoring role of managers and mitigate information asymmetry problems (Fulghieri et al., 2014; Surendranath et al., 2016) in the debt market by producing and delivering information. Many studies argue that credit ratings are related to firms' financial constraints and/or ability to access the debt market (Faulkender and Petersen, 2006; Campello et al., 2010; Karampatsas et al., 2014). There is evidence that credit ratings affect the investment activities of domestic firms (Kim and Shin, 2017). For example, credit ratings may affect corporate mergers and acquisitions (M&A), which are complex processes reflecting relatively large corporate investment decisions. However, there is little research on the influence of credit ratings on M&A activities in Korea, despite studies of this topic in other countries (Harford and Uysal, 2014; Karampatsas et al., 2014, Aktas et al., 2018). If credit rating agencies deliver information through credit ratings (Fulgieri et al., 2014, Surrendranath et al., 2016), companies that have received credit ratings (i.e., rated firms) will have fewer information asymmetry problems than those that have not. Boeh (2011) states that mitigating information asymmetry reduces the transaction and contract costs associated with M&A. As information asymmetry in the domestic stock market is a risk factor that increases the required return (Choe and Yang, 2007), credit ratings affect M&A activities. Therefore, rated firms are more likely to participate in M&A than non-rated firms are. A firm's credit rating level represents its financial constraints (Faulkender and Petersen, 2006; Campello et al., 2010; Karampatsas et al., 2014). As M&A increase the risk of bank-ruptcy (Bessembinder et al., 2009; Furfine and Rosen, 2011), companies with low credit ratings are highly likely to avoid acquiring other firms. Therefore, firms with high credit ratings are more likely to be bidders in M&A transactions than are firms with low credit ratings. However, M&A transactions can also efficiently relocate the assets of bankrupt firms (Hotchkiss and Mooradian, 1998). As financially distressed firms have a motive to sell their assets (Weitzel and Jonsson, 1989), they are more likely to sell their assets than non-distressed firms are. Therefore, this study argues that firms with low credit ratings are more likely to be M&A targets s than firms with high credit ratings are. This study yields three main findings. First, rated firms are more likely to participate in M&A than non-rated firms are, whether as bidders or as targets. This finding is more pronounced when firms face information asymmetry problems. We measure information asymmetry by the number of analysts and the competitiveness of the product market. When the number of analysts is zero (vs. one or more) or the market is non-competitive (vs. competitive), rated firms are more likely to be bidders (or targets). Therefore, a firm's credit rating affects its M&A activities through the benefit of information. In addition, the benefit of reduced information asymmetry available to rated firms affects the market reaction when acquirers announce their M&A projects. Second, we find that a firm's rating level affects its probability of being a target of M&A. Firms with very low credit ratings face particularly high levels of default risk and financial distress. When a firm is financially constrained or experiencing bad sales, or when a global financial crisis is underway, the negative effect of credit rating level on the firmatiprobability of being a target is more pronounced. Under the same circumstances, the effect of credit rating level on a firm's probability of being a bidder is also negative. These findings reject our hypothesis that a firm that is better able to conduct capital financing is more likely to be an acquirer. Third, we find that credit rating level and biddersrating level and r. is moreore pronouninverted U-shaped relationship. Our results suggest that firms with very low credit ratings are undervalued by investors in in terms of M&A projectswith very low credit ratings they have a high required or expected rate of return. In addition, managers of firms with very high credit ratings are likely to have high discretion in their investment decisions, because their firms have high credit quality. Such managers are also likely to pursue private benefits; an observation related to the free cash flow hypothesis. This study contributes to the empirical literature on credit ratings and firms' investment decisions. Research on the relationship between credit ratings and M&A activities is particularly scarce. We present new evidence that firms gain an information benefit through credit ratings. We also show that the principal– agent problem is particularly pronounced when firms have very high ratings.

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The Effect of Credit Rating Downgrade on Financial Policies of Incumbent Firms

Youngjoo Lee;Jin Q Jeon

Asian Review of Financial Research :: Vol.33 No.3 pp.377-402

Abstract
The Effect of Credit Rating Downgrade on Financial Policies of Incumbent Firms ×

This paper analyzes the impact of a downgrade in corporate credit rating on the financial policies of competitors in the same industry. Most previous research on credit ratings provides a model for estimating credit ratings based on firms' financial characteristics; the pattern of stock or bond returns after credit rating changes; the competitiveness of the credit rating market; or the reliability of ratings before or after the global financial crisis. Credit rating adjustment, however, is under-researched. This important event provides investors and other stakeholders with information on firm valuation and has a direct impact on financing costs, thus profoundly affecting firm growth and financial stability. We investigate the following two conflicting hypotheses. First, downgrading the credit rating of a particular firm may act as an industry-wide negative signal to the market. This will affect the investment returns of competing firms, which may lead competing firms within the industry to be more conservative in their financial policies, due to concern about the risk of a corresponding downgrade in their credit ratings. The second hypothesis is that downgrading the credit rating of a particular firm may increase the financial costs of the firm and thereby reduce the intensity of competition in the industry. This may lower the growth potential of the firm, which competitors can use as an opportunity to increase their investment by implementing a more aggressive financial policy. We call the effect described in the former hypothesis the “contagion effect,” and that described in the latter the “competition effect.” To test these conflicting hypotheses, we obtain all of the bond rating data of firms listed on the Korea Composite Stock Price Index from 2005 to 2018 and examine the changes in their corporate financial policy in three dimensions: cash holdings, capital expenditure, and long-term leverage. Studies document that cashing holdings are affected by market risk as well as the risk associated with firms' business activities. A change in credit ratings can also affect the method of raising funds. Increasing leverage leads to a decline in liquidity due to high interest payments. In addition, an increase in financing costs due to an increase in firm default risk tends to limit external financing for future investments. In addition, the impact of credit rating adjustments within an industry may vary depending on the competitive position of a firm experiencing a credit rating downgrade, the competitive position of competing firms, and the degree of competition in the industry. Firms in a less competitive industry can more aggressively use opportunities to implement financial policies, while firms in a more competitive industry may have to make more aggressive investments to survive. Our empirical results show that a credit rating downgrade tends to lead firms in the same industry to maintain a conservative financial policy by increasing their cash holdings and decreasing their capital expenditure and long leverage. However, this phenomenon varies across competitive positions within an industry. Firms taking a strong competitive position in the top 25th percentile of revenue are more likely to maintain a conservative financial policy when a rating downgrade occurs in their industry. This relationship is more significant when firms whose ratings have been downgraded are in the same competitive position, i.e., in the top 25th percentile of revenue. The results are consistent with the contagion effect hypothesis. In contrast, firms taking a weak competitive position, i.e., in the bottom 25th percentile of revenue, tend to maintain an aggressive financial policy. This relationship is also more significant, both statistically and economically, if firms whose credit ratings have been downgraded are in the weakly competitive group, i.e., the bottom 25th percentile of revenue. This finding is consistent with the competition effect hypothesis. We also find that the results above, linking the contagion effect with highly competitive firms and the competitive effect with weakly competitive firms, are more significant when the industry is more competitive, as measured by the Herfindahl-Hirschman Index. Most existing studies of credit ratings analyze credit rating prediction models, the stock and bond yield behaviors of firms with rating changes, or the reliability of credit ratings and related systems. This paper contributes to the credit rating literature by examining the effects of credit rating changes on the financial policies of competing firms. It also makes an important contribution to the literature on corporate finance, specifically corporate capital structure theory, by providing evidence that changes to firms' credit ratings are a key determinant of the financial and investment policies of competing firms in the industry. In addition, the finding that risk-seeking behavior varies with the competitive position of a firm may have important policy implications for relevant financial authorities seeking to enhance firms' financial soundness.

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ESG Performance Evidence from Mispricing and Idiosyncratic Volatility

Junesuh Yi

Asian Review of Financial Research :: Vol.33 No.3 pp.403-437

Abstract
ESG Performance Evidence from Mispricing and Idiosyncratic Volatility ×

This study explores the cause of the adverse relationship between ESG performance and corporate value through mispricing and idiosyncratic volatility. It calculates the rate of return for each ESG grade and the rate of return based on the degree of mispricing and idiosyncratic volatility. It also measures the returns of the group portfolios, which consist of a combination of the ESG grade and the degree of mispricing or the degree of idiosyncratic volatility. In addition, it calculates the net buying ratio by investor types on the ESG rating, and measures the investment performance by investor types by comparing the net buying ratio and returns of the group portfolios composed of ESG and mispricing or idiosyncratic volatility. This study finds that the ESG grade inversely relates with the rate of return. However, A+ grades display exceptionaly high returns. While idiosyncratic volatility presents a negative relationship with the rate of return, mispricing presents a positive relationship with the rate of return; thus, it is found that there is no arbitrage opportunity for financial transactions due to mispricing. On return analysis of the group portfolios composed of both ESG ratings and mispricing, the overvalued stock shows a higher return, so that mispricing is not corrected on a quarterly basis. Particularly, in the case of grade A or higher, the underestimated group displays a very large negative return. The return analysis of the group portfolios consisting of a combination of ESG rating and a degree of idiosyncratic volatility shows that the group with low idiosyncratic volatility presents higher returns than the group with high volatility. On the other hand, in the case of grades A and above, the group with low idiosyncratic volatility shows negative returns. A similar lower level of return for grade A or higher with undervalued and low idiosyncratic volatility portfolios is also found in groups composed of three-dimensional combinations of mispricing, performance persistence, and ESG ratings. Therefore, this is taken to be the cause of the return abnormality of the ESG excellence grade. On the other hand, corporate governance as sub-sector of ESG presents somewhat different results from environment or social responsibility. It shows higher returns in the group of grade A or higher corporate governance with underestimated and low idiosyncratic volatility. In addition, even in groups composed of three dimensions such as mispricing, idiosyncratic volatility, and governance ratings, the group (LL) with undervalued and low idiosyncratic volatility displays the second highest return. Accordingly, it is inferred that the market gives some degree of confidence in the level of governance. Upon analysis of the net purchase ratio for the ESG ratings by investor types, it is found that pension funds carry out the most faithful trading strategy on the ratings. The pension funds record net purchases for all grades of sub-sectors and demonstrate that the higher the grade on sub-sectors, the higher the net purchase ratio. In contrast, institutional investors present net sales in all cases except in the group of A or higher governance structure. On analyses of the groups consisting of ESG grades and mispricing or idiosyncratic volatility by investor types, institutional investors, pension funds, and individual investors present a higher net purchasing ratio on groups with overestimated and higher idiosyncratic volatility while foreign investors accomplish a higher net purchasing ratio on groups with lower idiosyncratic volatility. Consequently, the foreign investors present the best performance through smart trading strategy that they show net purchase to overestimated stocks, net sales of underestimated stock, and higher net purchase of low idiosyncratic volatility stocks whereas individual investors exhibit the lowest performance.

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Peer-to-peer Lending and Supply Chain Finance

Daehyeon Park;Doojin Ryu

Asian Review of Financial Research :: Vol.33 No.3 pp.439-463

Abstract
Peer-to-peer Lending and Supply Chain Finance ×

This paper analyzes reverse factoring in e-commerce, which is currently receiving increasing attention. As Internet technology advances during the Fourth Industrial Revolution, the e-commerce market is also growing. However, e-commerce retailers cannot keep up with the growth of the market, due to capital constraints. Supply chain finance can offer a solution to the capital constraints of e-commerce retailers. In particular, reverse factoring, a kind of supply chain finance, is a service that exchanges accounts receivable for discounted cash. It can ease the capital constraints of e-commerce retailers. Recently, peer-to-peer (P2P) lending platforms have begun to offer reverse factoring services to fill gaps in the provision of traditional financial institutions, such as banks. Supplying these reverse factoring services at a relatively low discount rate is conducive to the growth of e-commerce retailers. Therefore, we compare the discount rate of reverse factoring services according to whether the bank or the P2P platform provides the service. The existing literature on supply chain finance focuses on exploring whether retailers use supply chain finance. However, this paper compares the types of service provider used. Therefore, the models used in previous discussions are not directly applicable to the analysis in this paper. We extend the newsvendor model by reflecting the characteristics of P2P lending in our supply chain financial service analysis. We construct a demand function for retailers utilizing the newsvendor model. We also construct a supply function for each financer. We focus on the reverse auction system to explain the characteristics of P2P lending. A reverse auction is the opposite of a general auction. In the former, which many sellers compete in offering a price to a single consumer buying a product. In P2P lending, the P2P platform presents the target amount and rate of return for each loan. In this process, the platform sets the rate of return to the level at which the target amount can be raised, considering the competition among the investors. Therefore, P2P lending takes the form of a reverse auction. We consider the reverse auction form when constructing the supply of the P2P platform. This paper diverges from previous research in analyzing the demand for and supply of reverse factoring to calculate an equilibrium. The analysis reveals that the financer that can provide retailers with a low discount rate depends on market conditions: the situation in the sales market, the retailer's preference for liquidity, and the retailer's estimation of the credit risk of the e-commerce platform. The reverse factoring supply is divided into supply by the bank and supply by the P2P platform. Factors affecting the supply by the bank are the rate of return that the bank can obtain from an alternative investment option and the estimated credit risk of the e-commerce platform. Lastly, the risk aversion of P2P investors and the estimated credit risk of the e-commerce platform affect the supply by the P2P platform. We present policy implications based on these analyses. Given that P2P financing is a type of alternative financing, it is expected to offer a reverse factoring service to e-commerce retailers at a low discount rate. However, contrary to expectations, banks are currently offering services at a lower discount rate than P2P platforms are. This seems to be due to the inherent information asymmetry in the P2P lending market, which leads P2P investors to overestimate the credit risk of e-commerce platforms. This plays a key role in reducing the supply of reverse factoring through P2P platforms. If the bank's discount rate is rigid, the discount rate of the P2P platform must be reduced to reduce the burden on small e-commerce retailers. Therefore, policy discussions on ways of boosting P2P lending should be carried out. It is also essential to mitigate information asymmetry in the P2P lending market.

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재무연구 편집위원회 운영내규 외

한국재무학회

Asian Review of Financial Research :: Vol.33 No.3 pp.464-473

Abstract
재무연구 편집위원회 운영내규 외 ×

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