Flexible Budgeting under Uncertainty: A Real Options Perspective

This paper examines the relationships between uncertainty and the perceived usefulness of traditional annual budgets versus flexible budgets in 95 Swedish companies. We form hypotheses that the perceived usefulness of the annual budgets as well as the attitudes to more flexible budget alternatives are influenced by the uncertainty that the companies face. Our study distinguishes between two separate kinds of uncertainty: exogenous stochastic uncertainty (deriving from the firm’s environment) and endogenous deterministic uncertainty (caused by the strategic choices made by the firm itself). Based on a structural equations modelling analysis of data from a mail survey we found that the more accentuated exogenous uncertainty a company faces, the more accentuated is the expected trend towards flexibility in the budget system, and vice versa; the more endogenous uncertainty they face, the more negative are their attitudes towards budget flexibility. We also found that these relationships were not present with regard to the attitudes towards the usefulness of the annual budget. Noteworthy is, however, that there was a significant negative relationship between the perceived usefulness of the annual budget and budget flexibility. Thus, our results seem to indicate that the degree of flexibility in the budget system is influenced by both general attitudes towards the usefulness of traditional budgets and by the actual degree of exogenous uncertainty a company faces and by the strategy that it executes.

Strategic Priorities, Company Performance and Attitudes Towards Management Accounting Techniques: an Empirical Study

The study investigates whether there is an association between different combinations of emphasis on generic strategies (product differentiation and cost efficiency) and perceived usefulness of management accounting techniques. Previous research has found that cost leadership is associated with traditional accounting techniques and product differentiation with a variety of modern management accounting approaches. The present study focuses on the possible existence of a strategy that mixes these generic strategies. The empirical results suggest that (a) there is no difference in the attitudes towards the usefulness of traditional management accounting techniques between companies that adhere either to a single strategy or a mixed strategy; (b) there is no difference in the attitudes towards modern and traditional techniques between companies that adhere to a single strategy, whether this is product differentiation or cost efficiency, and c) companies that favour a mixed strategy seem to have a more positive attitude towards modern techniques than companies adhering to a single strategy

Price Inflation, Unemployment and Devaluations: The Finnish Experience of the 1990s

In this paper I provide some empirical answers to important questions such as the determinants of price inflation and the role of inflation polices. The results indicate that monetary policy is surprisingly impotent as a device for controlling inflation and there is little support that it influences the real variables. The low inflation after the Finnish devaluations in the beginning of 90s is foremost due to a previous imbalance in the labor markets and depressed aggregate demand.

Optimal Risk Adoption: A Real Options Approach

This study develops a real options approach for analyzing the optimal risk adoption policy in an environment where the adoption means a switch from one stochastic flow representation into another. We establish that increased volatility needs not decelerate investment, as predicted by the standard literature on real options, once the underlying volatility of the state is made endogenous. We prove that for a decision maker with a convex (concave) objective function, increased post-adoption volatility increases (decreases) the expected cumulative present value of the post-adoption profit flow, which consequently decreases (increases) the option value of waiting and, therefore, accelerates (decelerates) current investment.

Bank Run Risk and Optimal Reserves

We characterize the optimal reserves, and the generated probability of a bank run, as a function of the penalty imposed by the central bank, the probability of depositors’ liquidity needs, and the return on outside investment opportunities.

An Expenditure-Based Estimation of Self-Employment Income Underreporting in Finland

This paper estimates the extent of income underreporting by the self-employed in Finland using the expenditure based approach developed by Pissarides & Weber (1989). Household spending data are for the years 1994 to 1996. The results suggest that self-employment income in Finland is underreported by some 27% on average. Since income for the self-employed is about 8 % of all incomes in Finland, the size of this part of the black economy in Finland is estimated to be about 2,3% of GDP.

Screening Cycles

We demonstrate how endogenous information acquisition in credit markets creates lending cycles when competing banks undertake their screening decisions in an uncoordinated way, thereby highlighting the role of intertemporal screening externalities induced by lending market competition as a structural source of instability. We show that uncoordinated screening behavior of competing banks may be not only the source of an important financial multiplier, but also an independent source of fluctuations inducing business cycles. The screening cycle mechanism is robust to generalizations along many dimensions such as the lending market structure, the lending rate determination and the imperfections in the screening technology.

Information Sharing in Banking: A Collusive Device?

We show that information sharing among banks may serve as a collusive device. An informational sharing agreement is an a-priori commitment to reduce informational asymmetries between banks in future lending. Hence, information sharing tends to increase the intensity of competition in future periods and, thus, reduces the value of informational rents in current competition. We contribute to the existing literature by emphasizing that a reduction in informational rents will also reduce the intensity of competition in the current period, thereby reducing competitive pressure in current credit markets. We provide a large class of economic environments, where a ban on information sharing would be strictly welfare-enhancing.

New Evidence on the Properties of the Financial Statement Information Pricing Process

This study contributes to our knowledge of how information contained in financial statements is interpreted and priced by the stock market in two aspects. First, the empirical findings indicate that investors interpret some of the information contained in new financial statements in the context of the information of prior financial statements. Second, two central hypotheses offered in earlier literature to explain the significant connection between publicly available financial statement information and future abnormal returns, that the signals proxy for risk and that the information is priced with a delay, are evaluated utilizing a new methodology. It is found that the mentioned significant connection for some financial statement signals can be explained by that the signals proxy for risk and for other financial statement signals by that the information contained in the signals is priced with a delay.

Hedging Options with Different Time Units in the Pricing Models

This study examined the effects of the Greeks of the options and the trading results of delta hedging strategies, with three different time units or option-pricing models. These time units were calendar time, trading time and continuous time using discrete approximation (CTDA) time. The CTDA time model is a pricing model, that among others accounts for intraday and weekend, patterns in volatility. For the CTDA time model some additional theta measures, which were believed to be usable in trading, were developed. The study appears to verify that there were differences in the Greeks with different time units. It also revealed that these differences influence the delta hedging of options or portfolios. Although it is difficult to say anything about which is the most usable of the different time models, as this much depends on the traders view of the passing of time, different market conditions and different portfolios, the CTDA time model can be viewed as an attractive alternative.

Executive Stock Options: Exercise Policy and Market Reaction

In this paper I investigate the exercise policy, and the market reaction to that, of the executive stock option holders in Finland. The empirical tests are conducted with aggregated firm level data from 34 firms and 41 stock option programs. I find some evidence of an inverse relation between the exercise intensity of the options holders and the future abnormal return of the company share price. This finding is supported by the view that information about future company prospect seems to be the only theoretical attribute that could delay the exercise of the options. Moreover, a high concentration of exercises in the beginning of the exercise window is predicted and the market is expected to react to deviations from this. The empirical findings however show that the market does not react homogenously to the information revealed by the late exercises.

Real Estate Investment and Uncertainty: Econometric Modelling using Finnish Data

The purpose of this paper is to test for the effect of uncertainty in a model of real estate investment in Finland during the hihhly cyclical period of 1975 to 1998. We use two alternative measures of uncertainty. The first measure is the volatility of stock market returns and the second measure is the heterogeneity in the answers of the quarterly business survey of the Confederation of Finnish Industry and Employers. The econometric analysis is based on the autoregressive distributed lag (ADL) model and the paper applies a 'general-to-specific' modelling approach. We find that the measure of heterogeneity is significant in the model, but the volatility of stock market returns is not. The empirical results give some evidence of an uncertainty-induced threshold slowing down real estate investment in Finland.

With Good Reputation Size Does not Matter: Issue Frequency and the Determinants of Debt Maturity

This paper examines empirically the effect firm reputation has on the determinants of debt maturity. Utilising data from European primary bond market between 1999 and 2005, I find that the maturity choice of issuers with a higher reputation is less sensitive to macroeconomic conditions, market credit risk-premiums, prevailing firm credit quality and size of the debt issue. The annualised coupon payments are shown to be a significant factor in determining the debt maturity and reveal a monotonously increasing relationship between credit quality and debt maturity once controlled for. Finally, I show that issuers lacking a credit rating have an implied credit quality positioned between investment-grade and speculative-grade debt.

Maximum Loss Calculation using Scenario Analysis, Heavy Tails and Implied Volatility Patterns

The objective of this paper is to improve option risk monitoring by examining the information content of implied volatility and by introducing the calculation of a single-sum expected risk exposure similar to the Value-at-Risk. The figure is calculated in two steps. First, there is a need to estimate the value of a portfolio of options for a number of different market scenarios, while the second step is to summarize the information content of the estimated scenarios into a single-sum risk measure. This involves the use of probability theory and return distributions, which confronts the user with the problems of non-normality in the return distribution of the underlying asset. Here the hyperbolic distribution is used to describe one alternative for dealing with heavy tails. Results indicate that the information content of implied volatility is useful when predicting future large returns in the underlying asset. Further, the hyperbolic distribution provides a good fit to historical returns enabling a more accurate definition of statistical intervals and extreme events.

Bootstrap and Fast Double Bootstrap Tests of Cointegration Rank with Financial Time Series

The likelihood ratio test of cointegration rank is the most widely used test for cointegration. Many studies have shown that its finite sample distribution is not well approximated by the limiting distribution. The article introduces and evaluates by Monte Carlo simulation experiments bootstrap and fast double bootstrap (FDB) algorithms for the likelihood ratio test. It finds that the performance of the bootstrap test is very good. The more sophisticated FDB produces a further improvement in cases where the performance of the asymptotic test is very unsatisfactory and the ordinary bootstrap does not work as well as it might. Furthermore, the Monte Carlo simulations provide a number of guidelines on when the bootstrap and FDB tests can be expected to work well. Finally, the tests are applied to US interest rates and international stock prices series. It is found that the asymptotic test tends to overestimate the cointegration rank, while the bootstrap and FDB tests choose the correct cointegration rank.