Corporate credit risk prediction under stochastic volatility and jumps

This paper examines the impact of allowing for stochastic volatility and jumps (SVJ) in a structural model on corporate credit risk prediction. The results from a simulation study verify the better performance of the SVJ model compared with the commonly used Merton model, and three sources are provided to explain the superiority. The empirical analysis on two real samples further ascertains the importance of recognizing the stochastic volatility and jumps by showing that the SVJ model decreases bias in spread prediction from the Merton model, and better explains the time variation in actual CDS spreads. The improvements are found particularly apparent in small firms or when the market is turbulent such as the recent financial crisis.

Can book-to-market and size be risk factors that predict economic growth in Asia's emerging economies?

We investigate whether the two 2 zero cost portfolios, SMB and HML, have the ability to predict economic growth for markets investigated in this paper. Our findings show that there are only a limited number of cases when the coefficients are positive and significance is achieved in an even more limited number of cases. Our results are in stark contrast to Liew and Vassalou (2000) who find coefficients to be generally positive and of a similar magnitude. We go a step further and also employ the methodology of Lakonishok, Shleifer and Vishny (1994) and once again fail to support the risk-based hypothesis of Liew and Vassalou (2000). In sum, we argue that search for a robust economic explanation for firm size and book-to-market equity effects needs sustained effort as these two zero cost portfolios do not represent economically relevant risk.

Conditional coskewness and asset pricing

We explore the empirical usefulness of conditional coskewness to explain the cross-section of equity returns. We find that coskewness is an important determinant of the returns to equity, and that the pricing relationship varies through time. In particular we find that when the conditional market skewness is positive investors are willing to sacrifice 7.87% annually per unit of gamma (a standardized measure of coskewness risk) while they only demand a premium of 1.80% when the market is negatively skewed. A similar picture emerges from the coskewness factor of Harvey and Siddique (Harvey, C., Siddique, A., 2000a. Conditional skewness in asset pricing models tests. Journal of Finance 65, 1263–1295.) (a portfolio that is long stocks with small coskewness with the market and short high coskewness stocks) which earns 5.00% annually when the market is positively skewed but only 2.81% when the market is negatively skewed. The conditional two-moment CAPM and a conditional Fama and French (Fama, E., French, K., 1992. The cross-section of expected returns. Journal of Finance 47,427465.) three-factor model are rejected, but a model which includes coskewness is not rejected by the data. The model also passes a structural break test which many existing asset pricing models fail.

Diversification and value-at-risk

A pervasive and puzzling feature of banks’ Value-at-Risk (VaR) is its abnormally high level, which leads to excessive regulatory capital. A possible explanation for the tendency of commercial banks to overstate their VaR is that they incompletely account for the diversification effect among broad risk categories (e.g., equity, interest rate, commodity, credit spread, and foreign exchange). By underestimating the diversification effect, bank’s proprietary VaR models produce overly prudent market risk assessments. In this paper, we examine empirically the validity of this hypothesis using actual VaR data from major US commercial banks. In contrast to the VaR diversification hypothesis, we find that US banks show no sign of systematic underestimation of the diversification effect. In particular, diversification effects used by banks is very close to (and quite often larger than) our empirical diversification estimates. A direct implication of this finding is that individual VaRs for each broad risk category, just like aggregate VaRs, are biased risk assessments.

The taxing effects of the advance pricing arrangement program: A review of APAs and their impact on stakeholders

The current transfer pricing rules contained in Australia’s taxation regime are designed to counter the underpayment of tax by businesses engaged in international related-party dealings. Currently, these transactions must take place at an arm’s length price, a requirement which is becoming increasingly difficult to demonstrate. This results in an increased risk of an audit by the Australian Taxation Office. If a taxpayer wishes to avoid the risk of an audit, and any ensuing penalties, there is one option: an advance pricing arrangement (‘APA’). An APA is an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. This article investigates the use of APAs as a solution to the problem of transfer pricing and considers their impact on stakeholders. It is argued that while APAs provide a valuable practical tool for multinational entities facing the challenges of the taxation of global trading under the current regime, they may not be a practical long term solution.

Advance pricing arrangements : an Australian Tax Office success or a legislative failure?

Australia’s domestic income tax legislation and double tax agreements contain transfer pricing rules which are designed to counter the underpayment of tax by businesses engaged in international dealings between related parties. The current legislation and agreements require that related party transactions take place at a value which reflects an arm’s length price, that is, a price which would be charged between unrelated parties. For a host of reasons, it is increasingly difficult for multinational entities to demonstrate that they are transferring goods and services at a price which is reflective of the behaviour of independent parties, thereby making it difficult to demonstrate compliance with the relevant legislation. Further, where an Australian business undertakes cross-border related party transactions there is the risk of an audit by the Australian Tax Office (ATO). If a business wishes to avoid the risk of an audit, and any ensuing penalties, there is one option: an advance pricing arrangement (APA). An APA is an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. The ATO views the APA process as an important part of its international tax strategy and believes that there are complementary benefits provided to both the taxpayer and the ATO. The ATO promotes the APA process on the basis of creating greater certainty for all parties while reducing compliance costs and the risk of audit and penalty. While the ATO regards the APA system as a success, it may be argued that the implementation of such a system is simply a practical solution to an ongoing problem of an inherent failure in both the legislation and ATO interpretation and application of this legislation to provide certainty to the taxpayer. This paper investigates the use of APAs as a solution to the problem of transfer pricing and considers whether they are the success the ATO claims. It is argued that there is no doubt that APAs provide a valuable practical tool for multinational entities facing the challenges of the taxation of global trading under the current transfer pricing regime. It does not, however, provide a long term solution. Rather, the long term solution may be in the form of legislative amendment.

International transfer pricing : the Australian approach and lessons for Canada

In response to developments in international trade and an increased focus on international transfer-pricing issues, Canada’s minister of finance announced in the 1997 budget that the Department of Finance would undertake a review of the transfer-pricing provisions in the Income Tax Act. On September 11, 1997, the Department of Finance released draft transfer-pricing legislation and Revenue Canada released revised draft Information Circular 87-2R. The legislation was subsequently amended and included in Bill C-28, which received first reading on December 10, 1997. The new rules are intended to update Canada’s international transfer-pricing practices. In particular, they attempt to harmonize the standards in the Income Tax Act with the arm’s-length principle established in the OECD’s transfer pricing guidelines. The new rules also set out contemporaneous documentation requirements in respect of cross-border related-party transactions, facilitate administration of the law by Revenue Canada, and provide for a penalty where transfer prices do not comply with the arm’s-length principle. The Australian tax authorities have similarly reviewed and updated their transfer-pricing practices. Since 1992, the Australian commissioner of taxation has issued three rulings and seven draft rulings directly relating to international transfer pricing. These rulings outline the selection and application of transfer pricing methodologies, documentation requirements, and penalties for non-compliance. The Australian Taxation Office supports the use of advance pricing agreements (APAs) and has expanded its audit strategy by conducting transfer-pricing risk assessment reviews. This article presents a detailed review of Australia’s transfer-pricing policy and practices, which address essentially the same concerns as those at which the new Canadian rules are directed. This review provides a framework for comparison of the approaches adopted in the two jurisdictions. The author concludes that although these approaches differ in some respects, ultimately they produce a similar result. Both regimes set a clear standard to be met by multinational enterprises in establishing transfer prices. Both provide for audits and penalties in the event of noncompliance. And both offer the alternative of an APA as a means of avoiding transfer-pricing disputes with Australian and Canadian tax authorities.

Micro-credit is necessary but not sufficient for entrepreneurs in desperate poverty

Micro-credit has often been used as a poverty alleviation strategy. However, there is little evidence to suggest that micro-credit alone can promote economic activities because micro-credit does not teach anything by itself (Brett 2006; Mayoux 1999; Sievers & Vandenberg 2007). Mistakenly, the focus of micro-credit has been the alleviation of immediate poverty, rather than the development of economic activity that would provide a long term solution. Paraphrasing the age old saying, "Give a man a fish and you feed him for a day, teach him to fish and you will feed him for a life time" micro-credit enables the fisherman to buy a net, but in many cases does nothing to ensure that he knows how to use it to benefit his family and the community. If the borrower doesn't know how to use the net, he will return to his old way of doing things-but with the added burden of having to pay back the debt. Given the state of extreme poverty experienced by the vast majority of the population in developing countries, borrowed money is often used for purposes other than creating the foundations for a sustainable economic growth. Typical examples of how micro-credit is generally used include covering funeral costs, buying food, medicines, and other similarly important necessities. The main problem that derives from using loans in this way is that apart from not improving living conditions in a sustainable manner, borrowers are also exposed to the risk of over-indebtedness, with its subsequent human and social implications.

A data mining driven risk profiling method for road asset management

Road surface skid resistance has been shown to have a strong relationship to road crash risk, however, applying the current method of using investigatory levels to identify crash prone roads is problematic as they may fail in identifying risky roads outside of the norm. The proposed method analyses a complex and formerly impenetrable volume of data from roads and crashes using data mining. This method rapidly identifies roads with elevated crash-rate, potentially due to skid resistance deficit, for investigation. A hypothetical skid resistance/crash risk curve is developed for each road segment, driven by the model deployed in a novel regression tree extrapolation method. The method potentially solves the problem of missing skid resistance values which occurs during network-wide crash analysis, and allows risk assessment of the major proportion of roads without skid resistance values.

Fraud risk and the visibility of carbon

In recent years, carbon has been increasingly rendered ‘visible’ both discursively and through political processes that have imbued it with economic value. Greenhouse gas (GHG) emissions have been constructed as social and environmental costs and their reduction or avoidance as social and economic gain. The ‘marketisation’ of carbon, which has been facilitated through various compliance schemes such as the European Union Emissions Trading Scheme (EU ETS), the Kyoto Protocol, the proposed Australian Emissions Reduction Scheme and through the voluntary carbon credit market, have attempted to bring carbon into the ‘foreground’ as an economic liability and/or opportunity. Accompanying the increasing economic visibility of carbon are reports of frauds and scams – the ‘gaming of carbon markets’(Chan 2010). As Lohmann (2010: 21) points out, ‘what are conventionally classed as scams or frauds are an inevitable feature of carbon offset markets, not something that could be eliminated by regulation targeting the specific businesses or state agencies involved’. This paper critiques the disparate discourses of fraud risk in carbon markets and examines cases of fraud within emerging landscapes of green criminology.

Investor sentiment as conditioning information in asset pricing

This paper assesses whether incorporating investor sentiment as conditioning information in asset-pricing models helps capture the impacts of the size, value, liquidity and momentum effects on risk-adjusted returns of individual stocks. We use survey sentiment measures and a composite index as proxies for investor sentiment. In our conditional framework, the size effect becomes less important in the conditional CAPM and is no longer significant in all the other models examined. Furthermore, the conditional models often capture the value, liquidity and momentum effects.

Audit pricing and product differentiation in small private firms : evidence from Thailand

Purpose – There is limited evidence on how differences in economic environments affect the demand for and supply of auditing. Research on audit pricing has mainly focused on large client markets in developed economies; in contrast, the purpose of this paper is to focus on the small client segment in the emerging economy of Thailand which offers a choice between auditors of two different qualities. Design/methodology/approach – This paper is based on a random stratified sample of small clients in Thailand qualifying for audit exemption. The final sample consists of 1,950 firm-year observations for 2002-2006. Findings – The authors find evidence of product differentiation in the small client market, suggesting that small firms view certified public accountants as superior and pay a premium for their services. The authors also find that audit fees have a positive significant association with leverage, metropolitan location and client size. Audit risk and audit opinion are not, however, significantly associated with audit fees. Furthermore, the authors find no evidence that clients whose financial year ends in the auditors’ busy period pay significantly higher audit fees, and auditors engage in low-balling on initial engagements to attract audit clients. Research limitations/implications – The research shows the importance of exploring actual decisions regarding audit practice and audit pricing in different institutional and organizational settings. Originality/value – The paper extends the literature from developed economies and large/listed market setting to the emerging economy and small client market setting. As far as the authors are aware, this is the first paper to examine audit pricing in the small client market in an emerging economy.

The association between perception of health during pregnancy and the risk of cardiovascular disease: A prospective study

There is some evidence that self-rated perceptions of health are predictive of objective health outcomes, including cardiovascular disease, and mortality. The objective of this study was to examine the prospective association between perceptions of health during pregnancy and cardiovascular risk factors of mothers 21 years after the pregnancy. Data used were from the Mater University Study of Pregnancy (MUSP), a community-based prospective birth cohort study begun in Brisbane, Australia, in 1981. Logistic regression analyses were conducted. Data were available for 3692 women. Women who perceived themselves as not having a straight forward pregnancy had twice the odds (adjusted OR 2.0, 95% CI 1.1–3.8) of being diagnosed with heart disease 21 years after the pregnancy when compared with women with a straight forward pregnancy (event rate of 5.2 versus 2.6%). Women who experienced complications (other than serious pregnancy complications) during their pregnancy were also at 30% increased odds (adjusted OR 1.3, 95% CI 1.0–1.6) of having hypertension 21years later (event rate of 25.7 versus 20%). As a whole, our study sug- gests that pregnant women who perceived that they had complications and did not have a straight forward preg- nancy were likely to experience poorer cardiovascular outcomes 21years after that pregnancy.