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Abstract:
In this paper we empirically investigate to what extent three competing asset pricing models price an individual firm's stock differently in an internationally integrated world: (i) the multifactor ICAPM of Solnik-Sercu including both the global market portfolio and exchange rate risk premiums, (ii) the single factor ICAPM with only the global market portfolio, and (iii) the single factor domestic CAPM. We generalize the pricing error expressions of Stulz (1995b) for the domestic CAPM against the single factor ICAPM to the multifactor model with exchange rate factors included. Furthermore, we derive formal statistical tests for the existence of a pricing error of the domestic CAPM versus both the single factor ICAPM and the multifactor ICAPM. We test for the significance of these pricing errors in a sample of 2,483 firms from 10 industrialized countries using monthly data from 1980 to 1995. We find that the single factor ICAPM without exchange rate factors induces mispricing for more than 60% of all firms. The domestic CAPM leads to a substantial and statistically significant pricing error for approximately 7% of all firms.

Abstract:
It is a well-known stylized fact that financial returns are non-normal and tend to have fat-tailed distributions. This paper presents a methodology that accurately estimates the degree of fat-tailedness, characterized by the tail-index, in small samples. We present a simple approach based on the Hill estimator. Our estimator is a weighted average of a set of Hill estimators, with weights obtained by using simple least squares techniques. The estimator produces unbiased estimates for the tail-index in small samples and we also provide appropriate standard errors. Using this estimator we produce tail-index estimates for returns on stocks and exchange rates that are close to estimates obtained from extremely large datasets. The results indicate that many documented conclusions about the tail behavior of financial series have over-estimated their fat-tailedness in small samples.

Abstract:
In this paper, we assess cost and profit efficiency for a sample of banks operating on the Dutch banking market in the period 1992-1998, using stochastic frontier analysis. Over the entire period, the cost-efficient frontier deteriorates, but mean cost efficiency and profit efficiency are relatively stable at the industry level. No evidence is found for trend changes in mean efficiency due to the previous consolidation and deregulation. However, whereas all banks appear to perform rather similarly in terms of cost efficiency, in terms of profit efficiency large general banks and specialized bank clearly outperform small, general banks. Large banks appear to benefit from sheer size and perhaps market power. This is evidence in favor of the large banks behaving collusively and capturing oligopoly rents. Specialized banks operate savely and efficiently in what might be termed niche markets.

X-efficiency, Stochastic Frontiers, Banking

Abstract:
Most bank merger studies do not control for hidden bailouts, which may lead to biased results. In this study we employ a unique data set of approximately 1000 mergers to analyze the determinants of bank mergers. We use undisclosed information on banks' regulatory intervention history to distinguish between distressed and non-distressed mergers. Among merging banks, we find that improving financial profiles lower the likelihood of distressed mergers more than the likelihood of nondistressed mergers. The likelihood to acquire a bank is also reduced but less than the probability to be acquired. Both distressed and non-distressed mergers have worse CAMEL profiles than non-merging banks. Hence, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.

Mergers, Bailout, X-efficiency, Multinomial logit

Abstract:
The inability of most bank merger studies to control for hidden bailouts may lead to biased results. In this study, we employ a unique data set of approximately 1,000 mergers to analyze the determinants of bank mergers. We use data on the regulatory intervention history to distinguish between distressed and non-distressed mergers. We find that, among merging banks, distressed banks had the worst profiles and acquirers perform somewhat better than targets. However, both distressed and non-distressed mergers have worse CAMEL profiles than our control group. In fact, non-distressed mergers may be motivated by the desire to forestall serious future financial distress and prevent regulatory intervention.

Mergers, bailout, X-efficiency, multinomial logit

Abstract:
It is well known that returns on foreign exchange rates are not normal and tend to have fat-tailed distributions. Although the precise magnitude of the tail-fatness is crucial for applications such as risk analysis, little consensus exists in this respect due to estimation problems. In this paper, we apply a recent method to obtain unbiased inferences from the tails to re-examine the fat-tailedness of FX returns and show that the amount of fat-tailedness has been overestimated considerably. Additionally, goodness-of-fit statistics provide evidence of the appropriateness of assuming that a Student-t distribution underlies the data-generating process of FX returns. Both conclusions appear to hold more for floating than for fixed exchange rates.

Abstract:
We investigate the driving forces of corporate liquidity for a balanced panel of large Dutch non-financial firms during the period 1986-1997. We hypothesize that corporate liquidity targets exist and follow from static trade-off arguments. In the short run, however, liquidity may respond passively to current developments as well, producing liquidity dynamics in line with buffer stock behaviour. We therefore estimate corporate liquidity holdings in an error correction framework and find that liquidity targets are relevant and firms make efforts to converge towards these targets even in the short run. Short run dynamics, however, are in line with buffer stock predictions.

Corporate liquidity demand, precautionary liquidity, static trade-off

Abstract:
In this paper, we show the importance of accounting for heterogeneity among sample firms in stochastic frontier analysis. For a fairly homogenous sample of German savings and cooperative banks, we analyze how alternative theoretical assumptions regarding the nature of heterogeneity can be modeled and the extent which the respective empirical specifications affect estimated efficiency levels and rankings. We find that the level of efficiency scores is affected in the case of both cost and profitmodels. On the cost side especially, level and rank correlations show that different specifications identify different banks as being best or worst performers. Our main conclusion is that efficiency studies in general and bank efficiency studies in particular should account for heterogeneity across sample firms. Especially when efficiency measures are employed for policy purposes, a careful choice of models and transparency regarding maximization methods are essential to be able to make inferences about managerial behavior.

Heterogeneity, X-efficiency, benchmarking, bank production

Abstract:
In this paper we investigate pension preferences and the effect of individual freedom of choice on risk taking in the context of pension arrangements based on a representative survey of about 1000 Dutch citizens. The attitude towards pension schemes and portfolio choices is explained by individual characteristics. Our main conclusions are the following. Risk aversion is domain dependent and highest in the pension domain. The vast majority of respondents is in favour of compulsory saving for retirement and favours a defined benefit pension system. If offered a combined defined benefit/defined contribution system, the majority of the respondents would like to have a guaranteed pension income of 70% or more of their net labour income. Self-assessed risk tolerance and financial expertise are important explanatory variables of pension system attitude. Respondents are on average conservative in their investment policy. If given investor autonomy, they are willing to change the composition of their retirement savings portfolio in response to their personal financial situation, general economic conditions, and expectations of financial markets. Respondents may be inconsistent in their preferences. Especially respondents who have chosen a relatively safe portfolio (less stock, more bonds) appear to prefer the retirement income streams of the median investment portfolio to their own portfolio choice. Finally, the average respondent considers himself financially unsophisticated, but is not very eager to take control of retirement savings investment when offered the possibility to increase expertise.

Behavioural finance, risk tolerance, pension preferences, defined contribution schemes, freedom of choice, portfolio investment

Abstract:
This Paper analyses to what extent international and domestic asset pricing models lead to a different estimates of the cost of capital for an individual firm. We distinguish between (i) the multifactor ICAPM of Solnik (1983) and Sercu (1980) including both the global market portfolio and exchange rate risk premiums, and (ii) the single factor domestic CAPM. We test for the significance of the cost of capital differential in a sample of 3,293 stocks from nine countries in the period 1980-99. We find that the domestic CAPM yields a different estimate of the cost of capital from the multifactor ICAPM for only three percent of the firms in our sample. The difference amounts to on average 50 basis points for the US, 75 basis points for Germany and Japan and similar differentials for the other countries. We attribute these findings to strong country factors in individual stock returns.

Cost of capital, ICAPM, pricing error, exchange rate exposure

Abstract:
We revisit the Feldstein-Horioka (FH) puzzle using data for 23 Organisation for Economic Co-operation and Development (OECD) countries for the period 1973-2003. We document a sharp decline in the FH coefficient from the mid-1990s onward, supporting the hypothesis of increased economic and financial integration. Subsequently, we extend the literature and use a non-linear specification with interaction terms to empirically show that observed decreases in equity home bias (EHB) and increases in trade openness are structurally linked to the time variation in the FH coefficient. Thus, this paper empirically establishes a structural link between three puzzles in international macroeconomics and finance: the FH puzzle, the EHB puzzle and the trade home bias puzzle.

economic and financial integration, savings-investment correlation, current account imbalances

Abstract:
In this paper we investigate Dutch corporate liquidity management in general, and target adjustment behaviour in particular. To this purpose, we use a simple error correction model of corporate liquidity holdings applied to firm-level data for the period 1977-1997. We confirm the existence of long-run liquidity targets at the firm level. We also find that changes in liquidity holdings are driven by short-run shocks as well as the urge to converge towards targeted liquidity levels. The rate of target convergence is higher when we include more firm-specific information in the target. This result supports the idea that increased precision in defining liquidity targets associates with a faster observed rate of target convergence. It also suggests that the slow speeds of adjustment obtained in many macro studies on money demand are artefacts of aggregation bias.

Corporate liquidity demand, precautionary liquidity

Abstract:
Short-term nominal interest rates in the United States and the United Kingdom experienced a structural change from stationary to nonstationary processes somewhere in the period 1914-1918. The most popular story so far--based on switching-regression techniques--is that the founding of the Federal Reserve in November 1914 caused a simultaneous shift in both countries in early 1915. I use a recursive Bayesian method to show that this conclusion is flawed and the standard method lacks robustness. My results suggest a switch to nonstationarity in late 1915 for the UK and in late 1917 for the US, related to the start of interest targeting in each country after entry into World War I and the consequent need for cheap finance of military expenditures.

Abstract:
In this paper, we analyze bilateral real exchange rate behavior for fifteen countries over the period May 1925 to December 1937, using a modified principal components technique that is invariant to the choice of benchmark currency. For the gold exchange rate period May 1925 - August 1931, we find that half of real exchange rate variation originates from countries on floating nominal exchange rates, stabilizing their economies, and half from price level differences between countries on the gold standard. For the managed floating period September 1931 - December 1937, we conclude that real exchange rate movements between the sterling-bloc, the European gold-bloc, and the US/Canada are dominant. Within bloc variation is secondary and, moreover, mostly due to competitive devaluations during transition periods. Our results support earlier evidence that the nominal exchange rate regime to a large extent determines real exchange rate variation.

Abstract:
In this paper we examine the impact of domestic and ERM-wide monetary conditions on national inflation rates in Belgium, France, Germany, Italy and the Netherlands for the period 1973-1994 and two sub periods using an extended open-economy version of the standard P*-model. The results show that the domestic price gaps have gradually been crowded out by the European price gap since the establishment of the ERM for the four non-anchor countries, indicating a loss of monetary autonomy. For Germany, both the domestic and the European price gap are significant after 1986. Although Germany still has a certain degree of monetary independence, the results show that monetary conditions in Germany's immediate neighbors increasingly matter for inflation in Germany. This points to the need for greater attention for the development of aggregate European monetary conditions by all countries, including Germany, and closer coordination of monetary policy.

Abstract:
Increasing capital market integration has important implications for the calculation of the cost of capital. In an integrated world the cost of capital should be determined using the International Capital Asset Pricing Model rather than the domestic Capital Asset Pricing Model. In this paper we investigate this issue with an asset pricing model that explicitly allows for deviations from Purchasing PowerParity. The pricing error when using the domestic Capital Asset Pricing Model rather than an International Capital Asset Pricing Model is zero if diversifiable domestic risk is orthogonal to the global market portfolio return and foreign currency changes. We use Hansen's (1982) Generalized Method of Moments to test for orthogonality and implement this test for more than 3000 individual stocks of 10 different countries. We cannot reject that the global market portfolio and the foreign currencies affect the cost of capital of an individual firm through the effect of the global market on the risk premium of the local market and not through the global beta of the firm.

Abstract:
Risk premia, peso-problems and market-inefficiencies have been suggested as candidate explanations for the apparent rejection of the unbiased hypothesis. If various explanations interact, a panel approach is called for. In this paper we estimate different panel models, that allow for cross-sectional dependence of exchange rates, for fifteen currencies between 1979 and 1996. We show that the deviation from uncovered interest parity is smaller than commonly presumed. Estimates of the slope coefficients of the forward premium appear to be positive but still significantly different from unity. In addition it is shown that this coefficient is close to unity if only five to ten percent of the largest changes in the forward premium are taken into account. These findings point to the importance of peso-problems and inactivity bands as explanations for the apparent rejection of the uncovered interest parity relationship.