The Pricing of Catastrophe Equity Put Options with Default Risk*
Xingchun Wang(School of International Trade and Economics, University of International Business Economics)

In this paper, we present a pricing model for catastrophe equity put options with default risk by assuming that the default of the option issuer may occur at any time prior to maturity of the option. Catastrophic events are assumed to occur according to a doubly stochastic Poisson process, and stock price is affected by the catastrophe losses, which follow the compound doubly stochastic Poisson process. As for default risk, we adopt typical structural approaches, and we also allow the correlation between the underlying stock and the assets of the option issuer. Under this framework, we derive a pricing formula for catastrophe equity put options with default risk. Finally, numerical analysis is presented to illustrate effects of default risk on catastrophe equity put option prices.

*This study was supported by the National Natural Science Foundation of China (No. 11271203) and the Fundamental Research Funds for the Central Universities in UIBE (14QD03). The authors would like to thank the anonymous referees and associate editor for their helpful comments and valuable suggestions that led to several important improvements.

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Counter-Credit-Risk Yield Spreads: A Puzzle in China’s Corporate Bond Market
Jian Luo(Wang Yanan Institute for Studies in Economics, Xiamen University)
Xiaoxia Ye(Stockholm Business School, Stockholm University)
May Hu(Deakin Graduate School of Business, Deakin University)

In this paper, using China’s risk-free and corporate zero yields together with aggregate credit risk measures and various control variables from 2006 to 2013, we document a puzzle of counter-credit-risk corporate yield spreads. We interpret this puzzle as a symptom of the immaturity of China’s credit bond market, which reveals a distorted pricing mechanism latent in the fundamental of this market. We also find interesting results about relationships between corporate yield spreads and interest rates and risk premia and the stock index, and these results are somewhat attributed to this puzzle.

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Why do Firms Purchase Used Assets?*
Mufaddal Baxamusa(University of St Thomas)
Saima Javaid(King Abdulaziz University)
Khadija Harery(King Abdulaziz University)

We hypothesize that the increase in expectation about future technological change decreases the likelihood for the purchase of new assets because the change may make the new assets obsolete. To test this hypothesis, we use patents and citations data to represent the expected technological change. We find that the purchases of and the amount spent on used assets increase with the expectation of technological change, while time to completion of the purchase and the number of bids decrease with the increase in expectations about technological change. We exploit industry deregulations to establish identification. In contrast to the literature, we find no empirical support for financial constraint as a reason for purchasing used assets.

*This project was funded by the Deanship of Scientific Research, King Abdulaziz University (KAU). The authors gratefully acknowledge technical and financial support of KAU.

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[Shorter Articles]Managerial Talent and Corporate Social Responsibility (CSR): How Do Talented Managers View Corporate Social Responsibility?*
Pattanaporn ChatjuthamardA(SASIN Graduate Institute of Business Administration, Chulalongkorn University)
Pornsit Jiraporn(School of Graduate Professional Studies, Pennsylvania State University)
Shenghui Tong(Central University of Finance and Economics)
Manohar Singh(Pennsylvania State University)

Motivated by the ongoing debate on the costs and benefits of corporate social responsibility (CSR), we explore how talented managers view CSR investments. Based on nearly 20,000 observations across 17 years, our evidence reveals a nonmonotonic effect of managerial talent on CSR. Exploiting a novel measure of managerial ability, we find that talented managers view CSR investments favorably. However, only those with especially strong talent are in favor of CSR investments. For executives ranked above the 75th percentile in terms of managerial talent, an increase in managerial ability leads to more CSR investments, suggesting that these strongly talented managers perceive CSR as enhancing firm performance. In contrast, for those with weaker talent, CSR investments are negatively associated with managerial ability, implying that these weakly talented managers view CSR as a wasteful deployment of resources. Further evidence shows that our conclusion is unlikely confounded by endogeneity.

*Part of this research was carried out while Pornsit Jiraporn served as Visiting Scholar at SASIN Graduate Institute of Business Administration, Chulalongkorn University. This research is funded by The Kanchanapisek Chalermphrakiat Endowment, Office of Academic Affairs, Chulalongkorn University, Bangkok, Thailand.

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[Shorter Articles]The Influences of Major Currencies in Foreign Exchange Markets: A Regression-Based Measure and Its Application
Soo-Hyun Kim(College of Business Administration, Soongsil University)
Kyuseok Lee(College of Business, Korea Advanced Institute of Science and Technology (KAIST))

Based on the regression explanatory power, we propose a measure of the relative influences of a group of major currencies, including the US dollar, euro, Japanese yen, and UK pound, on the exchange rate behaviors of lesser currencies. Using the measure and 27 sample floating currencies, we empirically examine the cross-currency and temporal variations in the relative influences of two, three, and four major currencies during the 16-year post-euro period of 1999 to 2014.

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[Shorter Articles]A Bargaining Model of Friendly and Hostile Takeovers
Gino Loyola(Department of Management Control, University of Chile)
Yolanda Portilla(School of Economics and Business, Catholic University of Chile)

A bargaining model is developed that characterizes the conditions under which a takeover will either be friendly, hostile, or unsuccessful when the target management can tilt the selling procedure toward a white knight. The conditions considered mainly involve private control benefits, toehold size, and breakup fees. Also established by the model are the conditions for an efficient takeover. The proposed framework of strong management influence on takeover outcome, an alternative modeling of hostility and the adoption of a negotiation procedure, rather than an auction setup with strong shareholder influence as in most of the existing literature, delivers new insights into the US market of corporate control, which are consistent with the available evidence.

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[Shorter Articles]Statistical Arbitrage with Pairs Trading
Ahmet Goncu(Institute of Quantitative Finance, Xian Jiaotong Liverpool University)
Erdinc Akyildirim(Department of Banking and Finance, Akdeniz University)

We analyze statistical arbitrage with pairs trading assuming that the spread of two assets follows a mean-reverting Ornstein–Uhlenbeck process around a long-term equilibrium level. Within this framework, we prove the existence of statistical arbitrage and derive optimality conditions for trading the spread portfolio. In the existence of uncertainty in the long-term mean and the volatility of the spread, statistical arbitrage is no longer guaranteed. However, the asymptotic probability of loss can be bounded as a function of the standard error of the model parameters. The proposed framework provides a new filtering technique for identifying best pairs in the market. Backtesting results are given for some of the pairs of stocks that are studied in the literature.

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