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#04-01 Risk Management for International Investment Portfolios Using Forward Contracts and Options
#04-02 A Dynamic Stochastic Programming Model for International Portfolio Management
#04-03 A Conditional Value–at–Risk Model for Insurance Products with Guarantee
#04-04 Pricing Options on Scenario Trees
#04-05 Option Pricing and Trading with Artificial Neural Networks and Multi-Factor Parametric Models with Implied Parameters
#04-06 Real R&D Options with Time-to-learn and Learning-by-doing
#04-07 Pricing and Trading European Options by Combining Artificial Neural Networks and Parametric Models with Implied Parameters
#04-08 Computation of Feasible Portfolio Control Strategies for an Insurance Company Using a Discrete Time Asset/Liability Model
#04-09 Scenario Modelling for Selective Hedging Strategies
#04-10 Factors Affecting Research Productivity of Production and Operations Management Groups: An Empirical Study
#04-11 Cross-national Stability of a Leadership Model
#04-12 Real Options: Principles of Valuation and Strategy
#04-13 An Instrument for Measuring Web Site Services Quality of Online Business
#04-14 Review, Synthesis and Critical Analysis of the Bankruptcy Research in the 1990's
#04-15 Irrational Investor Response to Stock Splits in an Emerging Market
#04-16 Earning Management by Foreign Firms Preceding their Listing in US Stock Exchanges
#04-17 E-valuating the Role of E-service Quality on the Pricing of Internet Stock
#04-18 Country Closed-end Funds and International Diversification
#04-19 The Role of Financial Information in Explaining Financial Distress
#04-20 The Value relevance of Earnings and Cash Flows: Empirical Evidence for Japan
#04-21 The Distribution of Gains from Access to Stock
#04-22 Equity Culture and the Distribution of Wealth
#04-23 Asset and Debts of Cyprus Households: Changes Between the 1999 and 2002 Cyprus Surveys of Consumer Finances
#04-24 Credit Cards: Facts and Theories
#04-25 Explaining Bankruptcy Using Option Theories

 

Abstracts and Downloadables

 

 

HERMES Working Paper #04-01

 

Risk Management for International Investment Portfolios Using Forward Contracts and Options

 

Nikolas Topaloglou, Hercules Vladimirou and Stavros A. Zenios, July 2004

 

 

Abstract In this we introduce to the investment opportunity set of the portfolio management models options on stock indices as additional means to control risk exposures. Specifically, we consider two different types of European options on stock indices: unhedged (simple) and fully protected options (quantos). The first type of option has its strike price and payoffs expressed in the same currency as the stock index that constitutes the underlying; hence, it is also priced in the same currency units. This type of option is intended to hedge the market risk associated with the underlying stock index and does not account for changes in currency exchange rates. We use the term "simple option" to refer to stock index options of this type. On the contrary, quantos are options written on a foreign stock index that also protect against currency movements as they apply a prespecified exchange rate to convert the payoffs of the option to a different currency (i.e., the reference currency of the investor). The strike price and payoffs of this type of option are expressed in units of the base currency by using a prespecified exchange rate (usually the forward rate for the term of the option) as the conversion factor. Hence, the underlying of a quanto is the product of the value of the foreign stock index augmented by a fixed exchange rate. A quanto is an integrative instrument as it jointly protects against both the market risk of the stock index as well as the exchange risk between the index and the base currency; it is priced in units of the base currency.

The introduction of these options broadens the investment opportunity set and provides instruments geared towards risk control due to the asymmetric and nonlinear form of option payoffs. We suitably extend the portfolio optimization models so as to incorporate the options and we empirically investigate the ex ante and the ex post impact that these options have on the performance of international portfolios of financial assets. The residual currency risk from other foreign holdings (e.g., in bond indices) can be covered with forward currency exchange contracts that are also included in the models. The goal is to control the portfolio's total risk exposure and to attain an effective balance between portfolio risk and expected return. The results indicate that the inclusion of these types of options provides an efficient and effective way to control risk and to improve the performance of international portfolios. In fact, we find that the performance of the international portfolios is improved as we take a progressively integrated view towards total risk management; that is, as we progressively control more risk factors with appropriate hedging instruments.

In this paper we confine our attention to single-period models in order to simplify the notation and the presentation of the novel concepts. The problem addressed here concerns a single portfolio restructuring decision with a single-period planning horizon. The models take as primary inputs the composition of an initial multi-currency portfolio, along with the current prices of the assets, spot currency exchange rates, forward exchange rates for a term equal to the planning horizon, and the option prices. The stochastic elements concern the returns of the assets over the planning horizon - and consequently the asset prices at the horizon - the spot currency exchange rates and the option payoffs at the end of the horizon. The uncertainty in these parameters is depicted by means of discrete distributions (scenario sets).

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HERMES Working Paper #04-02

 

A Dynamic Stochastic Programming Model for International Portfolio Management

 

Nikolas Topaloglou, Hercules Vladimirou and Stavros A. Zenios, July 2004

 

 

Abstract We develop a multi-stage stochastic programming model for international portfolio management in a dynamic setting. We model uncertainty in asset prices and exchange rates in terms of scenario trees that reflect the empirical distributions implied by market data. The model takes a holistic view of the problem. It considers portfolio rebalancing decisions over multiple periods in accordance with the contingencies of the scenario tree. The solution jointly determines capital allocations to international markets, the selection of assets within each market, and appropriate currency hedging levels. We investigate the performance of alternative hedging strategies through extensive numerical tests with real market data. We show that appropriate selection of currency forward contracts materially reduces risk in international portfolios. We further find that multi-stage models consistently outperform single-stage models. Our results demonstrate that the stochastic programming framework provides a flexible and effective decisions support tool for international portfolio management.

Forthcoming in European Journal of Operational Research
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HERMES Working Paper #04-03

 

A Conditional Value–at–Risk Model for Insurance Products with Guarantee

 

Andrea Consiglio, Antonio Pecorella, and Stavros A. Zenios, 2004

 

 

Abstract We propose a model to select the optimal portfolio which underlies insurance policies with guarantee. The objective function is defined in order to minimize the conditional VaR of the distribution of the losses respect to a target return. We add operational and regulatory constraints to make the model as flexible as possible when used for real applications. We show that the integration of the asset and liability side yields superior performances respect to naive fixed–mix portfolios and asset based strategies. We validate the model on out–of–sample scenarios and provide insights on policy design.

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HERMES Working Paper #04-04

 

Pricing Options on Scenario Trees

 

Nikolas Topaloglou, Hercules Vladimirou and Stavros A. Zenios, 2004

 

 

Abstract We examine valuation procedures that can be applied to incorporate options in scenario-based portfolio optimization models. Stochastic programming models use discrete scenarios to represent the stochastic evolution of asset prices. At issue is the adoption of suitable procedures to price options on the basis of the postulated discrete distributions of asset prices so as to ensure internally consistent portfolio optimization models. We adapt and implement two methods to price European options in accordance with discrete distributions represented by scenario trees and assess their performance with numerical tests. We consider features of option prices that are observed in practice. We find that asymmetries and/or leptokurtic features in the distribution of the underlying materially affect option prices; we quantify the impact of higher moments (skewness and excess kurtosis) on option prices. We demonstrate through empirical tests using market prices of the S&P500 stock index and options on the index that the proposed procedures consistently approximate the observed prices of options under different market regimes, especially for deep out-of-the-money options.

Forthcoming in the Journal of Banking and Finance, 2007
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HERMES Working Paper #04-05

 

Option Pricing and Trading with Artificial Neural Networks and Multi-Factor Parametric Models with Implied Parameters

 

Panayiotis Andreou, Spiros H. Martzoukos, and Chris Charalambous, 2004

 

 

Abstract This paper tackles the pricing problem of European S&P 500 Index options traded in the Chicago Board of Exchange. We compare a) Artificial Neural Networks (ANNs) b) to parametric models with implied parameters, and c) to Hybrid ANNS that include information from the parametric models. As parametric models we consider the single-factor models like the Black and Scholes, and the (semi-parametric) Corrado and Su, and more advanced multi-factor models that either incorporate one or two classes of jumps, or stochastic volatility, or stochastic volatility and jumps. We compare models not only in respect to out-of-sample pricing accuracy, but also to the profit potential in trading with transaction costs. We also compare different approaches of deriving the implied parameters for the parametric models.

In the Proceedings of the International Joint Conference Networks / IEEE, 25-29 July, 2004
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HERMES Working Paper #04-06

 

Real R&D Options with Time-to-learn and Learning-by-doing

 

Nicos Koussis, Spiros H. Martzoukos, and Lenos Trigeorgis, 2004

 

 

Abstract We model R&D to enhance the value of a product or technology before final development. Such efforts may be directed towards improving quality, adding new features, or adopting technological innovations. They are implemented as optional, costly and interacting control actions expected to enhance value but with uncertain outcome, and the choice between accelerated versus staged (sequential) R&D. These issues are also especially interesting since the history of decisions affects future decisions and the distributions of asset prices and induces path-dependancy. We show that the existence of optional R&D efforts enhances the investment option value significantly. The impact of a dividend-like payout rate or of product volatility on optional R&D decisions may be different with R&D timing flexibility than without. The attractiveness of sequential strategies is enhanced in the presence of learning-by-doing and decreasing marginal reversibility of capital effects.

Annals of Operations Research, Volume 151, Issue 1, pp. 29-55, 2007
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HERMES Working Paper #04-07

 

Pricing and Trading European Options by Combining Artificial Neural Networks and Parametric Models with Implied Parameters

 

Panayiotis C. Andreou, Chris Charalambous, and Spiros H. Martzoukos, 2004

 

 

Abstract We compare the ability of the parametric Black and Scholes and Corrado and Su models, and Artificial Neural Networks to price European call options on the S&P 500 using daily data for the period January 1998 to August 2001. We use several historical and implied parameter measures. Beyond the standard neural networks, in our analysis we include hybrid networks that incorporate information from the parametric models. Our results are significant and differ from previous literature. We show that the Black and Scholes based hybrid artificial neural network models outperform the standard neural networks and the parametric ones. We also investigate the economic significance of the best models using trading strategies (extended with the Chen and Johnson modified hedging approach). We find that there exist profitable opportunities even in the presence of transaction costs.

European Journal of Operational Research, In Press, 2006
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HERMES Working Paper #04-08

 

Computing of Feasible Portfolio Control Strategies for and Insurance Company Using a Discrete Time Asset/Liability Model

 

Costas Frangos, Stavros A. Zenios, and Y. Yavin, 2004

 

 

Abstract A nonlinear discrete time asset/liability model is developed for an insurance company selling investment policies with a guaranteed minimum rate of return and a fixed maturity date. The model accommodates time-dependent investment strategies and transaction costs. At time instants where portfolio rebalancing takes place, the model implements a constraint equation dictating that the total value of assets sold must be equal to the total value of assets purchased plus the total transaction costs. Asset transactions are thus self-financing and no additional cash is required. A procedure is proposed for computing time-dependent portfolio control strategies and the initial shareholders capital, such that given nonlinear financial constraints and requirements are satisfied. Such control strategies are called feasible portfolio control strategies.

Mathematical and Computer Modelling, Volume 40, Issue 3-4, pp. 423-446, 2004
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HERMES Working Paper #04-09

 

Scenario Modelling for Selective Hedging Strategies

 

Andrea Beltratti, Andrea Laurent, and Stavros A. Zenios, 2004

 

 

Abstract We study currency risk management in the context of scenario analysis. We develop scenario-based optimization models that jointly determine the portfolio composition and the hedging strategy within each currency. Thus the model prescribes optimal selective hedging policies. We then study empirically the performance of the models. The new elements of our empirical analysis are: various horizons (one month and one semester), various currency bases, explicit incorporation of realistic transaction costs. The results show that selective hedging strategies dominate the alternatives under some conditions, and that transaction costs are very important in determining the profitability of various currency risk management strategies for both stocks and bonds at the one month horizon.

Journal of Economic Dynamics and Control, Volume 28, Issue 5, pp. 955-974, 2004
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HERMES Working Paper #04-10

 

Factors Affecting Research Productivity of Production and Operations Management Groups: An Empirical Stydy

 

G. C. Hadjinicolas and Andreas C. Andreou, 2004

 

 

Abstract This paper identifies factors that promote research productivity of production and operations management (POM)groups of researchers in US businesss chools. In this study, research productivity of a POM group is defined as the number of articles published per POM professor in a specific period of time. The paper also examines factors that affect Research quality, as measured by the number of articles published per POM professor in journals, which have been recognized in the POM literature as an elite set. The results show that three factors increase both the research productivity and the quality of the articles published by professors of a POM group. These factors are (a) the presence of a POM research center, (b) funding received from external sources for research purposes, and (c) better library facilities. Doctoral students do assist in improving research quality and productivity, but they are not the driving force. These results have important implications for establishing policy guidelines for business schools. Forexample, real-world problems are funded by external sources and have a higher probability of publication. Furthermore, schools could place more emphasis on external funding, as most engineering schools do, since groups receiving external funding are more productive in terms of research.

Journal of Applied Mathematics and Decision Science, Volume 2006, Article ID 96542, pp. 1-16
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HERMES Working Paper #04-11

 

Cross-National Stability of a Leadership Model

 

G. A. Marcoulides, L.A. Marcoulides, P. Nathanel and A. C. Soteriou, 2004

 

 

Abstract This study explored 60 Greek-Cypriot managers' perceptions of different dimensions of leadership. Analyses using structural equation modeling were performed to examine the invariance of the Flamholtz six-factor leadershipmodel. The same leadership styles observed in samples from countries previously studied were present in the sample from Cyprus. In terms of the importance assigned to each style of leadership, Cypriot managers emphasized the more directive styles to a greater extent than other styles.

Psychological Reports, Volume 94, Number 2, pp. 517-522, 2004
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HERMES Working Paper #04-12

 

Real Options: Examples and Principles of Valuation and Strategy

 

Han T. J. Smit and Lenos Trigeorgis, 2004

 

 

In J. McCahery and L.D.Ronneboog, Venture Capital Contracting and the Valuation of High Technology Projects, Oxford University Press (2003), pp. 227-250
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HERMES Working Paper #04-13

 

An Instrument for Measuring Web Site Service Quality of Online Business

 

A. Charitou, I. georgiou, and A. Soteriou, 2004

 

 

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HERMES Working Paper #04-14

 

Review, Synthesis and Critical Analysis of the Bankruptcy Research in the 1990's

 

A. Charitou and C. Georgiou, 2004

 

 

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HERMES Working Paper #04-15

 

Irrational Investors Response to Stock Splits in an Emerging Market

 

A. Charitou, N. Vafeas, and C. Zachariades, 2004

 

 

Abstract Using the creation and collapse of the Cyprus stock market bubble as a backdrop, we document substantial positive abnormal returns around the announcement and execution of stock splits in Cyprus. Split-induced returns cannot be explained by variables proxying for conventional liquidity and signalling hypotheses for stock-split activity. Positive split-induced returns are largely reversed in the post-split months. Post-split stock underperformance is inversely related to, and thus appears to be a correction for, the significant market overreaction at split execution. We suggest an investor irrationality explanation for these results, arguing that stock splits were associated with the creation of the bubble due to the inability of investors to understand splits correctly. We conclude that educating investors in emerging markets to process information correctly will improve the efficiency of such markets.

The International Journal of Accounting, Volume 40, Issue 2,pp. 133-149, Summer 2005
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HERMES Working Paper #04-16

 

Earnings Management by Foreign Firms Preceding Their Listing in US Stock Exchanges

 

A. Charitou and C. Louka, 2004

 

 

Abstract The purpose of this study is to determine whether foreign firms manipulate their earnings upward prior to entering U.S stock exchanges. The dataset consists of 145 Canadian firms that entered U.S stock exchanges during the period 1981-1999. Results indicate that Canadian firms report earnings in excess of cash flows by taking positive accruals prior to entering U.S stock exchanges. Moreover, cross listed firms that seem to manipulate earnings have negative cumulative abnormal returns over the three year period after their listing, whereas firms that do not seem to manipulate earnings outperform the NYSE and NASDAQ composite indices over the same period.

EFMA 2003 Helsinki Meetings Paper
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HERMES Working Paper #04-17

 

E-Valuating the Role of E-Service Quality on the Pricing of Internet Stocks

 

A. Charitou, A. Soteriou, and I. Georgiou, 2004

 

 

Abstract This paper explores the value relevance of the quality of services offered through the Web Site of an Internet firm. Although prior evidence shows that there is a relationship between service quality and financial performance, no previous studies have examined the impact of Web Site Service Quality (WSSQ) for online businesses. Even though existing research has explored both the WSSQ and the value drivers of Internet companies separately, no relationship has been established between WSSQ and firm value. Our study's design is based on a Web Site Service Quality measurement tool. Data reflecting the WSSQ levels of Internet companies were gathered and were statistically analyzed. Our results indicate that both Web Site Service Quality metrics and financial fundamentals affect the market value of Internet companies. Specifically, concerning WSSQ metrics, our analysis shows a positive relationship between the market value of an Internet company and i) the interactive capabilities of its Web Site and ii) the trust that the Web Site inspires to a customer. These findings may further justify the expenditures on the development of high quality Web Sites. Moreover, findings provide useful direction to Web Site managers as to the factors to be considered in designing Web Sites.

EFMA 2004 Basel Meeting Paper
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HERMES Working Paper #04-18

 

Country Closed-end Funds and International Diversification

 

A. Charitou, G. Nishiotis, and A. Makris, 2004

 

 

Forthcoming in Multinational Finance Journal
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HERMES Working Paper #04-19

 

The Role of Financial Information in Explaining Financial Distress

 

A. Charitou and M. Stephanou, 2004

 

 

In Club C. (ed.),The Blackwell Encyclopedia of Management: Accounting}
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HERMES Working Paper #04-20

 

The Value Relevance of Earnings and Cash Flows: Empirical Evidence for Japan

 

A. Charitou, C. Clubb, and A. Andreou, 2004

 

 

Abstract The Japanese equity market is one of the largest in the world. In recent years, fund managers worldwide have substantially increased their exposure to the Japanese capital market. In recent years, fund managers worldwide have substantially increased their exposure to the Japanese capital markets. In spite of the Japanese capital market's rapid growth and its increasing importance in the international financial world, there has been limited evidence linking security returns to earnings and cash flows. This study extends the growing empirical literature on the association of earnings and cash flow with security returns by using a Japanese dataset consisting of 6,662 firm-year observations for the period 1984-93. We hypothesize that (i) earnings and cash flows are jointly associated with stock returns, and (ii) the association between cash flows 9earnings) and security returns increases (decreases) when earnings are transitory. This study provides empirical evidence (i) that cash flows (earnings) have information content beyond earnings (cash flows) in explaining security returns, and (ii) that cash flows (earnings) play a more (less) important role in the marketplace when earnings are transitory. Moreover, results show that the explanatory power of our Japanese models is similar to the evidence provided in prior US studies, indicating that Japanese investors utilize earnings and cash flows in their pricing of equities as their US couterparts.

Journal of International Financial Management and Accounting, Issue 11, Number 1, pp. 1-22, 2000
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HERMES Working Paper #04-21

 

The Distribution of Gains from Access to Stock

 

Michael Haliassos and Yannis Bilias, 2004

 

 

Abstract Recent market developments raise doubts regarding further spread of household stock market participation. We study, computationally and econometrically, net gains from access to stocks, and estimate the potentially changing role of their determinants across the distribution of such gains for US households. We highlight conflicting influences on net gains using a computational portfolio model, and use empirical estimates to derive differences in characteristics of potential entrants relative to marginal investors by the end of the dramatic recent expansion in the stockholder base. Findings suggest that downturns can have significant effects around the participation margin, through their influence on incomes, wealth, and employment. The role of education is found more limited than typically estimated, and confined to the low end of the gains distribution. Estimated characteristics of potential entrants relative to marginal stockholders suggest that further growth in participation poses considerable challenges, in view of more limited finances, younger age, more limited education and financial alertness, and above all significantly less self-declared willingness to assume financial risk by potential stockholders compared to marginal investors. The hurdle to financial practitioners interested in expanding the stockolder base is not estimated to be small.

(Also available as CSEF Working Paper 125)
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HERMES Working Paper #04-22

 

Equity Culture and the Distribution of Wealth

 

Yannis Bilias, Dimitris Georgarakos, and Michael Haliassos, 2004

 

 

Abstract Household participation in stockholding has grown dramatically since 1989. Is wealth inequality lower now that more households invest in stocks? Does stockholding attract progressively 'smaller' investors? Theory often suggests that wider participation reduces wealth inequality by promoting access, while empirical participation literature raises concerns that newcomers may be progressively poorer, less educated, and less financially sophisticated. We study changes in US wealth inequality between 1989 and 2001, a period of expanding participation through a stock market boom and downturn. We document a growth in importance of inequality in equity wealth for net wealth inequality, despite equity's limited share. The relation between participation, wealth inequality, and composition of stockholders is not monotonic, but differs across boom and downturn. Indices sensitive to the upper part of the distribution, where the bulk of equity holdings is concentrated, suggest that increased participation was associated with increased net wealth inequality during the boom, but a reduction during the downturn. Our estimates based on quantile regression and counterfactual distributions imply that, during the boom, the composition of stockholders became less conducive to high equity holdings, but entries and exits during the subsequent downturn reversed this trend. Both resulted partly from changes in the configuration of financial attitudes and practices. Our findings point to the potential importance of (i) policies promoting financial education and sound advice, especially in booms attracting more 'marginal' stockholders; and (ii) incorporation of heterogeneous characteristics, including attitudes and practices, when modeling aggregate effects of changes in asset market participation.

(Also available as CFS Working Paper 2005/20)
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HERMES Working Paper #04-23

 

Assets and Debts of Cyprus Households: Changes Between the 1999 and 2002 Cyprus Surveys of Consumer Finances

 

Goergia Antoniou, Christiana Argyridou, Michael Haliassos, Alex Karagrigoriou, George Kyriacou, Michalis C. Michael, Maria Papagheorgiou, and George Syrichas, 2004

 

 

Abstract This paper describes participation of Cyprus households in various assets and debts using data from the first (1999) and second (2002) Cyprus Surveys of Consumer Finances. It complements our previous papers that separately described household participation in various types of assets (Haliassos et al., 2001) and of debts (Haliassos et al., 2003). We consider a wide range of assets, both financial and real, risky and relatively riskless. Debts considered encompass personal unsecured loans, including credit card debt, and loans secured by housing collateral, mainly mortgage debt. Findings are of considerable policy interest, as they show how various demographic groups changed their participation and exposure to various assets and loans between 1999, when the unparalleled stock market boom took place and 2002, following the burst of the stock market bubble.

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HERMES Working Paper #04-24

 

Credit Cards: Facts and Theories

 

Carol Bertaut and Michael Haliassos, 2004

 

 

Abstract We use data from several waves of the Survey of Consumer Finances to document credit and debit card ownership and use across US demographic groups. We then present recent theoretical and empirical contributions to the study of credit and debit card behavior. Utilization rates of credit lines and portfolios of card holders present several puzzles. Credit line increases initiated by banks lead households to restore previous utilization rates. High-interest credit card debt co-exists with substantial holdings of low-interest liquid assets and with accumulation of retirement assets. Although available evidence disputes ignorance of credit card terms by card holders, credit card rates do not respond to competition. There is a rising trend in bankruptcy and delinquency, partly attributable to an increased tendency of households to declare bankruptcy associated with reduced social stigma, ease of procedures, and financial incentives. Co-existence of credit card debt with retirement assets can be explained through self-control hyperbolic discounting. Strategic default motives contribute partly to observed co-existence of credit card debt with low-interest liquid assets. A framework of "accountant-shopper" households, in which a rational accountant tries to control an impulsive shopper, seems consistent with both types of co-existence and with observed utilization of credit lines.

In G. Bertola, R. Disney and C. Grant (Eds.), The Economics of Consumer Credit, MIT Press, pp. 181-238
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HERMES Working Paper #04-25

 

Explaining Bankruptcy Using Option Theories

 

Andrea Charitou and Lenos Trigeorgis, 2004

 

 

Abstract This study builds on, and extends, option-pricing theory to explain financial distress based on a sample of 420 distressed U.S. firms for the period 1986-2001. Our results indicate that the primary option variables, such as firm volatility, play an important role in explaining distress up to five years prior to bankruptcy filing. When the model is extended to account for the probability of default on interest and debt repayments due at intermediate times prior to debt maturity (due to voluntary equityholder default or due to cash flow problems), an option-motivated transformation of the cash flow coverage is shown to have incremental explanatory power, while the primary option variables remain statistically significant. Our theory-driven models have significant explanatory power in the years tested.

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