ELECTRONIC COMMERCE:
CONTINUALLY ADAPTING TO THE MARKET

Information technology is altering the way businesses are conducted – organizations are rethinking their strategy, policy, market demographics, service quality, and innovation. The Internet trading increasingly pulls producers and consumers on-line providing opportunities for new products and services. Employees are able to add value through innovation, data mining and information handling. Information content, accuracy, format, ease of use, and timeliness are continually improved affecting interorganizational relationship, supply chain, demand assessment, pre- and postsale services, and integration. This panelist will describe how electronic commerce has altered the market place. Challenges and opportunities provided by this technology will be discussed.

Leong Kai Hin, Universiti Malaya
Chan K. Thim, Universiti Telekom

This paper begins with an introductory background of the financial crisis that led to exchange control measures. There were many reasons that such a large magnitude of economic uncertainty was created in this part of the world. This "contagion effect", so called the worst financial crisis of the century is far from over and if not contained, will result in more damaging and shocking effects on the economies of these nations; in particular, Malaysia.

Section 2 explains the exchange control mechanism in terms of exchange rate risks and short-term capital risks. These two factors were the major cause of the economic calamities that spread like wild fires across the Southeast Asian nations. This type of risk factors was rather difficult to evaluate and subject to broad classifications. The exchange rate mechanism in Malaysia is not unlike those of its neighbouring states and the usage of risk management is very limited, probably in only a few financial instruments.

In section 3, there emerged empirical evidences from macroeconomics data that project the working (effectiveness) of these exchange control measures, which formed the basis for policy determination. Although implemented in less than six months, positive signals of recovery have surfaced to support the selective exchange control measures.

With references to Singapore (& Brunei) and China, section 4 examines the effectiveness of the exchange control measures with comparison and contrast as to draw peculiar trends of such policies to be recommended in the future. Recommendations for policies must consider the risk impact on global finances in order to avoid the "financial flu" attacking again.

Finally, the conclusion summarized the consequences of exchange control measures that have affected global finances. The key to understand the exchange control measures is pertinent in order to manage risk successfully and to reduce aftershock effects of the financial crisis.

BANKS’ EXECUTIVE COMPENSATION AND RISK MANAGEMENT-A FUNCTIONAL OR
DYSFUNCTIONAL RELATIONSHIP?

The question of the possible adverse impact of the structure of executive remuneration packages on the risk management of banks, and hence the regulatory goals of stability and efficiency of the financial system is the subject of this paper. This topic has recently been reviewed by financial system regulators, such as the Bank of England (Davies, 1997), and gained recognition by formal legislative recognition in the USA. The Federal Deposit Insurance Corporation in passing legislation banning the linking of executive compensation to volume of lending in FDIC supervised institutions, has recognized the adverse effects of a management reward focus. Also there is a similar recognition evident in the introduction of new core principles of prudential supervision by the Bank of International Settlement (BIS, 1997).

The hypothesis that the structure of executive remuneration packages in the financial sector is linked to adverse risk behavior in financial institutions has its basis in a set of constructs regarding management behavior known as agency theory. An increase in risk profile of banks can increase shareholders returns in terms of capital gains. It can also increase the return from the exercise of executive options.

In Australia the practice of rewarding executives according to volume of loans generated fell out of favor after the Australian Financial System incurred a record level of bad and doubtful debts by 1991. Such executive remuneration contracts were rewritten to grant only executive options upon employment or as a bonus. Buyback clauses were inserted in the articles of association of Australian banks after the practice of granting an increasing number of executive options was introduced in the early 1990’s. These buyback clauses also increase the potential for increasing executive remuneration, although the original intention may have been to return surplus capital. Some Australian banks announce buybacks before opening of trade (CBA) - others after close of trade (NAB) during which times executive options can be exercised with notification the next day.

What is evident is that if the net effect of the restructuring of executive remuneration packages is to increase the price of bank stock at the expense of risk management, with eventual effects on stability and efficiency, then agency relationships are being distorted by the structuring of contractual obligations.

The argument that incorrectly designed executive remunerations contracts could increase the risk taking propensity of bank management is examined empirically in this paper by testing whether there was any significant similarity in the direction of movement between the degree of income received in the form of profit related bonuses or share options, to the firm’s overall risk profile, in particular credit risk.

Microeconomic indicators of the performance of Australian banks between 1973 and 1993 were used in this study. The ratios calculated were indicative of executive compensation and credit, interest rate, liquidity and leverage risk. Other indicators of changes in agency relationships were tested such as financing, investing and lending patterns, dividend yield, and the ratio of off-balance sheet assets to on-balance sheet assets.

Two crucial turning points are clearly observable in the history of regulation the Australian Financial System which facilitates an events study of this nature which attempts to test for significant differences. Accompanying the changes in regulation were major changes in the role of executive management in banks and hence in their agency relationships and remuneration. The concentration of assets in four major public listed banks also makes data collection and analysis transparent.

The purpose of both the parametric and non-parametric tests applied were to determine if there were significant differences pre and post changes in regulatory arrangements which also dramatically changed the ways executives were rewarded.

The results showed that credit risk deteriorated significantly while top executive remuneration increased significantly post the events selected as being turning points in the restructuring of agency relationships between management and shareholders. Also the results do not show dividend yield changing significantly, but they do show a dramatic increase in both the amount and type of executive remuneration.

The trend in Australia and elsewhere to buybacks and executive options would appear to refute any claims that shareholder rewards are the exclusive motivation for bank management behavior. The results of this study have implications for formal legalization of control parameters to executive compensation, particularly when executive options are used in direct conjunction to buyback programs.

This paper is divided into seven sections – the first two reviewing the literature and formulating hypotheses, the third explaining data collection, analysis and testing and the fourth listing and interpreting the results. The final sections interpret the implications of the results in terms of the hypothesis, analyze why some banks outperformed or underperformed and finally draw conclusion regarding appropriate structuring of executive remuneration in financial institutions in order to promote agency relationships.

THE EFFECTS OF BACKGROUND RISK ON OPTIMAL PORTFOLIOS

The aim of this paper is to develop an analytical framework for investment decision making in globalize international financial markets. To this end we will use some results coming from the area of risk theory. We will also show how this framework can be applied to the particular case of noisy markets.

Our attention will be focused on the dependence between the risky asset and the background risk, which will be viewed as noisy risk in our applications. Background risk might arise due to any reason like war, earthquakes, moral hazard, informational asymmetries, nonmarketable assets (human capital, irreplaceable commodities,...), cross border risk, market risk, political risk, inefficiency.

In our framework the background risk will be an additive risk rather than a multiplicative risk. In our model, we consider a risk-averted investor, a risky asset, a riskless asset, and an additive background risk. The investor is supposed to maximize the expected utility of a von Neumann Morgenstern utility function.

First of all, we define the dependence between the risky asset and the background risk in several ways :

• the background risk is stochastically decreasing or increasing in the risky asset

• the risky asset and the background risk are positively or negatively likelihood ratio dependent- the background risk is positively or negatively dependent on the risky asset in the sense of the first, the second or the third stochastic dominance criteria

We point out the effect of the dependence between the two sources of risk on the demand for risky asset. We find that it is not necessarily true that the individual invests only in the riskless asset when the risky asset is fair, where fair means that the expected return of the risky asset is equal to the risk-free rate. In fact, the demand for risky asset is positive when the background risk and the risky asset are negatively dependent. In this case high returns are likely to be accompanied by low values of the background risk. The background acts like a hedge-portfolio. When the risky asset is fair, the absolute value of the demand for risky asset is lower than the percentage of additional background risk per asset’s risk.

By studying the increase in the strength of the dependence, we give the ways to obtain diversified portfolio in both positive and negative dependence : the demand for risky asset is an increasing function of this strength when dependence goes from perfect positive dependence to perfect negative dependence.

And finally we link our framework with the Capital Asset Pricing Model in the special case of noisy markets. We show that the demand is shifted in order to obtain a diversified portfolio because the investor willingness to buy marketable risk is modified by the presence of the background risk. The systematic risk of any risky asset is given by the usual beta added with a corrective term.

OWNERSHIP STRUCTURE, RISK, AND PERFORMANCE:
AN EMPIRICAL INVESTIGATION IN TURKISH COMPANIES

The relationship between equity ownership structure and firm performance has become a key issue in understanding the effectiveness of alternative corporate governance mechanisms. In light of massive privatization efforts in former Eastern block countries as well as experiences of developed economies of USA, Japan and Western Europe, researchers face vast amount of data to test various corporate governance issues brought out by the theory. In this paper we examine whether concentration of ownership and ownership mix have any impact on the risk taking behavior and performance of Turkish nonfinancial companies listed on Istanbul Stock Exchange (ISE). With public offerings of equity through IPOs, direct foreign investment and a large public sector in the economy, the Turkish market offers a very rich combination of corporate governance schemes to be compared. Moreover, privatization of publicly owned companies is still being debated on the basis of the impact of ownership mix on performance. A related issue surfaces with respect to the method of privatization. The merits of public offering of equity which leads to a more diffuse ownership versus private placement through block sales that results in a concentrated ownership is another controversy to be resolved. Hence we address ownership structure and ownership mix issues in the Turkish market in order to shed some light on this debate.

Our sample of companies includes 145 nonfinancial corporations listed on ISE as of the end of 1995. We excluded banks, leasing companies, investment companies, holding companies and insurance firms. Data on ownership structure and financial statements are obtained from ISE (1997). Market value data are provided in ISE (1996) and monthly bulletins of ISE.

We define ownership structure alternatively as the percentage share ownership of largest three stockholders and percentage owned by minority shareholders. Ownership mix refers to the type of majority shareholder(s). Hence we identify them as foreign owners, government and a conglomerate. In our empirical models, ownership mix variables are taken as dummy variables. We also employ control variables to account for differences in firm size and leverage. The results indicate that firms with concentrated ownership command a higher earnings multiple. Firms with government ownership have lower P/E ratios. Accounting measures of performance are not related with ownership structure and mix. In terms of risk taking, our findings reveal that highly concentrated and less diffuse companies have higher risk as suggested by larger standard deviation of monthly stock returns. Government owned firms in our sample display higher risk although they are larger on the average.

Findings with respect to ownership structure and mix are mostly similar to those reported in the literature for other countries. However, accounting measures of performance are a notable exception. There, we do not find any relationship between them and ownership measures and the signs of leverage and firm size as control variables are contrary to expectations. We attribute this anomaly to the distortion of balance sheets due to persistent inflation experienced in the country.

Another surprise result is the lack of any effect of foreign ownership and affiliation to a conglomerate. To an observer of Turkish corporate governance mechanisms, conglomerates and joint ventures should have certain advantages over other companies. Yet failure to disclose any such effects is an issue to be investigated further. One plausible explanation is the nature of our sample. As we include only the largest publicly traded companies in our sample, we suspect that large domestic companies with no conglomerate affiliation are not handicapped in terms of access to capital markets or procurement of projects, government incentives, qualified labor etc.

PRICE, VOLUME AND VOLATILITY SPILLOVER AMONG
NEW YORK, TOKYO AND LONDON STOCK MARKETS

This study objects to disentangle two possible interpretations: informational link hypothesis and contagion hypothesis by examining the effect of trading volume on inter-market dependence on stock returns. First, if correlation between international stock returns is caused by international contagion of liquidity traders’ sentiments or by resolution of heterogeneous interpretations of foreign news, such correlation will be positively influenced by foreign trading volume. Second, if international return interdependence is associated with the information containing in stock price changes in one market to another market, these interdependence are likely to be positively influenced by foreign price volatility but not by foreign trading volume. The use of trading volume enables us to assess the two possible channels of international transmission of international stock return and volatility by examining the causal relationship among the correlation of international stock returns, trading volume, and volatility.

In this paper, we examine the dynamic relationship among the U.S., Japan and U.K. daily stock market return volatility and trading volume using a multivariate generalized autoregressive conditional heteroskedastic (GARCH) model. The vultivariate GARCH model uses information from the history of more than one market. According to Conrad, Gultekin, and Kaul (1991), multivariate models provide more precise estimates of the parameters because they utilize information in entire variance-covariance matrix of the errors.

Data

The data set comprises daily market price index and trading volume series for the three largest stock exchanges: New York, Tokyo and London. For the New York Stock Exchange, we use the NYSE composite index. The data cover the period of January 2, 1970 - December 30, 1995, and consist of 6,568 observations for each series. For the Tokyo Stock Exchange, we use the Nikkei 225 index, which is taken from the PACAP database of the University of Rhode Island. The data cover the period of January 4, 1975 - December 30, 1995, and consist of 5,696 observations. For London, we use the FT-SE 100 index. The index covers the period of January 4, 1984 – December 30, 1995, and consists of 3,023 observations for each variable.

Method

We employ a three-step procedures developed by Gallant, Rossi and Tauchen (1992) to adjust for seasonal regularities. Then, we use these adjusted data to test for the robustness of the dynamic relations. In step one, we regress the original stock return series on dummy variables for day-of-the-week (one for each day from Tuesday through Friday), dummy variables for pre-holiday, dummy variables for turn-of-the year, and dummy variables for turn-of-the-month.

The following multivariate GARCH model is posited for the joint processes governing the daily rates of return for the Japan, U.S. and U.K. markets:

or

where the returns vector is denoted by r’_t . The residual vector is given by , with its corresponding conditional covariance matrix . e_t is represented by a column vector of forecast errors of the best linear predictor of r_t conditional on past information, denoted by , and including the P lagged values of r_t and trading volume. Where vech(.) denotes the column-stack operator of the lower portion of a symmetric matrix, is an vector of innovation, a isparameter vector, and b and c are matrices of constant parameters.

Empirical Evidences and concluding remarks:

Empirical results are consistent with the hypothesis that the cause of international transmission of stock returns and volatility is transmission of information from one stock market to another. Before the crash, the correlation between international stock returns might be caused by international contagion of liquidity traders’ sentiments or by resolution of heterogeneous interpretations of foreign news. With the development of communication technology, the more efficient stock markets become, the less contagion effect among national stock markets.

VOLATILITY ARBITRAGE IN FIXED INCOME MARKETS

Gunter Meissner, Hawaii Pacific University

In the fixed income markets, various derivatives can be replicated by other derivatives. This bears arbitrage opportunities. The article investigates three types of volatility-arbitrage in the fixed income markets: Cap-floor parity arbitrage, cap-floor forward volatility arbitrage, and bond option – swaption arbitrage.

1. Cap-Floor Parity Arbitrage

A standard popular type of arbitrage in the fixed income market is cap-floor parity arbitrage: Buying a cap and selling a floor with the same strike is equivalent to entering into a swap one period forward, where the strike is paid and the Libor rate is received.

If the floor volatility is higher than the cap volatility, as it is not unusual in the cap-floor market, an investor can buy the cap and sell the floor at the mid-market strike (zero cost) and enter into a long forward swap at the mid-market swap rate. To achieve this type of cap-floor parity arbitrage, only slight differences in the cap-floor implied volatility are necessary.

2. Cap-Floor Forward Volatility Arbitrage

Caps and floors are usually quoted as flat yearly implied volatilities. However, the volatility curve is usually inverted. So although we can derive the total value of the cap by pricing each caplet with a constant volatility, the first caplets actually have a higher volatility than the later ones.

The specific forward volatility, which is applied to each single caplet, is implicitly contained in the flat volatility curve and can be extracted by iteration. The paper suggests two methods, both based on Newton-Raphson, to generate the forward volatility.

If the flat volatility curve has a certain structure, especially being too inverted, arbitrage opportunities especially for long dated caps exist. Arbitrage opportunities can be found quite often in trading practice, as e.g. in August 1996 in the Japanese cap-floor market.

Cap-floor forward volatility arbitrage means that the trader buys the cap or floor at a lower price than the intrinsic value. This means that the cap has a positive theta and gamma. Therefore the trader will daily make money on the theta and while hedging also on the gamma, thus realizing a risk-less profit over time.

3. Bond option – Swaption arbitrage                                                                                                                              A payers-swaption, which gives the holder the right to pay a fixed rate and to receive a floating rate, can be viewed as a  put on a fixed rate bond with the strike equal to the par value of the floater. Also, a receivers-swaption, which gives the  holder the right to receive a fixed rate and to pay a floating rate, is equivalent to a call on a bond with the strike equal to the par value of the floater.

For the equations payer = put and receivers = call to hold, it is also necessary that the forward price of the bond option is equal to the value of the fixed side of the swaption (including a payment of the principal at swap maturity). Furthermore, the floating side of the swaption has to have a constant principal amount and the underlying swap has to start at option maturity T.

A difference between swaption and bond options is though, that in a swaption the geometric Brownian motion is modeled with the fair forward swap rate. Thus, the fair forward swap rate is log-normally distributed and prices are normally distributed. In a bond option, the geometric Brownian motion is modeled with the fair forward bond price, thus the forward bond price is log-normally distributed and rates are normally distributed. Consequently, the market prices bond options with bond price volatility and swaptions with rate or yield volatility. The elasticity based conversion from yield volatility to price volatility bears arbitrage opportunities due to different discounting used in trading practice.

For a cash-settled swaption, the expected swap cash flows are discounted with the mid market forward swap rate. For a swap-settled swaption, the expected swap cash flows are discounted with the forward discount factors, resulting from the swap curve. For a bond option, the discounting of the future cash flows is done with the constant yield of the bond.

Due to the different discounting, arbitrage between swaptions and bond option exists. The arbitrage is more likely, the steeper the yield curve and the higher the levels of volatilities and interest rates. Traders should check volatility arbitrage opportunities, which occur more often in non-mature markets.

ECONOMIC UNCERTAINTY AND CREDIT CRUNCH:
EVIDENCE FROM THE TURKISH BANKING SYSTEM

The most important role of financial institutions is the transfer of funds collected from surplus units as "deposits" to deficit units in the form of "direct loans." In recent years, the Turkish banks are being criticized by entrepreneurs and by the business community for staying away from a bank's true line of business and for decreasing the amount of loans extended. In response to this criticism, banks claim that the level of economic uncertainty makes it impossible to extend credit even to highly creditworthy firms.

The goal of this paper is twofold. First, it aims to document the changes in the amount and type of loans distributed by the Turkish banking system over the time period of 1986 to 1998, using monthly loan data. Second, the paper aims to see whether there is a relationship between the changes in the amount of loans distributed by banks and the level of economic uncertainty. This analysis is conducted in a multivariate regression framework after controlling for other factors that might affect the loan supply by banks and the loan demand by borrowers.

The balance sheet data for Turkish banks are obtained from the web site publications of the Central Bank of Turkey. It covers the period from 1986 to 1998. The inflation information is obtained from the International Monetary Funds’ International Financial Statistics Database.

In this paper, overall economic uncertainty is proxied by uncertainty of annual expected inflation, following Berument and Guner (1997). Berument and Guner (1997) show that interest rates increase as inflation rate or the variability of inflation increases.

Also, the conditional variability of inflation is estimated. Engle (1982) introduces the Autoregressive Conditional Heteroscedasticity (ARCH) model that allows the forecast variance to vary systematically over time. Bollerslev (1982) extends the ARCH model and models the conditional variance of the variable as a function of its own lagged values as well as the lagged values of squared residuals from the ARCH model. Following these developments, the conditional variance of inflation is estimated using a Generalized Autoregressive Conditional Heteroscedasticity (GARCH) model.

REVIEW OF LITERATURE

Previous studies that address the issue of credit crunch generally define credit crunch as a significant reduction in the supply of credit available to commercial borrowers. In order to decide that an economy is indeed experiencing an episode of credit crunch, at least two distinct time periods are compared against each other to test the existence of a secular decline in the amount of total credit extended by the banking system.

Research conducted in the late 1980s and the 1990s has focused on the impact of introducing Risk-Based Capital Standards on the lending behavior of American banks. The main discussion in this literature is about distinguishing between two completely different types of reductions in the amount of credit extended by the banking system. One possibility is that there is a weak loan growth rate as a result of the normal procyclical pattern of both loan demand and the creditworthiness of borrowers before the economy goes into a recession. The other possibility is that there is a downshift in credit supply as a result of new and increased requirements on bank capital that are now tied to the amount of risk the bank takes on in the asset portfolio. Since it is rather difficult to determine whether the observed slow credit growth is a demand or supply phenomenon, the evidence regarding the existence of a credit crunch remains controversial today.

CONTRIBUTION

The contribution this paper makes comes from the question it tackles concerning the relationship between economic uncertainty and the amount of bank credit available in a given economy. Previous research has examined the economic costs of inflation volatility on real growth and investment but not on bank credit. In this sense, by measuring economic uncertainty as the volatility of inflation, this paper provides an added dimension to the discussion regarding the impact of inflation on the workings of an economic system.

INVESTOR SENTIMENT AND CLOSED-END FUND PUZZLE IN AN EMERGING MARKET

The shares of closed-end funds generally sell at a price lower than the net asset value (NAV) of the underlying asset portfolio in the U.S. markets. Since these funds invest in publicly traded securities, like stocks and bonds, and the U.S. markets are efficient, this discount, named as closed-end fund puzzle, is surprising. Lee, Shleifer and Thaler (1991) identify four components of this puzzle that are well documented in the U.S. for closed-end mutual funds. First, closed-end funds start out at a premium of almost 10 percent. Second, although they start at a premium, they move to an average discount of over 10 percent within 120 days from the beginning of trading (Weiss, 1989). Third, discounts on closed-end funds are subject to wide fluctuations over time. Last, when closed-end funds are terminated through either liquidation or an open-ending, share prices rise and discounts shrink.

Although the closed-end puzzle is well documented in the developed markets, there is no study that examines the behavior of the closed-end funds in the emerging markets. The Istanbul Stock Exchange (ISE) is one of the emerging markets which has been attracting the attention of international fund managers. The empirical studies examining the ISE found that the market is not semi-strong form efficient and the evidence on the weak-form efficiency of the ISE is inconclusive (Aydogan and Muradoglu, 1998; Balaban and Kunter, 1996). Furthermore, the ISE has been operating since 1986, investment in stocks is a new alternative and principles of portfolio management are not used well by Turkish investors (Yüce, Önder and Mugan, 1998). If portfolio managers are using modern portfolio management techniques, then investors should be willing to pay higher price for the portfolio that is already formed. Hence, zero or positive premium is expected in the closed-end funds traded on the ISE.

This paper has three purposes. First, the relationship between NAV and stock prices of eleven mutual funds in the ISE, an emerging market, is investigated for the period between July 1995 and June 1998. Second, the behaviour of the discount or premium on closed-end funds is examined over time. Third, the validity of investor sentiment hypotheses for mutual funds in an emerging market is tested for the ISE. The investor sentiment hypothesis makes three predictions about closed-end fund discounts. First, discounts on funds should be correlated with each other. Second, new funds should start when old funds are trading at a premium. Third, changes in the discounts on the closed-end funds should be correlated with the returns on portfolio of stocks that are not related with the funds.

The data used in the analyses come from two different sources. The portfolio holdings and NAVs of closed-end funds are taken from the weekly bulletins of the ISE. The closing prices of the closed-end funds and the ISE-100 composite index on Fridays are obtained from the Datastream.

The results show that the Turkish closed-end funds are sold at a discount as well. The average value-weighted discount is 12.88 percent which is slightly higher than the reported discount for the U.S. closed-end funds. These discounts range from -12.38 percent to 41.97 percent. For four of the closed end funds, a premium is found. Furthermore, these discounts fluctuate from week to week. In addition, the fluctuations on the average discount changes are more than the fluctuation in the return on the ISE-composite index over the period analyzed.

In order to test the investor sentiment hypothesis, ten decile portfolios are formed based on the market capitalization of stocks traded on the ISE-National Market. Stocks are assigned to a portfolio based on their market capitalization at the end of each year. Hence, the first portfolio consists of 10 percent of all stocks that have the smallest equity value in the ISE-National market and the tenth portfolio consists of all stocks that have the highest equity value in the ISE-National market. Continuously compounded weekly returns on the ISE-composite index are used as the market return.

The results show that discounts on funds are highly correlated. The average pairwise correlation of monthly discounts of individual funds is 0.3322. Out of 110 correlations, only eleven of them are insignificant and twelve of them are negative. The examination of the average discount on closed-end funds before and after the introduction of the funds shows that except two funds that were started during the sample period, all of the other funds are started when the existing funds are selling at a premium. Furthermore, all except two funds enjoyed, on average, a premium for the first four weeks of the fund introduction.

The comparison of discounts on ten size portfolios and market returns shows that there is a negative relationship between the changes in discount and the return on all portfolios. When the discounts decline, stocks do well. The coefficient on the change in the value weighted discount (VWD) is lowest for the lowest value portfolio and it is highest for the largest size portfolio. However, the coefficients do not increase monotonically with portfolio size.

The results of this study suggest that mutual funds in emerging markets trade at a discount as well and the size of the discount is similar to what was observed for mutual funds in the U.S. Investor sentiment hypothesis can explain the discounts observed for the Turkish mutual funds. These findings imply that the modern portfolio management does not seem to have much value in emerging markets or Turkish fund managers do not use modern portfolio techniques as well.

WHAT DRIVES EXCHANGE RATES? :
THE CASE OF THE YEN/DOLLAR RATE

The purpose of this paper is to examine the mechanism of dynamic multilateral interactions between the yen/dollar exchange rate and macroeconomic variables under the flexible exchange regime. We found the dynamic behavior of the yen/U.S. dollar exchange rate is almost self-generating in the short run. In the long run, however, the predictions by the monetary approach to exchange rate determination appear to be valid. Our finding is also consistent with the portfolio-balance approach to exchange rate determination: While the value of the U.S. dollar depreciates when there is a positive shock in the Japanese trade balance, the value of the U.S. dollar appreciates when there is a positive shock in the U.S. trade balance. It implies that the macroeconomic variables identified by the theories of exchange rate determination do matter in the long run for the yen/dollar exchange rate during the flexible exchange period, but not in the short run. It also implies that the policy coordination between the two countries to stabilize the exchange rate will have an efficacy in the long run, but will have a limited or no efficacy in the short run.

AN EMPIRICAL STUDY OF THE THAI BAHT

This paper seeks to find the long-run relationship between Thai Baht and the currencies of its five major trading partners and to provide an empirical explanation for the collapse of the Thai Baht in 1997. Han (1998) presents a model which implies that the real exchange rates of major trading partners should have a long-run relationship (or co-movement) in order to maintain either a stabilized trade balance or price level. The relationship of the Thai Baht and the currencies of its five major trading partners: Japan, the United States, Germany, Netherlands, and Singapore is examined. A vector autoregression (VAR) is used to estimate a system of interrelated real exchange rates and to analyze the dynamic impact of random disturbances on the system of variables. It is found that, between 1981Q1 and 1998 Q1, when the real exchange rate of the Japanese Yen (against the US Dollar) increases (the Japanese Yen depreciates), the real exchange rate of the Thai Baht (against the US Dollar) decreases. This could cause a trade deficit for Thailand. The cointegrating relationship between the above five real exchange rates is further investigated using canonical cointegrating regression (CCR) and Johansen's LR test. Results from both methods conclude that the real exchange rates (against the US Dollar) of Thailand, Germany, Japan, Netherlands, and Singapore are cointegrated.

Han (1998) presents a general equilibrium model to capture the relations between the choice of currency basket weights and the balance of trade for an economy. It is shown in the model that in order to keep trade balance of the home country unchanged, an appropriate choice of currency basket weights has to be made. The choice of currency basket weights then implies a long-run relationship between the currency of the home country and its trading partners. For example, when the currency of partner A against the numeraire depreciates by 1%, the home country currency against the numeraire should also
depreciate, according to the currency basket weights of partner A, by to maintain the competitiveness. The total impact from all currencies in the basket on the value of the home currency should add up to one. This implication can be used to test the overall competitiveness of the home country when there are changes in the real exchange rates of its trading partners. It can also be used to analyze the effect of exchange rate movement of the home country on its balance of trade. It is well known that the inevitable collapse of the Thai Baht in 1997 was following months of trade deficits and a deteriorating current account. The model developed by Han (1998) provides an empirical implication to examine the property of the Thai Baht that started the financial crisis in Asia and later expended to Latin America and Russia.

Two econometric methodologies are used to examine the long-run property of the Thai Baht. The non-structural approach of vector autoregression (VAR) is first applied to estimate the response of the home country currency (Thai Baht) when the values of its trading partners' currencies depreciate or appreciate. The VAR results are further examined to assess the cause of trade balance surplus or deficit in the home country. The impulse response analysis and variance decomposition are also performed to show the impact of an external shock to the long-term path of Thai Baht. The AIC criterion is used to determine the lag periods. It is found that the log level of the Thai Baht mainly depends on its own past values, which indicates the relative inflexibility of the Thai Baht responding to changes in the currency values of its trading partners. The results also show that log levels of the five real exchange rates are close to I(1) process. It is also found that when the real exchange for the Japanese Yen against the US Dollar increases (the Japanese Yen depreciates), the real exchange rate for the Thai Baht against the US Dollar decreases (the Thai Baht appreciates). This would make Thai products relatively non-competitive, could cause a trade deficit with Japan, and then causes an increase in the deficit of its current account. The impulse response functions and variance decomposition are calculated using the ordering: log DM, log Guilder, log Yen, log the Singapore Dollar, and log Baht. It is observed that an increase in the log level of the Deutsche Mark and the Singapore Dollar is associated with an increase in the log level of the Thai Baht for the first two to three quarters, but this increase is reverse afterwards. Within about 12 quarters, the shock has almost disappeared. When there is a positive shock to the log levels of the Japanese Yen, there is a contemporaneous decrease in the log level of the Thai Baht. This effect reaches zero within about three-quarters, but reappears again at the fourth quarter and persists over the next eight quarters. When there is a positive shock to the log level of the Dutch Guilder, there is no immediate effect on the Thai Baht for about two quarters, and then a positive effect on the Thai Baht re-emerges at the third quarter and persists for the next nine quarters. It means that the Thai Baht has about six months lag to catch up with Guilder's depreciation. From the analysis of variance decomposition, it is found 72.5% of the variation in the Thai Baht, considering one period (quarter) horizon, comes from its past fluctuation, followed by the changes in the Singapore Dollar, the Deutsche Mark, the Japanese Yen, and the Dutch Guilder. Among the major trading partners, the Thai Baht is most sensitive to the change in the Singapore Dollar.

The long-run relationship between real exchange rates of trade-related countries is also investigated using the concept of cointegration. If a country pegs its currency to a basket, there should be a long-run relationship between the log levels of the real exchange rates (all measured against the numeraire) of countries involved. It means that the percentage change in the real exchange rates among trading partners should be cointegrated. The augmented Dickey-Fuller test is applied to test the nonstationarity of the log levels of real exchange rates. Johansen's LR test and the canonical cointegrating regression proposed by Park (1992) are used to test and to estimate the cointegrating vector.

After normalizing the cointegrating vector ()', it is implied in the model of Han (1998) that, if the trade balance of the home country is stabilized, the summation of the elements in the cointegrating vector ought to be zero. That is, the summation of the impact of all the currencies in the basket is negative one. If the summation of the elements in the cointegrating vector is negative, the percentage change in the home country's real exchange rate is less than the uniform percentage change in its trading partners' real exchange rates. It indicates that the home country currency is relatively inflexible, even comparing to the currencies chosen in its currency basket. The inflexibility will affect the home country's competitiveness in exports market. It may also cause international speculative attacks on the home currency.

THE DOLLAR, THE EURO, AND THE YEN AS INTERNATIONAL RESERVE
AND INVESTMENT CURRENCIES

Since EMU represents a currency area with a GDP level and a world market share comparable to the United States, it is widely expected that the euro becomes an important international currency. This paper suggests simple methods how to quantify the effects EMU may exert on the role of the dollar and the yen as the other major international currencies. Estimates presented indicate that indeed the euro may indeed lead to a significant decline in the market share of the dollar as an official reserve currency of central banks and as an investment currency of in private portfolios.

These effects hinge on the assumption that the euro achieves a reputation similar to the deutschmark before EMU started. The projected shifts can be expected to materialize only in the medium term so that no immediate abrupt changes in the demand for dollars will occur.

HOSTILE TAKEOVERS, BREACH OF TRUST AND THE CORPORATE HEDGING DECISION

This study examines the "breach of trust" problem associated with hostile takeovers in the context of the corporate hedging decision. A takeover threat exposes managers to the risk that their relationship-specific rents are appropriated by the raider. As a consequence, it reduces their incentives to engage in implicit contracting with company owners or to invest in firm-specific human capital. This has profound implications for the design of the corporate hedging program. Managers overemphasize the importance of short-term exposures and systematically undervalue the benefits of flexibility-based operative hedging using real options. It is shown that charter-based antitakeover measures may resolve this contracting problem in conjunction with golden parachutes. Statutory control of risk management and takeovers may, under certain conditions, achieve the same result.

The paper employs an incomplete contracting approach to examine how the threat of a hostile takeover affects management’s hedging decisions. The firm may reduce its exposure to financial risk with financial as well as operative means. The hold-up problem associated with the takeover threat reduces the incentives to carry out the effort-intensive acquisition of operational flexibility and, as a result, curtails the company’s ability to manage so-called operating exposures. In addition, operative hedging overemphasizes the benefits of diversification relative to operational flexibility. The takeover literature has advanced two explanations for the short-termism of management behavior. This study argues along the lines of Schnitzer (1995,1997) that the threat of rent appropriation forces managers to give short-term payoffs a greater role. It stands in contrast to Stein (1988) who argues that the takeover threat leads management to behave myopically and engage in short-term profit-boosting if the likelihood of an ownership change is negatively related to short-term performance. While both approaches yield the same behavioral outcome in the general takeover case, it can be demonstrated that the myopia hypothesis has very different implications for corporate hedging as it would rather support the excessive use of operative hedging in order to minimize short-term earnings volatility.

This study develops the missing link between the takeover and the hedging literature. Following Froot/Stein/Scharfstein (1993), we rationalize risk management on the basis of a capital market imperfections argument and add the corporate governance dimension to the literature analyzing the choice between financial and operative hedging instruments as well as real-option- vs. diversification-based operative hedging, in particular Chowdry/Howe (1996), Hommel (1999), Kogut/Kulatilaka (1994) and Mello/Parsons/Triantis (1995). The paper ties in directly with the ongoing governance reform debate in Europe and recent regulatory initiatives in Germany aimed at fixing minimum standards for carrying out takeovers and the supervisory board’s role in monitoring risk management. A critical evaluation of these regulatory changes concludes the paper.

DENATIONALIZATION OF GERMAN CORPORAT GOVERANCE – THE CASE OF HOECHST

Stefan Eckert, Otto-Friedrich-University Bamberg, Germany

In the economic literature a convergence of national corporate governance systems is predicted or even diagnosed. From the national perspective this development implies a transcending of national corporate governance systems, in other words a denationalization of corporate governance. The objective of this study is to analyze the process of denationalization of corporate governance for German public corporations and to explore the implications that arise for the internationalization of these companies.

Therefore on the one side it shall be analyzed whether the process of denationalization of corporate governance can be characterized in the case of German corporations as a gradual development or a process marked by radical changes. Furthermore the underlying factors that influence this process and the events that triggered changes in the denationalization process shall be explored. And it shall be judged whether there has been a radical change concerning the denationalization of corporate governance in the case of German companies in the 1990s.

On the other side, the consequences for the internationalization of companies shall be considered. Presumable implications drawn from previous theoretical and empirical findings are summarized in two hypotheses:

1. The increasing denationalization of corporate governance of German corporations induces a reduction in the relevance of international diversification at the corporate level.
2. The increasing denationalization of the governance of German corporations leads to an increasing relevance of internationalizing as a tool for internalizing internationally segmented markets.

As research method a case study design was chosen. An especially interesting research case seems to be Hoechst, a German company which is mainly operating in the pharmaceutical and the chemical sector. Case data was gathered from documents like annual reports, published interviews with company executives etc.

First empirical results are:

1. The process of the denationalization of corporate governance at Hoechst can not be characterized as a continuous process. Rather, it can be split into phases, which differ considerably according to the intensity of denationalization.
2. The most important "critical events" for the denationalization of corporate governance at Hoechst are: a) the taking over of a 24.9% stake of Hoechst by Kuwait in 1982, b) Jürgen Dormann becoming CEO in 1994, and c) the planned merger between Hoechst and Rhône-Poulenc, which has been announced in 1998.
3. A reduction in the relevance of international diversification during the phase of intense denationalization can not be found. Whereas product diversification has been reduced heavily, regional diversification seems to have been expanded.
4. Weak empirical evidence points to an increase in the relevance of internalizing internationally segmented markets.

CHANGING EXCHANGE RATE PROPERTIES
DURING THE EMS PERIOD?

The performance of the European Monetary System is still debated. Regarding microeconomic characteristics it has been claimed that the realizations of higher moments of exchange rate distribution would indicate increasing riskiness for agents. Other critics have argued that any progress of the EMS is fictitious as it has not performed better than other currencies over the same period. We analyze theses propositions by searching for trends in distributional properties of EMS exchange rates and comparing them to an outside benchmark. We find properties indicating decreasing risk. Moreover, this decline seems to be faster than for the world benchmark.

MULTIVARIATE STATISTICAL MODELLING FOR THE
CLASSIFICATION OF THE SHARES TRADED
AT THE IMKB AS TO THEIR AVERAGE EARNINGS

This study aims at developing multivariate models to classify the shares traded at the IMKB according to their average earnings. The use of the model that is successful in this classification will make it possible for the shares traded at the IMKB to be ranked within objective criteria. Though the brokers seem to rank the shares traded at the IMKB by considering various indicators, the univariate characteristic of this approach -the use of only one independent variable- produces a restrictive effect on its serviceability. The facts that the univariate approach yields contradictory results and that it does not have the capacity to evaluate all the features of a company and the relations between these features, and that these models’ capacity to predict and rank is lower than that of the multivariate models make the use of multivariate models more attractive for this purpose. Though in some researches are made some rankings based on the scores obtained through the attachment of subjective weight to several variables, this approach is hardly scientific because of the subjectivity it displayed in the handling of the selection of variables, the attachment of weight to the variables and the rankings according to the scores obtained. Hence, this study pursues a scientific approach in which several criteria are made use of, and aims at ranking the shares traded at the IMKB within objective and varied criteria.

In this study the IMKB earnings average is taken as the basis for the ranking criterion, and an attempt is made to develop a model that distinguishes between the 30 shares that have the highest average earnings and 30 shares that have to lowest average earnings. The success of the Multiple Regression Model, Multiple Discriminant Analysis, Logit and Probit that are the multivariate statistical techniques used in ranking (predicting financial failure) depends on how distinct the difference between the two or more groups to be distinguished. The job of the analyst gets easy when the difference is like the oppositeness of black and white. It gets difficult when it has gray tones. For example, the difference between the shares above and the shares below the IMKB earnings average is more abstract than the difference between the companies that went bankrupt and that didn’t go bankrupt, and the gray area in this definition is larger than that of the bankruptcy. Therefore, the gray area varies according to the selected definition, and the success of the model increases or decreases depending on the size of the gray area. While the size of the gray area is a significant factor in the selection of the definition, there is another factor, namely the appropriateness of the definition for the purpose. For example, when the brokers develop models to predict the performance of shares, they are expected to base the definition of financial failure on a definition that is also used here, such as earning below the average.

In the second stage, it has been decided on which independent variables to be used in model development, and the values of these variables have been calculated one by one for each of the companies. In this study, it has been decided to make use of financial ratios rather than mere accounting data. The reason for this choice is to overcome the effects of inflation on a large scale and have control over important variables, such as the size of the company, difference in sector and difference in risk. It is known that it doesn’t suffice to predict financial failure using only financial ratios, also qualitative variables, such as company news, are added to the analysis to test whether the usage of qualitative variables together with the quantitative ones, such as financial ratios, are improving the model performance or not.

At the end of the first two stages, the values of the dependent and independent variables were obtained, and in the third stage, the data table ready for analysis was checked for the last time and the ultimate form of the table was made. In this stage, decision was made on whether there was any outlier between the measured values.

Fourthly, models have been obtained through the use of Logit, one of the alternative multivariate statistical techniques.

The following picture is viewed after the models have been evaluated:

• General correct prediction percentage of the models does not differ a lot, whether the examined period is of 3, 6, 9, or 12 months. This shows that the financial panorama of the firms does not go through much change throughout the year.

• The fact that models involving small number of financial ratios are obtained for each examined period, shows both the serviceability of this type of analyses and the high correlation between financial ratios.

• Though the performance of the models obtained is found to be statistically significant, the fact that the predictive power of these models can not be more than 75 percent displays the inadequacy of using only financial ratios in these models. It is expected that, besides financial ratios, the use of qualitative data as an explanatory variable, such as company news, will add to the predictive power of the models.

SECURITY EXCHANGE COMMISSION IN BANGLADESH:
IS IT OPTIMALLY SETUP?

Introduction

Bangladesh has continued to maintain steady stability in macroeconomic front. In 1995-96, there was marked improvement in foreign exchange reserve (+ 32%), reduction in current account deficit (- 10.26%), improvement in revenue collection
(+ 10.95%), increase in investment (+ 9%) and further containment of rate of inflation (1.3%). The macro-economic stability has been lauded by multilateral donors and development organizations. Given the above scenario about the Bangladesh general economy, the natural question arises: why did the market crash in 1996? In Hoque (1997) paper, it was showed that the Dhaka Stock Exchange exhibited chaos reflecting a breakaway movement. The breakaway movement did take place to the downside subsequently. Why did the market move to a breakaway point? The paper addresses this question by analyzing primary historical documents and data collected from Security Exchange Commission (SEC) of Bangladesh and Investment Corporation of Bangladesh.

The primary thesis of this investigation is that the SEC of Bangladesh did not perform its role before and during the crash. It was setup for failure to begin with. A comparative analysis is drawn between SEC of USA and SEC of Bangladesh. Further, the analysis was corroborated with facts that are pending legal investigation.

Constitution and Function of Bangladesh SEC

The Securities and Exchange Commission (SEC) was established on 8 June 1993 under the Securities and Exchange Commission Act, 1993 in order to protect the interest of investors in securities, develop and regulate the securities market and ensure proper issuance of securities and compliance of the relevant law. Consistent with overall policies, SEC acts as a central regulatory agency performing wide range of functions covering the entire capital market including the proper issue of capital the establishment of fair trading practices and the close supervision of issuers, market and intermediaries.

The Board of SEC is the policy-making and oversight body, while the implementation and day to day regulatory functions are taken care of by the full-time Chairman and members. Thus the work and strategies of the Commission are to protect investors, foster investors' confidence, promote a healthy, active and properly administered securities market, facilitate capital information and inhibit fraud in the public offering of securities.

Is It Optimally Set Up?

As can be observed from above that the SEC of Bangladesh follows U.S. SEC in name and overall organizational structure. However, this is an ill adapted version of the SEC of USA. The SEC needs to be an independent, nonpartisan, quasijudicial regulatory agency with responsibility for administering the government securities laws. The purpose of these laws is to protect investors in securities markets that operate fairly and to ensure that investors have access to disclosure of all material information concerning publicly traded securities. The Commission also regulates firms engaged in the purchase or sale of securities, people who provide investment advice, and investment companies.

Biases of Bangladesh SEC

i) Political Bias

Five Commissioners sit on the SEC, with one designated as Chairman by the President of Bangladesh. All Commission members are appointed by the President, with the advice and consent of the parliament, Ministry of Finance. However, it does not follow US in restricting members to no more than three from the same political party.

ii) Inefficiency Bias

The Commission employs lawyers, accountants, financial analysts and examiners, investigators, economists and other professionals. From popular accounts it is revealed that SEC does not have enough expertise to conduct its business. The Commission is headquartered in Dhaka, and does not have regional or district offices in other cities, especially in Chittagong. More importantly, it does not have rigorous principal divisions to carry out its objectives. The Division of Corporation Finance, Division of Market Regulation, Division of Market Regulation, Division of Investment Management, Division of Enforcement, Office of Compliance Inspections and Examinations divisions a la its US counterpart are missing in rigor and /or structure, and are main reasons for turning a manageable problem into a full blown crisis. These divisions are hallmark of any SEC organization. These divisions found its expression in formal structures of U.S. SEC over a period of 40 some years. The case in point is Division of Enforcement which was created under U.S. SEC in August 1972, thirty eight years after the creation of SEC. This was created to consolidate enforcement activities that previously had been handled by various operating divisions. Thus Bangladesh SEC is beset with organizational bottleneck in addition to shortage of well trained personnel. Existence of SEC has raised complacency rather than efficiency and fairness of security dealings in Bangladesh.

Evidence of Mismanagement of Crisis

The SEC instituted a four member Enquiry Committee to look into alleged fraudulent acts and insider trading preceding the crash of 1996. Both Dhaka and Chittagong Stock exchanges experienced a bullish run from July to mid November 1996. During this period market capitalization, turnover and share price index increased by 265%, 1000% and 260% respectively. This bullish run was not justified by movement in fundamentals. Rather it was largely motivated by market manipulation and exploitation of uniformed and misinformed investors. In this respect the SEC has failed to carry out its basic duties. The executive summary of the Enquiry Committee states:

"SEC, instead of taking direct action against the wrongdoers. such as suspension of trading, canceling license of brokers, etc., took measures of corrective nature which failed, that too belatedly did not produce any positive results. SEC should have been more aggressive in taking punitive actions against the manipulators. Strong action could stop the debacles at the earlier stage and at a lesser cost to the investors."

The report goes on to illustrate the cases of flagrant violations of security rules by individuals and institutions. The delivery versus payment (DVP) mechanism was used as one of the main vehicle of manipulation. It is a system of settlement that allows the buyer and sellers of contracts to settle transactions directly without routing through the clearinghouse of the exchanges. The usual practice of settlement had not been followed and exchanges did not stop the violations. The report also cited inordinate delays in clearing applications for new IPOs by the SEC authorities thereby failing to ease bullish pressure.

Accounts from various sources including the medium of press confirm the findings stated above. It is also mentioned in popular as well financial press the SEC continues to suffer from paralysis of actions. The clearance for IPOs continues to be delayed. The disclosure requirement in a quarterly and annual basis for the existing companies are not strictly followed. Further, there is an enthusiasm for over-regulating appears to be prevalent among members of SEC. Until last year SEC used to fix the price of IPOs, a task that should never be under its jurisdiction. In a way the existence of SEC has created a false sense of security and complacency in the world of investment in Bangladesh. The uneasiness in governing SEC is reflected in the fact that SEC has seen three Chairmen in five years.

Given this complacency and inefficiency biases it is not surprising that the market moved away from fundamentals to a grossly overvalued situation warranting a crash.

Conclusion

Unexploited profit opportunities arise when the securities are mispriced. This happens when the prices move away from fundamentals. In this paper we posit that the movement away from fundamentals in Bangladesh Stock Markets essentially took place because of regulatory bias rather than irrational exuberance. Evidence of such bias can be traced to the inner working of the SEC. Because of its lack of knowledgeable personnel and rigorous structure, the SEC could not take appropriate actions in a timely manner to contain this movement. The result was a brutal adjustment precipitated by the market resulting in a crash to pre 1994 level. If short selling were allowed this would have been a great opportunity for profit and which in turn would have allowed a market correction. However, the crash made the ill informed and ordinary investors hanging with virtually valueless paper.

One of the lessons learned from the crash is that the SEC should be streamlined and made more visible and accountable. The process towards that will be to structure its inner mechanisms in accordance with the SEC of the U.S.

CHAOTIC SYSTEMS ANALYSIS OF MAJOR
STOCK MARKET INDICES

This paper considers deterministic chaos as a new test of weak-form market efficiency. Using the embedding theorem and the information dimension, it is demonstrated that the daily return of the stock price indices expressed in US dollars of different countries are either random or high-dimensional deterministic. Although 4,000 observations per market are used in the study, this figure is low relative to what is required in order to be able to further test the model. However, it does support the idea that thousands of data points are not enough in order to find regularity in the data, thus supporting the weak-form efficiency of financial markets in general and stock markets in particular. Since a low-order deterministic chaos is not found in the data, the weak-form market efficiency hypothesis is substantiated. The behavior of these stock indices cannot be predicted based solely on past price behavior.

The data set used in this study consists of daily stock market price indices for Canada, Europe 14, Europe Excluding the UK, the World Excluding USA, France, Germany, Japan, the UK, and USA. Except for the World Excluding USA stock price index, which includes data from January 1, 1982 to October 24, 1995, all of the daily stock price indices cover January 1, 1982 to September 5, 1997. Thus, all of the daily stock price indices consist of about 4,000 data points. For the purposes of this paper, we analyze the relative daily changes in the stock price indices expressed in percentages. These percentages are calculated from returns converted to U.S. Dollars.

The weak-form market efficiency hypothesis states that future securities prices cannot be predicted from current and past price and market information. This hypothesis suggests that investors cannot reliably earn abnormal returns merely by looking at this universally available information. Weak-form market efficiency has long been the subject of empirical scrutiny. The most basic test of the weak-form efficiency hypothesis is auto correlation. This test fits the time series of excess returns to a linear regression model. Auto correlation studies strongly support the weak-form market efficiency theory. Some studies do show, however, some small correlation between successive daily returns. Many of the authors of auto correlation studies have also conducted runs tests. A run is defined as two or more consecutive positive or negative changes. For a given time-series, these tests compare the expected number of runs, which is based on a random distribution, to the actual number. Consistent with a small positive relationship between successive one-day returns, Fama (1965) finds fewer runs than expected. For longer intervals, however, the number of runs is consistent with the number expected for a random series.

It is clear that the preponderance of traditional measures support the weak-form market efficiency hypothesis. It is possible, however, that price changes are governed by a process which appears stochastic given traditional methodologies but is actually deterministic. In the last few decades, researchers in the physical and biological sciences have recognized that certain low-dimension, nonlinear, deterministic systems can exhibit stochastic-like behavior. Such systems are termed chaotic systems.

While demonstration of the absence of determinism in the time-series will support the weak-form market efficiency hypothesis, the presence of determinism does not necessarily contradict the hypothesis since chaotic systems are extremely sensitive to small perturbations and may elude predictions. Recognizing the existence of deterministic chaos in economic data is important from both theoretical and practical points of view. From the theoretical point of view, knowing that a system is chaotic may assist in constructing mathematical models which provide a deeper understanding of its underlying dynamics. From the practical point of view, such a model may facilitate process's control and, in some cases, short-term predictions. The high sensitivity of chaotic systems to small perturbations makes long-term predictions impossible. Nevertheless, in some cases, short-term predictions within estimable error margins are not beyond the realm of possibility.

The investigation of chaos initially assumes that a time-series represents a deterministic dynamic system, with an unknown number of degrees of freedom, that is dense on an attractor. One assumes various embedding dimensions and constructs the phase space portrait. Subsequently, one computes various measures of the attractor such as (fractal) dimensions and Lyapunov exponents as functions of the embedding space's dimension. When the data represents a chaotic system, the attractor's dimension will initially increase as the embedding space dimension increases but eventually reaches an asymptotic value. When the data represents a truly random system, the attractor's dimension will continue to increase with the embedding space dimension.

Motivated by the study of linear systems, a frequent starting point in analyzing time-series is the construction of the power spectrum, which is equivalent to the computation of the auto correlation. The power spectrum may assist in the discovery of periodic or quasi-periodic behavior. In linear systems, modes in the power spectrum correspond to generalized degrees of freedom of the system, and broad-band power spectra are generated by an infinite-dimensional system. This is not true, however, in nonlinear systems; some low-dimension chaotic systems may exhibit broad-band power spectra.

The power spectra of the daily returns of stock price indices are depicted as a function of frequency -- all of the daily returns have a broad-band power spectrum, which implies lack of periodicity in the data. Although this type of power spectrum is consistent with random behavior, it is also common in many chaotic systems. The study has also determined that all the daily returns of stock price indices are nearly Gaussian. Although the Gaussian probability distribution is common in many stochastic processes, it is also exhibited by some chaotic, deterministic systems. The average mutual information is evaluated for the daily series of the returns of the stock price indices. Then the information dimension for the Canadian stock price indices is analyzed, by first computing the log of the average distance between the reference points and their p-th nearest neighbor as a function of the log of the number of selected points, k. Small values of k are then discarded due to their susceptibility to noise. Once these values are removed, the data forms nearly a straight line. The information dimension is the negative inverse of the slope of the line. The information dimension as a function of the embedding space dimension is then computed for various other stock price indices. The results of the study indicate that the daily returns of all the stocks' price indices are either random or a result of a high-dimension, deterministic process.

AN INTERNATIONAL ECONOMIC ANALYSIS OF FOREIGN DIRECT INVESTMENT
AND INTERNATIONAL INDEBTEDNESS

Saziye Gazioglu, University of Aberdeen, England
W. David McCausland, University of Aberdeen, England

This paper develops the micro-foundations of foreign direct investment and integrates this with a macro level analysis. In doing so, it highlights the importance of profit repatriation in generating different effects of foreign direct investment on net international
debt, trade, and competitiveness in developed economies compared to less developed economies.

AN INTERNATIONAL INVESTIGATION OF THE INFLUENCE
OF GROWTH OPPORTUNITIES ON FIRM LIQUIDITY

Working capital management is gaining increasing attention as an important factor in corporate performance. Analysts commonly assess the efficiency of working capital management by comparing liquidity ratios to benchmarks for companies in the same industry and country. There is evidence that working capital requirements differ across industries. For a sample of 1,181 U.S. firms during 1960-79, Hawawini, Viallet, and Vora (1986) find a significant industry effect on investment in working capital, suggesting that working capital policies conform to industry benchmarks. However, with increasing global competition spurred by integration of world markets, benchmarks representing efficiency levels in individual countries may be inappropriate. Relatively efficient companies in countries with generally inefficient working capital management may face a competitive disadvantage against mediocre companies from countries with more developed working capital management practices. It is important to evaluate working capital management across countries.

There is scant empirical evidence on differences in working capital policies and their determinants. Researchers have only recently started addressing some of these issues and have focused on cash management. Opler, Pinkowitz, Stulz, and Williamson (1998) and Kim, Mauer, and Sherman (1998) examine the determinants of cash holdings of U.S. firms from 1971-94. Their results show that firms with stronger growth opportunities and riskier activities tend to hold more cash, while those with greater access to capital markets hold less cash.

This paper studies trends in liquidity measures of companies in five countries spread across four continents, and investigates relations between changes in liquidity and growth opportunities. The countries, selected on the basis of availability of data on sufficiently large numbers of companies throughout the study period, are Australia, Canada, Japan, United Kingdom (U.K.) and U.S.A.

The data indicate that both the levels of liquidity measures and their trends vary across countries. Further, different liquidity measures rank countries differently. We find that real economic growth has a positive impact on changes in the cash ratio, quick ratio, and net working capital ratio, and a negative influence on changes in the current assets turnover. These findings, suggesting that firms adjust liquidity to reflect growth opportunities, caution against static comparisons of liquidity across countries, or even for firms in the same country. Since liquidity may be a strategic weapon, evaluation of working capital management must take into account differential growth opportunities available to firms.

Selected References

1. Baskin, Jonathan, "Corporate Liquidity in Games of Monopoly Power," Review of Economics and Statistics, 1987, 69, 312-319.
2. Hawawini, Gabriel, Claude Viallet and Ashok Vora, "Industry Influence on Corporate Working Capital Decisions," Sloan Management Review, 1986, Summer 15-24.
3. Kim, C., D. Mauer and A. Sherman, "The Determinants of Corporate Liquidity: Theory and Evidence," Journal of Financial and Quantitative Analysis, 1998, Sept. 335-.
4. Opler, Tim, Lee Pinkowitz, Rene Stulz and Rohan Williamson, "The Determinants and Implications of Corporate Cash Holdings," Journal of Financial Economics, 1998, forthcoming.
5. Pinkowitz, Lee and Rohan Williamson, "Bank Power and Cash Holdings: Evidence from Japan," Manuscript, Ohio State University, 1999.

FINANCIAL ANALYSIS OF EXPONENTIALLY INCREASING
INVENTORY HOLDING AND ORDERING COSTS

Sadik Cokelez, California State University, Dominguez Hills

 

This paper analyzes the total of annual inventory holding costs and ordering costs when holding costs and fixed costs of ordering and receiving increase exponentially and concurrently. The traditional model assumes that the holding cost per unit is constant during the entire year as well as the fixed order cost; but in real life such costs vary with inflation almost on a monthly basis. Especially, in those countries with soaring inflation rates such costs may even vary on a weekly basis.

This study develops the new total cost equation for the total of annual inventory holding costs and ordering costs under exponentially increasing holding and ordering costs. Modified notations for the varying holding costs and ordering costs are substituted into the traditional formula after finding the averages of these exponentially varying costs over a year.

The traditional total cost formula is based on the assumption that both H(annual inventory holding cost per unit) and C(fixed cost of ordering and receiving per order) are constant; but in real life it is plausible to assume that such costs increase in an exponential manner where the multiplying component is a^t(for the holding cost) or b^t(for the ordering cost).

In summary this paper contributes to quantitative analysis of inventory management related costs;the traditional total cost equation for the inventory carrying and ordering costs is modified to make it more suitable for real life operating situations by incorporating the possibility of exponential increases in the holding costs as well as in the ordering costs. The simultaneous changes in these two components are analyzed and a new total cost equation is derived.

This new total cost equation has implications on the new modified economic order quantity (EOQ) that is one of the major determinants of inventory management policies; this study can be extended by computing the modified EOQ on the basis of this new total cost equation.

CONGLOMERATE DIVERSIFICATION, FIRM PERFORMANCE
AND CORPORATE GOVERANCE

Akin Sayrak, University of Texas, Austin
John Martin, Baylor University

In this paper, we examine the relationship between corporate governance and diversification by analyzing the difference in buy-and-hold returns of conglomerates and pseudo-conglomerates (portfolios of focused firms matched by two-digit SIC classification). We identify conglomerates using the unrelated diversification component of the Entropy Measure and document a secular decline in the unrelated diversification of all firms over the period 1978-95. On average, conglomerates perform on par with the pseudo conglomerates. However, we find that firms with independent boards and low corporate complexity tend to over-perform their pseudo-conglomerate counterparts, whereas firms with dependent boards and high corporate complexity tend to underperform. Furthermore, the impact of corporate complexity is more pronounced for firms with independent boards. Our analysis indicates that an active market for corporate control has a positive impact on conglomerate performance. This suggests that external corporate control brings discipline and acts to the benefit of the shareholders.

ACCOUNTING DISCLOSURES UNDER ISLAMIC BANKING

One of the main objectives of financial reporting is to produce reports that fulfill users requirement and the figures presented reflect the true picture of the financial position of the organizations. For years, standards issued by the various professional bodies have guided the accountants and auditors in discharging their duties in preparing, presenting and auditing financial statements. In the case of accounting disclosures, the reporting requirements are usually governed by the International Accounting Standards (IAS) issued by the International Accounting Standards Committee (IASC). Although these standards of reporting are on voluntarily basis, many developed and developing countries choose to adopt the standards issued by the said body. By adopting these standards, the financial information prepared and presented are more acceptable and reliable.

As at to-date, IASC has issued standards that adequately cover the normal accounting policies and procedures of business entities worldwide. On the contrary, these standards are mainly meant for business transactions with no religious restrictions. Islam, for example, prohibits its followers from dealing with interest. Therefore, any organization established on Islamic principles must conform to this law and Islamic banks are one of the organizations, which fall in this category. Presently, there are more than 150 Islamic financial institutions operating globally and serve the banking need of the Muslim communities. The operations of these institutions are different with those of conventional banks because they do not associate themselves with interest. All deposits and lending facilities are governed by the Islamic banking principles. However, no attempt has been made by the IASC to promulgate guidelines or standards to deal with this kind of institutions. In the absence of standards for Islamic financial institutions, each bank has its own style of reporting its financial affairs. The Accounting and Auditing Organization have initiated the step toward standardizing Islamic financial reporting for Islamic Financial Institutions (AAOIFI). AAOIFI has just completed its initial works in establishing standards in the area of Islamic accounting principles and practices of disclosure. These standards, however, are yet to be fully adopted by Islamic financial institutions.

Another distinctive feature of Islamic financial institutions is that they usually have a special body call Shariah Supervisory Board (SSB) who will issue a statement that their operations are in accordance with Islamic principles. At present, even the reporting technique and format used by the various SSBs of Islamic banks worldwide differ. Each SSB has its own style of reporting.

This paper will discuss the accounting disclosure practices among the various Islamic banks in the world and the efforts by the AAOIFI to promulgate accounting and auditing standards for these banks. The reporting style and contents of the various SSB reports will also be highlighted.

BANK INTEREST RATES AND ADAPTIVE EXPECTATION OF
"DIVIDEND YIELDS" IN ISLAMIC BANKING:
A TEST OF RATIONAL EXPECTATION

Why study: At the start of 1997, there were 166 Islamic financial institutions that are designed on the basis of profit-sharing contracts in deposit and loan activities while also using the more common method of mark-up and lease arrangements. As is well known, conventional banks accept deposits and make loans based on pre-fixed mandatory interest rates. Pre-fixing of interest rates, despite being an odd method compared with most transactions (example share purchase, venture capital, etc.), has been justified in that this lets banks assume the risk of loans/deposits going bad. But Islam considers such contracts stipulating giving/taking of pre-fixed interest rates as one-sided, and thus unfair.

The question that arises is how do economic agents form expectations about the likely yield an Islamic deposits or loans at a future date since the yields are not pre-specified. Some writers note that, in an economy with conventional and Islamic banks existing side by side as they do in all but three countries, Islamic banks appear to use the conventional bank interest rates to determine the yield, the "dividend rate", offered by the Islamic banks. But this idea as to whether this is in fact the case has not been directly tested. The aim of this paper is to present evidence on this practical question.

Known knowledge: There are several instances of similar behavior in the mainstream economics. Two examples are: expected future sales affect the inventory decisions of firms; the unobserved permanent income may actually determine the consumption behavior of individuals, though individual’s income may vary much more erratically. This kind of situations are modeled as partial adjustment behavior, whereby individuals can be conceived as using revealed information, such as the conventional bank interest rates, to form expectations about the currently unobservable future dividend rates of Islamic banks.

Method of Study: Thus, we use the powerful econometric method of partial lagged adjustment model to test this behavior. The model requires that the data be available on both series. That is, we observe the announced dividend rates over time and the pre-fixed interest rates on deposits, investment funds and loans. If indeed bank management decides on dividend rates at a future date by following the interest rates at current times, then there ought to be a reliable statistical relation between the two variables.

Findings: Findings relate to how banks and credit unions determine the dividend rates. In the cases of Islamic banks, we report a strong relation between conventional interest rates and dividend rates. The conventional bank interest rate variables for savings, and term deposits are strongly influencing current dividend rates of Islamic banks. We also find the past dividend rate established by the bank is also a strong factor in the determination of the current dividend rate, as it should be. The latter suggests that the banks adjusts the past dividend rates by reference to the conventional interest rates. However, the evidence from the credit unions is just opposite meaning that conventional interest rates offered by the credit unions do not affect the dividend rates offered by the credit unions. This is a puzzle on which further research is needed.

DETERMINANTS OF BANK PROFITABILITY:
FINDINGS ON ISLAMIC BANKS

Sudin Haron, The Northern University of Malaysia

Why study: Researchers have managed, over the last three decades, to identify factors that significantly influence bank profitability. But such studies have been all about conventional banks. Today, there are more than 150 Islamic banks operating in 35 Muslim and non-Muslim countries with fund mobilized totaling US$80 billion. Except Pakistan, Iran and Sudan, which have converted the conventional banking entirely to Islamic banking, Islamic banks in other countries operate side by side with conventional banks. Therefore, it is interesting to know whether factors, which have influences on profitability of conventional banks, have similar effects on Islamic banks to add new findings to the body of knowledge in banking literature.

Known knowledge: Factors that influence bank profitability are divided into internal and external. Internal factors are further classified into two broad categories: (1) financial statement variables relating to the decisions which directly involve the items in balance sheets and income statements, and (2) non-financial statement variables such as number of branches, location, size of branches and banks, technology, and efficiency. The external factors verified as impacting on profitability are regulation, competition, concentration, market share, ownership, money supply, interest rate and inflation.

Method of Study: The approach used in this study is similar to those used in conventional bank studies. While almost all-external and internal factors, which have been shown to affect profitability, are examined, some variables such as number of branches, location, concentration and ownership were excluded in this study. New variables such as profit sharing and mark-up ratios with borrowers and profit-sharing ratios with depositors are included in this study because these ratios are only applicable to Islamic banks.

Findings: Since there were conflicting findings from studies of conventional banking, thus, the results of this study also in some cases confirmed the findings of several researchers while contradicting findings of others. This study finds that all three sources of funds for Islamic banks are positively related with profitability. Similarly funds invested in mark-up activities are positively related to profitability compared to activities based on profit-sharing. The profit-sharing ratio between banks and the borrowers seems to be very favorable to the banks, whereas the profit-sharing ratio between the banks and the depositors indicates a mutual advantage. In terms of expense management, this study offers no peculiar findings. While interest rates, inflation and size significantly impact on the profits of conventional banks, similar results were found for Islamic banking. In the case of market share and money supply, these factors were found to have an adverse effect on profits and these results are opposite to the findings of earlier studies. This study also found competition has no effect on bank profitability.

The findings reported in this worldwide study of Islamic financial institutions affirms that the unique factors of this class of banks affect profitability, and that such affects are based on economic rationale. Since this form of banking is only about 25 years old, we find there is need for more competition to improve the variety of services as well as standardize the Shariah ethical standards for audit of Islamic banks across countries.

ISLAMIC BANKING AND STOCK MARKET:
THE CASE OF IRAN

The relationship among businesses as providers of capital is a basic variable that shapes accounting system in each country. In the British-American accounting models, Choi and Mueller (1997) have argued that majority of financing capital is through stock market while in the continental accounting model it is through banks. Today, banks have done majority of financing capital in Iran. The role of Tehran Stock Exchange for mobilization of funds is limited. Islam permits profit sharing while prohibits interest (riba). The central requirement of the Islamic banking system is the replacement of the rate of interest with the rate of return on real activities as a mechanism for allocating resources. Islamic banks are considered as financial institutions and not as a monetary institution or intermediaries. In other words, they act in the capacity of an investor and not as a lender for carrying on trade, investment or service with the objective of generating profits.

In the Iranian banking system, the difference between expected profit and predetermined profit is not clear. When banks provide financial facilities to customers, the expected share of the bank's profit is predetermined based on an economic income. While the difference between profit and riba is the element of uncertainty in the expected profit, the share of profit that banks pay to depositors is lower than the inflation rate. In the case of hyperinflation, which exists in Iran, people do not have an incentive to deposit or investment in the banking system. Consequently, there is a huge amount of money circulating outside the banking system in search of profitable investment opportunities. Of course, this is contrary to the goals of Islamic banking which is supposed to eliminate the distance between money market, commodities and services markets. Harei (1994) has stated that in the Islamic view there is not recognition of purchasing power for lender, while according to Sadr (1984) maintenance f the purchasing power equivalent to the rate of inflation is permitted. According to Mutahhari (1985) modern banking in general and Islamic banking in particular is a new subject. Traditional contracts such as Musharaka (joint- venture or profit sharing) and Mudaraba (trust funding) and other ancient contracts are not sufficient for today sophisticated financial system. According to Behshti (1992) the best way from Islamic view for mobilization of funds is the stock exchange rather than banks. Despite the mobilization of funds, Islamic laws by stock market is more practical than banks the share of stock market for financing of needed capital is very limited in Iran.

REFERENCES

Beheshti, S.M. (1992). Islamic Economic, Fajar Press, Tehran, Iran.
Choi, F. and Mueller GG, 1997. International Accounting, 2nd Ed., Prentice Hall.

SYNDICATED LOANS

The market for syndicated loans is one of the fastest growing sectors of the global money and capital markets. Over $1 trillion dollars of new credit lines were extended to borrowers in 1