CAPM and Capital Budgeting:Present/Future, Equilibrium/Disequilibrium, Decision/Valuation

-- Carlo Alberto Magni

This paper expands on the results obtained in Magni (2009) regarding investment decisions with the Capital Asset Pricing Model (CAPM). It is shown that four different decision criteria are deductively drawn from this model: the disequilibrium Net Present Value (NPV), the equilibrium NPV, the disequilibrium Net Future Value (NFV), and the equilibrium NFV. It is shown that all of them may be used for accept-reject decisions, but only the equilibrium NPV and the disequilibrium NFV may be used for valuation, given that they have the additivity property. However, it is possible to deductively dismiss the two nonadditive indexes if the `accept/reject' problem is reframed as a choice among mutually exclusive alternatives. As for the remaining (additive) measures, the equilibrium NPV and the disequilibrium NFV are unreliable for both valuation and decision, because despite their additivity, they do not signal arbitrage opportunities whenever there is some state of nature for which they are decreasing functions with respect to the end-of-period cash flow. In this case, the equilibrium value of a project is not the price it would have if it was traded in the security market. This result is the capital-budgeting counterpart of Dybvig and Ingersoll's (1982) result.

© 2010 IUP. All Rights Reserved.

Choosing Not to Borrow: An Evaluation of Perception and Sociocultural Factors Underlying Voluntary Self-Exclusion

-- Eric Osei-Assibey

The purpose of this study is to investigate the underlying sociocultural factors that drive the majority of microentrepreneurs to voluntarily exclude themselves from seeking external finance, despite complaints of severe financial constraints. Using structured questionnaire, data on some 176 microenterprises in Ashanti region of Ghana were collected. A simple conceptual framework was utilized to classify various forms of financially constrained and unconstrained microenterprises. A logistic regression technique was then applied to a utility function model of credit demand. The findings suggest that voluntary self-exclusion is not only driven by microenterprise or owner's socioeconomic status, but also most significantly by their perceived difficulties in accessing external finance and negative cultural-religious biases toward credit use or borrowing as well as financial illiteracy. The study further finds that most microentrepreneurs are interest inelastic or insensitive suggesting that they are more interested in easier and faster access to finance rather than the cost of borrowing. The evidence implies that policies directed at building all-inclusive financial system by focusing on supply side alone are unlikely to be successful. Complementary target policies that tackle the fundamental issues of negative perceptions and mistrusts on the financial institutions by creating awareness through extensive financial literacy programs and social mobilization would be a holistic approach in solving the problem. Besides, innovations in religion-compliant financial institutions should be promoted to meet the financing needs of those who exclude themselves because of religious beliefs.

© 2010 IUP. All Rights Reserved.

Reasons Motivating Firms to Hedge: A Review of the Empirical Literature

-- Indranarain Ramlall

This paper undertakes a review of the reasons as to why firms hedge. Basically, the empirical literature pertaining to hedging is split into three main parts. The first part of the literature underscores the strong incentives for shareholders to hedge by virtue of three main forces which comprise the convex tax structure, expected financial distress costs along with underinvestments under imperfect capital markets. The second part shows that, the managers of firms are induced to hedge not only under managerial risk aversion motive but also to send strong signals of their skills to the market. Finally, the hedging literature considers the alternative modes of hedging which may be derivative-based or non-derivative-based. The paper also points out the need of being cautious when dealing with the empirical evidences based on hedging since results are not always foolproof for diverse reasons.

© 2010 IUP. All Rights Reserved.

The Impact of Risk on Banks' Technical and Scale Efficiency: Empirical Evidence from the Chinese Banking Sector

-- Fadzlan Sufian

By employing the Data Envelopment Analysis (DEA) method, this paper attempts to examine the impact of risks on Chinese banks' technical and scale efficiency estimates. To do so, it follows the procedures set by Drake and Hall (2003) to include risk factor as a non-discretionary input variable. The empirical findings suggest that scale inefficiency has greater influence than pure technical inefficiency in determining the Chinese banking sector's total technical efficiency. The results suggest that potential economies of scale are overestimated in the range of 22% to 30% when the risk factor is excluded. Moreover, the inclusion of risk factor benefits the city commercial banks the most, and the joint-stock commercial banks the least.

© 2010 IUP. All Rights Reserved.

Macroeconomic Environment and Financial Sector's Performance: Econometric Evidence from Three Traditional Approaches

-- Muhammad Shahbaz, S M Aamir Shamim and Naveed Aamir

Stable macroeconomic condition is the prerequisite for sound and healthy performance of the financial sector in the country. The study explores the impact of macroeconomic environment on financial sector's performance in Pakistan. In doing so, it employs the Fully Modified Ordinary Least Square (FMOLS) approach for cointegration (long-run association) and error correction method for short-run relation. Also Ng-Perron test is used to find out the integrating order of the running variables. The present paper reveals that previous policies of financial institutions and economic growth have improved the level of financial development. Increases in both government spending as well as foreign remittances push the performance of the financial sector upwards. Contrarily, the efficiency of financial markets deteriorates on account of rising inflation due to its damaging impact, while literacy rate has a negative influence on the banking sector in Pakistan. Trade openness along with improved capital inflows open new directions to improve the development of financial markets in the country. Further, performance of the financial sector is attached to qualified institutions. The high savings rate declines the efficiency of banking sector and political instability retards the performance of financial markets.

© 2010 IUP. All Rights Reserved.