Browsing by Author "Agarwal, Vineet"
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Item Open Access Bankruptcy Risk Prediction and Pricing: Unravelling the Negative Distress Risk Premium(Cranfield University, 2012-04) Bauer, Julian; Agarwal, VineetIn sharp contrast to the basic risk-return assumption of theoretical finance, the empirical evidence shows that distressed firms underperform non-distressed firms (e.g. Dichev, 1998; Agarwal and Taffler, 2008b). Existing literature argues that a shareholder advantage effect (Garlappi and Yan, 2011), limits of arbitrage (Shleifer and Vishny, 1997) or gambling retail investor (Kumar, 2009) could drive the underperformance. Herein, I test these potential explanations and explore the drivers of distress risk. In order to do so, I require a clean measure of distress risk. Measures of distress risk have usually been accounting-based, market-based or hybrids using both information sources. I provide the first comprehensive study that employs a variety of performance tests on different prediction models. Cont/d.Item Open Access Comparing the performance of market-based and accounting-based bankruptcy prediction models(Elsevier Science B.V., Amsterdam., 2008-01-01T00:00:00Z) Agarwal, Vineet; Taffler, Richard J.Recently developed corporate bankruptcy prediction models adopt a contingent claims valuation approach. However, despite their theoretical appeal, tests of their performance compared with traditional simple accounting-ratio-based approaches are limited in the literature. We find the two approaches capture different aspects of bankruptcy risk, and while there is little difference in their predictive ability in the UK, the z-score approach leads to significantly greater bank profitability in conditions of differential decision error costs and competitive pricing regime. (C) 2007 Published by Elsevier B.V.Item Open Access The consequences of financial regulation.(2017-10) Aghanya, Daniel Efe; Poshakwale, Sunil S.; Agarwal, VineetGiven the importance of the financial services for capital accumulation, financial stability, and global financial intermediaries, the last decade has witnessed widespread calls for vigilant regulation of the sector, especially since 2007 to 2009 financial crisis. This has reinvigorated the debates on the economic benefits and costs of regulating the financial services. In this work, I examine the impact of financial regulation on the financial sector to better understand its influence on compliance costs, quality of financial reporting, and risk-taking, as well as the wider impact on the stock market liquidity and price informativeness. I also examine the impact of the UK’s decision to leave the European Union (BREXIT) on the UK stock market and industry. In the first paper, I review the empirical evidence on the literature on financial regulation published over the past thirty-five years with the aim: (1) to extend my understanding of its impact on the financial sector, (2) evaluate whether the regulation achieves the purpose it was designed, and (3) provide insights and suggestions for future research. I find several useful insights have been generated over the past two decades. Despite this progress, I find that most empirical studies were done in the United States, research on other regulatory context is under-researched. Further, most empirical research on costs of regulation exclude the financial sector, and we know that this sector is highly regulated. There is a need for more empirical research to provide insight on the regulatory cost burden to the financial sector. In the second paper, I examine how the Statutory Audit and Corporate Reporting Directives (SACORD) affect the compliance costs, risk-taking and quality of financial reporting of the EU banks. Using a natural experiment, I find that post SACORD, compliance costs of the EU banks increase by 11 to 26 percent. Further, there is a significant increase in risk-taking and a decline in the reporting quality. I conclude that as far as the EU banks are concerned, these regulations do not appear to have the desired effects of improving the reporting quality and constraining risk-taking. In the third paper, I investigate the impact of the MiFID on stock price informativeness and liquidity in the European Union (EU). Using data from 28 EU countries and the Difference in Differences approach, I find that post-MiFID the stock prices reflect greater firm-specific information and the market becomes more liquid. Consistent with the ‘Hysteresis Hypothesis’ the evidence shows that the impact of MiFID regarding price informativeness is greater for countries that have superior quality of regulation. The results are robust with respect to the choice of price informativeness and liquidity proxies as well as the control variables. Finally, in the fourth paper, I analyse the impact of UK referendum outcome (Brexit) on stock prices, along three key arguments made by proponents. I document that restricting EU labour movement is associated with a decline in market value by 9.64% to 10.35% over a 10-day event window. Further, sectors with a majority of their business operations outside the EU fared better than sectors that requires a lot of workforce from the EU. I find evidence that highly regulated sectors benefit more from expected deregulation of EU-derived laws except for the financial institutions. Additionally, internationally focused companies’ performed better than domestically focused firms. In sum, my evidence shows that the market expectations about labour restrictions, streamlining regulation and trade policies significantly affect firm values.Item Open Access Does Financial Distress Risk Drive the Momentum Anomaly?(Financial Management Association -- J S Rader, 2008-01-01T00:00:00Z) Agarwal, Vineet; Taffler, Richard J.This paper brings together the evidence on two asset pricing anomalies-continuation of prior returns (momentum) and the market mispricing of distressed firms-using UK data. Our analysis demonstrates both these effects are driven by market underreaction to financial distress risk. In particular, we find momentum is proxying for distress risk, and is largely subsumed by our distress risk factor. We also find, as with US studies, no evidence that size and book-to-market (B/M) effects in stock returns are linked to financial distress.Item Open Access Does the distress factor hypothesis explain the size and value effects in equity returns?(2002-08) Agarwal, Vineet; Taffler, RichardThe distress factor hypothesis says that value stocks and small stocks are distressed and therefore higher returns on such stocks are merely a compensation for higher risk. I test this hypothesis using z-scores, a cleaner proxy for bankruptcy risk than other proxies used in the literature such as dividend reductions or omissions. I find that unconditionally, distressed stocks earn significantly lower returns than non-distressed stocks and much underperformance is uninfluenced by size and B/M factors. I also find that z-score, size and B/M effects are stronger in different months suggesting little common variation between the three factors. The results show that size and B/M effects are unrelated to bankruptcy risk on an unconditional basis. Of crucial importance is a consideration of the time varying behaviour of bankruptcy risk premia and I consider explicitly the impact of changes in GDP growth rate and the impact of stock market movements on the pricing of distressed firms. I find that risk of bankruptcy is a systematic risk with distressed stocks registering strong underperformance during ‘bad’ states of the world. As with unconditional analysis, the results show there is no link between distress factor and size and B/M effects. Size and B/M effects are stronger in non-distressed stocks. To ensure that the empirical results are robust across different methodologies, I significantly expand on the work of Dichev (1998) by employing two different portfolio formation methods and individual securities in my analysis. My main results on z-scores are robust though size and B/M effects are sensitive to alternative trading rules. I also test the Fama & French (1993) three-factor model for the UK and find that it is unable to explain returns on negative z-score portfolios. A four-factor model that includes a factor mimicking the z-score effect is better specified. The primary contribution of this study is the direct evidence it provides on the distress factor hypothesis of higher returns on value stocks and small stocks and the four-factor model for stock returns. This research has important implications both for extant asset pricing theories and for practitioners especially in evaluation of portfolio performance and computation of abnormal returns.Item Open Access The impact of regulations on compliance costs, risk-taking, and the reporting quality of the EU banks(Elsevier, 2019-12-14) Poshakwale, Sunil S.; Aghanya, Daniel; Agarwal, VineetThe paper examines how the Statutory Audit and Corporate Reporting Directives (SACORD) affect the compliance costs, risk taking and quality of financial reporting of the EU banks. Using a natural experiment, we find that post SACORD, both compliance costs and risk taking increase significantly. However, the implementation of additional regulations seems to be effective in terms of improved quality of financial reporting. When we analyse the impact by size, we find that smaller banks face disproportionately higher increase in compliance costs while larger banks seem to engage in greater risk taking.Item Open Access The impact of statutory audit and corporate reporting directives on compliance costs, risk-taking and reporting quality of the EU banks(European Financial Management Association, 2017-05-01) Aghanya, Daniel; Poshakwale, Sunil S.; Agarwal, VineetThe paper examines the effects of recently introduced Statutory Audit and Corporate Reporting Directives (SACORD) on compliance costs and risk taking of the EU banks. Using data of 80 EU banks and 71 non-EU banks for the period 2004 to 2013, we estimate the effects of SACORD regulation compliance costs, risk taking and quality of reporting. Our results show that the economic effects of SACORD on audit fees are approximately 19 to 33 percent higher relative to the non-EU banks. We also find robust evidence of significant increase in in total compliance costs. The findings are consistent with those reported in the previous literature mainly for the US banks that regulation increases compliance costs. Further, we find that post SACORD, there is a significant increase in risk-taking and a decline in reporting quality. Findings suggest that the SACORD regulation does not appear to have the desired effects of constraining risk-taking by banks.Item Open Access Implied volatility and the cross section of stock returns in the UK(Elsevier, 2019-01-14) Poshakwale, Sunil S.; Chandorkar, Pankaj Avinash; Agarwal, VineetThe paper examines the relationship and the cross-sectional asset pricing implications of risk arising from the innovations in the short and the long-term implied market volatility on excess returns of the FTSE100 and the FTSE250 indices and the 25 value-weighted Fama-French style portfolios in the UK. Findings suggest that after controlling for valuation, macroeconomic, leading economic and business cycle indicators, returns exhibit a strong negative relationship with the innovations in both the short and the long-term implied market volatility. The cross-sectional regression provides new evidence that changes in both short and long-term implied market volatility are significant asset pricing factors with negative prices of risk, which suggests that (i) investors care about ex-ante volatility and (ii) they are willing to pay for insurance for future uncertainty.Item Open Access Investor emotions and the psychodynamics of asset pricing bubbles: a Chinese perspective(Taylor and Francis, 2022-11-12) Taffler, Richard; Bellotti, Xijuan; Agarwal, Vineet; Li, LingluThis paper explores the powerful emotions unleashed during asset pricing bubbles. Adopting a psychoanalytic perspective, we develop a five-stage path-dependent model of such financial crises and test this empirically on the Chinese 2005–2008 and 2014–2016 stock market bubbles. Results are consistent with our underlying theory and demonstrate how investors experience a range of highly charged emotions directly related with different market states during such episodes. Our evidence suggests that if we wish properly to understand and explain such destructive events, we also need to recognize the fundamental role investor unconscious fantasies and market psychodynamic processes play in their etiology.Item Open Access Market in Financial Instruments Directive (MiFID), stock price informativeness and liquidity(Elsevier, 2019-12-23) Aghanya, Daniel; Agarwal, Vineet; Poshakwale, Sunil S.The paper examines the impact of MiFID on stock price informativeness and liquidity in 28 EU countries. We find that post-MiFID the stock prices reflect greater firm specific information and the market becomes more liquid. Consistent with the ‘Catch-up Hypothesis’ our evidence shows that the impact of MiFID in terms of price informativeness is greater for countries that have weaker quality of regulation. We find that regulation with enforcement improves market efficiency. Our results are robust with respect to the choice of price informativeness and liquidity proxies as well as the control sample.Item Open Access Modelling Credit Risk for SMEs in Saudi Arabia(2017-07) Albaz, Naif; Zhao, Huainan; Agarwal, VineetThe Saudi Government’s 2030 Vision directs local banks to increase and improve credit for the Small and Medium Enterprises (SMEs) of the economy (Jadwa, 2017). Banks are, however, still finding it difficult to provide credit for small businesses that meet Basel’s capital requirements. Most of the current credit-risk models only apply to large corporations with little constructed for SMEs applications (Altman and Sabato, 2007). This study fills this gap by focusing on the Saudi SMEs perspective. My empirical work constructs a bankruptcy prediction model based on logistic regressions that cover 14,727 firm-year observations for an 11-year period between 2001 and 2011. I use the first eight years data (2001-2008) to build the model and use it to predict the last three years (2009-2011) of the sample, i.e. conducting an out-of-sample test. This approach yields a highly accurate model with great prediction power, though the results are partially influenced by the external economic and geopolitical volatilities that took place during the period of 2009-2010 (the world financial crisis). To avoid making predictions in such a volatile period, I rebuild the model based on 2003-2010 data, and use it to predict the default events for 2011. The new model is highly consistent and accurate. My model suggests that, from an academic perspective, some key quantitative variables, such as gross profit margin, days inventory, revenues, days payable and age of the entity, have a significant power in predicting the default probability of an entity. I further price the risks of the SMEs by using a credit-risk pricing model similar to Bauer and Agarwal (2014), which enables us to determine the risk-return tradeoffs on Saudi’s SMEs.Item Open Access Modelling credit risk for SMES in Saudi Arabia.(2017-07) Al Baz, Naif A.; Zhao, Huainan; Agarwal, VineetThe Saudi Government’s 2030 Vision directs local banks to increase and improve credit for the Small and Medium Enterprises (SMEs) of the economy (Jadwa, 2017). Banks are, however, still finding it difficult to provide credit for small businesses that meet Basel’s capital requirements. Most of the current credit-risk models only apply to large corporations with little constructed for SMEs applications (Altman and Sabato, 2007). This study fills this gap by focusing on the Saudi SMEs perspective. My empirical work constructs a bankruptcy prediction model based on logistic regressions that cover 14,727 firm-year observations for an 11-year period between 2001 and 2011. I use the first eight years data (2001-2008) to build the model and use it to predict the last three years (2009-2011) of the sample, i.e. conducting an out-of-sample test. This approach yields a highly accurate model with great prediction power, though the results are partially influenced by the external economic and geopolitical volatilities that took place during the period of 2009-2010 (the world financial crisis). To avoid making predictions in such a volatile period, I rebuild the model based on 2003-2010 data, and use it to predict the default events for 2011. The new model is highly consistent and accurate. My model suggests that, from an academic perspective, some key quantitative variables, such as gross profit margin, days inventory, revenues, days payable and age of the entity, have a significant power in predicting the default probability of an entity. I further price the risks of the SMEs by using a credit-risk pricing model similar to Bauer and Agarwal (2014), which enables us to determine the risk-return tradeoffs on Saudi’s SMEs.Item Open Access Size and book-to-market anomalies and omitted leverage risk(Taylor & Francis, 2010-04-01T00:00:00Z) Agarwal, Vineet; Poshakwale, Sunil S.Ferguson and Shockley (2003. Equilibrium 'anomalies'.Journal of Finance 58: 2549-2580) develop a theoretical model and argue that size and book-to-market (B/M) effects in stock returns derive their cross-sectional explanatory power because they proxy for leverage and financial distress. Using UK data from 1979 to 2006, we provide evidence that the size factor of Fama and French (1993. Common risk factors in the returns on stocks and bonds.Journal of Financial Economics 33: 3-56) is indeed proxying for distress risk, while their distress factor is capturing leverage risk. However, anomalously low returns and higher exposure of small size and value stocks to the distress factor reduces the expected returns on these stocks and results in larger pricing errors. This leads to poor performance of the Ferguson and Shockley (2003. Equilibrium 'anomalies'.Journal of Finance 58: 2549-2580) model in the time series. Underperformance of distressed stocks casts doubt on the hypothesis that the explanatory power of size and B/M factors is due to the omitted debt claims in equity only proxy for market portfolio.