The project was implemented within the framework of the HSE's Basic Research Programme.
The project consists of two basic lines of research. The two projects in this area focus on financial markets, in particular their microstructure and the pricing of financial derivatives. The research analyses the role of information in the process of generating liquidity on financial markets and the role of firm-specific risk in the overall option-implied variation of stock returns.
The second area relates to problems of corporate governance. In particular, the two projects of this area study the role of countries’ political proximity in cross-border M&A transactions and the efficiency and financial performance of nationalized companies in Russia.
1. Research Object: In the first project, securities trading is modeled when informed agents are present on both sides of the market—as liquidity demanders and liquidity suppliers. The model has different settings and accounts for cases of hidden and displayed liquidity. The objects of the second project are prices of options on common stocks. The third project explores the role of political affinity for the initial bid premium offered by an acquirer in cross-border deals. The fourth project studies government takeovers in Russia during the period 2004-2008.
2. Research Purpose: In the first project, a theoretical model is used to examine the impact of hidden liquidity on market quality. The specific questions asked are whether hidden liquidity enhances the quality of the market in terms of execution costs to uninformed traders and the informational efficiency of prices. The second project contributes to the literature analyzing the role of firm-specific risk in the overall option-implied variation of stock returns. The third project sheds light on the importance of political affinity on the cross-border acquisition process and particularly the initial acquisition premium. The fourth project studies the effects of nationalization on company performance using a sample of Russian firms.
3. Empirical Base of the Research: Projects 2, 3, and 4 use empirical methods. The second project uses a sample of options on 30 US low dividend paying stocks in 1999-2008. The third project empirically tests the relationship between political affinity and the acquisition premium on a sample of 925 cross-border acquisitions from 1990-2008. This sample is by construction limited to listed target firms and, therefore, includes large target and acquiring firms. We measure political affinity ‘based on the similarity of nations' roll-call voting in the United Nations General Assembly’. The fourth project uses a hand-collected database of 107 nationalization transactions. Nationalization is defined as the transfer of control over a company from private owners to the state. In particular, we use 25% and 50% state ownership as two alternative thresholds that define a nationalization transaction if they are exceeded as a result of an acquisition. Financial data on the target firms before and after the nationalization is obtained in order to construct our performance indicators and to estimate which are the determinants of the likelihood to be nationalized.
4. Research results: The principal finding of the first project is that hiding the liquidity supplied by informed traders has a favorable impact on market quality. The greater intensity of competition resulting from the migration of informed agents toward liquidity provision dominates the profit enhancement associated with the concealment of their orders. When liquidity is displayed, less informed agents are drawn into liquidity provision and instead they trade as liquidity demanders; competition is less intense and market quality is lower. The quality of the market with hidden liquidity is better because more informed agents are drawn into liquidity provision and they trade more aggressively as liquidity providers than they would as liquidity demanders—ie the choices of strategy type and the intensity of trading interact to determine market quality.
In the second project, a new model of option pricing is introduced, which explicitly accounts for scheduled jumps caused by quarterly earnings announcements in the underlying stock. While the diffusion process volatility reflects the systematic risk component, the jump magnitude reveals the firm-specific uncertainty. Empirical tests using a vast number of options with different strikes and maturities on several US stocks during 1999-2008 provide some evidence of superiority of the model over Black-Scholes in terms of fitting option prices. Applying the model to a sample of options on 30 low dividend paying stocks, it is shown that firm-specific risk is perceived to be higher for technology firms, smaller firms, and firms in financial distress. For the fraction of firm-specific uncertainty in the overall uncertainty, however, size loses significance whereas the liquidity of the option markets becomes a moderating factor. Moreover, some weak evidence is found that relative importance of firm-specific risk diminishes in crises, as it becomes dominated by systematic risk component.
The third project finds strong and robust evidence that the initial premium in cross-border deals is negatively related to political affinity. Moreover, the size of the acquiring and target firms moderates this effect. A larger size affects both the ability of firms to successfully gain clout among governments and their importance on the political agenda of governments. Also, the effect of political affinity is found to be reduced when the level of domestic political constraints that governments face in implementing their foreign policy objectives is higher.
The results of the fourth project show no significant effects of nationalization on size, revenue, operating efficiency, and return on assets. There is some evidence that financial leverage goes up in the two years following nationalization as compared to the year before. If government ownership provides an implicit state guarantee, this increase in the leverage ratio seems to be a rational reaction of the management of target companies. The absence of effects on financial performance might be explained by the fact that state ownership might have opposing effects on performance. On the one hand, it might be less efficient deficiencies in corporate governance, inefficient hiring decisions, etc. On the other hand, SOEs may benefit from better access to credit, in particular from state-owned banks, implicit state guarantees, and direct subsidies.
5. Implementation of Research Results: All projects have great practical relevance for the pricing of financial instruments, the regulation of financial markets, policies in the area of M&A, and nationalization vs. privatization.
6. International partners:
Christian Julliard, London School of Economics, Academic Director of the International Laboratory of Financial Economics at ICEF
Olivier Bertrand, SKEMA Business School, France
Thomas George, Bauer School of Business, University of Houston
Dimitrios Tsomocos, Said Business School, University of Oxford
Branko Urosevic, National Bank of Serbia and University of Belgrade