Working paper series / Johann-Wolfgang-Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften : Finance & Accounting
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92
The classical approaches to asset allocation give very different conclusions about how much foreign stocks a US investor should hold. US investors should either allocate a large portion of about 40% to foreign stocks (which is the result of mean/variance optimization and the international CAPM) or they should hold no foreign stocks at all (which is the conclusion of the domestic CAPM and mean/variance spanning tests). There is no way in between.
The idea of the Bayesian approach discussed in this article is to shrink the mean/variance efficient portfolio towards the market portfolio. The shrinkage effect is determined by the investor's prior belief in the efficiency of the market portfolio and by the degree of violation of the CAPM in the sample. Interestingly, this Bayesian approach leads to the same implications for asset allocation as the mean-variance/tracking error criterion. In both cases, the optimal portfolio is a combination of the market portfolio and the mean/variance efficient portfolio with the highest Sharpe ratio.
Applying both approaches to the subject of international diversification, we find that a substantial home bias is only justified when a US investor has a strong belief in the global mean/variance efficiency of the US market portfolio and when he has a high regret aversion of falling behind the US market portfolio. We also find that the current level of home bias can be justified whenever-regret aversion is significantly higher than risk aversion.
Finally, we compare the Bayesian approach of shrinking the mean/variance efficient portfolio towards the market portfolio to another Bayesian approach which shrinks the mean/variance efficient portfolio towards the minimum-variance portfolio. An empirical out-of-sample study shows that both Bayesian approaches lead to a clearly superior performance compared to the classical mean/variance efficient portfolio.
102
Open source projects produce goods or standards that do not allow for the appropriation of private returns by those who contribute to their production. In this paper we analyze why programmers will nevertheless invest their time and effort to code open source software. We argue that the particular way in which open source projects are managed and especially how contributions are attributed to individual agents, allows the best programmers to create a signal that more mediocre programmers cannot achieve. Through setting themselves apart they can turn this signal into monetary rewards that correspond to their superior capabilities. With this incentive they will forgo the immediate rewards they could earn in software companies producing proprietary software by restricting the access to the source code of their product. Whenever institutional arrangements are in place that enable the acquisition of such a signal and the subsequent substitution into monetary rewards, the contribution to open source projects and the resulting public good is a feasible outcome that can be explained by standard economic theory.
103
The theoretical derivation of credit market segmentation as the result of a free market process
(2003)
Information asymmetries make it difficult for banks to assess accurately whether specific entrepreneurs are able and/or willing to repay their loans. This leads to implicit interest rate ceilings, i.e. banks "refuse" to increase their interest rates beyond this ceiling as this would lower their net returns. Although the maximum interest rate increases as the size of enterprises decreases, such ceilings nonetheless constrain the banks’ ability to set interest rates at a level that would enable them to cover costs. If transaction costs are high, the total costs associated with granting small and medium-sized loans will exceed the maximum average return which the banks can earn by issuing such loans. For this reason, banks do not lend to small and medium-sized enterprises, and, as a consequence, these businesses have no access to formal sector loans. Because micro and small enterprises have a very high RoI, it is worthwhile for them to rely on expensive informal loans to finance their operations, at least until they reach a certain size. Once they have reached this size, however, it does not make economic sense for them to continue taking out informal credits, and thus they face a growth constraint imposed by the credit market. Medium-sized enterprises earn a lower RoI than small ones, which is why borrowing in the informal credit market is not a worthwhile option for them. Moreover, they do not have access to credit from formal financial institutions, and are thus excluded from obtaining any kind of financing in either of the two credit markets. As the result of free, unregulated market forces we get a stable equilibrium in which the credit market is segmented into an informal (small loan) segment, a formal (large loan) segment and, in between, a "non-market" (medium loan) segment.
105
This paper analyses the long-term effects of improved small-scale lending, often provided by microfinance institutions set up with the support of development aid. The analysis shows that some common assumptions about microfinance are not true at all: First, it shows that the impact on income will accrue not to the microenterprises themselves, but rather to the consumers of their products. Second, microfinance will have a significant positive effect on the wage levels of employees in the informal sector. Third, microfinance will cause high growth rates in the informal production sector, whereas the trade sector will either contract or at best grow very little.
106
This paper is a draft for the chapter German banks and banking structure of the forthcoming book The German financial system . As such, the paper starts out with a description of past and present structural features of the German banking industry. Given the presented empirical evidence it then argues that great care has to be taken when generalising structural trends from one financial system to another. Whilst conventio nal commercial banking is clearly in decline in the US, it is far from clear whether the dominance of banks in the German financial system has been significantly eroded over the last decades. We interpret the immense stability in intermediation ratios and financing patterns of firms between 1970 and 2000 as strong evidence for our view that the way in which and the extent to which German banks fulfil the central functions for the financial system are still consistent with the overall logic of the German financial system. In spite of the current dire business environment for financial intermediaries we do not expect the German financial system and its banking industry as an integral part of this system to converge to the institutional arrangements typical for a market-oriented financial system. This Version: March 25, 2003
107
Intangible assets as goodwill, licenses, research and development or customer relations become in high technology and service orientated economies more and more important. But comparing the book values of listed companies and their market capitalization the financial reports seems to fail the information needs of market participants regarding the estimate of the proper firm value. Moreover, with the introduction of Anglo-American accounting systems in Europe and Asia we can observe even in the accounts of companies sited in the same jurisdiction diverging accounting practices for intangible assets caused by different accounting standards. To assess the relevance of intangible assets in Japanese and German accounts of listed companies we therefore measure certain balance sheet and profit and loss relations according to goodwill and self-developed software. We compare and analyze valuation rules for goodwill and software costs according to German GAAP, Japanese GAAP, US GAAP and IAS to determine the possible impact of diverging rules in the comparability of the accounts. Our results show that the comparability of the accounts is impaired because of different accounting practices. The recognition and valuation of goodwill and self-developed software varies significantly according to the accounting regime applied. However, for the recognition of self-developed software, the effect on the average impact on asset coefficients or profit is not that high. Moreover, an industry bias can only be found for the financial industry. In contrast, for goodwill accounting we found major differences especially between German and Japanese Blue Chips. The introduction of the new goodwill impairment only approach and the prohibition of the pooling method may have a major impact especially for Japanese companies’ accounts.
108
Past research suggests that international real estate markets show return characteristics and interrelationships with other asset classes, which probably qualify them as an interesting component of national and international asset allocation decisions. However, the special characteristics of real estate assets are quite distinct from that of financial assets, such as stocks and bonds. This is also the case for real estate return distributions. Therefore, the proper integration of real estate markets into asset allocation decisions requires profound understanding of real estate returns' distributional characteristics .
Because of the particular characteristics of real estate, representing real estate markets through reliable a time-series is a complex task. Consequently, reliable real estate indices with a sufficiently long history in major international real estate markets are only scarcely available. Most of the research that has been done on real estate returns was done for the U.K. and U.S., where eligible indices exist. On the other hand, in other important real estate markets, such as Germany, either little or no research has been perfoimed.
In this analysis, the methodology of Maurer, Sebastian and Stephan (2000) for indirectly deriving an appraisal-based index for the German commercial real estate market will be applied. This approach is solely based on publicly available data from German open-ended real estate investment trusts. It could also provide a solution to deriving a reliable real estate time-series for other markets.
We will extend previous analyses for the U.K. and U.S. to provide additional fundamental insights into the return characteristics of the German commercial real estate market. Despite univariate considerations, the main focus is the interrelationships between various international real estate markets, as well as between those respective markets and the international stock and bond markets.
109
As past research suggest, currency exposure risk is a main source of overall risk of international diversified portfolios. Thus, controlling the currency risk is an important instrument for controlling and improving investment performance of international investments. This study examines the effectiveness of controlling the currency risk for international diversified mixed asset portfolios via different hedge tools. Several hedging strategies, using currency forwards and currency options, were evaluated and compared with each other. Therefore, the stock and bond markets of the, United Kingdom, Germany, Japan, Switzerland, and the U.S, in the time period of January 1985 till December 2002, are considered. This is done form the point of view of a German investor. Due to highly skewed return distributions of options, the application of the traditional mean-variance framework for portfolio optimization is doubtful when options are considered. To account for this problem, a mean-LPM model is employed. Currency trends are also taken into account to check for the general dependence of time trends of currency movements and the relative potential gains of risk controlling strategies.
110
An economy in which deposit-taking banks of a Diamond/ Dybvig style and an asset market coexist is modelled. Firstly, within this framework we characterize distinct financial systems depending on the fraction of households with direct investment opportunities that are less efficient than those available to banks. With this fraction comparatively low, the evolving financial system can be interpreted as market-oriented. In this system, banks only provide efficient investment opportunities to households with inferior investment alternatives. Banks are not active in the secondary financial market nor do they provide any liquidity insurance to their depositors. Households participate to a large extent in the primary as well as in the secondary financial markets. In the other case of a relatively high fraction of households with inefficient direct investment opportunities, a bank-dominated financial system arises, in which banks provide liquidity transformation, are active in secondary financial markets and are the only player in primary markets, while households only participate in secondary financial markets. Secondly, we analyze the effect a run on a single bank has on the entire financial system. Interestingly, we can show that a bank run on a single bank causes contagion via the financial market neither in market-oriented nor in extremely bank-dominated financial systems. But in only moderately bank-dominated (or hybrid) financial systems fire sales of long-term financial claims by a distressed bank cause a sudden drop in asset prices that precipitates other banks into crisis.
111
What constitutes a financial system in general and the German financial system in particular?
(2003)
This paper is one of the two introductory chapters of the book "The German Financial System". It first discusses two issues that have a general bearing on the entire book, and then provides a broad overview of the German financial system. The first general issue is that of clarifying what we mean by the key term "financial system" and, based on this definition, of showing why the financial system of a country is important and what it might be important for. Obviously, a definition of its subject matter and an explanation of its importance are required at the outset of any book. As we will explain in Section II, we use the term "financial system" in a broad sense which sets it clearly apart from the narrower concept of the "financial sector". The second general issue is that of how financial systems are described and analysed. Obviously, the definition of the object of analysis and the method by which the object is to be analysed are closely related to one another. The remainder of the paper provides a general overview of the German financial system. In addition, it is intended to provide a first indication of how the elements of the German financial system are related to each other, and thus to support our claim from Section II that there is indeed some merit in emphasising the systemic features of financial systems in general and of the German financial system in particular. The chapter concludes by briefly comparing the general characteristics of the German financial system with those of the financial systems of other advanced industrial countries, and taking a brief look at recent developments which might undermine the "systemic" character of the German financial system.