Encyclopedia of finance - springer (2013) - cheng few lee, alice c.lee

Encyclopedia of Finance

The Editors

Cheng-Few Lee, Rutgers University, USA

Alice C. Lee, Boston, MA, USA*

ADVISORY BOARD

James R. Barth, Auburn University and Milken Institute, USA

Ivan Brick, Rutgers University, USA

Chun-Yen Chang, National Chiao Tung University, Taiwan, Republic of China

Wayne Ferson, Boston College, USA

Joseph E. Finnerty, University of Illinois, USA

Martin J. Gruber, New York University, USA

Hyley Huang, Wintek Corporation, Taiwan, Republic of China

George Kaufman, Layola University, USA

John Kose, New York University, USA

Robert A. Schwartz, City University of New York, USA

*Disclaimer: Any views or opinions presented in this publication are solely those of the authors and do not necessarily represent those of State

Street Corporation. State Street Corporation is not associated in any way with this publication and accepts no liability for the contents of this

publication.

Cheng-Few Lee • Alice C. Lee

Editors

Encyclopedia of Finance

Second Edition

Editors

Cheng-Few Lee

Department of Finance

Rutgers University,

New Brunswick, NJ, USA

ISBN 978-1-4614-5359-8 ISBN 978-1-4614-5360-4 (eBook)

DOI 10.1007/978-1-4614-5360-4

Springer New York Heidelberg Dordrecht London

Library of Congress Control Number: 2012952929

# Springer Science+Business Media New York 2013

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imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and

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Printed on acid-free paper

Springer is part of Springer Science+Business Media (www.springer.com)

Alice C. Lee

State Street,

Boston, MA, USA

Preface to the Second Edition

Since the first edition was published in 2006, this encyclopedia has been very popular in both

academic and practitioner professions. It has been the most downloaded book in the area of

finance and economics, which was published by Springer.

In this new edition, we have revised Part I, Part II and Appendices extensively. In Part I, we

added more than 200 terminologies and essays. In Part II, we added 24 new chapters. Finally,

we added four new appendices. The new chapters and appendices can be found in the table

content.

Seventy-four papers included in Part II can be classified into eight groups as follows:

(a) Investment analysis and portfolio management (chapters 4, 8, 11, 13, 20, 22, 30, 32, 35,

41, 46, 49, 55, 62, and 66)

(b) Financial management and corporate finance (chapters 12, 19, 23, 27, 28, 29, 33, 40, 43,

52, 57, 64, 68, 69, 70, 71, 72, and 73)

(c) International finance (chapters 5, 7, 16, 31, 34, 42, 43, 48, 51, 53, and 67)

(d) Microstructure (chapters 17, 18, 21, 31, 36, 37, 38, 39, and 45)

(e) Asset pricing (chapters 9, 10, 11, 13, 35, 58, and 63)

(f ) Financial institutions and markets (chapters 2, 3, 14, 25, 47, and 54)

(g) Derivatives (chapters 6, 29, 44, and 65)

(h) Real estate finance (chapters 15, 26, 59, and 50)

(i ) Risk management (chapters 5, 6, 7, 23, 24, 25, 40, 56, 60, 61, 74, and 75)

For both undergraduate and graduate students, this encyclopedia is a good supplementary

material for the above-listed finance courses. In addition, this encyclopedia can be a good

supplementary material for financial accounting courses. We believe that this encyclopedia

will not only be useful to students but also for professors and practitioners in the field of

finance as a reference.

We would like to thank the contributors for willingness to share their expertise and their

thoughtful essays in Part II. We would like to thank Mr. Brian J. Foster of Springer for his

coordination and suggestions to this book. Finally, we would also like to express our gratitude

to our secretary and assistant, Ms. Miranda Mei-Lan Luo and Tzu Tai, for their efforts in

helping us pull together this tremendous repository of information.

We hope that the readers will find the encyclopedia to be an invaluable resource.

NJ, USA Cheng-Few Lee

MA, USA Alice C. Lee

v

Preface to the First Edition

Finance has become one of the most important and popular subjects in management school

today. This subject has progressed tremendously in the last 40 years, integrating models and

ideas from other areas such as physics, statistics, and accounting. The financial markets have

also rapidly expanded and changed extensively because of improvement in technology and the

ever changing regulatory and social environment. For example, there has been a rapid

expansion of financial concepts, instruments, and tools due to increased computing power

and seemingly instantaneous information sharing through networks. The internationalization

of businesses and economies will continue to impact the field of finance. With all this progress

and expansion in finance and society, we thought that it would be useful to put together an

updated comprehensive encyclopedia as a reference book for both students and professionals

in an attempt to meet the demand for a key source of fundamental finance terminology and

concepts.

This Encyclopedia of Finance contains five parts. Part I includes finance terminology and

short essays. Part II includes 50 important finance chapters by well-known scholars and

practitioners, such as James R. Barth, Ren-Raw Chen, Thomas C. Chiang, Quentin C. Chu,

Wayne E. Ferson, Joseph E. Finnerty, Thomas S.Y. Ho, C.H. Ted Hong, Cheng Hsiao, Jing￾Zhi Huang, Mao-wei Hung, John S Jahera Jr., Haim Levy, Wilbur G. Lewellen, Joseph P.

Ogden, Fai-nan Peng, Gordon S. Roberts, Robert A. Schwartz, K.C. John Wei, and Gillian

Yeo, among others. Topics covered in both Part I and Part II include fundamental subjects

such as financial management, corporate finance, investment analysis and portfolio manage￾ment, options and futures, financial institutions, international finance, and real estate finance.

Part III contains appendices which discuss and derive some fundamental finance concepts and

models, Part IV lists references, and Part V provides both subject and author indexes.

Fifty papers included in Part II can be classified into eight groups as follows:

(a) Investment analysis and portfolio management (chapters 3, 7, 10, 12, 19, 21, 29, 31, 34,

40, 45, and 48)

(b) Financial management and corporate finance (chapters 11, 18, 22, 26, 27, 28, 32, 39, and 42)

(c) International finance (chapters 4, 6, 15, 30, 33, 41, 42, 47, and 50)

(d) Microstructure (chapters 16, 17, 20, 30, 35, 36, 37, 38, and 44)

(e) Asset pricing (chapters 8, 9, 10, 12, and 34)

(f ) Financial institutions and markets (chapters 1, 2, 13, 24, and 46)

(g) Derivatives (chapters 5, 28, and 43)

(h) Real estate finance (chapters 14, 25, and 49)

(i ) Risk management (chapters 4, 5, 6, 22, 23, 24, and 39)

For both undergraduate and graduate students, this encyclopedia is a good supplementary

material for the above-listed finance courses. In addition, this encyclopedia can be a good

supplementary material for financial accounting courses. We believe that this encyclopedia

will not only be useful to students but also for professors and practitioners in the field of

finance as a reference.

We would like to thank the contributors for willingness to share their expertise and their

thoughtful essays in Part II. We would like to thank Ms. Judith L. Pforr, of Springer, for her

coordination and suggestions to this book. Finally, we would also like to express our gratitude

vii

to our secretaries Ms. Miranda Mei-Lan Luo, Ms. Sue Wang, Ms. Ting Yen, and Ms. Meetu

Zalani for their efforts in helping us pull together this tremendous repository of information.

We hope that the readers will find the encyclopedia to be an invaluable resource.

NJ, USA Cheng-Few Lee

MA, USA Alice C. Lee

viii Preface to the First Edition

About the Editors

Cheng-Few Lee is a distinguished professor of finance at Rutgers Business School, Rutgers

University, and was chairperson of the Department of Finance from 1988 to 1995. He has also

served on the faculty of the University of Illinois (IBE professor of finance) and the University

of Georgia. He has maintained academic and consulting ties in Taiwan, Hong Kong, China and

the United States for the past three decades. He has been a consultant to many prominent

groups including, the American Insurance Group, the World Bank, the United Nations, The

Marmon Group Inc., Wintek Corporation and Polaris Financial Group.

Professor Lee founded the Review of Quantitative Finance and Accounting (RQFA) in

1990 and the Review of Pacific Basin Financial Markets and Policies (RPBFMP) in 1998, and

serves as managing editor for both journals. He was also a co-editor of the Financial Review

(1985–1991) and the Quarterly Review of Economics and Business (1987–1989).

In the past 39 years, Dr. Lee has written numerous textbooks ranging in subject matter from

financial management to corporate finance, security analysis and portfolio management to

financial analysis, planning and forecasting, and business statistics. Dr. Lee has also published

more than 200 articles in more than 20 different journals in finance, accounting, economics,

statistics, and management. Professor Lee has been ranked the most published finance

professor worldwide during 1953–2008. Professor Lee has written many textbooks ranging

in subject matter from financial management to corporate finance, security analysis and

portfolio management to financial analysis, planning and forecasting, and business statistics.

Alice C. Lee is currently a vice president in finance at State Street Corporation, heading up

a group that provides analytics and valuations in support to the corporate Chief Accounting

Officer. She was also previously a Vice President in the Model Validation Group, Enterprise

Risk Management, at State Street Corporation. Her career spans over 20 years of experience,

with a diverse background that includes academia, engineering, sales, and management

consulting. Her primary areas of expertise and research are corporate finance and financial

institutions. She is coauthor of Statistics for Business and Financial Economics, 2e and 3e

(with Cheng F. Lee and John C. Lee), Financial Analysis, Planning and Forecasting, 2e

(with Cheng F. Lee and John C. Lee), and Security Analysis, Portfolio Management, and

Financial Derivatives (with Cheng F. Lee, Joseph Finnerty, John C. Lee and Donald Wort).

In addition, she has coedited other annual publications including Advances in Investment

Analysis and Portfolio Management (with Cheng F. Lee).

ix

Contents

Part I Terms and Essays ...........................................

1 Terms and Essays .............................................. 3

Part II Papers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

2 Deposit Insurance Schemes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

James R. Barth, Cindy Lee, and Triphon Phumiwasana

3 Gramm-Leach-Bliley Act: Creating a New Bank for a New Millenium . . . . . 213

James R. Barth and John S. Jahera

4 Pre-funded Coupon and Zero-Coupon Bonds: Cost of Capital Analysis . . . . . 219

Suresh Srivastava and Ken Hung

5 Intertemporal Risk and Currency Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

Jow-Ran Chang and Mao-Wei Hung

6 Credit Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

Ren-Raw Chen and Jing-Zhi Huang

7 International Parity Conditions and Market Risk . . . . . . . . . . . . . . . . . . . . . 243

Thomas C. Chiang

8 Treasury Inflation-Protected Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

Quentin C. Chu and Deborah N. Pittman

9 Asset Pricing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263

Wayne E. Ferson

10 Conditional Asset Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273

Wayne E. Ferson

11 Conditional Performance Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Wayne E. Ferson

12 Working Capital and Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

Joseph E. Finnerty

13 Evaluating Fund Performance Within the Stochastic

Discount Factor Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297

J. Jonathan Fletcher

14 Duration Analysis and Its Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

Iraj J. Fooladi, Gady Jacoby, and Gordon S. Roberts

15 Loan Contract Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

Aron A. Gottesman

xi

16 Chinese A and B Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

Yan He

17 Decimal Trading in the U.S. Stock Markets . . . . . . . . . . . . . . . . . . . . . . . . . . 325

Yan He

18 The 1997 NASDAQ Trading Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

Yan He

19 Reincorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333

Randall A. Heron and Wilbur G. Lewellen

20 Mean Variance Portfolio Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341

Cheng Hsiao and Shin-Huei Wang

21 Online Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347

Chang-Tseh Hsieh

22 A Critical Evaluation of the Portfolio Performance Indices

Under Rank Transformation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351

Ken Hung, Chin-Wei Yang, Matthew Brigida, and Dwight B. Means, Jr.

23 Corporate Failure: Definitions, Methods, and Failure

Prediction Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 357

Jenifer Piesse, Cheng-Few Lee, Hsien-Chang Kuo, and Lin Lin

24 Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367

Thomas S.Y. Ho and Sang Bin Lee

25 Term Structure: Interest Rate Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377

Thomas S.Y. Ho and Sang Bin Lee

26 Review of REIT and MBS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387

Cheng-Few Lee and Chiuling Lu

27 Experimental Economics and the Theory of Finance . . . . . . . . . . . . . . . . . . . 395

Haim Levy

28 Merger and Acquisition: Definitions, Motives, and Market Responses . . . . . . 411

Jenifer Piesse, Cheng-Few Lee, Lin Lin, and Hsien-Chang Kuo

29 Multistage Compound Real Options: Theory and Application . . . . . . . . . . . . 421

William T. Lin, Cheng-Few Lee, and Chang-Wen Duan

30 Market Efficiency Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445

Melody Lo

31 The Microstructure/Micro-Finance Approach to Exchange Rates . . . . . . . . . 449

Melody Lo

32 Arbitrage and Market Frictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

Shashidhar Murthy

33 Fundamental Tradeoffs in the Publicly Traded Corporation . . . . . . . . . . . . . 459

Joseph P. Ogden

34 The Mexican Peso Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465

Fai-Nan Perng

35 Portfolio Performance Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 471

Lalith P. Samarakoon and Tanweer Hasan

xii Contents

36 Call Auction Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477

Robert A. Schwartz and Reto Francioni

37 Market Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483

Robert A. Schwartz and Lin Peng

38 Market Makers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487

Robert A. Schwartz and Lin Peng

39 Structure of Securities Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491

Robert A. Schwartz and Lin Peng

40 Accounting Scandals and Implications for Directors:

Lessons from Enron . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

Pearl Tan and Gillian Yeo

41 Agent-Based Models of Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 501

Nicholas S.P. Tay

42 The Asian Bond Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507

Khairy Tourk

43 Cross-Border Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

Geraldo M. Vasconcellos and Richard J. Kish

44 Jump Diffusion Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525

Shin-Huei Wang

45 Networks, Nodes, and Priority Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535

Daniel G. Weaver

46 The Momentum Trading Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545

K.C. John Wei

47 Equilibrium Credit Rationing and Monetary Nonneutrality

in a Small Open Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549

Ying Wu

48 Policy Coordination Between Wages and Exchange

Rates in Singapore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557

Ying Wu

49 The Le Chatelier Principle of the Capital Market Equilibrium . . . . . . . . . . . 565

Chin W. Yang, Ken Hung, and John A. Fox

50 MBS Valuation and Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

C.H. Ted Hong and Wen-Ching Wang

51 The Impacts of IMF Bailouts in International Debt Crises . . . . . . . . . . . . . . . 581

Zhaohui Zhang and Khondkar E. Karim

52 Corporate Governance: Structure and Consequences . . . . . . . . . . . . . . . . . . 587

Bikki Jaggi

53 A Survey Article on International Banking . . . . . . . . . . . . . . . . . . . . . . . . . . 607

James Winder

54 Hedge Funds: Overview, Strategies, and Trends . . . . . . . . . . . . . . . . . . . . . . 621

John M. Longo

Contents xiii

55 An Appraisal of Modeling Dimensions for Performance

Appraisal of Global Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 633

G.V. Satya Sekhar

56 Structural Credit Risk Models: Endogenous Versus

Exogenous Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 645

Michael B. Imerman

57 Arbitrage Opportunity Set and the Role of Corporations . . . . . . . . . . . . . . . . 659

James S. Ang and Yingmei Cheng

58 Equity Premium Puzzle: The Distributional Approach . . . . . . . . . . . . . . . . 675

Nadezhda Safronova

59 Understanding Ginnie Mae Reverse Mortgage H-REMICs:

Its Programs and Cashflow Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 691

C. H. Ted Hong and George H. Lee

60 An Analysis of Risk Treatment in the Field of Finance . . . . . . . . . . . . . . . . . . 705

Fernando Go´mez-Bezares and Fernando R. Go´mez-Bezares

61 The Trading Performance of Dynamic Hedging Models:

Time Varying Covariance and Volatility Transmission Effects . . . . . . . . . . . 713

Michael T. Chng and Gerard L. Gannon

62 Portfolio Insurance Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 727

Lan-chih Ho, John Cadle, and Michael Theobald

63 Time-Series and Cross-Sectional Tests of Asset Pricing Models . . . . . . . . . . . 745

Kyung-Jin Choi, Dongcheol Kim, and Soon-Ho Kim

64 Alternative Methods for Estimating Firm’s Growth Rate . . . . . . . . . . . . . . . 755

Ivan E. Brick, Hong-Yi Chen, and Cheng-Few Lee

65 A Comparison of Formulas to Compute Implied Standard Deviation . . . . . . 765

James S. Ang, Gwoduan David Jou, and Tsong-Yue Lai

66 Securities Transaction Taxes: Literature and Key Issues . . . . . . . . . . . . . . . . 777

Anna Pomeranets

67 Financial Control and Transfer Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 783

Savita A. Sahay

68 Alternative Models for Evaluating Convertible Bond:

Review and Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 795

Lie-Jane Kao, Cheng-Few Lee, and Po-Cheng Wu

69 A Rationale for Hiring Irrationally Overconfident Managers . . . . . . . . . . . . . 803

Oded Palmon and Itzhak Venezia

70 The Statistical Distribution Method, the Decision-Tree Method

and Simulation Method for Capital Budgeting Decisions . . . . . . . . . . . . . . . . 813

Cheng-Few Lee and Tzu Tai

71 Valuation of Interest Tax Shields . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 825

Michael Dothan

72 Usefulness of Cash Flow Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 835

Savita A. Sahay

xiv Contents

73 Nonlinear Models in Corporate Finance Research: Review, Critique,

and Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 851

Sheng-Syan Chen, Kim Wai Ho, Cheng-Few Lee, and Keshab Shrestha

74 Futures Hedge Ratios: A Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871

Sheng-Syan Chen, Cheng-few Lee, and Keshab Shrestha

75 Credit Risk Modeling: A General Framework . . . . . . . . . . . . . . . . . . . . . . . . 891

Ren-Raw Chen

Appendix A Derivation of Dividend Discount Model . . . . . . . . . . . . . . . . . . . . . . . 911

Appendix B Derivation of DOL, DFL and DCL . . . . . . . . . . . . . . . . . . . . . . . . . . . 913

Appendix C Derivation of Crossover Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 915

Appendix D Capital Budgeting Decisions with Different Lives . . . . . . . . . . . . . . . . 917

Appendix E Derivation of Minimum-Variance Portfolio . . . . . . . . . . . . . . . . . . . . . 919

Appendix F Derivation of an Optimal Weight Portfolio Using

the Sharpe Performance Measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . 921

Appendix G Applications of the Binomial Distribution

to Evaluate Call Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 923

Appendix H Derivation of Modigliani and Miller (M&M) Proposition I

and II with Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 929

Appendix I Derivation of Capital Market Line (CML) . . . . . . . . . . . . . . . . . . . . . 931

Appendix J Derivation of Capital Market Line (SML) . . . . . . . . . . . . . . . . . . . . . . 933

Appendix K Derivation of Black-Scholes Option Pricing Model . . . . . . . . . . . . . . . 935

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 937

Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 977

Author Index ..................................................... 1003

Contents xv