Discussion Papers

Findings from research and studies conducted at the Financial Research Center (FSA Institute) are organized and published as Discussion Papers to stimulate further discussion and comment.

The views expressed in the papers are those of the authors and do not necessarily reflect the views of the Financial Services Agency or the FSA Institute.

Discussion Papers (FY 2011)

No.	Title/Author(s)
DP2011-11 (March 2012)	Understanding the Changing Ownership Structure of Japanese Firms : Investment Style of Foreign and Domestic Institutional Investors Hideaki Miyajima and Takaaki Hoda Abstract | Full text (PDF:1,033KB) (Full text is available only in Japanese.)
DP2011-10 (March 2012)	Price Run-Up and Trading Volume Just Before and After Takeover Announcements in Japan : Characteristics of Illegal Insider Trading Koichi Iwai Abstract | Full text (PDF:766KB) (Full text is available only in Japanese.)
DP2011-9 (March 2012)	Recent Studies on Managerial Compensation Tomoya Nakamura Abstract | Full text (PDF:1,244KB) (Full text is available only in Japanese.)
DP2011-8 (January 2012)	Mutual Fund Systems in the United States, Europe and Cayman Islands Akiko Nomura Abstract | Full text (PDF:605KB) (Full text is available only in Japanese.)
DP2011-7 (January 2012)	Credit Risk Discovery in Japanese CDS and Stock Markets: An Empirical Analysis using Time-series Models with Structural Breaks Koichi Iwai Abstract | Full text (PDF:469KB) (Full text is available only in Japanese.)
DP2011-6 (January 2012)	Contemporaneous Correlation between CDS Spreads and Stock Returns: Evidence from a Dynamic Conditional Correlation GARCH Model Koichi Iwai Abstract | Full text (PDF:746KB) (Full text is available only in Japanese.)
DP2011-5 (August 2011)	Credit Rationing, Earnings Manipulation, and Renegotiation-Proof Contract Tomoya Nakamura Abstract | Full text (PDF:439KB)
DP2011-4 (August 2011)	Endogenous Alleviation of Overreaction Problem by Aggregate Information Announcement Tomoya Nakamura and Hiroki Arato Abstract | Full text (PDF:469KB)
DP2011-3 (August 2011)	Why Does the Law of One Price Fail in Japanese ETF Markets? Koichi Iwai Abstract | Full text (PDF:562KB)
DP2011-2 (August 2011)	Determinants of the CDS Spreads of Japanese Firms Before and After the Global Financial Crisis Koichi Iwai Abstract | Full text (PDF:612KB)
DP2011-1 (June 2011)	Initiatives to Establish a Macroprudential System Kei Kodachi Abstract | Full text (PDF:862KB) (Full text is available only in Japanese.)

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Abstracts

DP2011-11
''Understanding the Changing Ownership Structure of Japanese Firms : Investment Style of Foreign and Domestic Institutional Investors''

Hideaki Miyajima, Special Research Fellow, Financial Research Center (FSA Institute)
Takaaki Hoda, Associate professor, Otaru University of Commerce

The ownership structure of Japanese firms has dramatically changed since the financial crisis of 1997. Instead of the former insider-dominated structure of cross shareholdings between banks and firms or among firms, now the institutional investors (both domestic and foreign) whose motivation for holding stock is to maximize the financial return have become the major shareholders. However, the investment behaviors of both institutional investors and their impacts on stock return have not been fully clarified yet. This paper tries to explain such behavior. Based on our originally constructed ownership data, we show the following points.

First, the investment style of foreign institutions is consistently affected by “home bias” in the sense that they prefer stocks which have large market capitalization, high liquidity, and high foreign sales, while their concerns about risk have decreased, suggesting that they are becoming more familiar with the Japanese market by developing their local arms. They also show some preference for a high level of corporate governance. Second, comparing the investment style between the domestic and foreign investors, while the target universe of the domestic ones is larger as they cover small and mid-size firms, they similarly choose those stocks with low valuation, large market cap, high liquidity, financial stability, and pay for performance. The investment style of both domestic and foreign institutions has been converging, it is no longer the case that domestic institutional investors do not prioritize to maximize financial return due to their independence from their affiliated companies/groups. On the other hand, however, financial institutions such as banks and life insurance companies show an opposite investment style from that of institutional investors, keeping characteristics as stable shareholders. Lastly, we found that the changes in ownership by institutional investors and stock price performance in the following year are positively correlated and the economic impact on stock price return is almost the same between domestic and foreign ones. From this fact, we tentatively conclude that impacts on stock price return due to the behaviors of domestic and foreign investors have also been converging.

Keywords : corporate governance, institutional investors, home bias, outside director, voting right

DP2011-10
''Price Run-Up and Trading Volume Just Before and After Takeover Announcements in Japan : Characteristics of Illegal Insider Trading''

Koichi Iwai, Research Fellow, Financial Research Center (FSA Institute)

This paper investigates market reaction before and after the announcement of takeover bids in the Japanese market. Findings from the analysis are that, in the case where there is insider trading, some signs tend to appear in market prices and trading volumes that suggest the conduct of such trading. Specifically, in comparison with the cases where insider trading is not detected, insider trading cases had the following characteristics: (1) cumulative abnormal return and/or cumulative abnormal trading volume tend to be larger, (2) conditional variance of equity returns is likely to be affected by abnormal trading volume, and (3) conditional variance of equity return is more closely related to risk premium.

Keywords : takeover bids, insider trading, abnormal equity returns, abnormal trading volume

DP2011-9
''Recent Studies on Managerial Compensation''

Tomoya Nakamura, Research Fellow, Financial Research Center (FSA Institute)

Managerial compensation has increased dramatically in the United States from the 1980's. Because such a surge in the compensation could not be explained by existing studies, researchers have presented new theoretical and empirical papers. This paper will first examine how managerial compensation is treated in the theories of corporate governance. It will then explain the limitations of the classical agency theory. Finally, it will briefly look at rent extraction views and market competition views.

Keywords : corporate governance, managerial compensation, agency theory, rent extraction view, competition view

JEL classification : D2, D3, D34, J3

DP2011-8
''Mutual Fund Systems in the United States, Europe and Cayman Islands''

Akiko Nomura, Special Research Fellow, Financial Research Center (FSA Institute)

This paper summarizes mutual fund systems in the United States, European Union (UCITS), Luxembourg and Cayman Islands.

Mutual funds in the United States, the world's largest in terms of assets under management, are regulated by the federal securities laws including Investment Company Act of 1940. An investment company contracts with investment advisors, custodians, transfer agents and other services providers. The board of directors of an investment company oversees whether the company is operated properly. For important decisions such as a change in the investment advisor, shareholders' approvals are required.

In Europe, publicly-offered funds are regulated by the Undertakings for Collective Investment in Transferable Securities Directive (UCITS Directive). Management companies and depositaries play important roles in the management of UCITS. Management companies are responsible for the investment management and administration, and depositaries are responsible for the safekeeping of assets, among other things. They can delegate their functions to third parties but remain liable. Luxembourg is the country with the largest UCITS registrations. It requires major administration functions of UCITS, such as net asset value calculation, to be kept in Luxembourg, while investment advisory can be conducted abroad.

In Cayman Islands, mutual funds are regulated by the Mutual Funds Law (2009 Revision). Regulation is kept relatively simple and the law mainly stipulates the requirements regarding mutual fund licenses and mutual fund administration.

Keywords : mutual funds, investment company, the United States, UCITS, Luxembourg, Cayman Islands

DP2011-7
''Credit Risk Discovery in Japanese CDS and Stock Markets: An Empirical Analysis using Time-series Models with Structural Breaks''

Koichi Iwai, Research Fellow, Financial Research Center (FSA Institute)

We investigate the price formation in Japanese CDS and stock markets using the sample of Japanese non-financial firms. We found that CDS spread, equity return, and Distance-to-Default have experienced structural breaks at around the Global Financial Crisis. CDS market and stock market do not have cointegration relationship and neither of them plays significant role in price discovery for the most of our sample while stock market is dominant in price discovery for some of the sample. These findings suggest that information production is not active in Japanese CDS market. In addition, analyzing intertemporal transactions between CDS and stock markets would be beneficial from the perspective of market surveillance.

Keywords : CDS, Price Discovery, Structural Break

DP2011-6
''Contemporaneous Correlation between CDS Spreads and Stock Returns: Evidence from a Dynamic Conditional Correlation GARCH Model''

Koichi Iwai, Research Fellow, Financial Research Center (FSA Institute)

This paper investigates contemporaneous correlation between CDS and stock markets using a DCC-GARCH model. We found that the correlations are negative especially for the period after the Global Financial Crisis, although the negative relationships are not generally significant. Our empirical results show that the correlations seem to be affected by the level of a firm's creditworthiness.

Keywords : CDS spread, correlation between CDS markets and stock markets, DCC-GARCH

DP2011-5
''Credit Rationing, Earnings Manipulation, and Renegotiation-Proof Contract''

Tomoya Nakamura, Research Fellow, Financial Research Center (FSA Institute)

This paper considers the situation where an manager borrows the funds from an investor and carries out long-term project with credit rationing problem. If the manager has myopic preference, credit rationing problem will be compounded by renegotiation depending on earnings signal. Moreover, we compare the transparent accounting system and the opaque one. If the parties can renegotiate the initial contract, credit rationing problem will be more relaxed in the opaque system than the transparent one.

Keywords : Credit rationing, Earnings manipulation, Renegotiation, Managerial my-opia

JEL classification : D82, E51, G34, J33

DP2011-4
''Endogenous Alleviation of Overreaction Problem by Aggregate Information Announcement''

Tomoya Nakamura, Research Fellow, Financial Research Center (FSA Institute)

Hiroki Arato, Assistant Professor, Faculty of Urban Liberal Arts, Tokyo Metropolitan University

We investigate how public information should be disclosed by the authorities in a multi-region economy characterized by strategic complementarities. We find that under aggregate information announcement which discloses information regarding the whole economy, each agent converts purely public information into imperfect public information endogenously. This makes the agents' beliefs more dispersed and alleviates their overreaction. Then, we compare aggregate information announcement with separate information announcement which discloses information regarding each region. The quality of aggregate information is more degraded than that of separate information. However, we show that the aggregate information announcement policy can be better than the separate one in plausible situations.

Keywords : Aggregate information, Social welfare, Transparency, Disclosure, Beauty Contest

JEL classification : C72, D82, D83, and E58

DP2011-3
''Why Does the Law of One Price Fail in Japanese ETF Markets?''

Koichi Iwai, Research Fellow, Financial Research Center (FSA Institute)

This paper investigates possible obstacles to the Law of One Price in Japanese ETF markets. Our findings suggest that there are at least two major reasons why the Law fails in the markets. First, the difference in the speed of price discovery between the primary and secondary markets causes mispricing. Unique institutions in Japanese ETF markets could be potential sources of this phenomenon. Second, idiosyncratic noise trader risks seem to prevent arbitrageurs from engaging in long-short arbitrage trading. Unlike previous studies, systematic investor sentiment is not found to be a major obstruction in Japanese ETF markets.

Keywords : Exchange-traded funds, the Law of One Price, investor sentiment, market microstructure

DP2011-2
''Determinants of the CDS Spreads of Japanese Firms Before and After the Global Financial Crisis''

Koichi Iwai, Research Fellow, Financial Research Center (FSA Institute)

The global financial crisis has led to even greater interest in credit default swap (CDS) markets. CDS markets are regarded as one of the underlying causes in the financial crisis, and given the circumstances that regulatory reviews have been progressed, rigorously examining price formation in CDS markets before and after the crisis would be important for considering the functions of the CDS market and how future regulation ought to be. Nevertheless, only a limited understanding of price formation in the Japanese CDS market has been accumulated so far. The aim of this paper is to empirically verify the determinants of CDS spreads whose reference entities are Japanese non-financial corporations. I regard as the possible determinants of CDS spreads both the structural variables and some state variables which capture overall market trends and macroeconomic development. Analyses in this paper succeed to find several characteristics of price formation in the CDS market, including some phenomena never reported before. First, structural variables satisfy the sign condition and are generally significant, but they cannot fully explain the fluctuation of CDS spreads. Even if market- and macro-related variables are included in addition to the structural variables as the independent variables, the explanatory power of the model is generally low. It is arguable that the so-called “credit spread puzzle” exists in the Japanese CDS market as well. Second, a phenomenon not reported in foreign countries is confirmed, namely, that the explanatory power of the regression model improves after the financial crisis. A possible reason for this is that, after the onset of the financial crisis, market fluctuations in foreign countries begin to have a considerable impact on the Japanese CDS market. Third, it seems that some unobservable systemic factors become main factors for CDS spreads variations after the financial crisis. These findings will help to understand the price formation mechanisms in the Japanese CDS market.

Keywords : Credit default swaps (CDSs), Structural model, Dynamic Heterogeneous Panel Model

DP2011-1
''Initiatives to Establish a Macroprudential System''

Kei Kodachi, Special Research Fellow, Financial Research Center (FSA Institute)

The term “macroprudential” has become an important keyword in financial regulatory reforms in response to financial crisis at the international and national level. It has become generally consensus among policymakers that the ultimate goal of macroprudential policy is to identify, deal with and reduce systemic risks. There are considered a variety of macroprudential approaches in the U.S. and European regulatory reforms. In their reforms, new organizations responsible for macroprudential policy commonly have been established, that have the mandate to identify systemic risks. These organizations are independent from the regulatory and supervisory authorities and the monetary policy committees in the central banks. They clarify the governance and accountability of macroprudential policies. On the other hand, the macroprudential practices with the defined tools have not been established yet. This paper captures the characteristics of macroprudential policies from the U.S. and European regulatory reforms.

Keywords : macroprudence, systemic risk, organizations responsible for macroprudential policy, multidisciplinary approach