The purpose of this paper is to investigate the effect of default risk and transaction costs on the investor’s asset allocation and the liquidity premium. More precisely, it aims…
Abstract
Purpose
The purpose of this paper is to investigate the effect of default risk and transaction costs on the investor’s asset allocation and the liquidity premium. More precisely, it aims at answering the following question: can default risk generate a first-order effect on the investor’s asset allocation and a liquidity premium of the same order of magnitude as transaction costs?
Design/methodology/approach
The author proposes a very simple consumption-investment model in which an infinitely lived investor allocates her wealth between a risky asset and a riskless security, and incurs in proportional transaction costs when exchanging them. In addition, the risky asset may default at some random time, thus reducing the available wealth of the agent. Two different scenarios of default risk are considered. In the total default scenario, the value of the risky asset drops to zero when default occurs, whereas, in the partial default case, the proceeds from the liquidation of the risky asset amount to 50 percent of its value.
Findings
The paper shows that default risk can generate a first-order effect on the investor’s asset allocation. On the contrary, the liquidity premium is one order of magnitude smaller than the transaction costs, implying that the additional source of risk determined by the possibility of default is not able to generate a first-order effect on asset pricing.
Originality/value
To the author knowledge, this is the first paper that investigates the interaction of default risk and transaction costs on the investor’s asset allocation and its effects on the liquidity premium.
Details
Keywords
Giovanni Walter Puopolo, Emanuele Teti and Veronica Milani
The purpose of this paper is to investigate the effects of the application of green standards on the companies’ financial returns. It aims at answering the following question…
Abstract
Purpose
The purpose of this paper is to investigate the effects of the application of green standards on the companies’ financial returns. It aims at answering the following question: does the market reward or penalize the players that carry out responsible management policies toward environment?
Design/methodology/approach
Using US data from 2009 to mid-2014 and employing two financial models, that is Capital Asset Pricing Model and Fama-French three-factor model, the authors first estimate the extra remuneration provided to investors. Then, the authors link this extra return to a green-based factor. The green-factor data are taken from Newsweek Green Rankings, which annually publishes an environmental ranking of the 500 biggest publicly traded companies in the USA.
Findings
The analysis demonstrates that there exists no linear relationship between the adoption of green standards and financial returns, i.e. the “green-behavior” does not affect the remuneration required by investors. These results could be justified by the fact that the implementation of environmentally friendly standards is quite a new one.
Research limitations/implications
The results could be subject to major changes in next few years, due to the increasing attention over environmental issues.
Originality/value
The paper investigates the financial profitability and the creation of economic value of a topical managerial issue, in light of the increasing importance of social responsible behavior for the companies. To the authors knowledge, this is the first paper that examines this topic.