Finance

We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large "rms rely heavily on present value techniques and the capital asset pricing model, while small "rms are relatively likely to use the payback criterion. A surprising number of "rms use "rm risk rather than project risk in evaluating new investments. Firms are concerned about "nancial #exibility and credit ratings when issuing debt, and earnings ଝ We thank Franklin Allen for his detailed comments on the survey instrument and the overall project. We appreciate the input of (C.R. Harvey).

We propose a cross-sectional time-series model to assess the impact of market liberalizations in emerging equity markets on the cost of capital, volatility, beta, and correlation with world market returns. Liberalizations are defined by regulatory changes, the introduction of depositary receipts and country funds, and structural breaks in equity capital f lows to the emerging markets. We control for other economic events that might confound the impact of foreign speculators on local equity markets. Across a range of specifications, the cost of capital always decreases after a capital market liberalization with the effect varying between 5 and 75 basis points.

Understanding volatility in emerging capital markets is important for determining the cost of capital and for evaluating direct investment and asset allocation decisions. We provide an approach that allows the relative importance of world and local information to change through time in both the expected returns and conditional variance processes. Our time-series and cross-sectional models analyze the reasons that volatility is different across emerging markets, particularly with respect to the timing of capital market reforms. We find that capital market liberalizations often increase the correlation between local market returns and the world market but do not drive up local market volatility.

If asset returns have systematic skewness, expected returns should include rewards for accepting this risk. We formalize this intuition with an asset pricing model that incorporates conditional skewness. Our results show that conditional skewness helps explain the cross-sectional variation of expected returns across assets and is significant even when factors based on size and book-to-market are included. Systematic skewness is economically important and commands a risk premium, on average, of 3.60 percent per year. Our results suggest that the momentum effect is related to systematic skewness. The low expected return momentum portfolios have higher skewness than high expected return portfolios.

Previous studies identify predetermined variables that predict stock and bond returns through time. This paper shows that loadings on the same variables provide significant cross-sectional explanatory power for stock portfolio returns. The loadings are significant given the three factors advocated by Fama and French~1993! and the four factors of Elton, Gruber, and Blake~1995!. The explanatory power of the loadings on lagged variables is robust to various portfolio grouping procedures and other considerations. The results carry implications for risk analysis, performance measurement, cost-of-capital calculations, and other applications. EMPIRICAL ASSET PRICING is in a state of turmoil. The Capital Asset Pricing Model CAPM; see Sharpe~1964! and Black~1972!! has long served as the backbone of academic finance and numerous important applications. However, studies have identified empirical deficiencies in the CAPM, challenging its preeminence. The most powerful challenges include market capitalization and related financial ratios that can predict the cross section of returns. For example, the firm "size-effect" drew attention as a challenge to the CAPM. Ratios of stock market price to earnings or the book value of equity are studied by Basu~1977!, Banz~1981!, Chan, Hamao, and Lakonishok~1991!, and Fama and French 1992!, among others. With the CAPM under such strenuous attack the field is hungry for a replacement model. 1 There are some natural heirs waiting in the wings, including the intertemporal equilibrium models of Merton~1973! and Breeden

We present a new methodology for estimating time-varying conditional skewness. Our model allows for changing means and variances and uses a maximum likelihood framework with instruments and assumes a noncentral t-distribution. We apply this method to daily, weekly and monthly stock returns, and nd that conditional skewness is important. In particular, we show that the evidence of asymmetric variance is consistent with conditional skewness. Inclusion of conditional skewness also impacts the persistence in conditional variance. and [email protected]. The phone-numbers are 919-660-7768 and 202-687-3771 respectively. We thank the referee and Tim Bollerslev for their insightful comments. .

Regulatory changes that appear comprehensive will have little impact on the functioning of a developing market if they fail to lead to foreign portfolio inflows. We specify a reduced-form model for a number of financial time series and search for a common, endogenous break in the data generating process. We also estimate a confidence interval for the break. Our endogenous break dates are accurately estimated but do not always correspond closely to dates of official capital market reforms. Indeed, the endogenous dates are usually later than official dates, highlighting the important distinction between market liberalization and market integration. r (C.R. Harvey). 0304-405X/02/$ -see front matter r 2002 Elsevier Science B.V. All rights reserved. PII: S 0 3 0 4 -4 0 5 X ( 0 2 ) 0 0 1 3 9 -3

Emerging markets have long posed a challenge for finance. Standard models are often ill suited to deal with the specific circumstances arising in these markets. However, the interest in emerging markets has provided impetus for both the adaptation of current models to new circumstances in these markets and the development of new models. The model of market integration and segmentation is our starting point. Next, we emphasize the distinction between market liberalization and integration. We explore the financial effects of market integration as well as the impact on the real economy. We also consider a host of other issues such as contagion, corporate finance, market microstructure and stock selection in emerging markets. Apart from surveying the literature, this article contains new results regarding political risk and liberalization, the volatility of capital flows and the performance of emerging market investments. D

Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that it significantly predicts future returns, whereas alternative measures such as turnover do not. Consistent with liquidity being a priced factor, unexpected liquidity shocks are positively correlated with contemporaneous return shocks and negatively correlated with shocks to the dividend yield. We consider a simple asset-pricing model with liquidity and the market portfolio as risk factors and transaction costs that are proportional to liquidity. The model differentiates between integrated and segmented countries and time periods. Our results suggest that local market liquidity is an important driver of expected returns in emerging markets, and that the liberalization process has not fully eliminated its impact. (JEL G12, G15, F30)

We provide an analysis of real economic growth prospects in emerging markets after nancial liberalizations. We identify the¯nancial liberalization dates and examine the in°uence of liberalizations while controlling for a number of other macroeconomic and nancial variables. Our work also introduces an econometric methodology that allows us to use extensive time-series as well as cross-sectional information for our tests. Wē nd across a number of di®erent speci¯cations that¯nancial liberalizations are associated with signi¯cant increases in real economic growth. The e®ect is larger for countries with high education levels.