Vidhan K. Goyal
Professor of Finance, HKUST
  • Home
  • Research
  • Teaching
  • Awards
  • Photos
  • Blog
  • Contact

Best Performing Economy with the Worst Performing Market

10/13/2014

1 Comment

 
Chinese economy is the world’s fastest growing economy. Its real GDP has grown by a factor of eight since 1991. And, according to IMF, China is now officially the largest economy in the world based on purchasing power parity.

In a recent paper, Franklin Allen, Jun Qian, Susan Shan and Julie Zhu contrast this impressive growth with poor performance of its stock markets. How could the world’s fastest growing economy have such a poorly performing stock market? The question is intriguing and fundamentally important for Chinese policymakers and regulators.

The underperformance of Chinese equities is phenomenal. If you invested $1 in a value-weighted Chinese stock portfolio in year 2000, that dollar would have become $0.62 by the end of 2012. Compare that to investing in a globally diversified world portfolio, where the same dollar would have become $1.67 by the end of 2012. In case you are wondering, Japan is the second worst performing country after China.

Several reasons are offered for such underwhelming performance of Chinese stock markets. The main reason appears to be the listing process that determines which firms get listed. The listed firms are doing poorly, and there is some evidence that unlisted private firms are actually doing quite well. Better firms are listing abroad instead of listing locally. One problem with listing is that firms have to go through an administrative process which works on a quota system. The listing process is also biased towards large firms with a track-record of profitability. These profit requirements distort the businesses of these firms. It is not surprising that many firms manage earnings prior to their listing to appear profitable. Moreover, the listing criteria also distorts the real operating decisions of these firms.

Chinese firms rarely delist because of poor performance. Very few Chinese firms have gone through a bankruptcy process – so the poorly performing firms continue to operate and exhibit further deterioration in performance over time.

Many economists feel that much of the growth of Chinese firms is due to over-investment in fixed assets. So, while there is lots of growth (investment-financed), the profits aren't there. The return on invested capital of Chinese firms is surprisingly low compared to firms in other countries. 

My view is that we are just scratching the surface of the problem. It will take a lot more work to understand what's causing the disconnect between the economy and the stock market. Clearly, regulations play a role, but also the growth oriented policies adopted by Chinese firms may be responsible for poor performance. There is too much speculation into the causes. So, I look forward to reading more research in this area.

1 Comment

Trading with Superstitious Investors

10/9/2014

0 Comments

 
Numbers play a big role in the Chinese culture. So, most buildings don't have the fourth floor or floors ending in 4, but you see plenty of floors ending with eight. In the Chinese culture, the number 4 is considered unlucky, but the number 8 is considered auspicious. The number eight sounds similar to the word which means prosperity and wealth. And, therefore, housing prices are inflated when the floor number or the number in the address is a lucky one. The airlines routes to Hong Kong and China more often include the number 8 in their route numbers. Chinese firms more often include lucky numbers in their listing codes and those with the right numbers in their listing codes trade at a premium. It is not because these firms are particularly better but because of investor place a premium on them because of the superstition. Of course, HKUST being the university of science and technology does not give in to these numbering conventions which are common in the rest of Hong Kong - so we do have the fourth floor in our building. 

My colleague, Utpal Bhattacharya, is looking at trading of individual Taiwanese investors to see if their trading is affected by these superstitious beliefs. Utpal and his coauthors find that superstition is common among retail traders. Individual Taiwanese investors often prefer submitting orders at prices that end in 8 and avoid submitting orders that end in 4.  Not surprisingly, these investors underperform less superstitious investors and institutional investors. But what really surprised me is the finding that these investors do poorly in all of their trading - even when they are trading in the market using market orders. Utpal then concluded in the seminar today that people who engage in superstitious trading also have poor cognitive abilities. This is perhaps worded too strongly. 


Superstition has its place and I have seen really smart people having superstitious beliefs and actually doing quite well in the process. Michael Jordan, one of the best known basketball players of all time, always wore his lucky shorts to all the NBA Championship games. Their is a reason why it works - and the reason is that just knowing that you have luck on your side gives you confidence and changes the way you play, which then results in better outcomes on average. What is unclear is whether superstition made you a more confident investors to the point of overconfidence and that hurt your trading performance. So, superstition could be good to harmless in some situations, but harmful in others. The trick is to know when to employ it to your advantage.
0 Comments

Latest Research from the Finance Group

10/3/2014

0 Comments

 

Provision of Trade Credit around Debt Covenant Violations

What happens to trade credit when banks obtain additional control rights as the borrowing firm defaults on its debt contracts? Zilong Zhang, a PhD student at HKUST is examining conflicts that arise between trade creditors and bank lenders following the violation of debt covenants. Covenants violations grant bank lenders with additional control rights that banks can use to secure their own claims at the expense of suppliers. 

The study uses a clever regression design to exploit the discontinuity created at the point of violation. Firms around the violation threshold are similar and yet those violating covenants experience a significant decline in trade credit.  Further, the reduction in trade credit is much larger when there is a greater probability of banks intervening in corporate decisions that may adversely affect junior creditors. In addition, Zilong  shows that dependent suppliers are more adversely affected.

Zilong is now extending his work to examine whether firms take the possibility of these conflicts into account in structuring their debt contracts. Do firms include fewer covenants in debt contracts when the suppliers are dependent? How are other features of debt contracts affected by these conflicts? His preliminary results on this are fascinating, and they show  that firms do take into account the possibility of conflicts among creditors when they negotiate debt contracts with bank lenders.

Zilong is on the market this year.  You can read more about this research and other exciting work that he is doing here.
0 Comments

    Vidhan K. Goyal

    Teaching and Research in Finance

    Archives

    October 2014

    Categories

    All

    RSS Feed

Powered by Create your own unique website with customizable templates.