Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma

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Thu, 29 Jun 2006

A First Cut Estimate of the Equity Risk Premium in India

Prof S K Barua and I wrote a paper estimating the equity risk premium in India using data for the last 25 years. We address the shortcomings of existing indices by constructing our own total return index for the 1980s and early 1990s. We use our estimates of the extent of financial repression during this period to construct a series of the risk free rate in India going back to the early 1980s. We find that the equity risk premium is about 8.75% on a geometric mean basis and about 12.50% on an arithmetic mean basis. There is no significant difference between the pre reform and post reform period: the premium has declined marginally on a geometric mean basis and has risen slightly on an arithmetic mean basis. The reason for this divergence between the sub period behaviour of the two means is the increase in the annualized standard deviation of stock market returns from less than 20% in the pre reform period to about 25% in the post reform period. The higher standard deviation depresses the geometric mean in the post reform period.

Posted at 15:14 on Thu, 29 Jun 2006     View/Post Comments (0)     permanent link

Tue, 27 Jun 2006

Volatility so far has been benign

Yesterday, I wrote an article in the Financial Express saying that volatility in the Indian stock market so far has been benign and there is no need for regulatory intervention. You can also read the story here. The article concludes by saying that:

The volatility that we have witnessed so far has been benign. While there have been large losses, there have been no major defaults or bankruptcies. Risk management systems at the exchanges have held up well. The volatility has been large enough to grab headlines but not large enough to cripple the markets. Volatility on this scale serves to focus attention on the huge fundamental uncertainty that exists. Several years of booming economies and rising asset prices have led to a reduction of risk premiums to the point where risk is probably under priced in many markets. A period of heightened volatility serves as a gentle reminder that prices can go down as well as go up. If this reminder leads to a re-pricing of risk in domestic and global markets, that is also welcome.

Posted at 14:27 on Tue, 27 Jun 2006     View/Post Comments (0)     permanent link

Fri, 23 Jun 2006

Partnoy on Rating Agencies

Frank Partnoy has an interesting paper entitled “How And Why Credit Rating Agencies Are Not Like Other Gatekeepers”. I have talked about rating agencies on this blog here and here. Partnoy brings several new insights into this discussion.

Partnoy also has an extended discussion criticizing the way ratings agencies rate CDOs and argues that CDOs are there only because of rating arbitrage: “Put another way, credit rating agencies are providing the markets with an opportunity to arbitrage the credit rating agencies’ mistakes”. I would not agree with this part of Partnoy’s analysis. The intense competition between the two major rating agencies to produce better CDO rating models would rather suggest that rating arbitrage is a passing phase in a maturing market.

But Partnoy has written a very informative and thought provoking paper on rating agencies. I entirely agree that the time has come to eliminate the regulatory use of ratings completely.

Posted at 18:40 on Fri, 23 Jun 2006     View/Post Comments (3)     permanent link

Thu, 22 Jun 2006

Governance of Investment Institutions

Just before my long vacation, I wrote an article for CFO-Connect arguing that the corporate governance problems of the twentieth century are essentially problems of governance at the big investment institutions. These problems meant that shareholder empowerment ceased to be an effective corporate governance weapon. I also argue that I expect this century to be different because of the rise of hedge funds and also improvements in governance at other institutions. If shareholder empowerment works, empowerment and reform of the Board becomes less important than reconnecting the Board to the company. That leads to a different way of looking at Sarbanes-Oxley.

The text of this article as I wrote it is available here. The scanned image of the article as it appeared in print is also available.

This is my first post after a long vacation.

Posted at 11:01 on Thu, 22 Jun 2006     View/Post Comments (2)     permanent link