Abstract: The recurrence of global financial crisis attracts academic attention of volatility transmission in international stock markets. This project strives to produce a thorough and in-depth review of extant literatures in this field. This topic is to be investigated from three perspectives, theoretical foundation, econometric models and empirical findings. Firstly, economic factors, information transmission and contagion are explained to pave the theoretical foundation of international transmission. Secondly, the evolution of relevant econometric models is reviewed with specific emphasis on the ARCH family and data related issues. Thirdly, empirical evidence is provided in terms of transmission direction, leverage effect and transmission during crisis. The final conclusions indicate directions for further research.
Keywords: Stock markets; Volatility; International transmission; Spillover
Introduction
Theoretical Rationale
The traditional view on the value effect of bank mergers believes that bank mergers can achieve overall benefits when the post-merger entity generates more value than the sum of the two pre-merger banks (Pilloff, Santomero,1998).
Performance improvement, increasing market power and diversification are factors commonly considered as the cause of gains created by merger in the academic world. However, the empirical tests sometimes show mergers do not generate profits. Hence, other factors, like the managerial hubris, government regulatory are used by studies to explain the failure of generating merger benefits. This section is going to theoretically explain the logic in value creation of bank mergers from the value maximizing and non value maximizing driven factors' perspectives.
Causes for bank merger gains
Performance improvement is considered as the primary cause of merger gains (Houston et al, 1999). It is also believed that increase in market power by market concentration and diversification both can result in value creation.
Improvement in Performance
One of the motives for bank mergers comes from a belief that bank mergers can generate benefits by improving the performance (Pilloff, 1996). The performance improvement can be achieved in following two ways.
Cost reduction is the most frequently mentioned cause of performance improvement in the literature. Clark(1988) mentions that mergers can generate scale economies, when average costs decline as the business expands by eliminating the redundant cost. Pilloff and Santomero (1998) explain that cost efficiency can also be enhanced by transformation of a higher level of management skill on reducing expenses from acquirer to target.
In another aspect, merger may result in revenue enhancement which improves the performance and leads to value gains. Dermine et al. (1999) explain that mergers may result in cross-selling new products to existing customers thus increase revenue. Forcarelli et al.(2002) also mention that gains can come from allocating one bank's higher profitable products(or services) to the other bank which is less capable of providing it. Moreover, large size and capital base can promote the demand for underwriting services (Dermine et al., 1999).
Increasing Market Power and Market Concentration
Akhavein et al (1997)state that the market concentration by in-market mergers allowing the merged bank to use the increasing market power to set higher price for its service or product which consequently result in higher profits. On the contrary, Berger (1995) suggests that increasing market power may have adverse effect because setting higher rates is less favorable to consumers which will lead to decrease in the sum of total consumer and producer surplus.
Diversification
Segal (1974) claims that diversification of bank mergers is possible to reduce the bank risk of solvency and keep revenue stream stable. DeLong(2001)also support this view and conclude that in theory, diversifying mergers can generate gains by creating an internal capital market which result in lower cost of capital. There are opposing views on diversification. Hunter and Wall (1989) relate bank mergers to "too big to fail" theory and propose a hypothesis that the bank may merge in order to get a substantive and focused core of deposit so that it can be insured by FDIC on 100 percent of its deposits. Another opposing view is the hypothesis of scale economies created by focusing merger (same geographic area and same activity) mentioned above.
Factors Weaken Bank Merger's Value Effects
According to the literature, some factors which is not motivated by maximizing the shareholder and firm's value influence the value creation of bank mergers. Managerial hubris and government regulatory are the most commonly mentioned ones. Besides, stock market inefficiency arouses controversy for measurement of real merger gains.
Managerial Hubris and Corporate Control Problems
There are many studies doubting for the value effect of bank mergers. They point out that one reason for the failure of bank mergers in creating acquiring bank shareholders' wealth is the managerial hubris or corporate control problems. Calomiris and Karceski (1998) and Ryan (1999) demonstrate that managements are sometimes not motivated by maximizing shareholder's wealth. Gorton and Rosen (1995) explain that those mergers are primarily driven by empire building because managers tend to receive higher executive compensation with increase in firm size.
Poor corporate control will have some impact on the merger results. Berger (1995) argues that managers incline to reduce insolvency risk and neglect the decrease in shareholder utility in order to protect firm's human capital. Houston et al.(2001) argue that reluctance to lay off staff eliminates large effects of cost reduction.
For the target bank side, Hadlock et al. (1999) demonstrate that the bank managers who hold large share of stock may be reluctant to be acquired, which in consequence eliminates the potential of value maximization by mergers.
The role of government
The government's impact on bank merger decisions has been discussed a lot by the literature. Sushka and Bendeck (1987)
From one hand, Houston et al.(2001)mention that government may impose the geographic and product market restrictions which are believed to be a obstacle of improving bank efficiency and performance
On the other hand, as Berger et al.(1999)demonstrate, the government may design policies to prevent the anti-competitive effects of mergers which result from excessive increase of market power. Moreover, those actions also aim to prevent the abuse of "too large to fail" policy and limit government's liability.
stock market inefficiency
Many literatures use stock price gains concerning the announcement of merger to measure benefits from bank mergers. However, this method is not an entirely accurate barometer for the value creation. Healy et al.(1991) explain that it is difficult to determine whether the gains are from stock market inefficiency or real economic performance improvements. Cornett and Tehranian (1991) support this view and outline that if one bank take advantage of this inefficiency, it can earn profits from bidding the undervalued bank. They define these gains have nothing to do with performance improvement and may happen without merger.
Methodology
From reviewing the literature on bank mergers, the basic two methods for analyzing the gains from merger is examining operating performance through past accounting data and stock market reaction by event study methodology. Some researches also use both of the two approaches to reduce potential biases.
Event Studies Methodology
Event studies methodology is a gains measurement focusing on the stock market return to the acquirers, targets or combined entity' stockholders within a period of time before and after the merger announcement. It is first widely used by bank merger studies in 1980s (Rhoades ,1994). Many studies use a standard market model to calculate abnormal returns and cumulated abnormal returns associated with merger announcement ( see Neely, 1987; Desai and Stover ,1985; De and Duplichan, 1987) Some studies use models derived from the standard market model , for example log-transformed standard model( see Lobue,1984 ), "mean-adjusted returns" model (see Sushka and Bendeck ,1988), and two-factor model (see Cox and Portes ,1998).
In order to find out the relationship between merger gains with other factors researchers interested in, like firm size, pre-performance of targets and acquirers, whether the merger is diversified, DeLong(2001) combines the Event studies methodology with cross sectional analysis to conduct a multi-regression function, analyzing all the factors affecting stock returns associated with mergers. Some recent studies follow this method (see Gupta and Misra, 2007)
Event methodology arouses controversy on the accuracy of analyzing the actual gains from bank mergers.
Some studies analyze the acquiring and acquired bank as a whole(Cornett, et.al,2006), some studies analyze acquires and targets separately, or combined the above two analysis together(e.g.Spong and Shoenhair,1992)
Operating performance methodology
From early 1990s, most studies focus on using operating performance methodology, which shows a growing concern with cost reduction and efficiency in the banking industry (Rhoades ,1994). Part of the OP studies observe the changes in profit ratios and cost ratios before and after merger(e.g. Rhoades,1986) while other studies (see Spindt and Tarhan, 1991; Chamberlain, 1992;)use a pair-match approach where those performance ratios of merging banks are compared to a control group of non merging banks.
Besides simple cost and profit ratios, subsequent studies add other ratios to do more specific and accurate analysis on the issue of bank merger gains. Berger and Humphrey(1992) believe that analysis using only simple cost and revenue ratios without the control of other cost-affecting factors can lead to biases, hence they add product mix and input prices. Peristiani(1997) supports this view and also add bank outputs(loans, retail and saving deposits) into the function. Other studies also add several other measures like operating cash flows (Healy et al.,1992) and net income from investments in marketable securities(Cornett, Tehranian,1991)
Operating performance methodology is carried out in different statistic tests. Early studies use univariate t test to compare the cost and revenue ratios between acquiring banks, acquired banks and non-merging banks (e.g. Rose, 1987) .In order to do deeper research on the causes of merger gains, more recent studies (see DeYoung, 1993; Akhavein,et.al,1997) use multiple regression to see whether the gains in performance result from the mergers and to which level merger gains are influenced by factors mentioned in the hypothesis
Empirical literature review
There are two traditional measurement used to evaluate the gains from merger. One is
There are two kinds of diversification, geographical and product/service diversification.
Cost reduction is the most frequently mentioned cause of performance improvement in the literature. Clark(1988) demonstrates that mergers can generate scale economies, when average costs decline as the business expands, that is, distributing overhead of one bank via two previously separate banks activities. DeYoung (1993) makes a point that cost reduction can be achieved by closing the redundant bank branches, eliminating the duplicate managerial positions and vacating overlapping headquarter facilities. Meanwhile, Pilloff and Santomero(1998) demonstrate that cost efficiency can be enhanced when the acquiring bank transfer a higher level of management skill on reducing expenses to the target one.
Operating performance methodology
From early 1990s, most studies focus on using operating performance methodology, which shows a growing concern with cost reduction and efficiency in the banking industry (Rhoades ,1994). Part of the OP studies observe the changes in profit ratios and cost ratios before and after merger(e.g. Rhoades,1986) while other studies (see Spindt and Tarhan, 1991; Chamberlain, 1992;)use a pair-match approach where those performance ratios of merging banks are compared to a control group of non merging banks.
Besides simple cost and profit ratios, subsequent studies add other ratios to do more specific and accurate analysis on the issue of bank merger gains. Berger and Humphrey(1992) believe that analysis using only simple cost and revenue ratios without the control of other cost-affecting factors can lead to biases, hence they add product mix and input prices. Peristiani(1997) supports this view and also add bank outputs(loans, retail and saving deposits) into the function. Other studies also add several other measures like operating cash flows (Healy et al.,1992) and net income from investments in marketable securities(Cornett, Tehranian,1991)
Operating performance methodology is carried out in different statistic tests. Early studies use univariate t test to compare the cost and revenue ratios between acquiring banks , acquired banks and non-merging banks(e.g. Rose, 1987) .In order to do deeper research on the causes of merger gains, more recent studies (see DeYoung, 1993; Akhavein,et.al,1997) use multiple regression to see whether the gains in performance result from the mergers and to which level merger gains are influenced by factors mentioned in the hypothesis
Sample collection related issue
One issue for sample collection is the selection of sample coverage when applying Operating Performance methodology. First, it varies from one case study (see Crane and Linder,1993) to thousands cases(e.g. Peristiani, 1993b). Some studies' samples focus on a certain small geographic region (e.g. Crane and Linder, 1992) while some studies cover nationwide samples (see Srinivasan and Wall, 1992).
Why do bank mergers? Are bank mergers profitable? Where do the gains come from? These three questions are
There is a wide spectrum of opinions on the cause of the value creation, like
In addition, stock market inefficiency may cause biases on the measurement of actual merger gains (Cornett, Tehranian,1991).
closing the redundant bank branches, eliminating the duplicate managerial positions and vacating overlapping headquarter facilities.
Value maximizing driven causes
According to Rhoades (1994)'s review on the approaches used in 1980-1993 period (the burgeoning period of bank merger performance studies),
investigate in bank mergers' value effects based on these two fundamental methodologies and also make some improvement and expansion.
Event methodology studies have variations in event window period.
