Great credit risk is a big headache which blocks the development of the banking sector of China. Based on the panel data of the Chinese banking sector from 2002 to 2006, this paper empirically examines the effects of foreign strategic investors’ participation on the risk behavior of Chinese banks. The results show that foreign strategic investors (FSI) had a positive, but limited impact on the credit risk of Chinese banks. Further analysis reveals that the risk management abilities of Chinese banks have improved apparently when the proportion of shareholding of the leading foreign strategic investors exceeds 15 percent, which results in a significant drop of the credit risk. However, due to the ‘minority ownership’ restriction on foreign investors' stock shares, the positive effect of the participation of foreign strategic investors is limited. The visible decline in both non-performing loans (NPLs) and the NPL ratio of Chinese banks mainly reflects the rapid growth of China's economy and benefits a lot from the massive financial restructuring of state-owned banks.

Chinese banks generate large profits and have relatively low nonperforming loans. However, good financial performance does not, in itself, guarantee that banks efficiently intermediate the economy’s financial resources. This paper first examines how efficient Chinese banks are in financial intermediation, using the stochastic production frontier approach. Quality of loans are controlled for by focusing on net loans and correcting for nonperforming loans; Hong Kong SAR banks are included in the sample to have a more universally representative production frontier. The results suggest that Chinese banks indeed became more efficient during 2001–07. Nevertheless, a majority of banks remain quite inefficient, including several large state owned banks and many city banks. Large banks tend to hoard deposits and operate beyond the point of diminishing returns to scale, while smaller banks operate at increasing returns to scale. This suggests that reallocating deposits from large to smaller banks would increase overall efficiency. The paper finds no significant correlation between bank efficiency and profitability. Possible factors leading to large profits in the banking system, despite wide-spread inefficiencies, are low deposit interest rates, large interest margins, and high market concentration. Moving to indirect monetary policy and deepening capital markets to channel some of the savings to productive investment would help improve the efficiency of financial intermediation. This may spur loan growth, however, which will need to be handled with monetary policy and regulatory/supervisory tools.

What might interest rate liberalization do to intermediation and the cost of capital in China? China’s most binding interest rate control is a ceiling on the deposit rate, although lending rates are also regulated. Through case studies and model-based simulations, we find that liberalization will likely result in higher interest rates, discourage marginal investment, improve the effectiveness of intermediation and monetary transmission, and enhance the financial access of underserved sectors. This can occur without any major disruption. International experience suggests, however, that achieving these benefits without unnecessary instability, requires vigilant supervision, governance, and monetary policy, and a flexible policy toolkit.

Early-stage ?rms usually have a single large Research and Development (R&D) project that requires multi-stage investment. Firms? volatility can dramatically change due to the evolvement of R&D e¤orts and stage clearing. First, the success (failure) of R&D e¤orts within each stage (jump risk) decreases (increases) the un- certainty (i.e. volatility) level of the ?rms?future returns ?"jump e¤ect". Second, at the end of each stage, ?rms decide whether to continue next stage investment upon re-evaluating the project prospect conditional on the resolution of technical uncertainty and other information; as ?rms survive each investment stage and are becoming mature, the uncertainty level of their future returns should eventually decrease in later investment stages that lead to maturity ?"stage-clearing e¤ect". Ignoring these e¤ects results in incorrect estimation of ?rms?future volatility, an important element for early-stage ?rm valuation. In this paper, I develop a gener- alized Markov-Switching EARCH methodology for early-stage ?rms with discrete stage-clearing and jumps. My methodology can identify structural changes in the idiosyncratic volatility and also explore the relation between price changes and future volatility. Using a hand-collected dataset of early-stage biotech ?rms, I con?rmed the existence of the "stage-clearing e¤ect" and the "jump e¤ect". In the second part of my paper, I model early-stage ?rms as sequences of nested call options with jumps that lead to mature ?rms. "Jump e¤ect" arises because the early-stage ?rms are modeled as compound call options with jumps on the underly- ing cash ?ows, the volatility of the early-stage ?rms at each stage is determined by the compound call option elasticity to the underlying cash ?ows. If the downside (upside) jump happens, the value of the underlying cash ?ows decreases (increases), which makes the compound call option elasticity go up (down). As a result, the compound call option becomes riskier (less risky). "Stage-clearing e¤ect" arises because as ?rms exercise their option to continue investment, the new options that ?rms enter into will eventually become a less risky option.

Theoretical models predict that the value of a real option should be increasing in the volatility of the underlying asset. Thus, if real options are economically important, then firm values should be positively related to volatility. Consistent with this prediction, we find evidence that stock returns are contemporaneously positively correlated with changes in volatility. Moreover, this positive relation is stronger for firms that are more likely to have more real options and for firms with more irreversible investment opportunities. Most importantly, we find that the sensitivity of firm values to changes in volatility declines significantly after firms exercise their real options. These results indicate that real options constitute an economically meaningful component of firm values.

We find that firms that timed their external financing more in the past (i.e., that issued more capital when market conditions were good) have a lower expected cost of equity than those that timed their issuance less. This result is economically significant, and holds for numerous specifications. The benefits of market-timing activity are more pronounced for equity than for debt. These findings are consistent with the hypothesis that the gains from future market-timing activity are priced by current investors, and suggest that investors in the secondary market believe in the ability of firms to successfully time the market. We also find that the benefits of timing activity are enhanced for firms with a higher fraction of shares held by dedicated long-term investors, and are reduced for firms with shareholders that are more likely to time their own trades.

In this paper we use the new developed Markov Switching Unit Root test to examine the status of real and financial integration of China, Japan, the European Union, and the United States based on the empirical validity of real interest parity, uncovered interest parity, and relative purchasing power parity. We found strong evidence in favour of those parity conditions and hence concluded that real and financial integration between China and other four countries was well established.

Abstract This paper deals with constructing Finite Dimensional Realization (FDR) of HJM with time-invariant hump shape volatility by applying Linear Realization Theory. Two realization algorithms, Standard Observable Canonical Realization and Jordan Canonical Realization, are introduced. The equivalence between Jordan Canonical Realization algorithm and commonly adopted method of constructing FDR is shown by concrete example. At the same time, simulation results indicate that Standard Observable Canonical Realization is better choice for constructing FDR than Jordan Canonical Realization in terms of more precisely capturing the state variables.

Dynamic allocation of control rights between managers and investors affects policy of the dividend and value of enterprise. The paper studied the relevant factors that affect optimal debt ratio and allocation of control right. We suggest that the enterprise decrease the debt ratio with the increase of moral hazard, liquidity risk and investors’ absolute risk aversion. With the increase of shareholder’s control right, the relationship between shareholder’s control right and managers’ moral hazard is reversed from positive to negative. The implication of the paper is moderate debt ratio may achieve the tough constraint on the managers’ decision.

Using a sample of listed subsidiaries and their parent companies in China, I study top executive compensation and turnover and their relationship to firm performance in business groups in China. The empirical results support the hypothesis that the pay-performance sensitivity of managerial compensation (CEO turnover) in a listed firm is positively (negatively) related to the accounting performance of its parent company. Using related party transactions to proxy for the correlation between the two firms, I find that management compensation in a listed firm is related to the performance of its parent company if related party transactions exist between them. In addition, I find a stronger relationship between the compensation (turnover) in a listed subsidiary and the performance of its parent company when the percentage of common directors and managers are less than median level. This result indicates that the incentive system can be used to align the interests of managers in the listed firm with that of its parent company when the information asymmetry is high and the parent company can not effectively monitor. Using brand name as a proxy for reputation, I find that management compensation and CEO turnover in group firms are more likely to be sensitive to the performance measures in their parent companies if both use the same brand name.