The equity duration of South African growth companies : a theoretical and empirical evaluation

[摘要] ENGLISH ABSTRACT:This assignment sets out to address the concept of equity duration, where equity duration isviewed as a measure of the interest rate sensitivity of common stock's market value. Thetraditional use of standard dividend discount models, results in extremely long durationestimates for equities - in the order of 10 years for income stocks to 25 years and more forgrowth companies whose cash flows are not expected to materialize until some future period.Leibowitz (1986) identified an alternative approach for assessing equity duration empirically.These empirical estimates of actual stock price sensitivity to underlying changes in interestrates imply that equities behave as if they are much shorter duration instruments.Various attempts have been made to reconcile the difference between theoretical predictionsof equity duration and empirical findings. The differences in duration of assets in place andgrowth opportunities are given as a possible reason for the above mentioned differences. It isargued that investment opportunities are similar to options a company has. These option-likecharacteristics of growth opportunities may alter the basic relationship between equityvaluation and interest rate changes.The option framework suggests that the duration of growth companies may be shorter (notlonger) than those of assets in place. The results from option theory can however not beapplied directly to growth options, since some of the assumptions may not be valid in thecase of growth options. The presence of these growth options makes it virtually impossibleto calculate equity duration theoretically.This study empirically tests the relationship between growth opportunities and equityduration by focussing the attention on the interest rate sensitivity of South African growthcompanies.The following hypotheses regarding equity duration and growth companies are postulated:• There is a significant difference in interest rate sensitivity between growth companies andlow-growth companies.• There is a significant difference between duration of growth companies measured usingnominal interest rates and duration of growth companies using real interest rates. All non-mining companies on the Johannesburg Securities Exchange SA, for the period 1980to 2000, were analysed. These companies were sorted into different portfolios that reflectedtheir growth opportunities. Market capitalisation, book-to-market and price-earnings ratioswere used as proxies to rank companies according to growth opportunities.The results from univariate regressions suggest positive duration for common equities. Thenegative relationship between equity returns and changes in nominal interest rates areindependent of size, book-to-market or price-earnings ratios of the sampled companies.Including the market factor as an independent variable results in markedly different equityduration. The duration is correlated with size, as both coefficients and t-statistics increasewhen moving from small companies to larger companies. In addition, the small companieshave negative not positive duration, as was the case for simple univariate regressions.There is also some evidence that high growth portfolios, as measured by low book-to-marketand high price-earnings ratios, are less sensitive to interest rate changes than low growthportfolios.Employing all three Fama and French's factors, there is no longer a cross-sectionaldependence on company size, with the mean duration being close to zero and statisticallyinsignificant in virtually all cases. Also, when dividing changes in the nominal interest rateinto changes in real rates and changes in inflation, it does not significantly affect theestimates of equity duration.The author found no evidence to support the stated hypotheses, when employing the Famaand French's three factor model. This may mean that the relationships are subsumed in theFama and French risk factors.

[发布机构] Stellenbosch University