order splitting with multiple capacitated suppliers this paper studies an integrated decision making model for a supply chain system where a manufacturer faces a price sensitive demand and multiple capacitated suppliers two issues that are often considered separately in the literature the goal is to maximize total profit by determining an optimal selling price and at the same time acquiring enough supplying capacity the problem is proved to be np hard in the ordinary sense a heuristic algorithm and an optimal dynamic programming algorithm are developed computational experiments are conducted to study the efficiency and effectiveness of the algorithms some managerial insights are observed

a theory of corporate financial decisions with liquidity and solvency concerns this paper studies the impact of both liquidity and solvency concerns on corporate finance i present a tractable model of a firm that optimally chooses capital structure cash holdings dividends and default while facing cash flows with long term uncertainty and short term liquidity shocks the model explains how changes in solvency affect liquidity and also how liquidity concerns affect solvency via capital structure choice these interactions result in a dynamic cash policy in which cash reserves increase in profitability and are positively correlated with cash flows the optimal dividend distributions implied by the model are smoothed relative to cash flows i also find that liquidity concerns lead to a decrease of dispersion of credit spreads

monitoring liquidation and security design by identifying the possibility of imposing a credible threat of liquidation as the key role of informed bank finance in a moral hazard context we characterize the circumstances under which a mixture of informed and uninformed market finance is optimal and explain why bank debt is typically secured senior and tightly held we also show that the effectiveness of mixed finance may be impaired by the possibility of collusion between the firms and their informed lenders and that in the optimal renegotiation proof contract informed debt capacity will be exhausted before appealing to supplementary uninformed finance article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

why is bank debt senior a theory of asymmetry and claim priority based on influence costs this theory can explain why bank debt is universally senior consistent with the presence of conflict lawyers and absolute priority violations in financial distress better organized banks would more strongly contest priority in financial distress if they were junior because deterrence can reduce creditors total expenses in a priority contest the ex post stronger lobbyist litigant should be senior ex ante for equivalent reasons the theory can advise when public debt should be senior to trade credit and or implicit contracts and can even suggest one rationale for the absolute priority rule apr this article further shows that chapter hi creditor reimbursement procedures can lower overall costs article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

an asset allocation puzzle comment should the proportion of risky assets in the risky part of an investor s portfolio depend on the investor s risk aversion according to basic financial theory in particular the mutual fund separation theorem with a riskless asset the answer is no the theorem states that rational investors should divide their assets between a riskless asset and a risky mutual fund the composition of which is the same for all investors risk aversion affects only the allocation between the riskless asset and the fund however niko canner et al 1997 cmw hereafter observed that popular investment advice does not conform to this theory they reported the stocks bonds and cash allocations recommended by four advisors for conservative moderate and aggressive investors as shown in table 1 which is reproduced from cmw the advisors recommend a bond stock ratio that varies directly with risk aversion for example fidelity recommends a bond stock ratio of 1 50 for a conservative more riskaverse investor a ratio of 1 00 for a moderate less risk averse investor and a ratio of 0 46 for an aggressive still less risk averse investor the inconsistency between such advice and the separation theorem is called an asset allocation puzzle by cmw they attempted to solve the puzzle by relaxing key assumptions in the theory but finally reached a negative conclusion although we cannot rule out the possibility that popular advice is consistent with some model of rational behavior we have so far been unable to find such a model p 181 however they suggested that consideration of intertemporal trading might help resolve the puzzle in the present paper we provide theoretical support for the popular advice the two key insights are that the investor s horizon may exceed the maturity of the cash asset and that the investor rebalances the portfolio as time passes if the investor s horizon exceeds the maturity of cash which might be a money market security with maturity of one to six months then cash is not the riskless asset as is commonly assumed in the basic theory in a theory allowing portfolio rebalancing as opposed to a buy and hold framework it is not unreasonable to assume that the investor can synthesize a riskless asset a zero coupon bond maturing at the horizon using a bond fund and cash then bonds will be both in the synthetic riskless asset and in the risky mutual fund and we show that in this case the theoretical bond stock ratio varies directly with risk aversion for any hyperbolic absolute risk aversion hara investor as an example of the type of results that a specific model can produce we provide a continuous time model with closed form solutions which produces theoretical bond stock ratios similar to the popular advice the present paper is organized as follows in the next section we analyze the popular advice in terms of the theory of mutual fund separation of david cass and joseph e stiglitz 1970 we show that this theory is relevant both in static and dynamic frameworks and use it to analyze the popular advice in complete and incomplete markets in section ii we analyze the popular advice in the context of robert c merton s 1971 continuous time statement of mutualfund separation and present an illustrative model in which a crra investor makes continuous time portfolio decisions under interest rate and stock price uncertainty in section iii numerical results are compared with the popular advice section iv is a conclusion bajeux besnainou department of finance school of business and public management george washington university 2023 g street nw washington dc 20052 jordan national economic research associates 1255 23rd street nw washington dc 20037 portait cnam and essec finance chair cnam 2 rue conte paris france this research was supported by a grant from the institute for quantitative investment research we thank two anonymous referees for their comments 1 hara functions include quadratic utility which is one way of justifying mean variance preferences and constant relative risk aversion crra utility both quadratic and crra utility were considered in the cmw analysis

base stock policies for production inventory problems with uncertain capacity levels abstract in this paper we consider a single item stochastic demand production inventory problem where the maximum amount that can be produced or ordered in any given period is assumed to be uncertain inventory levels are reviewed periodically the system operates under a stationary modified base stock policy the intent of our paper is to present a procedure for computing the optimal base stocl level of this policy under expected average cost per period criterion this procedure would provide guidance as to the appropriate amount of capacity to store in the form of inventory in the face of stochastic demand and uncertain capacity in achieving this goal our main contribution is to establish the analogy between the class of base stock production inventory policies that operate under demand capacity uncertainty and the g g 1 queues and their associated random walks we also present example derivations for some important capacity distributions

can the trade off theory explain debt structure we examine the optimal mixture and priority structure of bank and market debt using a tradeoff model where banks have the unique ability to renegotiate outside formal bankruptcy flexible bank debt offers a superior tradeoff between tax shields and bankruptcy costs ease of renegotiation limits bank debt capacity however optimal debt structure hinges upon which party has bargaining power in private workouts weak firms have high bank debt capacity and utilize bank debt exclusively strong firms lever up to their lower bank debt capacity augment with market debt and place the bank senior therefore the tradeoff theory offers an explanation for i why young small firms use bank debt exclusively ii why large mature firms employ mixed debt financing and iii why bank debt is senior the tradeoff theory also generates predictions consistent with international evidence in countries where the bankruptcy regime entails soft tough enforcement of contractual priority bank debt capacity is low high implying greater less reliance on market debt

uncertain dynamics correlation effects and robust investment decisions abstract we analyze a firm s investment problem when the dynamics of project value and investment cost are uncertain we provide an explicit solution using a robust method for an ambiguity averse firm taking this into account ambiguity aversion regarding a common risk factor impacts differently than ambiguity aversion regarding investment cost residual risk correlation between project value and investment cost matters ambiguity aversion regarding common risk can decrease the investment probability only if correlation is positive ambiguity aversion regarding residual risk always increases the investment probability when only project value is risky volatility can monotonically decrease the investment threshold this does not hold with the multiple prior method

temporary versus permanent shocks explaining corporate financial policies we investigate corporate financial policies in the presence of both temporary and permanent shocks to firms cash flows in our framework cash flows can be negative and are imperfectly correlated with firm value and earnings volatility differs from asset volatility these results are consistent with empirical stylized facts they are also contrary to the implications of existing dynamic capital structure models that allow only for permanent shocks to cash flows temporary shocks increase the importance of financial flexibility and may provide an intuitively simple and realistic explanation of empirically observed financial conservatism and low leverage phenomena the theoretical framework developed in this article general enough to be used in various corporate finance applications jel g12 g32 g33

the valuation of floating rate instruments abstract a framework for valuing floating rate notes is developed to examine the effects of 1 lags in the coupon formula 2 special contractual features and 3 default risk evidence from a sample of floaters indicates they sold at significant discounts while lags in the coupon formulas and other contractual features make these notes more variable they do not account for the magnitude of the discounts we conclude that the fixed default premium in the coupon formula of a typical note is inadequate to compensate for time varying default premiums demanded by investors who treat other corporate short term paper as close substitutes

a periodic review production planning model with uncertain capacity and uncertain demand optimality of extended myopic policies increasing product complexity manufacturing environment complexity and an increased emphasis on product quality are all factors leading to uncertainties in production processes these uncertainties are in the form of unplanned machine maintenance varying production yields and rework among others in planning for production an adequate model must incorporate these uncertainties into the representation of the production process this paper treats the aggregate planning problem for a single product with random demand and random capacity in the single period problem random capacity does not affect the optimal policy but results in a unimodal nonconvex cost function in the multiple period and infinite horizon settings order up to policies that are dependent on the distribution of capacity are shown to be optimal in spite of a nonconvex cost in the infinite horizon setting an intuitive description of the situation leads to the notion of a class of extended myopic policies requiring the consideration o

optimal financial policy and firm valuation since the classic work of miller and modigliani 1961 laid down the principles for the valuation of firms under conditions of certainty some two decades ago academic interest in the problem of valuing the individual firm has waned yet in addition to the obvious importance of this problem for security analysts investors and acquirers of corporations the issue of firm valuation is fundamental to much of the theory of corporate finance what determines the risk of the firm how the rate of return required by investors may be inferred from capital market data the influence of financing policy on firm value and other issues of central concern to the theory of financial management this almost total neglect of firm valuation is attributable perhaps to the overwhelming influence of the research programme initiated by the development of the capital asset pricing model only three years after the publication of the above mentioned paper by miller and modigliani in its primary form the capital asset pricing model is a statement about the equilibrium rates of return on securities rather than about the equilibrium values of securities it is straightforward to transform the model into a statement about the dependence of current equilibrium values upon an exogenously specified distribution of end of period values however in this form the model is inherently unsatisfactory since it fails to take account of the fact that in reality the distribution of end of period firm values is not exogenously given but is determined as part of a subsequent capital market equilibrium attempts to iterate the single period capital asset pricing model over several periods in order to avoid the need to take the distribution future security values as exogenous have been unsuccessful for the most part since not being able to derive they have been forced to assume both the requisite normality of the distribution of subsequent security prices and the legitimacy of ignoring endogenously determined shifts in the individual investor s investment

the structure of periodic review policies in the presence of random yield this work provides a comprehensive analysis of a general periodic review production inventory model with random variable yield existence of an order point whose value does not depend on yield being random is proved in the single period case without specifying the yield model and using a very general cost structure when yield is a random multiple of lot size the nonorder up to optimal policy is characterized for a finite horizon model the finite horizon value functions are shown to converge to the solution of an infinite horizon functional equation and the infinite horizon order point is shown to be no smaller than when yield is certain

an equilibrium model of bond pricing and a test of market efficiency in two previous and related papers 3 4 the authors have reported the results of estimating a particular equilibrium model of bond pricing using quarterly data on canadian government bonds for the period 1964 to 1979 this paper reports the results of applying a similar model to the pricing of u s government bonds for the period 1958 1979 using data from the crsp government bond file the paper also extends the previous empirical analysis by evaluating the ability of the pricing model to detect underpriced and overpriced bonds the data reveal a strong relation between price prediction errors and subsequent bond returns

bond ladders and optimal portfolios we analyze complex bond portfolios within the framework of a dynamic general equilibrium asset pricing model equilibrium bond portfolios are nonsensical and imply a trading volume that vastly exceeds observed trading volume on financial markets instead portfolios that combine bond ladders with a market portfolio of equity assets are nearly optimal investment strategies the welfare loss of these simple investment strategies when compared to the equilibrium portfolio converges to zero as the length of the bond ladder increases this article therefore provides a rationale for naming bond ladders as a popular bond investment strategy

term premiums in bond returns abstract this paper examines expected returns on u s treasury bills and on u s government bond portfolios expected bill returns are estimated from forward rates and from sample average returns both estimation methods indicate that expected returns on bills tend to peak at eight or nine months and never increase monotonically out to twelve months reliable inferences are limited to treasury bills and thus to maturities up to a year the variability of longer term bond returns preempts precise conclusions about their expected returns

bank information monopolies and the mix of private and public debt claims this article examines the determinants of the mix of private and public debt using detailed information on the debt structure of 250 publicly traded corporations from 1980 through 1990 we find that the relationship between bank borrowing and the importance of growth opportunities depends on the number of banks the firm uses and whether the firm has public debt outstanding for firms with a single bank relationship the reliance on bank debt is negatively related to the importance of growth opportunities in contrast among firms borrowing from multiple banks the relationship is positive

entrepreneurial finance and nondiversifiable risk w e develop a dynamic incomplete markets model of entrepreneurial firms and demonstrate the implications of nondiversifiable risks for entrepreneurs interdependent consumption portfolio allocation financing investment and business exit decisions we characterize the optimal capital structure via a generalized tradeoff model where risky debt provides significant diversification benefits nondiversifiable risks have several important implications more risk averse entrepreneurs default earlier but choose higher leverage lack of diversification causes entrepreneurial firms to underinvest relative to public firms and risky debt partially alleviates this problem and entrepreneurial risk aversion can overturn the risk shifting incentives induced by risky debt we also analytically characterize the idiosyncratic risk premium jel g11 g31 e20

an empirical investigation of u s firms in reorganization the purpose of this paper is to understand the institutional features of chapter 11 from an empirical examination of thirty firms that have emerged from reorganization we find the recontracting framework of chapter 11 to be complex lengthy and costly violations of absolute priority in favor of stockholders are frequently encountered these deviations may result from the bargaining process of chapter 11 or from a recontracting process between creditors and stockholders which recognizes the ability of stockholder oriented management to preserve firm value an example of such recontracting addresses myers underinvestment problem an investigation of the effects of chapter 11 on the pricing of risky debt is also provided the purpose of this paper is to understand the institutional features of chapter

optimal capital structure and bankruptcy choice dynamic bargaining versus liquidation abstract we model a firm s optimal capital structure decision in a framework in which it may later choose to enter either chapter 11 reorganization or chapter 7 liquidation creditors anticipate equityholders ex post reorganization incentives and price them into the ex ante credit spreads using a realistic dynamic bargaining model of reorganization we show that the off equilibrium threat of costly renegotiation can lead to lower leverage even with liquidation in equilibrium if reorganization is less efficient than liquidation the added option of reorganization can actually make equityholders worse off ex ante even when they liquidate on the equilibrium path

inventory control with markovian capacity and the option of order rejection we consider a stochastic inventory control problem with markovian capacity and the option of order rejection we show its optimal policy to be the combination of a capacity dependent modified base stock production policy and a capacity dependent critical point order acceptance policy when capacity is stochastically monotone we show that the policy parameters change over the current capacity level in an intuitive way all these results can be extended to the infinite horizon case with or without cost discounting our computational study substantiates the benefits from both exploiting the markovian behavior of the capacity and rejecting orders when necessary

the effect of capital structure on a firm s liquidation decision abstract a firm s liquidation can impose costs on its customers workers and suppliers an agency relationship between these individuals and the firm exists in that the liquidation decision controlled by the firm as the agent affects other individuals the customers workers and suppliers as principals the analysis in this paper suggests that capital structure can control the incentive conflict problem of this relationship by serving as a pre positioning or bonding mechanism appropriate selection of capital structure assures that incentives are aligned so that the firm implements the ex ante value maximizing liquidation policy

a non stationary periodic review production inventory model with uncertain production capacity and uncertain demand abstract in this paper we consider a nonstationary periodic review dynamic production inventory model with uncertain production capacity and uncertain demand the maximum production capacity varies stochastically it is known that order up to or base stock critical number policies are optimal for both finite horizon problems and infinite horizon problems we obtain upper and lower bounds of the optimal order up to levels and show that for an infinite horizon problem the upper and the lower bounds of the optimal order up to levels for the finite horizon counterparts converge as the planning horizons considered get longer furthermore under mild conditions the differences between the upper and the lower bounds converge exponentially to zero

high and volatile real interest rates where does the fed fit in the federal reserve s new procedures for the conduct of monetary policy introduced on october 6 1979 have been the subject not only of considerable academic and political interest but also of intense debate b friedman 1982 roley 1982 walsh 1982 1984 mascaro and meltzer 1983 among others the fed s new operating procedures generally are perceived to have resulted in abnormally high and volatile real interest rates and thus to have contributed to if not been totally responsible for the deepest recession in postwar history in this paper we address the following question was the advent of the increased volatility and level of the real rate of interest concurrent with the fed s october 1979 change in operating procedures that is was the real rate of interest high and more volatile immediately after the october 1979 change in policy procedures in which case we might infer a connection between the fed s change in policy procedures and the increased volatility and level of the real rate or did the real rate become high and more volatile some time following the policy change which might lead us to conclude that the increased volatility and the increased level of the real rate was connected to some other event s occurring after the october 1979 policy change

the empirical implications of the cox ingersoll ross theory of the term structure of interest rates the one factor version of the cox ingersoll and ross model of the term structure is estimated using monthly quotes on u s treasury issues trading from 1952 through 1983 using data from a single yield curve it is possible to estimate implied short and long term zero coupon rates and the implied variance of changes in short rates analysis of residuals points to a probable neglected tax effect the term structure of interest rates is important to economists because the relationship among the yields on default free securities that differ in their term to maturity reflects the information available to the market about the future course of events the expectations hypothesis the liquidity preference hypothesis hicks 10 and the market segmentation hypothesis culbertson 6 are theories of the term structure that predict little more than that the implied forward rate is either equal to or not equal to the expectation of future spot rates cox ingersoll and ross 5 cir model the term structure of interest rates in a competitive equilibrium context their model has elements in common with the earlier hypotheses of the term structure however the cir model has a rich class of empirical implications not only for the pricing of default free securities but also for the pricing of bond options callable bonds and other types of financial claims this paper examines the extent to which the model in its simplest one factor form is descriptive of the prices of u s treasury bills bonds and notes traded from 1952 to 1983 section i describes the model and the parsimonious representation of bond prices which it implies section ii describes the data and section iii outlines the preliminary results obtained by fitting the model to observed data the final section outlines directions for future research

inventory control in a fluctuating demand environment we present an inventory model where the demand rate varies with an underlying state of the world variable this variable can represent economic fluctuations or stages in the product life cycle for example we derive some basic characteristics of optimal policies and develop algorithms for computing them in addition we show that certain monotonicity patterns in the problem data are reflected in the optimal policies

the asset allocation puzzle is still a puzzle abstract intertemporal hedging activity has been advocated as being the solution to the asset allocation puzzle a standing assumption made in the dynamic asset allocation literature is that one or several bonds can perfectly hedge the interest rate risk and related market price of risk in the economy in a multi asset world ceteris paribus such an assumption biases the portfolio allocation of a non myopic investor towards bonds we extend the literature to allow for an incomplete bond market when solving for the optimal portfolio choice of a rational investor it is shown that investors with a high level of risk aversion could invest more in stocks than in bonds

an empirical analysis of the determinants of corporate debt ownership structure i examine the relation between corporate debt ownership structure and several firm characteristics suggested by recent theory the results demonstrate the importance of monitoring and information costs the likelihood and costs of inefficient liquidation and borrowers incentives in affecting firms debt source preferences several theoretical predictions receive support while others do not the results also suggest important differences between bank and private non bank debt which contrasts with most theoretical models additionally i find evidence of systematic use of bank debt by firms with access to public debt suggesting the benefits attributed to bank debt in theoretical models remain important after firms gain access to public debt markets although different lenders appear to have different maturity preferences the results also suggest debt maturity and debt ownership decisions may be separable

how big is the tax advantage to debt this paper uses an option valuation model of the firm to answer the question what magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios we incorporate into the model differential personal tax rates on capital gains and ordinary income we conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms when it is possible for the value of the underlying assets to jump discretely to zero differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms moreover if the tax advantage to debt is small the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt to firm value ratios the observed range of debt to firm value ratios in the u s economy is roughly speaking from zero to 60 percent traditional explanatory models of capital structure have focused on the tradeoff between the tax shield and bankruptcy costs arising from the use of debt finance 2 9 10 18 19 other

analysis of an inventory system under supply uncertainty in this paper we analyze a periodic review single item inventory model under supply uncertainty the objective is to minimize expected holding and backorder costs over a finite planning horizon under the supply constraints the uncertainty in supply is modeled using a three point probability mass function the supply is either completely available partially available or the supply is unavailable machine breakdowns shortages in the capacity of the supplier strikes etc are possible causes of uncertainty in supply we demonstrate various properties of the expected cost function and show the optimality of order up to type policies using a stochastic dynamic programming formulation under the assumption of a bernoulli type supply process in which the supply is either completely available or unavailable and when the demand is deterministic and dynamic we provide a newsboy like formula which explicitly characterizes the optimal order up to levels an algorithm is given that computes the optimal inventory levels over the planning horizon extensions and computational analysis are presented for the case where the partial supply availability has positive probability of occurrence

financial distress stock returns and the 1978 bankruptcy reform act we study distress risk premia around a bankruptcy reform that shifts bargaining power in financial distress from debtholders to shareholders we find that the reform reduces risk factor loadings and returns of distressed stocks the reform effect is stronger for firms with lower firm level shareholder bargaining power an increase in credit spreads of riskier relative to safer firms in particular for firms with lower firm level shareholder bargaining power confirms a shift in bargaining power from bondholders to shareholders out of sample tests reveal that a reversal of the reform s effect leads to a reversal of factor loadings and returns

asset sale debt restructuring and liquidation this paper considers a dynamic model in which shareholders of a firm in distress have a choice of whether the firm proceeds to debt restructuring or direct liquidation at an arbitrary time in the model we show the following results fewer asset sales lower financing debt renegotiation and running costs a lower premium to the debt holders a lower cash flow volatility and a higher initial coupon increase the shareholders incentive to choose debt restructuring to avoid full liquidation in the debt renegotiation process the shareholders arrange the coupon reduction and use equity financing to retire a part of the debt value to the debt holders the timing of debt restructuring always coincides with that of liquidation without debt renegotiation most notably the shareholders do not prefer asset sale in debt restructuring even if they face high financing costs the possibility of debt renegotiation in the future increases the initial leverage ratio in the optimal capital structure

optimal consumption and portfolio policies when asset prices follow a diffusion process abstract we consider a consumption portfolio problem in continuous time under uncertainty a martingale technique is employed to characterize optimal consumption portfolio policies when there exist nonnegativity constraints on consumption and on final wealth we also provide a way to compute and verify optimal policies our verification theorem for optimal policies involves a linear partial differential equation unlike the nonlinear partial differential equation of dynamic programming the relationship between our approach and dynamic programming is discussed we demonstrate our technique by explicitly computing optimal policies in a series of examples in particular we solve the optimal consumption portfolio problem for hyperbolic absolute risk aversion utility functions when the asset prices follow a geometric brownian motion the optimal policies in this case are no longer linear when nonnegativity constraints on consumption and on final wealth are included by these examples one can see that our approach is much easier than the dynamic programming approach

institutional investors and long term investment evidence from chile developing countries are trying to develop long term financial markets and institutional investors are expected to play a key role this paper uses unique evidence on the universe of institutional investors from the leading case of chile to study to what extent mutual funds pension funds and insurance companies hold and bid for long term instruments and which factors affect their choices the paper uses monthly asset level portfolios to show that despite the expectations mutual and pension funds invest mostly in short term assets relative to insurance companies the significant difference across maturity structures is not driven by the supply side of debt or tactical behavior instead it seems to be explained by manager incentives related to short run monitoring and the liability structure that combined with risk factors tilt portfolios toward short term instruments even when long term investing yields higher returns thus the expansion of large institutional investors does not necessarily imply longer term markets

capital structure and debt structure using a novel dataset that records individual debt issues on the balance sheets of public firms we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation relative to high credit quality firms lowcredit quality firms are more likely to have a multi tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non bank debt with loose covenants we discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts jel g32

an asset allocation puzzle this paper examines popular advice on portfolio allocation among cash bonds and stocks it documents that this advice is inconsistent with the mutual fund separation theorem which states that all investors should hold the same composition of risky assets in contrast to the theorem popular advisors recommend that aggressive investors hold a lower ratio of bonds to stocks than conservative investors the paper explores various possible explanations of this puzzle and finds them unsatisfactory copyright 1997 by american economic association

optimal priority structure capital structure and investment we study the interaction between financing and investment decisions in a dynamic model where the firm has multiple debt issues and equityholders choose the timing of investment jointly optimal capital and priority structures can virtually eliminate investment distortions because debt priority serves as a dynamically optimal contract examining the relative efficiency of priority rules observed in practice we develop several predictions about how firms adjust their priority structure in response to changes in leverage credit conditions and firm fundamentals notably financially unconstrained firms with few growth opportunities prefer senior debt while financially constrained firms with or without growth opportunities prefer junior debt moreover lower rated firms are predicted to spread priority across debt classes finally our analysis has a number of important implications for empirical capital structure research including the relations between market leverage book leverage and credit spreads and tobin s q the influence of firm fundamentals on the agency cost of debt and the conservative debt policy puzzle the author 2011 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

an investigation of cost differences between public sales and private placements of debt abstract we examine the cost differences between public sales and private placements of debt for a sample of public utility issues the lowest cost method depends on a firm s transaction costs which comprise flotation costs agency costs and the costs of searching the market our findings suggest that firms minimize the cost of issuing securities by selecting the market providing the lowest transaction costs

dynamic asset allocation in a mean variance framework the aim of this article is to analyze the portfolio strategies that are mean variance efficient when continuous rebalancing is allowed between the current date 0 and the horizon t under very general assumptions when a zero coupon bond of maturity t exists the dynamic efficient frontier is a straight line the slope of which is explicitly characterized every dynamic mean variance efficient strategy can be viewed as buy and hold combinations of two funds the zero coupon bond of maturity t and a continuously rebalanced portfolio an appropriate dynamic strategy defining the latter is explicitly derived for two particular price processes and comparisons of the efficient frontiers static versus dynamic are provided in these cases

zero leverage and the value in waiting to have debt abstract this paper documents that the real option to have debt motivates some firms to remain debt free even when standard trade off theory predicts that these firms should have leverage the real option has a first order effect similar to the effect of bankruptcy costs in addressing the zero leverage puzzle the observation that many firms seemingly forgo sizable debt benefits by remaining debt free the debt free firms value includes the option whose value is derived from future debt benefits and hedging bankruptcy costs this paper proposes an optimal timing model for having debt and finds support for the model s predictions through calibrations and simulations

bond and option pricing when short rates are lognormal this article describes a one factor model for bond and option pricing that is based on the short term interest rate and that allows the target rate mean reversion and local volatility to vary deterministically through time for any horizon the distribution of possible short rates is lognormal so the rate neither falls below zero nor reflects off a barrier at zero a model like this allows one to match the yield curve the volatility curve and the cap curve surprisingly adding to future local volatility lowers the volatility curve a conventional binary tree with probabilities of 0 5 but variable time spacing is used to value bonds and options when the inputs are constant the slope of the yield curve starts out positive and ends up negative while its curvature shifts from negative to positive even when mean reversion is zero the volatility curve has a negative slope the differential cap curve rises steeply through the effects of volatility and then falls steeply through the effects of discounting and a falling forward rate used as the strike price

liquidation fire sales and acquirers private information abstract we develop a dynamic model in which a distressed firm optimizes an exit choice between sell out and default as well as its timing we assume that the distressed firm is not informed about the acquirer s asset valuation we show that the firm delays liquidation to decrease the acquirer s information rent notably the firm can change the exit choice from sell out to default when the screening cost is high in this case shareholders declare default regardless of the acquirer s valuation which provides the acquirer the maximum information rent together with the deadweight costs of bankruptcy the maximal information rent which causes a wealth transfer from debt holders of the bankrupt firm to the acquirer lowers the sales price and debt recovery this mechanism can explain many empirical findings about fire sales and acquirers excess gains higher volatility leverage and asymmetric information increase the likelihood of a fire sale but higher bankruptcy costs could play a positive role in preventing a fire sale with asymmetric information the firm can reduce debt issuance to avoid the risk of a fire sale

debt valuation renegotiation and optimal dividend policy the valuation of debt and equity reorganization boundaries and firm s optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game theoretic setting which can accommodate varying bargaining powers to the two claimants two formulations of reorganization are presented debt equity swaps and strategic debt service resulting from negotiated debt service reductions we study the effects of bond covenants on payout policies and distinguish liquidity induced defaults from strategic defaults we derive optimal equity issuance and payout policies the debt capacity of the firm and the optimal capital structure are characterized

dynamic asset allocation portfolio decomposition formula and applications a new decomposition of the optimal portfolio in dynamic models with von neumann morgenstern preferences and ito prices is established the formula rests on a change of numeraire that uses pure discount bonds as units of account the dynamic hedging demand has two components the first hedge insures against fluctuations in an optimally designed bond with a maturity date matching the investor s horizon the second hedge immunizes against fluctuations in the market price of risk in the bond numeraire various applications are examined new results concerning the behavior of extremely risk averse individuals the demand for bonds and its long horizon limit and the optimal portfolio in incomplete markets are derived the author 2009 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please email journals permissions oxfordjournals org oxford university press

bonds versus stocks investors age and risk taking abstract it has become increasingly popular to advise investors to relocate their funds from a primarily stock portfolio to a primarily bond portfolio as they get older however the well known decision rules such as mean variance or stochastic dominance rules are unable to explain this common practice almost stochastic dominance asd and almost mean variance amv approaches are used to examine the dominance of stock and bond portfolios asd and amv rules unambiguously support the popular practice of advising higher stock to bond ratio for long investment horizons hence we provide an explanation to the practitioners recommendation within the expected utility paradigm

inflation and real interest rates on assets with different risk characteristics given the importance of ex ante real interest rates to economic decision making it is no surprise that much empirical research focuses on them 1 several recent studies find that the ex ante real returns for short term u s treasury securities are not constant and are negatively correlated both with inflation and with nominal interest rates this paper examines the extent to which these findings hold for assets of longer maturity are robust with respect to the choice of price index and are stable over time we expand the set of assets studied to include those of longer maturity both publicly and privately issued for two reasons first their ex ante real returns may differ substantially from that of a short term nominally riskless security second because longer maturity assets have risk characteristics closer to capital their ex ante real returns are potentially more relevant for investment and savings decisions we explore the use of various price indices because the index used in most studies the consumer price index severely overstates inflation during the 1970s as a result of its inappropriate treatment of residential housing costs 2 this overstatement casts doubt on an important finding of previous studies that there are long stretches of time during the 1970s when ex ante real rates are significantly negative given the existence of holding costs for the goods relevant to most price indices and the absence of a riskless real return no arbitrage conditions are violated by a negative ex ante real rate however its persistence is problematical because asset holders are typically assumed to have a positive rate of time preference which ensures a positive ex ante real rate in the long run we find that before 1979 a negative relationship of ex ante real rates both with inflation and with nominal interest rates appears for the longer maturity assets as well as the short term nominally riskless asset indeed the relationship grows

analysis of an inventory system under backorder correlated deterministic demand and geometric supply process abstract in this article we propose a single item periodic review model that investigates the effects of changes in the demand process that occur after stockout realizations we investigate a system where the demands in successive periods are deterministic but affected by the backorder realizations in order to capture the effects of changes in the demand process we use a geometric type supply availability we analytically derive the necessary components for obtaining profit related performance measures and provide computational analysis

resolution of financial distress under chapter 11 abstract we develop a contingent claims model for a firm in financial distress with a formal account for renegotiations under the u s bankruptcy procedure known as chapter 11 shareholders and two classes of creditors senior and junior alternatively propose a reorganization plan subject to a vote the bankruptcy judge can intervene in any renegotiation round to impose a plan the multiple stage bargaining process is solved in a non cooperative game theory setting the calibrated model yields the liquidation rate the duration of chapter 11 and the frequency of deviations from the absolute priority rule which are consistent with empirical evidence

the use of equity financing in debt renegotiation debt renegotiation is often modeled as pure debt for equity or debt for debt swaps in the theoretical literature however the empirical evidence in the debt repurchase literature shows that a combination of debt and equity along with asset sales is used in renegotiation in this paper we analyze the use of equity financing in addition to debt financing and asset sales in debt repurchases firms with larger volatility lower cash flow growth rates or higher recovery rates are more likely to use equity financing in debt renegotiation flotation and renegotiation costs the bargaining power of the creditors and macroeconomic variables also influence this choice when equity issuance is a possible source of financing in renegotiation firms optimally choose smoother coupons and welfare increases as compared to pure debt for debt swaps we provide closed form solutions for the optimal use of funding and we derive novel testable empirical implications regarding the use of equity financing in debt repurchases

utilitarianism and fairness in portfolio positioning abstract the paper introduces the theory of optimal positioning of financial products it is illustrated in the context of long term intertemporal portfolio allocation and can be applied for example to asset allocation funds we embed this problem in location theory the portfolio is optimized within the investors risk aversion dimension for the crra utility functions we compute explicitly the distance functions for the first utilitarian criterion the average utility of the investors is maximized for the second one fairness criterion the choice of portfolio is optimized so that the average monetary loss due to the lack of customization is minimized given the distribution of investors risk aversion we provide a solution method and an algorithm to optimally position standardized portfolio along one of these two criteria

semi analytical solutions for dynamic portfolio choice in jump diffusion models and the optimal bond stock mix this paper studies the optimal portfolio selection problem in jump diffusion models where an investor has a hara utility function and there are potentially a large number of assets and state variables more specifically we incorporate jumps into both stock returns and state variables and then derive semi analytical solutions for the optimal portfolio policy up to solving a set of ordinary differential equations to greatly facilitate economic insights and empirical applications of jump diffusion models to examine the effect of jump risk on investors behavior we apply our results to the bond stock mix problem and particularly revisit the bond stock ratio puzzle in jump diffusion models our results cast new light on this puzzle that unlike pure diffusion models it cannot be rationalized by the hedging demand assumption due to the presence of jumps in stock returns

valuing debt options empirical evidence abstract a two factor model using the instantaneous rate of interest and the return on a consol bond to describe the term structure of interest rates the brennan schwartz model is used to derive theoretical prices for american call and put options on us government bonds and treasury bills these model prices are then compared with market prices the theoretical model used to value the dept options also provides hedge ratios which may be used to construct zero investment portfolios which in theory are perfectly riskless several trading strategies based on these riskless portfolios are examined

the volatility of short term interest rates an empirical comparison of alternative models of the term structure of interest rates we estimate and compare a variety of continuous time models of the short term riskless rate using the generalised method of moments we find that the most successful models in capturing the dynamics of the short term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate a number of well known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility we show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk

debt and seniority an analysis of the role of hard claims in constraining management we argue that long term debt has a role in controlling management s ability to finance future investments a company with high widely held debt will find it hard to raise capital since new security holders will have low priority relative to existing creditors conversely for a company with low debt we show there is an optimal debt equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments we derive conditions under which equity and a single class of senior long term debt work as well as more complex contracts for controlling investment behavior

ex ante costs of violating absolute priority in bankruptcy a basic question for the design of bankruptcy law concerns whether value should be divided in accordance with absolute priority research done in the past decade has suggested that deviations from absolute priority have beneficial ex ante effects in contrast this paper shows that ex post deviations from absolute priority also have negative effects on ex ante decisions taken by shareholders such deviations aggravate the moral hazard problem with respect to project choice increasing the equityholders incentive to favor risky projects as well as with respect to borrowing and dividend decisions

pricing interest rate derivative securities this article shows that the one state variableinterest rate models of vasicek 1977 and cox ingersoll and ross 1985b can be extended sothat they are consistent with both the current termstructure of interest rates and either the currentvolatilities of all spot interest rates or the currentvolatilities of all forward interest rates theextended vasicek model is shown to be very tracta ble analytically the article compares option pricesobtained using the extended vasicek model withthose obtained using a number of other models