bluuebunny/crossref_metadata_2025 huggingface dataset:
An Option‐Theoretic Approach to the Valuation of Dividend Reinvestment and Voluntary Purchase Plans
Authors: DAMMON ROBERT M. , SPATT CHESTER S.
Published: April 2012

Many firms with dividend reinvestment plans also allow their shareholders to voluntarily invest supplemental funds to purchase additional shares. The purchase price for newly‐issued shares often is determined by the average stock price over a prespecified time period preceding the investment date. This gives the firm's shareholders an option to invest in additional shares only when the stock price exceeds the computed average. This paper uses both theoretical and numerical methods to analyze the value of these voluntary purchase options in theory and practice.
Bankruptcy and Insider Trading: Differences Between Exchange‐Listed and OTC Firms
Authors: GOSNELL THOMAS , KEOWN ARTHUR J. , PINKERTON JOHN M.
Published: April 2012

Over the two‐year period prior to the bankruptcy announcement, insider trading is significantly greater for OTC bankrupt firms, but not for exchange‐listed firms, than for an industry‐size matched sample of nonbankrupt firms. In addition, the level of insider selling increases over the final five months leading to the first public announcement of OTC firms. Finally, firms displaying the most negative price reaction over the announcement period are found to have a significantly larger proportion of insider selling than other firms.
A Comparison of Forward and Futures Prices of an Interest Rate‐Sensitive Financial Asset
Authors: MEULBROEK LISA
Published: April 2012

This paper focuses on contractual distinctions as an explanation for the price divergence between futures and forward contracts. Specifically, it investigates the effect of marking‐to‐market on the observed price differences using the pricing model described in Cox, Ingersoll, and Ross (CIR) (1981, Journal of Financial Economics 9, 321–346). Using previously unavailable data, this paper employs Eurodollars, an interest rate‐sensitive financial asset, to test the CIR model. Unlike prior empirical studies, test results support both the weak prediction concerning the sign of the average price difference and the stronger prediction that specific covariances explain the variation in the price differences.
Transformed Securities and Alternative Factor Structures
Authors: HUANG ROGER D. , JO HOJE
Published: April 2012

Grinblatt and Titman (1985) reformulate a result of Chamberlain and Rothschild (1983) to show that the approximate factor structure of Chamberlain and Rothschild is asymptotically equivalent to the strict factor structure of Ross (1976) as long as investors can always repackage securities into an equal number of arbitrary portfolios. This paper uses a Procrustes rotation methodology that is compatible with the repackaging interpretation of Grinblatt and Titman to show that the empirical structure of stock prices is consistent with the convergency hypothesis.
The Structure of Corporate Ownership in Japan
Authors: PROWSE STEPHEN D.
Published: April 2012

I examine the structure of corporate ownership in a sample of Japanese firms in the mid 1980s. Ownership is highly concentrated in Japan, with financial institutions by far the most important large shareholders. Ownership concentration in independent Japanese firms is positively related to the returns from exerting greater control over management. This is not the case in firms that are members of corporate groups (keiretsu). Ownership concentration and the accounting profit rate in both independent and keiretsu firms are unrelated. The results are consistent with the notion that there exist two distinct corporate governance systems in Japan —one among independent firms and the other among firms that are members of keiretsu.
An Empirical Comparison of Alternative Models of the Short‐Term Interest Rate
Authors: CHAN K. C. , KAROLYI G. ANDREW , LONGSTAFF FRANCIS A. , SANDERS ANTHONY B.
Published: April 2012

We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized 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.
The January Anomaly: Effects of Low Share Price, Transaction Costs, and Bid‐Ask Bias
Authors: BHARDWAJ RAVINDER K. , BROOKS LEROY D.
Published: April 2012

The January effect is primarily a low‐share price effect and less so a market value effect. In the recent 1977–1986 period, after‐transaction‐cost raw and excess January returns are lower on low‐price stocks than on high‐price stocks. Failure of informed traders to eliminate significantly large before‐transaction‐cost excess January returns on low‐price stocks is potentially explained by higher transaction costs and a bid‐ask bias. At the least, the January anomaly found in prior tests is not persistent, and thereby, not likely to be exploitable by typical investors.
Time and the Process of Security Price Adjustment
Authors: EASLEY DAVID , O'HARA MAUREEN
Published: April 2012

This paper delineates the link between the existence of information, the timing of trades, and the stochastic process of prices. We show that time affects prices, with the time between trades affecting spreads. Because the absence of trades is correlated with volume, our model predicts a testable relation between spreads and normal and unexpected volume, and demonstrates how volume affects the speed of price adjustment. Our model also demonstrates how the transaction price series will be a biased representation of the true price process, with the variance being both overstated and heteroskedastic.
Dual Trading in Futures Markets
Authors: FISHMAN MICHAEL J. , LONGSTAFF FRANCIS A.
Published: April 2012

With dual trading, brokers trade both for their customers and for their own account. We study dual trading and find that customers who are less likely to be informed have higher expected profits with dual trading while customers who are more likely to be informed have higher expected profits without dual trading. We also examine the effects of frontrunning. We test the major empirical implications of our model. Consistent with the model, dual traders earn higher profits than non‐dual traders, and customers of dual‐trading brokers do better than customers of non‐dual‐trading brokers.
Reference Variables, Factor Structure, and the Approximate Multibeta Representation
Authors: REISMAN HAIM
Published: April 2012

The Arbitrage Pricing Theory (APT) implies that if asset returns have a factor structure, then an approximate multibeta representation holds with respect to the factors as reference variables. This paper assumes that asset returns satisfy a factor structure and derives a condition under which the approximate multibeta representation holds with respect to a set of reference variables which may not be the factors. This condition is that the regression matrix of the reference variables on the factors is nonsingular. Implications for the testability of the APT are also discussed.
Inflation and Asset Returns in a Monetary Economy
Authors: MARSHALL DAVID A.
Published: April 2012

Postwar U.S. data are characterized by negative correlations between real equity returns and inflation and by positive correlations between real equity returns and money growth. These patterns are closely matched quantitatively by an equilibrium monetary asset pricing model. The model also implies negative correlations between expected asset returns and expected inflation, and it predicts that the inflation‐asset return correlation will be more strongly negative when inflation is generated by fluctuations in real economic activity than when it is generated by monetary fluctuations.
Debt Financing and Tax Status: Tests of the Substitution Effect and the Tax Exhaustion Hypothesis Using Firms' Responses to the Economic Recovery Tax Act of 1981
Authors: TREZEVANT ROBERT
Published: April 2012

This study tests the joint prediction of the substitution effect and the tax exhaustion hypothesis that an increase in non‐debt tax shields leads to a decrease in leverage. Controls are introduced for the debt securability effect, the pecking order theory of financing, and the probability of losing tax shields. Using the relationship between changes in investment tax shields and changes in debt tax shields of firms in response to the Economic Recovery Tax Act of 1981, strong empirical support is found for predictions based on the substitution effect and the tax exhaustion hypothesis.
Information, Asset Prices, and the Volume of Trade
Authors: HUFFMAN GREGORY W.
Published: April 2012

A dynamic equilibrium model is constructed in which agents with access to different information sets participate in the capital market. Agents must use the equilibrium price of capital to make optimal forecasts of the return to holding capital. Examples show that the volume of trade, as well as the price of capital, can be highly correlated with a measure of the information content of prices. This measure of information is the difference between the unconditional entropy of the dividend and the entropy of the dividend conditional on observing the price of capital.
Dividend Surprises Inferred from Option and Stock Prices
Authors: BAE‐YOSEF SASSON , SARIG ODED H.
Published: April 2012

This paper introduces a new method to measure the unexpected component of dividend announcements. While measures used previously were based on various arbitrary models of dividend expectations, our suggested method compares the reaction of stock and option prices to dividend announcements. Our measure is compared to commonly used model‐based measures, to a Box‐Jenkins time‐series‐based measure, and to a Value‐Line Investor Survey‐based measure of dividend surprises. The new measure is more highly correlated with the market's reaction to the announcements than are alternative measures of dividend surprises. The new measure is also shown to be insensitive to the extent to which the options used to identify unexpected dividend announcements are in‐ or out‐of‐the‐money.
An Empirical Analysis of Illegal Insider Trading
Authors: MEULBROEK LISA K.
Published: April 2012

Whether insider trading affects stock prices is central to both the current debate over whether insider trading is harmful or pervasive, and to the broader public policy issue of how best to regulate securities markets. Using previously unexplored data on illegal insider trading from the Securities and Exchange Commission, this paper finds that the stock market detects the possibility of informed trading and impounds this information into the stock price. Specifically, the abnormal return on an insider trading day averages 3%, and almost half of the pre‐announcement stock price run‐up observed before takeovers occurs on insider trading days. Both the amount traded by the insider and additional trade‐specific characteristics lead to the market's recognition of the informed trading.
Managers' Trading Around Stock Repurchases
Authors: LEE D. SCOTT , MIKKELSON WAYNE H. , PARTCH M. MEGAN
Published: April 2012

We analyze personal open market trades by managers around stock repurchases by tender offer. With the exception of Dutch auction offers, managers trade their firm's shares prior to repurchase announcements as though repurchases convey favorable inside information to outsiders. Prior to fixed price repurchase offers that do not follow takeover‐related events, managers increase their buying and reduce their selling of their firm's shares. Prior to repurchases that follow takeover‐related events, only a decrease in selling is found. No abnormal trading precedes Dutch auction repurchase offers.
Additional Evidence on Integration in the Canadian Stock Market
Authors: MITTOO USHA R.
Published: April 2012

This paper reexamines the integration of the Canadian and U.S. stock markets in the 1977–86 period that is relatively free from capital controls. The study employs both the CAPM and the APT frameworks. Under both models, the evidence is consistent with segmentation in the 1977–81 subperiod, but supports integration in the 1982–86 subperiod. Using the APT framework, we also find that the Canadian stocks interlisted on the U.S. exchanges and NASDAQ are priced in an integrated market and segmentation is predominant for the non‐interlisted Canadian stocks.
The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems
Authors: JENSEN MICHAEL C.
Published: April 2012

Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increasing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.
Measuring Asset Values for Cash Settlement in Derivative Markets: Hedonic Repeated Measures Indices and Perpetual Futures
Authors: SHILLER ROBERT J.
Published: April 2012

Two proposals are made that may facilitate the creation of derivative market instruments, such as futures contracts, cash settled based on economic indices. The first proposal concerns index number construction: indices based on infrequent measurements of nonstandardized items may control for quality change by using a hedonic repeated measures method, an index number construction method that follows individual assets or subjects through time and also takes account of measured quality variables. The second proposal is to establish markets for perpetual claims on cash flows matching indices of dividends or rents. Such markets may help us to measure the prices of the assets generating these dividends or rents even when the underlying asset prices are difficult or impossible to observe directly. A perpetual futures contract is proposed that would cash settle every day in terms of both the change in the futures price and the dividend or rent index for that day.
Influence Costs and Capital Structure
Authors: BAGWELL LAURIE SIMON , ZECHNER JOSEF
Published: April 2012

This paper analyzes the role of capital structure in the presence of intrafirm influence activities. The hierarchical structure of large organizations inevitably generates attempts by members to influence the distributive consequences of organizational decisions. In corporations, for example, top management can reallocate or eliminate quasi rents earned by their employees, while at the same time, they must rely on these employees to provide them with information vital to their decision making. This creates the opportunity for lower level managers to influence top management's discretionary decisions. As a result, divisional managers may attempt to inflate the corporate perception of their relative contributions to the firm, or to take actions that make the elimination of their rents more costly for the firm. This incentive to influence is especially acute when managers fear losing their jobs, for example in the event of a divestiture.

Since the firm's capital structure can affect future divestiture decisions, it can be chosen to reduce or increase the divisional managers' incentives to influence top management's decisions. The control of influence activities arises at the expense of restrictions on future divestiture decisions. Hence, there emerges an optimal capital structure that trades off the costs of influence activities against the costs of making poor divestiture decisions. The findings suggest that capital structure can also be chosen to control influence activities that arise under less extreme motivations.

We identify several key factors that determine the optimal capital structure: the top management's prior assessment of the likelihood that it will be optimal to divest a specific division; the costs of influence activities to the firm and to the divisional managers; and the difference in the valuation of the division's assets in the current firm and under alternative uses.
Price Formation and Equilibrium Liquidity in Fragmented and Centralized Markets
Authors: BIAIS BRUNO
Published: April 2012

This paper compares centralized and fragmented markets, such as floor and telephone markets. Risk‐averse agents compete for one market order. In centralized markets, these agents are market makers or limit order traders. They are assumed to observe the quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. We analyze differences in bidding strategies reflecting differences in market structures. The equilibrium number of dealers is shown to be increasing in the frequency of trades and the volatility of the value of the asset. The expected spread is shown to be equal in both markets, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets.
The Value of Bank Durability: Borrowers as Bank Stakeholders
Authors: SLOVIN MYRON B. , SUSHKA MARIE E. , POLONCHEK JOHN A.
Published: April 2012

We examine the value of bank durability to borrowing firms. The analysis is based on theoretical models of the asset services view of intermediation which imply that private information and associated relationship‐specific activities are intrinsic to bank lending. We analyze share price effects on firms with lending relationships with Continental Illinois Bank during its de facto failure and subsequent FDIC rescue. We find the bank's impending insolvency had negative effects and the FDIC rescue positive effects on client firm share prices. We conclude that borrowers incur significant costs in response to unanticipated reductions in bank durability and thus are bank stakeholders.
The Valuation Effects of Warrant Extensions
Authors: HOWE JOHN S. , WEI PEIHWANG
Published: April 2012

In this paper, we examine the warrant price and stock price reactions to the announcement of warrant life extensions. As predicted by option‐pricing theory, warrant prices increase in response to an extension. Our principal finding is that the stocks of firms making the extension announcements experience positive abnormal returns on average. We interpret the evidence as supportive of an anticipation hypothesis in which the market perceives the decision to extend the warrants' expiration date as a favorable indication for the stock price before the subsequent expiration.
CEO Compensation in Financially Distressed Firms: An Empirical Analysis
Authors: GILSON STUART C. , VETSUYPENS MICHAEL R.
Published: April 2012

This paper studies senior management compensation policy in 77 publicly traded firms that filed for bankruptcy or privately restructured their debt during 1981 to 1987. Almost one‐third of all CEOs are replaced, and those who keep their jobs often experience large salary and bonus reductions. Newly appointed CEOs with ties to previous management are typically paid 35% less than the CEOs they replace. In contrast, outside replacement CEOs are typically paid 36% more than their predecessors, and are often compensated with stock options. On average, CEO wealth is significantly related to shareholder wealth after firms renegotiate their debt contracts. However, managers' compensation is sometimes explicitly tied to the value of creditors' claims.
Market Discounts and Shareholder Gains for Placing Equity Privately
Authors: HERTZEL MICHAEL , SMITH RICHARD L.
Published: April 2012

Despite selling at substantial discounts, private placements of equity are associated with positive abnormal returns. We find evidence that discounts reflect information costs borne by private investors and abnormal returns reflect favorable information about firm value. Results are consistent with the role of private placements as a solution to the Myers and Majluf underinvestment problem and with the use of private placements to signal undervaluation. We also find some evidence of anticipated monitoring benefits from private sales of equity. For the smaller firms that comprise our sample, information effects appear to be relatively more important than ownership effects.
Macroeconomic Influences and the Variability of the Commodity Futures Basis
Authors: BAILEY WARREN , CHAN K. C.
Published: April 2012

We provide evidence that the spread between commodity spot and futures prices (the basis) reflects the macroeconomic risks common to all asset markets. The basis of many commodities is correlated with the stock index dividend yield and corporate bond quality spread. Explanatory power is related to exposure to macroeconomic fluctuations: about 40 percent of the variation in the basis of a portfolio of commodities with high business cycle sensitivity is explained by the stock and bond yields. Further diagnostics indicate that these associations are largely due to the presence of risk premiums, rather than spot price forecasts, in the basis.
Empirical Testing of Real Option‐Pricing Models
Authors: QUIGG LAURA
Published: April 2012

This research is the first to examine the empirical predictions of a real option‐pricing model using a large sample of market prices. We find empirical support for a model that incorporates the option to wait to develop land. The option model has explanatory power for predicting transactions prices over and above the intrinsic value. Market prices reflect a premium for the option to wait to invest that has a mean value of 6% in our sample. We also estimate implied standard deviations for individual commercial property prices ranging from 18 to 28% per year.
Predictable Stock Returns: The Role of Small Sample Bias
Authors: NELSON CHARLES R. , KIM MYUNG J.
Published: April 2012

Predictive regressions are subject to two small sample biases: the coefficient estimate is biased if the predictor is endogenous, and asymptotic standard errors in the case of overlapping periods are biased downward. Both biases work in the direction of making t‐ratios too large so that standard inference may indicate predictability even if none is present. Using annual returns since 1872 and monthly returns since 1927 we estimate empirical distributions by randomizing residuals in the VAR representation of the variables. The estimated biases are large enough to affect inference in practice, and should be accounted for when studying predictability.
A Reexamination of Traditional Hypotheses about the Term Structure: A Comment
Authors: MCCULLOCH J. HUSTON
Published: April 2012

An example of a continuous time economy is given whose general equilibrium term structure of interest rates obeys the Expectations Hypothesis for continuously compounded interest rates and returns, contradicting the 1981 claim by Cox, Ingersoll, and Ross that such an economy is mathematically impossible. This example does not generate exploitable arbitrage opportunities of the type Cox, Ingersoll, and Ross claim must arise. The “Logarithmic Expectations Hypothesis,” as we call it, it therefore an acceptable benchmark from which to measure term premia in continuous time term structure modeling.
Stock Price Volatility, Ordinary Dividends, and Other Cash Flows to Shareholders
Authors: ACKERT LUCY F. , SMITH BRIAN F.
Published: April 2012

This paper shows that the results of variance‐bound tests depend on how cash distributions to shareholders are measured. As in prior studies, we find apparent evidence of excess volatility when a narrow definition of cash flow (dividends only) is applied. However, we are unable to reject the hypothesis of market efficiency when the cash flow measure also includes share repurchases and takeover distributions in addition to ordinary cash dividends.
The Reverse LBO Decision and Firm Performance: Theory and Evidence
Authors: DEGEORGE FRANÇOIS , ZECKHAUSER RICHARD
Published: April 2012

We investigate the transition from private to public ownership of companies that had previously been subject to leveraged buyouts (LBOs). We show that the information asymmetry problem firms face when they go to public markets for equity, as well as behavioral and debt overhang effects, will produce a pattern in which superior performance before an offering should be expected, with disappointing performance subsequently. We find empirical evidence of this phenomenon by studying 62 reverse LBOs that went public between 1983 and 1987. The market appears to anticipate this pattern.
Sensitivity of Multivariate Tests of the Capital Asset‐Pricing Model to the Return Measurement Interval
Authors: HANDA PUNEET , KOTHARI S. P. , WASLEY CHARLES
Published: April 2012

The capital asset‐pricing model's (CAPM) primary empirical implication is a positively sloped linear relation between a security's expected rate of return and its relative risk (beta). Recent research indicates that inferences about the risk‐return relation are sensitive to the choice of the return measurement interval. We perform multivariate tests of the Sharpe‐Lintner CAPM using monthly and annual returns on market‐value‐ranked portfolios. The CAPM is rejected using monthly returns, a result consistent with previous research. In contrast, we fail to reject the CAPM when annual holding period returns are used.
The Trades of Market Makers: An Empirical Analysis of NYSE Specialists
Authors: HASBROUCK JOEL , SOFIANOS GEORGE
Published: April 2012

This paper presents a transaction‐level empirical analysis of the trading activities of New York Stock Exchange specialists. The main findings of the analysis are the following. Adjustment lags in inventories vary across stocks, and are in some cases as long as one or two months. Decomposition of specialist trading profits by trading horizon shows that the principal source of these profits is short term. An analysis of the dynamic relations among inventories, signed order flow, and quote changes suggests that trades in which the specialist participates have a higher immediate impact on the quotes than trades with no specialist participation.
Risk Management: Coordinating Corporate Investment and Financing Policies
Authors: FROOT KENNETH A. , SCHARFSTEIN DAVID S. , STEIN JEREMY C.
Published: April 2012

This paper develops a general framework for analyzing corporate risk management policies. We begin by observing that if external sources of finance are more costly to corporations than internally generated funds, there will typically be a benefit to hedging: hedging adds value to the extent that it helps ensure that a corporation has sufficient internal funds available to take advantage of attractive investment opportunities. We then argue that this simple observation has wide ranging implications for the design of risk management strategies. We delineate how these strategies should depend on such factors as shocks to investment and financing opportunities. We also discuss exchange rate hedging strategies for multinationals, as well as strategies involving “nonlinear” instruments like options.
Jump Diffusion Option Valuation in Discrete Time
Authors: AMIN KAUSHIK I.
Published: April 2012

We develop a simple, discrete time model to value options when the underlying process follows a jump diffusion process. Multivariate jumps are superimposed on the binomial model of Cox, Ross, and Rubinstein (1979) to obtain a model with a limiting jump diffusion process. This model incorporates the early exercise feature of American options as well as arbitrary jump distributions. It yields an efficient computational procedure that can be implemented in practice. As an application of the model, we illustrate some characteristics of the early exercise boundary of American options with certain types of jump distributions.
Accounting for Forward Rates in Markets for Foreign Currency
Authors: BACKUS DAVID K. , GREGORY ALLAN W. , TELMER CHRIS I.
Published: April 2012

Forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure (the intertemporal marginal rate of substitution). Representative agent theory with time‐additive preferences cannot account for either of these properties. We show that the theory does considerably better along these dimensions when the representative agent's preferences exhibit habit persistence, but that the theory fails to reproduce some of the other properties of the dataâ€”in particular, the strong autocorrelation of forward premiums.
The Impact of Large Portfolio Insurers on Asset Prices
Authors: DONALDSON R. GLEN , UHLIG HARALD
Published: April 2012

We develop a simple model in which the presence of portfolio insurers in a market of risk‐averse traders leads to multiple equilibria for the pricing of financial assets and can cause an increase in volatility, including insurance‐induced price drops. We demonstrate, however, that centralized portfolio insurance firms may actually reduce, not increase, volatility, even if the existence of these firms increases the total amount of funds under insurance.
Why Option Prices Lag Stock Prices: A Trading‐based Explanation
Authors: CHAN KALOK , CHUNG Y. PETER , JOHNSON HERB
Published: April 2012

While many studies find that option prices lead stock prices, Stephan and Whaley (1990) find that stocks lead options. We find no evidence that options, even deep out‐of‐the‐money options, lead stocks. After confirming Stephan and Whaley's results, we show their results can be explained as spurious leads induced by infrequent trading of options. We show that the stock lead disappears when the average of the bid and ask prices is used instead of transaction prices. Hence, we find no evidence of arbitrage opportunities associated with the stock lead.
Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?
Authors: GOH JEREMY C. , EDERINGTON LOUIS H.
Published: April 2012

We examine the reaction of common stock returns to bond rating changes. While recent studies find a significant negative stock response to downgrades, we argue that this reaction should not be expected for all downgrades because: (1) some rating changes are anticipated by market participants and (2) downgrades because of an anticipated move to transfer wealth from bondholders to stockholders should be good news for stockholders. We find that downgrades associated with deteriorating financial prospects convey new negative information to the capital market, but that downgrades due to changes in firms' leverage do not.
Moral Hazard and the Portfolio Management Problem
Authors: STOUGHTON NEAL M.
Published: April 2012

This paper investigates the significance of nonlinear contracts on the incentive for portfolio managers to collect information. In addition, the manager must be motivated to disclose this information truthfully. We analyze three contracting regimes: (1) first‐best where effort is observable, (2) linear with unobservable effort, and (3) the optimal contract within the Bhattacharya‐Pfleiderer quadratic class. We find that the linear contract leads to a serious lack of effort expenditure by the manager. This underinvestment problem can be successfully overcome through the use of quadratic contracts. These contracts are shown to be asymptotically optimal for very risk‐tolerant principals.
Rational Prepayments and the Valuation of Collateralized Mortgage Obligations
Authors: MCCONNELL JOHN J. , SINGH MANOJ
Published: April 2012

This article presents a procedure for evaluating collateralized mortgage obligation (CMO) tranches. The solution procedure is in the spirit of a dynamic programming problem in which an individual mortgagor's decision to prepay is the feedback control variable―the mortgagor seeks to minimize the value of the mortgage subject to refinancing costs. We employ a two‐step procedure to solve this dynamic programming problem. The first step uses an implicit finite difference backward solution procedure to determine the “optimal” prepayment boundary for a class of mortgagors, each of whom confronts the same proportional refinancing cost. This step is repeated for several different classes of mortgagors that differ in the level of refinancing costs that they confront. The outcome of this first step is a series of prepayment boundaries―one set of boundaries for each level of refinancing costs (i.e., one set of boundaries for each refinancing cost category of mortgagors). In the second step, the prepayment boundaries determined in the first step are used in conjunction with Monte Carlo simulation to value the CMO tranches. The essence of the second step is that when the simulated interest rate hits the boundary for a particular class, it triggers a prepayment scenario for that class of mortgagors. We conduct extensive sensitivity analysis to determine the robustness of this approach (and our solution procedure) to alternative single‐factor models of the term structure of interest rates and to alternative specifications of the distribution of refinancing cost levels confronted by mortgagors. The sensitivity analysis indicates that CMO tranche valuation is not particularly sensitive to alternative models of the term structure so long as the models are consistent with the current yield curve, but, even when alternative specifications of the refinancing cost categories generate nearly identical values for the collateral underlying the CMO (i.e., the generic mortgage‐backed securities), the resulting tranche values can differ widely between the two specifications. The results point out the importance of accurate estimation of the distribution of refinancing costs when the rational valuation model is used for the analysis of CMO tranches.
Market Microstructure and the Ex‐Date Return
Authors: CONRAD JENNIFER S. , CONROY ROBERT
Published: April 2012

This article examines the role of measurement biases, due to order flow effects, in abnormal split ex‐day returns. We conjecture that postsplit orders consist of numerous small buyers and fewer larger sellers. This change in order flow causes closing prices to occur more frequently at the ask price, consistent with Maloney and Mulherin (1992) and Grinblatt and Keim (1991). In addition, this change causes specialists' spreads to increase, perhaps to offset larger average inventories. We examine both NYSE and NASDAQ samples and find that order flow biases can explain approximately 80 percent (48 percent) of the NYSE (NASDAQ) ex‐day return.
Market Statistics and Technical Analysis: The Role of Volume
Authors: BLUME LAWRENCE , EASLEY DAVID , O'HARA MAUREEN
Published: April 2012

We investigate the informational role of volume and its applicability for technical analysis. We develop a new equilibrium model in which aggregate supply is fixed and traders receive signals with differing quality. We show that volume provides information on information quality that cannot be deduced from the price statistic. We show how volume, information precision, and price movements relate, and demonstrate how sequences of volume and prices can be informative. We also show that traders who use information contained in market statistics do better than traders who do not. Technical analysis thus arises as a natural component of the agents' learning process.
Trading Profits in Dutch Auction Self‐Tender Offers
Authors: KADAPAKKAM PALANI‐RAJAN , SETH SARABJEET
Published: April 2012

We document abnormal trading profits in Dutch auction self‐tenders. Tender period profits—buying after announcement and selling just before expiration—are 1.74 percent (Bhagat, Brickley, and Lowenstein (1987) report similar profits for interfirm tenders). Buying just before expiration and tendering yields abnormal profits of 1.36 percent (Lakonishok and Vermaelen (1990) report 9 percent for fixed‐price self‐tenders using a filter rule). Total profits from buying just after announcement and tendering remain positive after adjusting for bid‐ask spreads. Trading profits are higher for smaller firms, and positively correlated with tender period unsystematic risk, suggesting that they arise due to the pricing of event risk.
Holiday Trading in Futures Markets
Authors: FABOZZI FRANK J. , MA CHRISTOPHER K. , BRILEY JAMES E.
Published: April 2012

In this paper, we find significantly higher preholiday returns in futures contracts compared to nonholiday returns. The findings are consistent with the inventory adjustment hypothesis, since higher preholiday returns associated with lower trading volume are most pronounced for exchange‐closed holidays. There is evidence of positive postholiday returns associated with higher trading volume for exchange‐open holidays. This is consistent with positive holiday sentiments. The holiday effect is uniquely independent: The magnitude of excess holiday returns is the largest among all seasonal variations.
Time‐Series Variation in Dividend Pricing
Authors: EADES KENNETH M. , HESS PATRICK J. , KIM E. HAN
Published: April 2012

Ex‐dividend day returns vary over time. The ex‐day returns of high‐yield stocks are persistently positive for some time periods and negative for others; in contrast, ex‐day returns of low‐yield stocks are always positive and less variable. We are unable to explain the variation with changes in the tax code, but we do find a strong effect for the introduction of negotiated commissions. We find evidence that corporate dividend capturing is affecting ex‐day returns and confirm the findings of Gordon and Bradford (1980) that the price of dividends is countercyclical.
Security Analysis and Trading Patterns When Some Investors Receive Information Before Others
Authors: HIRSHLEIFER DAVID , SUBRAHMANYAM AVANIDHAR , TITMAN SHERIDAN
Published: April 2012

In existing models of information acquisition, all informed investors receive their information at the same time. This article analyzes trading behavior and equilibrium information acquisition when some investors receive common private information before others. The model implies that, under some conditions, investors will focus only on a subset of securities (“herding”), while neglecting other securities with identical exogenous characteristics. In addition, the model is consistent with empirical correlations that are suggestive of oft‐cited trading strategies such as profit taking (short‐term position reversal) and following the leader (mimicking earlier trades).
Expected Returns, Time‐varying Risk, and Risk Premia
Authors: EVANS MARTIN D. D.
Published: April 2012

A new empirical model for intertemporal capital asset pricing is presented that allows both time‐varying risk premia and betas where the latter are identified from the dynamics of the conditional covariance of returns. The model is more successful in explaining the predictable variations in excess returns when the returns on the stock market and corporate bonds are included as risk factors than when the stock market is the single factor. Although changes in the covariance of returns induce variations in the betas, most of the predictable movements in returns are attributed to changes in the risk premia.
Ex‐Day Behavior: Tax or Short‐Term Trading Effects
Authors: LASFER M. AMEZIANE
Published: April 2012

This study examines the behavior of share prices around the ex‐dividend dates before and after the introduction of the 1988 Income and Corporation Taxes Act that reduced substantially the tax differential between dividends and capital gains in the United Kingdom. We find that, in the pre‐1988 period when the differential taxation of dividends and capital gains is high, ex‐day returns are positive and significant. In contrast, in the post‐1988 period, ex‐day returns are, in most cases, negative and insignificant. Further analysis reveals that, while ex‐day returns are significantly related to dividend yield and to the length of the settlement period, they are not affected by the commonly used measures of transaction costs, such as the bid‐ask spread and trading volume, or by the day of week, month of the year, type of dividend distribution, or number of days to the actual receipt of the cash dividend. We conclude that taxation affects significantly ex‐day share prices in the United Kingdom.
The Valuation of Cash Flow Forecasts: An Empirical Analysis
Authors: KAPLAN STEVEN N. , RUBACK RICHARD S.
Published: April 2012

This article compares the market value of highly leveraged transactions (HLTs) to the discounted value of their corresponding cash flow forecasts. For our sample of 51 HLTs completed between 1983 and 1989, the valuations of discounted cash flow forecasts are within 10 percent, on average, of the market values of the completed transactions. Our valuations perform at least as well as valuation methods using comparable companies and transactions. We also invert our analysis by estimating the risk premia implied by transaction values and forecast cash flows, and relating those risk premia to firm and industry betas, firm size, and firm book‐to‐market ratios.
Covenants and Collateral as Incentives to Monitor
Authors: RAJAN RAGHURAM , WINTON ANDREW
Published: April 2012

Although monitoring borrowers is thought to be a major function of financial institutions, the presence of other claimants reduces an institutional lender's incentives to do this. Thus loan contracts must be structured to enhance the lender's incentives to monitor. Covenants make a loan's effective maturity, and the ability to collateralize makes a loan's effective priority, contingent on monitoring by the lender. Thus both covenants and collateral can be motivated as contractual devices that increase a lender's incentive to monitor. These results are consistent with a number of stylized facts about the use of covenants and collateral in institutional lending.
Predictability of Stock Returns: Robustness and Economic Significance
Authors: PESARAN M. HASHEM , TIMMERMANN ALLAN
Published: April 2012

This article examines the robustness of the evidence on predictability of U.S. stock returns, and addresses the issue of whether this predictability could have been historically exploited by investors to earn profits in excess of a buy‐and‐hold strategy in the market index. We find that the predictive power of various economic factors over stock returns changes through time and tends to vary with the volatility of returns. The degree to which stock returns were predictable seemed quite low during the relatively calm markets in the 1960s, but increased to a level where, net of transaction costs, it could have been exploited by investors in the volatile markets of the 1970s.
The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity
Authors: SERCU PIET , UPPAL RAMAN , VAN HULLE CYNTHIA
Published: April 2012

With transaction costs for trading goods, the nominal exchange rate moves within a band around the nominal purchasing power parity (PPP) value. We model the behavior of the band and of the exchange rate within the band. The model explains why there are below‐unity slope coefficients in regression tests of PPP, and why these increase toward unity under hyperinflation or with low‐frequency data. Our results are independent of the presence of nontraded goods in the economy.
Explaining Forward Exchange Bias…Intraday
Authors: LYONS RICHARD K. , ROSE ANDREW K.
Published: April 2012

Intraday interest rates are zero. Consequently, a foreign exchange dealer can short a vulnerable currency in the morning, close this position in the afternoon, and never face an interest cost. This tactic might seem especially attractive in times of fixed‐rate crisis, since it suggests an immunity to the central bank's interest rate defense. In equilibrium, however, buyers of the vulnerable currency must be compensated on average with an intraday capital gain as long as no devaluation occurs. That is, currencies under attack should typically appreciate intraday. Using data on intraday exchange rate changes within the European Monetary System, we find this prediction is borne out.
Time‐Varying World Market Integration
Authors: BEKAERT GEERT , HARVEY CAMPBELL R.
Published: April 2012

We propose a measure of capital market integration arising from a conditional regime‐switching model. Our measure allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. We find that a number of emerging markets exhibit time‐varying integration. Some markets appear more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets. While there is a perception that world capital markets have become more integrated, our country‐specific investigation suggests that this is not always the case.
Returns from Investing in Equity Mutual Funds 1971 to 1991
Authors: MALKIEL BURTON G.
Published: April 2012

Several recent studies suggest that equity mutual fund managers achieve superior returns and that considerable persistence in performance exists. This study utilizes a unique data set including returns from all equity mutual funds existing each year. These data enable us more precisely to examine performance and the extent of survivorship bias. In the aggregate, funds have underperformed benchmark portfolios both after management expenses and even gross of expenses. Survivorship bias appears to be more important than other studies have estimated. Moreover, while considerable performance persistence existed during the 1970s, there was no consistency in fund returns during the 1980s.
Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift?
Authors: MICHAELY RONI , THALER RICHARD H. , WOMACK KENT L.
Published: April 2012

This article investigates market reactions to initiations and omissions of cash dividend payments. Consistent with prior literature we find that the magnitude of short‐run price reactions to omissions are greater than for initiations. In the year following the announcements, prices continue to drift in the same direction, though the drift following omissions is stronger and more robust. This post‐dividend initiation/omission price drift is distinct from and more pronounced than that following earnings surprises. A trading rule employing both samples earns positive returns in 22 out of 25 years. We find little evidence for clientele shifts in either sample.
What Constitutes Evidence of Discrimination in Lending?
Authors: FERGUSON MICHAEL F. , PETERS STEPHEN R.
Published: April 2012

We analyze a simple model of bank lending in order to ascertain what can be inferred from relative denial and default rates about lending discrimination. We show that if minority applicants are of lower average creditworthiness than majority applicants, then, contrary to a popular argument, a uniform, nondiscriminatory credit policy cannot simultaneously produce (i) higher denial rates for minority applicants, and (ii) equal default rates for minority and majority applicants. Moreover, we show that equality of denial or default rates always implies discrimination. In particular, equal denial (default) rates imply discrimination against majority (minority) applicants.
Venture Capitalists and the Oversight of Private Firms
Authors: LERNER JOSH
Published: April 2012

This article examines the representation of venture capitalists on the boards of private firms in their portfolios. If venture capitalists are intensive monitors of managers, their involvement as directors should be more intense when the need for oversight is greater. I show that venture capitalists' representation on the board increases around the time of chief executive officer turnover, while the number of other outsiders remains constant. I also show that distance to the firm is an important determinant of the board membership of venture capitalists, as might be anticipated if the oversight of local firms is less costly than more distant businesses.