bluuebunny/crossref_metadata_2025 huggingface dataset:
Insider Trading in the OTC Market
Authors: LIN JI‐CHAI , HOWE JOHN S.
Published: April 2012

In this paper, we examine the profitability of insider trading in firms whose securities trade in the OTC/NASDAQ market. Although the evidence suggests timing and forecasting ability on the part of insiders, high transaction costs (especially bid‐ask spreads) appear to eliminate the potential for positive abnormal returns from active trading. By implication, outside investors who mimic the trading of insiders are also precluded from earning abnormal profits. In addition, we provide evidence on the determinants of insiders' profits. The data suggest that insiders closer to the firm trade on more valuable information than insiders removed from the firm.
Capital Structure and the Informational Role of Debt
Authors: HARRIS MILTON , RAVIV ARTUR
Published: April 2012

This paper provides a theory of capital structure based on the effect of debt on investors' information about the firm and on their ability to oversee management. We postulate that managers are reluctant to relinquish control and unwilling to provide information that could result in such an outcome. Debt is a disciplining device because default allows creditors the option to force the firm into liquidation and generates information useful to investors. We characterize the time path of the debt level and obtain comparative statics results on the debt level, bond yield, probability of default, probability of reorganization, etc.
Are the Latent Variables in Time‐Varying Expected Returns Compensation for Consumption Risk?
Authors: FERSON WAYNE E.
Published: April 2012

Multibeta asset pricing models are examined using proxies for economic state variables in a framework which exploits time‐varying expected returns to estimate conditional betas. Examples include multiple consumption‐beta models and models where asset returns proxy for the state variables. When the state variables are not specified, the tests indicate two or three time‐varying expected risk premiums in the sample of quarterly asset returns. Conditional betas relative to consumption generate less striking evidence against the model than betas relative to asset returns, but both the consumption and the market variables fail to proxy for the state variables.
Empirical Estimates of Beta When Investors Face Estimation Risk
Authors: CLARKSON PETER M. , THOMPSON REX
Published: April 2012

We examine empirical implications of models of differential information that formalize the following intuition: securities for which there is relatively little information are perceived as relatively more risky because of the greater uncertainty surrounding the exact parameters of their return distributions. The implication that beta risk for low information firms should decline as information increases is confirmed with several data sets. We find such a decline over the first several periods subsequent to initial public offerings and initial listings. There is also an abrupt risk decline at the first annual earnings announcement.
Relative Price Variability, Real Shocks, and the Stock Market
Authors: KAUL GAUTAM , SEYHUN H. NEJAT
Published: April 2012

In this paper, we investigate the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return‐inflation regressions. The evidence shows that the negative stock return‐inflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability.
Evaluating the Performance of International Mutual Funds
Authors: CUMBY ROBERT E. , GLEN JACK D.
Published: April 2012

In this paper, we examine the performance of a sample of fifteen U.S.‐based internationally diversified mutual funds between 1982 and 1988. Two performance measures are used, the Jensen measure and the positive period weighting measure proposed by Grinblatt and Titman. We find no evidence that the funds, either individually or as a whole, provide investors with performance that surpasses that of a broad, international equity index over this sample period.
International Investment Restrictions and Closed‐End Country Fund Prices
Authors: BONSER-NEAL CATHERINE , BRAUER GREGGORY , NEAL ROBERT , WHEATLEY SIMON
Published: April 2012

Some closed‐end country funds trade at large premiums relative to their net asset values. This paper examines whether international investment restrictions raise country fund price‐net asset value ratios by segmenting international capital markets. We test whether a relation exists between announcements of changes in investment restrictions and changes in these ratios using weekly data from May 1981 to January 1989. The results provide evidence that some foreign markets are at least partially segmented from the U.S. capital market.
Statistical Properties of the Roll Serial Covariance Bid/Ask Spread Estimator
Authors: HARRIS LAWRENCE
Published: April 2012

Exact small sample population moments of the standard serial covariance and variance estimators are derived under the assumptions of the Roll bid/ask spread model. Noise explains why serial covariance estimates are often positive in annual samples of daily and weekly returns. Small sample estimator bias partially explains why weekly estimates are more negative than daily estimates. Noise causes the Roll spread estimator to be severely biased by Jensen's inequality. The French‐Roll adjusted variance estimator is unbiased but noisy. Empirical tests confirm the major implications.
The Effect of Executive Stock Option Plans on Stockholders and Bondholders
Authors: DeFUSCO RICHARD A. , JOHNSON ROBERT R. , ZORN THOMAS S.
Published: April 2012

Executive stock option plans have asymmetric payoffs that could induce managers to take on more risk. Evidence from traded call options and stock return data supports this notion. Implicit share price variance, computed from the Black‐Scholes option pricing model, and stock return variance increase after the approval of an executive stock option plan. The event is accompanied by a significant positive stock and a negative bond market reaction. This evidence is consistent with the notion that executive stock options may induce a wealth transfer from bondholders to stockholders.
On Viable Diffusion Price Processes of the Market Portfolio
Authors: BICK AVI
Published: April 2012

The assumption that the market portfolio follows a specified diffusion process implies, in a simple equilibrium framework, that the representative individual must have a certain utility function which is identified in the paper. Not every diffusion process is viable, i.e., can be “endogenized” to be the market portfolio's price process in such an equilibrium model. The paper provides necessary and sufficient conditions for viability which imply that viable diffusion processes constitute a rather restricted family.
Overreaction or Fundamentals: Some Lessons from Insiders' Response to the Market Crash of 1987
Authors: SEYHUN H. NEJAT
Published: April 2012

This paper shows that i) the Crash was a surprise to corporate insiders; ii) insiders became buyers of stock in record numbers immediately following the Crash; iii) stocks that declined more during the Crash were also purchased more by insiders; and iv) stocks that were purchased more extensively by insiders during October 1987 showed larger positive returns in 1988. The overall evidence suggests that overreaction was an important part of the Crash.
Security Pricing and Deviations from the Absolute Priority Rule in Bankruptcy Proceedings
Authors: EBERHART ALLAN C. , MOORE WILLIAM T. , ROENFELDT RODNEY L.
Published: April 2012

Claims ultimately awarded to shareholders of firms in reorganization were examined for a sample of 30 filings under the 1978 Bankruptcy Reform Act. We measured the amount paid to shareholders in excess of that which they would have received under the absolute priority rule and found that this amount represents, on average, 7.6% of the total awarded to all claimants. Evidence is also reported that common share values reflect a significant proportion of value ultimately received in violation of absolute priority, suggesting that deviations from the rule were expected by the equity markets.
International Capital Structure Equilibrium
Authors: HODDER JAMES E. , SENBET LEMMA W.
Published: April 2012

This paper develops a theory of capital structure in an international setting with corporate and personal taxes. We generalize the Miller analysis to an international equilibrium characterized by differential international taxation and inflation in otherwise perfect international capital markets. Our analysis highlights the key role that corporate tax arbitrage plays in generating an international capital structure equilibrium, and we set forth a number of mechanisms for tax arbitrage transactions. We close the paper by outlining some implications of our analysis for national differences in capital structure, the International Fisher Effect, and international tax effects on yield differentials.
Determinants of Secondary Market Prices for Developing Country Syndicated Loans
Authors: BOEHMER EKKEHART , MEGGINSON WILLIAM L.
Published: April 2012

This paper presents our investigation of the factors that determine secondary market prices of developing country syndicated loans. Trading volume in this market has almost doubled yearly from 1985 to 1988 while average market prices declined from 73% to 41% of par value during the same period. We find that loan values depend on a country's solvency rather than its liquidity and show that a country's adoption of a debt conversion program significantly decreases its loans' market prices. Furthermore, the debt moratoria by Brazil and Peru, as well as the developing‐country‐specific provisions made by U.S. banks, impact loan prices negatively.
Deposit Insurance and Wealth Effects: The Value of Being “Too Big to Fail”
Authors: O'HARA MAUREEN , SHAW WAYNE
Published: April 2012

This paper investigates the effect on bank equity values of the Comptroller of the Currency's announcement that some banks were “too big to fail” and that for those banks total deposit insurance would be provided. Using an event study methodology, we find positive wealth effects accruing to TBTF banks, with corresponding negative effects accruing to non‐included banks. We demonstrate that the magnitude of these effects differed with bank solvency and size. We also show that the policy to which the market reacted was that suggested by the Wall Street Journal and not that actually intended by the Comptroller.
Changes in Interstate Banking Laws: The Impact on Shareholder Wealth
Authors: BLACK HAROLD A. , FIELDS M. ANDREW , SCHWEITZER ROBERT L.
Published: April 2012

This study examines the impact on shareholder wealth of changes in interstate banking laws. The research demonstrates that changes in state statutes which allow interstate banking have a positive impact on the stock prices of regional banking organizations and a negative impact on the stock prices of money center banks. Interstate banking statutes initially exclude those states in which the money center banks are headquartered. The findings provide evidence that, by excluding money center banks from expansion across state lines, the competition from the regional banks may have an adverse competitive effect on the money center banks.
Corporate Risk Management and the Incentive Effects of Debt
Authors: CAMPBELL TIM S. , KRACAW WILLIAM A.
Published: April 2012

This paper demonstrates how the incentive of manager‐equityholders to substitute toward riskier assets, commonly referred to as the “asset substitution problem,” is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager‐equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager‐equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level.
Do Managerial Objectives Drive Bad Acquisitions?
Authors: MORCK RANDALL , SHLEIFER ANDREI , VISHNY ROBERT W.
Published: April 2012

In a sample of 326 US acquisitions between 1975 and 1987, three types of acquisitions have systematically lower and predominantly negative announcement period returns to bidding firms. The returns to bidding shareholders are lower when their firm diversifies, when it buys a rapidly growing target, and when its managers performed poorly before the acquisition. These results suggest that managerial objectives may drive acquisitions that reduce bidding firms' values.
An Examination of the Impact of the Garn‐St. Germain Depository Institutions Act of 1982 on Commercial Banks and Savings and Loans
Authors: CORNETT MARCIA MILLON , TEHRANIAN HASSAN
Published: April 2012

This paper evaluates the effects of events leading to the passage of the Garn‐St. Germain Depository Institutions Act of 1982. The evidence suggests that the call for reform by President Reagan's Housing Commission and the Senate passage of the bill produced positive abnormal returns to stockholders of large savings and loans and commercial banks. Stockholders of small S&Ls and banks, on the other hand, generally experienced negative abnormal returns. Furthermore, when hopes of passage of the Act faded, significant negative (positive) abnormal returns were experienced by stockholders of large (small) S&Ls and banks.
Heteroskedasticity in Stock Return Data: Volume versus GARCH Effects
Authors: LAMOUREUX CHRISTOPHER G. , LASTRAPES WILLIAM D.
Published: April 2012

This paper provides empirical support for the notion that Autoregressive Conditional Heteroskedasticity (ARCH) in daily stock return data reflects time dependence in the process generating information flow to the market. Daily trading volume, used as a proxy for information arrival time, is shown to have significant explanatory power regarding the variance of daily returns, which is an implication of the assumption that daily returns are subordinated to intraday equilibrium returns. Furthermore, ARCH effects tend to disappear when volume is included in the variance equation.
Can Futures Market Data Be Used to Understand the Behavior of Real Interest Rates?
Authors: MISHKIN FREDERIC S.
Published: April 2012

This paper examines whether futures market data can be used to understand the behavior of real interest rates. Several ways of examining the data indicate that futures market data are not particularly informative about real interest rates. Not only does this evidence cast some doubt on results in previous research that make use of futures market data to draw inferences about real interest rates, but it also indicates that future research on real interest rates may need to turn to a different line of attack.
Default Risk and the Duration of Zero Coupon Bonds
Authors: CHANCE DON M.
Published: April 2012

This paper applies a contingent claims approach to examine the duration of a zero coupon bond subject to default risk. One replicating portfolio for a default‐prone zero coupon bond contains a long position in the default‐free asset plus a short position in a put option on the underlying assets. The duration of the bond is shown to be a weighted combination of the duration of the default‐free bond and the put option. The duration is less than maturity and is not an immunizing duration. The technique is then extended to subordinated debt.
Stock Dividends, Stock Splits, and Signaling
Authors: MCNICHOLS MAUREEN , DRAVID AJAY
Published: April 2012

This paper provides evidence that firms signal their private information about future earnings by their choice of split factor. Split factors are increasing in earnings forecast errors, after controlling for differences in pre‐split price and firm size. Furthermore, price changes at stock dividend and split announcements are significantly correlated with split factors, holding other factors constant, and with earnings forecast errors. These correlations suggest that management's choice of split factor signals private information about future earnings and that investors revise their beliefs about firm value accordingly. The analysis also suggests, however, that announcement returns are significantly correlated with split factors after controlling for earnings forecast errors. This suggests that earnings forecast errors measure management's private information about future earnings with error, that split factors signal other valuation‐relevant attributes, or that a signaling explanation is incomplete.
Pricing Options with Extendible Maturities: Analysis and Applications
Authors: LONGSTAFF FRANCIS A.
Published: April 2012

Many common types of financial contracts incorporate options with extendible maturities. This paper derives closed‐form expressions for options that can be extended by the optionholder and presents a number of applications including the valuation of American options with stochastic dividends, junk bonds, and shared‐equity mortgages. We also derive closed‐form expressions for writer‐extendible options and discuss the writer's economic incentives for extending an out‐of‐the‐money option. We apply these results to show that corporate debtholders have a strong incentive to extend the maturity of defaulting debt if there are liquidation costs. We model and solve the debtholders' optimal extension problem and show that the possibility of an extension can induce shareholders in highly levered firms to accept negative NPV projects.
Using Generalized Method of Moments to Test Mean‐Variance Efficiency
Authors: MACKINLAY A. CRAIG , RICHARDSON MATTHEW P.
Published: April 2012

This paper develops tests of unconditional mean‐variance efflciency under weak distributional assumptions using a Generalized Method of Moments framework. These tests are potentially more robust than commonly employed tests which rely on the assumption that asset returns are normally distributed and temporarily i.i.d. Using returns for size‐based portfolios from 1926 to 1988 we show that the conclusion concerning the mean‐variance effilciency of market indexes can be sensitive to the test considered.
An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs
Authors: DUMAS BERNARD , LUCIANO ELISA
Published: April 2012

The presence of any friction in financial markets qualitatively changes the nature of the optimization problem faced by an investor. It requires one to either act or do nothing, an issue which, of course, does not arise in frictionless situations. The investor considered here accumulates wealth without consuming until some terminal point in time when he consumes all. His objective is to maximize the expected utility derived from that terminal consumption. We postpone the terminal point far into the future to obtain a stationary portfolio rule. The portfolio policy is in the form of two control barriers between which portfolio proportions are allowed to fluctuate. We show how to calculate them.
Corporate Performance, Corporate Takeovers, and Management Turnover
Authors: MARTIN KENNETH J. , MCCONNELL JOHN J.
Published: April 2012

This paper examines the hypothesis that an important role of corporate takeovers is to discipline the top managers of poorly performing target firms. We document that the turnover rate for the top manager of target firms in tender offer‐takeovers significantly increases following completion of the takeover and that prior to the takeover these firms were significantly under‐performing other firms in their industry as well as other target firms which had no post‐takeover change in the top executive. We interpret the results to indicate that the takeover market plays an important role in controlling the nonvalue maximizing behavior of top corporate managers.
Event Risk: An Analysis of Losses to Bondholders and “Super Poison Put” Bond Covenants
Authors: CRABBE LELAND
Published: April 2012

Ten percent of the investment‐grade industrial bonds that were associated with major capital restructurings between 1983 and 1988 had already been downgraded to speculative grade as of August 1989. In response to these downgrades, and the corresponding wealth losses for bondholders, over 40 percent of recently issued investment‐grade industrial bonds are protected from this type of “event risk” by virtue of specialized covenants. These event‐risk convenants may have initially reduced interest costs for borrowers by roughly 20 to 30 basis points. However, the magnitude of the effect appears to have declined along with the general decline in corporate restructurings.
The Effects of Stock Repurchases on Rival Firms
Authors: HERTZEL MICHAEL G.
Published: April 2012

This paper investigates the stock price behavior of rival firms in the same industry as firms announcing stock repurchase tender offers. Using a sample of 134 repurchase announcements, I find that rival firms on average realize insignificant announcement period abnormal returns. Negative rival stock price performance is detected over longer intervals surrounding the announcement period and for a subset of announcements which ex ante were identified as most likely to affect rivals. This evidence, however, is statistically weak and does little to alter the overall conclusion that the information in repurchase announcements is primarily firm‐specific.
Investor Sentiment and the Closed‐End Fund Puzzle
Authors: LEE CHARLES M. C. , SHLEIFER ANDREI , THALER RICHARD H.
Published: April 2012

This paper examines the proposition that fluctuations in discounts of closed‐end funds are driven by changes in individual investor sentiment. The theory implies that discounts on various funds move together, that new funds get started when seasoned funds sell at a premium or a small discount, and that discounts are correlated with prices of other securities affected by the same investor sentiment. The evidence supports these predictions. In particular, we find that both closed‐end funds and small stocks tend to be held by individual investors, and that the discounts on closed‐end funds narrow when small stocks do well.
The World Price of Covariance Risk
Authors: HARVEY CAMPBELL R.
Published: April 2012

In a financially integrated global market, the conditionally expected return on a portfolio of securities from a particular country is determined by the country's world risk exposure. This paper measures the conditional risk of 17 countries. The reward per unit of risk is the world price of covariance risk. Although the tests provide evidence on the conditional mean variance efficiency of the benchmark portfolio, the results show that countries' risk exposures help explain differences in performance. Evidence is also presented which indicates that these risk exposures change through time and that the world price of covariance risk is not constant.
Production‐Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations
Authors: COCHRANE JOHN H.
Published: April 2012

This paper describes a production‐based asset pricing model. It is analogous to the standard consumption‐based model, but it uses producers and production functions in the place of consumers and utility functions. The model ties stock returns to investment returns (marginal rates of transformation) which are inferred from investment data via a production function. The production‐based model is used to examine forecasts of stock returns by business‐cycle related variables and the association of stock returns with subsequent economic activity.
Are Stock Returns Predictable? A Test Using Markov Chains
Authors: MCQUEEN GRANT , THORLEY STEVEN
Published: April 2012

This paper uses a Markov chain model to test the random walk hypothesis of stock prices. Given a time series of returns, a Markov chain is defined by letting one state represent high returns and the other represent low returns. The random walk hypothesis restricts the transition probabilities of the Markov chain to be equal irrespective of the prior years. Annual real returns are shown to exhibit significant nonrandom walk behavior in the sense that low (high) returns tend to follow runs of high (low) returns in the postwar period.
The Theory of Capital Structure
Authors: HARRIS MILTON , RAVIV ARTUR
Published: April 2012

This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax‐based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided.
Taxes and the Capital Structure of Partnerships, REIT's, and Related Entities
Authors: JAFFE JEFFREY F.
Published: April 2012

Academic finance has explored the effect of taxes on corporate capital structure in great detail. By contrast, the effect of taxes on the capital structure of partnerships, REIT's, and related entities has received little attention. The present paper shows that, under general conditions, the values of partnerships and REIT's are invariant to leverage, contradicting the sparse literature in the area. A proof similar to that of Modigliani‐Miller is employed. The effect of real world imperfections is also examined.
Arbitrage Asset Pricing under Exchange Risk
Authors: IKEDA SHINSUKE
Published: April 2012

This paper extends the APT to an international setting. Specifying a linear factor return‐generating model in local currency terms, we show that the usual risk‐diversification rule in the APT does not yield a riskless portfolio unless currency fluctuations obey the same factor model as asset returns. We then consider an arbitrage portfolio whose exchange risk is hedged by foreign riskless bonds. Under the resulting no‐arbitrage conditions, the expected returns are not on the same hyperplane, unlike the closed‐economy APT, unless they are adjusted by the cost of exchange risk hedging.
The Role of Acquisitions in Foreign Direct Investment: Evidence from the U.S. Stock Market
Authors: HARRIS ROBERT S. , RAVENSCRAFT DAVID
Published: April 2012

This paper examines foreign direct investment by studying shareholder wealth gains for 1273 U.S. firms acquired during the period 1970‐1987. Three findings stand out. First, cross‐border takeovers are more frequent in research and development intensive industries than are domestic acquisitions; furthermore, in three‐fourths of cross‐border transactions the buyer and seller are in related industries. These industry patterns suggest that costs and imperfections in product markets play an important role in foreign direct investment. Second, targets of foreign buyers have significantly higher wealth gains than do targets of U.S. firms. This cross‐border effect is comparable in size to the wealth effects of all‐cash and multiple bids, two effects receiving substantial attention in the finance literature, and is robust to inclusion of these two variables. Third, while the cross‐border effect on wealth gains is not well explained by industry and tax variables, it is positively related to the weakness of the U.S. dollar, indicating a significant role for exchange rate movements in foreign direct investment.
Venture Capitalist Certification in Initial Public Offerings
Authors: MEGGINSON WILLIAM L. , WEISS KATHLEEN A.
Published: April 2012

This paper provides support for the certification role of venture capitalists in initial public offerings. Consistent with the certification hypothesis, a comparison of venture capital backed IPOs with a control sample of nonventure capital backed IPOs from 1983 through 1987 matched as closely as possible by industry and offering size indicates that venture capital backing results in significantly lower initial returns and gross spreads. In effect, the presence of venture capitalists in the issuing firms serves to lower the total costs of going public and to maximize the net proceeds to the offering firm. In addition, we document that venture capitalists retain a significant portion of their holdings in the firm after the IPO.
Diagnosing Asset Pricing Models Using the Distribution of Asset Returns
Authors: SNOW KARL N.
Published: April 2012

This paper develops a set of diagnostic tests which can shed light on why a particular model is failing and indicate what steps might be taken to make the model consistent with asset returns. Theoretical bounds on the moments of a stochastic discount factor are derived as a function of the moments of observed asset returns. Particular attention is paid to restrictions on moments other than the variance. These bounds can also be used to measure the information about the distribution of the discount factor contained in the moments of various asset returns. As an application of this methodology, bounds on the discount factor are estimated using size‐based portfolios, and the results are used to analyze the small firm effect. Empirical results indicate, for the period 1926–1975, that moments of the returns of small firms contain information about the discount factor that is not contained in the moments of the returns of large firms and/or a proxy of the aggregate wealth portfolio. However, this difference disappears when more recent data is included.
The Effect of Volatility Changes on the Level of Stock Prices and Subsequent Expected Returns
Authors: HAUGEN ROBERT A. , TALMOR ELI , TOROUS WALTER N.
Published: April 2012

This paper estimates volatility changes in daily returns to the Dow Jones Industrial Average over the sample period 1897 through 1988. This allows a direct investigation of the reaction of the level of stock prices and subsequent expected returns to these estimated changes in volatility. We provide empirical evidence consistent with relatively large and systematic revisions in stock prices and subsequent expected returns to volatility changes. However, there appears to be an asymmetry in the market's reaction to volatility increases as opposed to volatility decreases. A majority of our volatility changes cannot be associated with the release of significant economic information.
Option Prices and the Underlying Asset's Return Distribution
Authors: GRUNDY BRUCE D.
Published: April 2012

This work examines the relation between option prices and the true, as opposed to risk‐neutral, distribution of the underlying asset. If the underlying asset follows a diffusion with an instantaneous expected return at least as large as the instantaneous risk‐free rate, observed option prices can be used to place bounds on the moments of the true distribution. An illustration of the paper's results is provided by the analysis of the information concerning the mean and standard deviation of market returns contained in the prices of S&P 100 Index Options.
Default Premiums in Commodity Markets: Theory and Evidence
Authors: BAILEY WARREN , NG EDWARD
Published: April 2012

We model the effect of nonperformance risk on forward and futures pricing and look for evidence of nonperformance risk in precious metals futures prices from the “Hunt Brothers”episode. Changes in default premiums are measured and related to the sequence of events in the metals markets during this period. Results suggest first that ex ante costs of nonperformance can be a significant, priced factor in commodity markets and second that the arrival of new information is often associated with changes in these costs. The evidence has implications for both theoretical and empirical research on commodity markets.
A Theory of Workouts and the Effects of Reorganization Law*
Authors: GERTNER ROBERT , SCHARFSTEIN DAVID
Published: April 2012

We present a model of a financially distressed firm with outstanding bank debt and public debt. Coordination problems among public debtholders introduce investment inefficiencies in the workout process. In most cases, these inefficiencies are not mitigated by the ability of firms to buy back their public debt with cash and other securities‐the only feasible way that firms can restructure their public debt. We show that Chapter 11 reorganization law increases investment, and we characterize the types of corporate financial structures for which this increased investment enhances efficiency.
The Losses Realized in Bank Failures
Authors: JAMES CHRISTOPHER
Published: April 2012

This paper examines the losses realized in bank failures. Losses are measured as the difference between the book value of assets and the recovery value net of the direct expenses associated with the failure. I find the loss on assets is substantial, averaging 30 percent of the failed bank's assets. Direct expenses associated with bank closures average 10 percent of assets. An empirical analysis of the determinants of these losses reveals a significant difference in the value of assets retained by the FDIC and similar assets assumed by acquiring banks.
Disclosure, Liquidity, and the Cost of Capital
Authors: DIAMOND DOUGLAS W. , VERRECCHIA ROBERT E.
Published: April 2012

This paper shows that revealing public information to reduce information asymmetry can reduce a firm's cost of capital by attracting increased demand from large investors due to increased liquidity of its securities. Large firms will disclose more information since they benefit most. Disclosure also reduces the risk bearing capacity available through market makers. If initial information asymmetry is large, reducing it will increase the current price of the security. However, the maximum current price occurs with some asymmetry of information: further reduction of information asymmetry accentuates the undesirable effects of exit from market making.
Insider Trading around Dividend Announcements: Theory and Evidence
Authors: JOHN KOSE , LANG LARRY H. P.
Published: April 2012

The informational role of strategic insider trading around corporate dividend announcements is studied based on the efficient equilibrium in a signalling model with endogenous insider trading. Insider trading immediately prior to the announcement of dividend initiations has significant explanatory power. For firms with insider selling prior to the dividend initiation announcement, the excess returns are negative and significantly lower than for the remaining firms (with no insider trading or just insider buying) as implied by our model. Another implication is that dividend increases may elicit a positive or negative stock price response depending on the firm's investment opportunities.
The Intra‐Industry Effects of Going‐Private Transactions
Authors: SLOVIN MYRON B. , SUSHKA MARIE E. , BENDECK YVETTE M.
Published: April 2012

We demonstrate that bids to take firms private generate significantly positive valuation effects for industry rivals of target firms. These valuation effects cannot reflect either synergy or monopoly since no consolidation of operating firms is involved in such transactions. Participation by buyout specialists in the bid does not significantly affect these gains. Bids by outsiders and bids by incumbent managers generate similar valuation effects for industry rivals. The effect on share prices of industry rivals is inversely related to the capitalized values of rival firms relative to the target firm. We also report valuation effects for target firms.
S&P 100 Index Option Volatility
Authors: HARVEY CAMPBELL R. , WHALEY ROBERT E.
Published: April 2012

Using transaction data on the S&P 100 index options, we study the effect of valuation simplifications that are commonplace in previous research on the timeseries properties of implied market volatility. Using an American‐style algorithm that accounts for the discrete nature of the dividends on the S&P 100 index, we find that spurious negative serial correlation in implied volatility changes is induced by nonsimultaneously observing the option price and the index level. Negative serial correlation is also induced by a bid/ask price effect if a single option is used to estimate implied volatility. In addition, we find that these same effects induce spurious (and unreasonable) negative cross‐correlations between the changes in call and put implied volatility.
Dynamic Stock Markets with Multiple Assets: An Experimental Analysis
Authors: O'BRIEN JOHN , SRIVASTAVA SANJAY
Published: April 2012

We study the performance of the rational expectations hypothesis in multiperiod experimental markets with multiple assets. We find that the markets are generally inefficient from the point of view of full information aggregation. However, arbitrage relationships hold, and it is not possible to detect the informational inefficiency by using some standard tests of market efficiency. These findings suggest that the lack of arbitrage opportunities and the failure of common tests to reject inefficiency are not sufficient to conclude that a market is informationally efficient.
New Evidence on The January Effect Before Personal Income Taxes
Authors: JONES STEVEN L. , LEE WINSON , APENBRINK RUDOLF
Published: April 2012

We examine the returns of stocks in Cowles Industrial Index before and after the introduction of personal income taxes in 1917. This is distinct from earlier studies because we cross‐sectionally analyze the relationship between the returns of the individual stocks and measures of tax‐loss selling potential and size. We find that excess returns at the turn‐of‐the‐year and for the month of January were not significant until after 1917. These results provide strong support for the tax‐loss selling hypothesis as an explanation for the January seasonal in the returns of small firms.
The Valuation Effects of Private Placements of Convertible Debt
Authors: FIELDS L. PAIGE , MAIS ERIC L.
Published: April 2012

Share price reactions to announcements of 61 private placements of convertible debt securities are investigated and a significant positive average abnormal return of 1.80% is documented. This unique result contrasts with the negative average abnormal return associated with public sales of convertible debt securities. The positive effect on common shareholders' wealth appears to be related to the relative size of the private issue and unrelated to the degree to which the convertible bond is “out‐of‐the‐money” at issuance.
Long‐Lived Private Information and Imperfect Competition
Authors: HOLDEN CRAIG W. , SUBRAHMANYAM AVANIDHAR
Published: April 2012

We develop a multi‐period auction model in which multiple privately informed agents strategically exploit their long‐lived information. We show that such traders compete aggressively and cause most of their common private information to be revealed very rapidly. In the limit as the interval between auctions approaches zero, market depth becomes infinite and all private information is revealed immediately. These results are in contrast to those of Kyle (1985) in which the monopolistic informed trader causes his information to be incorporated into prices gradually, and, when the interval between auctions is vanishingly small, market depth is constant over time.
Option Replication in Discrete Time with Transaction Costs
Authors: BOYLE PHELIM P. , VORST TON
Published: April 2012

Option replication is discussed in a discrete‐time framework with transaction costs. The model represents an extension of the Cox‐Ross‐Rubinstein binomial option pricing model to cover the case of proportional transaction costs. The method proceeds by constructing the appropriate replicating portfolio at each trading interval. Numerical values of these prices are presented for a range of parameter values. The paper derives a simple Black‐Scholes type approximation for the option prices with transaction costs and demonstrates numerically that it is quite accurate for plausible parameter values.
Swaps: Plain and Fanciful
Authors: LITZENBERGER ROBERT H.
Published: April 2012

The outstanding face amount of plain vanilla interest rate swaps exceeds two trillion dollars. While pricing and hedging of such swaps appear to be quite simple, many existing theories are based on the incorrect characterization of a swap as a simple exchange of a fixed for a floating rate note. This characterization is not consistent with standarized swap contracts and the treatment of swaps in bankruptcy. This paper provides an alternative perspective on swaps.
Mergers and the Value of Antitrust Deterrence
Authors: ECKBO B. ESPEN
Published: April 2012

While the U.S. has pursued a vigorous antitrust policy towards horizontal mergers over the past four decades, mergers in Canada have until recently been permitted to take place in a virtually unrestricted antitrust environment. The absence of an antitrust overhang in Canada presents an interesting opportunity to test the conjecture that the rigid market share and concentration criteria of the U.S. policy effectively deters a significant number of potentially collusive mergers. The effective deterrence hypothesis implies that the probability of a horizontal merger being anticompetitive is higher in Canada than in the U.S. However, parameters in cross‐sectional regressions reject the market power hypothesis on samples of both U.S. and Canadian mergers. Judging from the Canadian evidence, there simply isn't much to deter.
Management Buyout Proposals and inside Information
Authors: LEE D. SCOTT
Published: April 2012

This paper explores stock price behavior surrounding withdrawn buyout proposals to determine whether managers' proposal announcements reveal any information which is unrelated to the efficiency gains associated with completed buyouts. On average, firms whose managers withdraw buyout proposals do not sustain significantly positive stock price effects unless they receive subsequent acquisition bids. In addition, managers of firms with completed buyouts are no more likely to have access to inside information than managers who withdrew proposals. I interpret this evidence as inconsistent with the notion that inside information commonly motivates management buyout proposals.
Beatrice: A Study in the Creation and Destruction of Value
Authors: BAKER GEORGE P.
Published: April 2012

This paper chronicles the history of the Beatrice company from its founding in 1891 as a small creamery, through its growth by acquisition into a diversified consumer and industrial products firm, and its subsequent leveraged buyout and sell‐off. The paper analyzes the value consequences the firm's acquisition and divestiture policies, its organizational strategy, and its governance. The analysis sheds light on a number of issues in organization theory, strategy, and corporate finance, including the sources of value in diversifying aquisitions, the cost of over‐centralization and weak corporate governance, and the mechanisms of value creation in the market for corporate control.
Capital Structure as an Optimal Contract Between Employees and Investors
Authors: CHANG CHUN
Published: April 2012

The ex ante optimal contract between investors and employees is derived endogenously and is interpreted in terms of debt, equity, and employees' compensation. Although public equity financing is feasible in this model through verified accounting income, debt is needed to force value‐enhancing restructuring before the income realizes. The optimal debt level, however, is lower than that which maximizes the value of the firm when there is nonmonetary restructuring‐related cost to employees. The paper explains how stock prices react to exchange offers, how earnings can be diluted by a decrease in leverage, and why employees' claims are generally senior to those of investors. New testable implications about leverage and compensation levels are derived.
Optimal Contracting and Insider Trading Restrictions
Authors: FISCHER PAUL E.
Published: April 2012

Restrictions on trading by insider agents are analyzed using an optimal contracting framework. Prohibition of insider trading is shown to be Pareto preferred if, and only if, a revelation or moral hazard problem exists. If prohibition of insider trading is valuable, then trade registration with a delay is shown to be as valuable as complete prohibition. Short selling restrictions, however, are generally of less value than complete prohibition. Finally, regulation of insider agent trading by governmental institutions and/or professional associations is discussed.
The Effect of Bond Rating Agency Announcements on Bond and Stock Prices
Authors: HAND JOHN R. M. , HOLTHAUSEN ROBERT W. , LEFTWICH* RICHARD W.
Published: April 2012

This paper examines daily excess bond returns associated with announcements of additions to Standard and Poor's Credit Watch List, and to rating changes by Moody's and Standard and Poor's. Reliably nonzero average excess bond returns are observed for additions to Standard and Poor's Credit Watch List when an expectations model is used to classify additions as either expected or unexpected. Bond price effects are also observed for actual downgrade and upgrade announcements by rating agencies. Excluding announcements with concurrent disclosures weakens the results for downgrades, but not upgrades. The stock price effects of rating agency announcements are also examined and contrasted with the bond price effects.
Interest Rate Volatility and the Term Structure: A Two‐Factor General Equilibrium Model
Authors: LONGSTAFF FRANCIS A. , SCHWARTZ EDUARDO S.
Published: April 2012

We develop a two‐factor general equilibrium model of the term structure. The factors are the short‐term interest rate and the volatility of the short‐term interest rate. We derive closed‐form expressions for discount bonds and study the properties of the term structure implied by the model. The dependence of yields on volatility allows the model to capture many observed properties of the term structure. We also derive closed‐form expressions for discount bond options. We use Hansen's generalized method of moments framework to test the cross‐sectional restrictions imposed by the model. The tests support the two‐factor model.
Arbitrage With Holding Costs: A Utility‐Based Approach
Authors: TUCKMAN BRUCE , VILA JEAN‐LUC
Published: April 2012

Unit time costs, or holding costs, are incurred in many arbitrage contexts. Examples include losing the use of short sale proceeds and lending funds at below market rates in reverse repurchase agreements. This paper analyzes the investment problem of a risk averse arbitrageur who faces holding costs. The model allows prices to deviate from “fundamental” values without allowing for riskless arbitrage opportunities. After characterizing an arbitrageur's optimal strategy, the model is examined in the context of the Treasury market. The analysis reveals that holding costs are an important friction in this market and that they can significantly affect arbitrageur behavior.
Herd on the Street: Informational Inefficiencies in a Market with Short‐Term Speculation
Authors: FROOT KENNETH A. , SCHARFSTEIN DAVID S. , STEIN JEREMY C.
Published: April 2012

Standard models of informed speculation suggest that traders try to learn information that others do not have. This result implicitly relies on the assumption that speculators have long horizons, i.e., can hold the asset forever. By contrast, we show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know. There can be multiple herding equilibria, and herding speculators may even choose to study information that is completely unrelated to fundamentals.