bluuebunny/crossref_metadata_2025 huggingface dataset:
Some Results in the Theory of Arbitrage Pricing
Authors: INGERSOLL JONATHAN E.
Published: April 2012

This paper derives a stronger version of Huberman's recent “preference free” pricing theorem. This pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model. It must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals. This result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under Huberman's bound. Some applications to empirical tests and performance measurement are also discussed.
Earnings and Dividend Announcements: Is There a Corroboration Effect?
Authors: KANE ALEX , LEE YOUNG KI , MARCUS ALAN
Published: April 2012

We examine abnormal stock returns surrounding contemporaneous earnings and dividend announcements in order to determine whether investors evaluate the two announcements in relation to each other. We find that there is a statistically significant interaction effect. The abnormal return corresponding to any earnings or dividend announcement depends upon the value of the other announcement. This evidence suggests the existence of a corroborative relationship between the two announcements. Investors give more credence to unanticipated dividend increases or decreases when earnings are also above or below expectations, and vice versa.
Ordering Uncertain Options under Inflation: A Note
Authors: LEVY HAIM , LEVY AZRIEL
Published: April 2012

Stochastic dominance rules (SD) have been extended to the case where investors are allowed to borrow and lend at the riskless interest rate. Stochastic dominance rules with a riskless asset (SDR) are much more effective than SD rules. However, it seems that this benefit is eliminated by an uncertain inflation, since riskless assets become risky once uncertain inflation is considered.

We prove in this paper that SDR criteria are valid also in the face of uncertain (and independent) inflation. Moreover, while the mean‐variance (MV) efficient set increases with uncertain inflation, the stochastic dominance efficient sets decrease.
Stock Returns, Inflation, and Economic Activity: The Survey Evidence
Authors: HASBROUCK JOEL
Published: April 2012

The primary purpose of this paper is the use of survey expectations data to study the empirical relationships between stock returns, inflation, and economic activity. In the course of this analysis and as a secondary purpose, the paper discusses general considerations involving the use of expectations proxies and makes recommendations for econometric techniques. The main empirical findings are: (1) Hypothesized relationships between expected economic activity and expected inflation do not in practice appear to be important in explaining the negative relationship between expected inflation and stock returns. (2) Nevertheless, the survey data do lend some support to the hypothesis of a quantity theory relationship between expected inflation and expected economic activity, holding constant monetary growth. (3) The cross‐forecaster dispersion of economic activity forecasts, a proxy for real uncertainty, appears to be a significant determinant of stock returns. Inclusion of this variable eliminates the negative impact of expected inflation.
Mean‐Gini, Portfolio Theory, and the Pricing of Risky Assets
Authors: SHALIT HAIM , YITZHAKI SHLOMO
Published: April 2012

This paper presents the mean‐Gini (MG) approach to analyze risky prospects and construct optimum portfolios. The proposed method has the simplicity of a mean‐variance model and the main features of stochastic dominance efficiency. Since mean‐Gini is consistent with investor behavior under uncertainty for a wide class of probability distributions, Gini's mean difference is shown to be more adequate than the variance for evaluating the variability of a prospect. The MG approach is then applied to capital markets and the security valuation theorem is derived as a general relationship between average return and risk. This is further extended to include a degree of risk aversion that can be estimated from capital market data. The analysis is concluded with the concentration ratio to allow for the classification of different securities with respect to their relative riskiness.
A Simple Formula for the Expected Rate of Return of an Option over a Finite Holding Period
Authors: RUBINSTEIN MARK
Published: April 2012

Under conditions consistent with the Black‐Scholes formula, a simple formula is developed for the expected rate of return of an option over a finite holding period possibly less than the time to expiration of the option. Under these conditions, surprisingly, the expected future value of a European option, even prior to expiration, is shown equal to the current Black‐Scholes value of the option, except that the expected future value of the stock at the end of the holding period replaces the current stock price in the Black‐Scholes formula and the future value of a riskless invesment of the striking price replaces the striking price. An extension of this result is used to approximate moments of the distribution of returns from an option portfolio.
The American Put Option Valued Analytically
Authors: GESKE ROBERT , JOHNSON H. E.
Published: April 2012

An analytic solution to the American put problem is derived herein. The hedge ratio and other derivatives of the solution are presented. The formula derived implies an exact duplicating portfolio for the American put consisting of discount bonds and stock sold short. The formula is extended to consider put options on stocks paying cash dividends. A polynomial expression is developed for evaluating these formulae. Values and hedge ratios for puts on both dividend and nondividend paying stocks are calculated, tabulated, and compared with values derived by numerical integration and binomial approximation. As with European options, evaluating an analytic formula is more efficient than approximating the stock price process or the partial differential equation by binomial or finite difference methods. Finally, applications of this American put solution are discussed.
Optimal Release of Information By Firms
Authors: DIAMOND DOUGLAS W.
Published: April 2012

This paper provides a positive theory of voluntary disclosure by firms. Previous theoretical work on disclosure of new information by firms has demonstrated that releasing public information will often make all shareholders worse off, due to an adverse risk‐sharing effect. This paper uses a general equilibrium model with endogenous information collection to demonstrate that there exists a policy of disclosure of information which makes all shareholders better off than a policy of no disclosure. The welfare improvement occurs because of explicit information cost savings and improved risk sharing. This provides a positive theory of precommitment to disclosure, because it will be unanimously voted for by stockholders and will also represent the policy that will maximize value ex ante. In addition, it provides a “missing link” in financial signalling models. Apart from the effects on information production analyzed in this paper, most existing financial signalling models are inconsistent with a firm taking actions which facilitate future signalling because release of the signal makes all investors worse off.
The Impact of Inflation on the Aggregate Debt‐Asset Ratio
Authors: HOCHMAN SHALOM , PALMON ODED
Published: April 2012

This paper demonstrates that, contrary to the results of previous studies, the impact of inflation on the aggregate debt‐asset ratio cannot be determined theoretically. However, it is shown that inflation is likely to increase this ratio when personal income tax schedules are indexed to the price level and/or when leverage‐related costs are relatively high and the personal tax rate on income from holding common stocks is relatively low.
Taxes, Default Risk, and Yield Spreads
Authors: YAWITZ JESS B. , MALONEY KEVIN J. , EDERINGTON LOUIS H.
Published: April 2012

This paper develops a model of bond prices and yield spreads that incorporates the effect of both taxes and differences in default probabilities. The tax loss consequences of default are recognized. Traditionally, tax‐free (municipal) bond yields have been viewed as linearly related to taxable yields with a slope coefficient equal to one minus the tax rate and the intercept representing differences in default risk. While our model supports the linearity assumption, it implies that the slope and intercept are both functions of both the break‐even tax rate and the default probability(ies). Clientele effects among both municipal and taxable bonds are demonstrated. Finally, the implied marginal tax rates and the implied default probabilities are estimated for different categories of municipal bonds.
Yes, The APT Is Testable
Authors: DYBVIG PHILIP H. , ROSS STEPHEN A.
Published: April 2012

The Arbitrage Pricing Theory (APT) has been proposed as an alternative to the mean‐variance Capital Asset Pricing Model (CAPM). This paper considers the testability of the APT and points out the irrelevance for testing of the approximation error. We refute Shanken's objections, including his assertion that Roll's critique of the CAPM is applicable to the APT. We also explain the testability of the APT on subsets, and we explore the relationship between the APT and the CAPM.
A Sequential Signalling Model of Convertible Debt Call Policy
Authors: HARRIS MILTON , RAVIV ARTUR
Published: April 2012

In this paper we attempt to resolve two puzzles concerning convertible debt calls. The first is that although it has been shown that conversion of these bonds should optimally be forced as soon as this is feasible, actual calls are significantly delayed relative to this prescription. The second is that common stock returns are significantly negative around the announcement of the call of a convertible debt issue. Our purpose is to simultaneously rationalize managers' observed call decisions and the market's reaction to them in a framework in which managers behave optimally given their private information, compensation schemes, and investors' reactions to their call decisions. Moreover, investors' reactions are rational in the sense of Bayes' rule given managers' call policy. In equilibrium, a decision to call is (correctly) perceived by the market as a signal of unfavorable private information. In addition to rationalizing observed call delays and negative stock returns at call announcement, several other testable implications are derived.
Options on the Spot and Options on Futures
Authors: BRENNER MENACHEM , COURTADON GEORGES , SUBRAHMANYAM MARTI
Published: April 2012

This paper analyzes and compares the valuation of two types of options that relate to the same asset: options on the asset itself and options on the futures on the asset. The early exercise privilege plays a central role in explaining the differences between the values of the two options. It is shown that in the case of a cash instrument that does not make interim payments, such as gold, the value of a call option on the spot is smaller than the call option on the futures contract; the opposite is true for put options. The early exercise boundaries, which characterize when it pays to exercise, are also compared and analyzed.
Dispersion of Financial Analysts' Earnings Forecasts and the (Option Model) Implied Standard Deviations of Stock Returns
Authors: AJINKYA BIPIN B. , GIFT MICHAEL J.
Published: April 2012

This study examines whether the information implied by simultaneous levels of option and stock prices (specifically, the implied standard deviation of returns) reflects other contemporaneously available information. The independent contemporaneous measure considered is the observed dispersion (across several financial analysts), at a point in time, in the forecasts of earnings per share for a given firm. The results indicate that implied standard deviations clearly reflect the contemporaneous dispersion in analysts' forecasts incrementally, i.e., beyond the information contained in the historical time series of returns.
The Rule 415 Experiment: Equity Markets
Authors: BHAGAT SANJAI , MARR M. WAYNE , THOMPSON G. RODNEY
Published: April 2012

Rule 415 allows a firm to register all the securities it reasonably expects to sell over the next two years and then, at the management's option, to sell those securities over these two years whenever it chooses. This paper examines whether equity offerings made under Rule 415 (shelf offerings) differ in issuing costs from equity offerings not sold under this rule. We find that shelf offerings cost 13% less for syndicated issues and 51% less for nonsyndicated issues. We also investigate the empirical relevance of the market overhang argument which suggests that shelf registrations depress the price of the registering firm's shares more than traditional registrations. Our data does not support the market overhang argument.
Moral Hazard and Information Sharing: A Model of Financial Information Gathering Agencies
Authors: MILLON MARCIA H. , THAKOR ANJAN V.
Published: April 2012

We propose a theory of information gathering agencies in a world of informational asymmetries and moral hazard. In a setting in which true firm values are certified by screening agents whose payoffs depend on noisy ex post monitors of information quality, the formation of information gathering agencies (groups of screening agents) is justified on two grounds. First, it enables screening agents to diversify their risky payoffs. Second, it allows information sharing. The first effect itself is insufficient despite the risk aversion of screening agents and the stochastic independence of the monitors used to compensate them.
Reformulating Tax Shield Valuation: A Note
Authors: MILES JAMES A. , EZZELL JOHN R.
Published: April 2012

Standard financial theory (in the absence of agency costs and personal taxes) implies that each dollar of debt contributes to the value of the firm in proportion to the firm's tax rate. To derive this result, incremental debt is assumed permanent. This paper shows that when the firm acts to maintain a constant market value leverage ratio, the marginal value of debt financing is much lower than the corporate tax rate. Since Hamada's [2] unlevering procedure for observed equity betas was derived under the assumption of permanent debt, we derive an unlevering procedure consistent with the assumption of a constant leverage ratio.
The Use of Electronic Funds Transfers to Capture the Effects of Cash Management Practices on the Demand for Demand Deposits: A Note
Authors: DOTSEY MICHAEL
Published: April 2012

The rapidly increasing use of more sophisticated cash management practices is a factor influencing the demand for money that is not considered in standard models of money demand. Within the framework of an inventory theoretic model of money demand, this paper provides theoretical grounds for using the number of electronic funds transfers as an indication of increasing cash management sophistication. Specifically, the demand for demand deposits is determined from the solution of a simultaneous equation system that also determines the optimal level of cash management. Therefore, the level of cash management services influences transactions costs, implying that transactions costs are endogenous. The number of electronic funds transfers is closely linked to the level of cash management services and is therefore related to transactions costs. Models of money demand that treat transactions costs as exogenous and fixed are therefore misspecified and will not perform well when transactions costs are changing. By explicitly incorporating the changing nature of transactions costs through the use of electronic funds transfers, the problems of instability and poor predictive power associated with the demand for money in the 1970's are overcome.
Derivation of the Capital Asset Pricing Model without Normality or Quadratic Preference: A Note
Authors: KWON YOUNG K.
Published: April 2012

Derivation of the capital asset pricing model requires various assumptions including normality or quadratic preference. The objective of this note is to show that the normality or quadratic preference assumption can be replaced by the fair game condition that assets' residual returns have zero mean conditional upon the return of the market portfolio.
On Jumps in Common Stock Prices and Their Impact on Call Option Pricing
Authors: BALL CLIFFORD A. , TOROUS WALTER N.
Published: April 2012

The Black‐Scholes call option pricing model exhibits systematic empirical biases. The Merton call option pricing model, which explicitly admits jumps in the underlying security return process, may potentially eliminate these biases. We provide statistical evidence consistent with the existence of lognormally distributed jumps in a majority of the daily returns of a sample of NYSE listed common stocks. However, we find no operationally significant differences between the Black‐Scholes and Merton model prices of the call options written on the sampled common stocks.
Risk Aversion and Arbitrage
Authors: GREEN RICHARD C. , SRIVASTAVA SANJAY
Published: April 2012

This paper characterizes conditions under which asset returns and consumption are consistent with risk‐averse preferences. It is shown that risk aversion is equivalent to “zero arbitrage” on a transformation of the payoff space. The implicit state prices which are dual to this no‐arbitrage condition can be interpreted as prices of “pure consumption hedges.” This zero‐arbitrage restriction implies the usual restrictions associated with nonsatiation. The analysis holds in both complete and incomplete market settings.
A Simple Econometric Approach for Utility‐Based Asset Pricing Models
Authors: BROWN DAVID P. , GIBBONS MICHAEL R.
Published: April 2012

Utility‐based models of asset pricing may be estimated with or without assuming a distribution for security returns; both approaches are developed and compared here. The chief strength of a parametric estimator lies in its computational simplicity and statistical efficiency when the added distributional assumption is true. In contrast, the nonparametric estimator is robust to departures from any particular distribution, and it is more consistent with the spirit underlying utility‐based asset pricing models since the distribution of asset returns remains unspecified even in the empirical work. The nonparametric approach turns out to be easy to implement with precision nearly indistinguishable from its parametric counterpart in this particular application. The application shows that log utility is consistent with the data over the period 1926–1981.
The Analytics of Performance Measurement Using a Security Market Line
Authors: DYBVIG PHILIP H. , ROSS STEPHEN A.
Published: April 2012

Security market line (SML) analysis, while an important tool, has never been fully justified from a theoretical standpoint. Assuming symmetric information and an inefficient index, we show that SML analysis can be grossly misleading, since, in general, efficient and inefficient portfolios can plot above and below the SML. On a more positive note, if SML analysis uses the return on a marketed riskless asset for the zero‐beta rate, efficient portfolios must plot above the SML. Nonetheless, arbitrarily inefficient portfolios also plot above the SML.
Adjustment Costs and Capital Asset Pricing
Authors: HUFFMAN GREGORY W.
Published: April 2012

Discrete‐time models of asset pricing have hitherto generally avoided studying the relationship between the underlying technology inherent in the economy and the determinants of the price of capital. A fully articulated economy is constructed in which there is a nontrivial technology for producing capital. The existence of adjustment costs in augmenting the quantity of capital has interesting implications for the stochastic properties of asset prices, as well as other macroeconomic variables. Examples of such economies are used to illustrate this point.
A Theoretical Analysis of Real Estate Returns
Authors: FOGLER H. RUSSELL , GRANITO MICHAEL R. , SMITH LAURENCE R.
Published: April 2012

In this paper, we consider two hypotheses for the recent performance of real estate returns. The first is the random event argument that real estate is positively correlated with unanticipated inflation but that structural change in expected returns due to a change in the perceived sensitivity of returns to unanticipated inflation has not taken place. The second is the hedge demand argument that formulates the structural shift hypothesis. The paucity of real estate and other expectations data as well as the general identification problem make it extremely difficult to distinguish between these hypothesis. Our tests consist of estimates of inflation betas for various asset categories overtime as well as estimates of the hedge vector, . Although some support for the hedge argument is found, the results are not strong enough to reject the random event argument and conclude that a decline in the required return on real estate due to a relative increase in inflation beta drove returns during the 1970's.
An Investigation of Transactions Data for NYSE Stocks
Authors: WOOD ROBERT A. , McINISH THOMAS H. , ORD J. KEITH
Published: April 2012

Using transactions data, the behavior of returns and characteristics of trades at the micro level is examined. A minute‐by‐minute market return series is formed and tested for normality and autocorrelation. Evidence of differences in return distributions is found among overnight trades, trades during the first 30 minutes following the market opening, trades at the close, and trades during the remainder of the day. The latter distribution is found to be normal. Unusually high returns and standard deviations of returns are found at the beginning and the end of the trading day. When the beginning‐and end‐of‐the‐day effects are omitted, autocorrelation in the market return series is reduced substantially. A number of patterns in trading are reported.
In Defense of Technical Analysis
Authors: TREYNOR JACK L. , FERGUSON ROBERT
Published: April 2012

Many investors occasionally receive what they believe to be nonpublic information about a security. Others feel that by applying superior analytical skills to public information, they are able to arrive at valuable insights that are not generally appreciated. In either case, there is a substantial opportunity for profit if the investor is correct. The investor must be correct on two counts. First, the estimate of the worth of the information must be reasonably accurate in terms of its impact on the price of the stock, and second, the investor must make a realistic assessment of the likelihood that the market already has received the information or insight in question. This paper is concerned only with the latter problem. The probability distribution of the date on which the market receives information already in the hands of the investor is calculated for a simple model of information propagation. It is then shown how this probability distribution can be brought to bear on the management of a portfolio.
Risk A version and Information Structure: An Experimental Study of Price Variability in the Securities Markets
Authors: ANG JAMES S. , SCHWARZ THOMAS
Published: April 2012

This study investigates the differences in the behaviors between the speculative investors and the conservative investors in two separate experimental markets. Although the market for speculators shows greater price volatility in both bid/ask spread within a trade as well as with intraperiod variances, it exhibits several desirable properties. Specifically, the price patterns tend to converge closer, and at a greater speed to either the prior information equilibrium price or the rational expectation equilibrium price. It also achieves better allocational efficiency. And, it is also less likely to be misled by potentially “false” price information.
Spinoff/Terminations and the Value of Pension Insurance
Authors: MARCUS ALAN J.
Published: April 2012

This paper derives the value of Pension Benefit Guarantee Corporation (PBGC) pension insurance under two scenarios of interest. The first allows for voluntary plan termination, which appears to be legal under current statutes. In the second scenario, termination is prohibited unless the firm is bankrupt. Empirical estimates of PBGC liabilities are calculated. These show that prospective PBGC liabilities greatly exceed current reserves for plan terminations, that even under a bankruptcy‐only termination rule, PBGC liabilities still would be quite sensitive to discretionary funding policy, and that the increasingly common practice of pension spinoff/terminations, substantially increases the present value of the PBGC's contingent liabilities.
Depositors' Welfare, Deposit Insurance, and Deregulation
Authors: CHAN YUK‐SHEE , MAK KING‐TIM
Published: April 2012

We develop an analytical model to address the question of optimal deposit insurance policy and to examine the impact of deregulation on depositors' welfare and the soundness of the insurance system. We find that the optimal level of regulation depends critically on the functional relationship between risk and return. We show that in general deregulation of bank activities and/or of deposit rate ceilings will in volve tradeoff between depositors' welfare and the soundness of the insurance system. Our analysis also indicates that risk‐sensitive premium and capital requirement schedules may not be efficient in managing the risk of banks.
The Pricing of Oil and Gas: Some Further Results
Authors: MILLER MERTON H. , UPTON CHARLES W.
Published: April 2012

The Hotelling Valuation Principle (HVP) implies that the unit value of an exhaustible natural resource can be written as a function of its current price, net of extraction costs; other variables such as interest rates have no additional explanatory power. The results of earlier tests using data from 1979–1981 strongly support the HVP. This paper presents a series of follow‐up tests using time‐series cross‐section data covering the period August 1981 to December 1983. Because the variance of petroleum prices in this period was substantially less than in the earlier period, the follow‐up sample proved generally noninformative. The sample also contains some observations on oil and gas royalty trusts. Tests of the HVP using these trust data yielded generally satisfactory results, although—given the limited sample size—the results must be viewed with caution.
Term Structure Movements and Pricing Interest Rate Contingent Claims
Authors: HO THOMAS S. Y. , LEE SANG‐BIN
Published: April 2012

This paper derives an arbitrage‐free interest rate movements model (AR model). This model takes the complete term structure as given and derives the subsequent stochastic movement of the term structure such that the movement is arbitrage free. We then show that the AR model can be used to price interest rate contingent claims relative to the observed complete term structure of interest rates. This paper also studies the behavior and the economics of the model. Our approach can be used to price a broad range of interest rate contingent claims, including bond options and callable bonds.
Can Tax‐Loss Selling Explain the January Seasonal in Stock Returns?
Authors: CHAN K. C.
Published: April 2012

This paper analyzes the tax‐loss selling hypothesis as an explanation of the January seasonal in stock returns and argues that rational tax‐loss selling implies little relation between the January seasonal and the long‐term loss. Empirical results show that the January seasonal is as strongly related to the long‐term loss as it is to the short‐term loss. The evidence is inconsistent with a model that explains the January seasonal by optimal tax trading.
The Effects of Different Taxes on Risky and Risk‐free Investment and on the Cost of Capital
Authors: ZHU YU , FRIEND IRWIN
Published: April 2012

This paper analyzes the major factors which determine the effects of taxation on the value of risky assets and on the cost of capital, and shows how the magnitudes and even the signs of these effects depend on the values assumed for a few key parameters in the model. Using plausible values for these parameters, it is shown that the results obtained are frequently counter‐intuitive.
Beating the Foreign Exchange Market
Authors: SWEENEY RICHARD J.
Published: April 2012

Filter rule profits found in foreign exchange markets in the early days of the current managed float persist in later periods, as shown by statistical tests developed and implemented here. The test is consistent with, but independent of, a wide variety of asset pricing models. The profits found cannot be explained by risk if risk premia are constant over time. Inclusion of the home‐foreign interest rate differential in computing profits has little effect on the comparison of filter returns to those of buy‐and‐hold.
Asset Pricing and Expected Inflation
Authors: STULZ RENÉ M.
Published: April 2012

This paper provides an equilibrium model in which expected real returns on common stocks are negatively related to expected inflation and money growth. It is shown that the fall in real wealth associated with an increase in expected inflation decreases the real rate of interest and the expected real rate of return of the market portfolio. The expected real rate of return of the market portfolio falls less, for a given increase in expected inflation, when the increase in expected inflation is caused by an increase in money growth rather than by a worsening of the investment opportunity set. The model has empirical implications for the effect of a change in expected inflation on the cross‐sectional distribution of asset returns and can help to understand why assets whose return covaries positively with expected inflation may have lower expected returns. The model also agrees with explanations advanced by Fama [5] and Geske and Roll [10] for the negative relation between stock returns and inflation.
Excess Asset Reversions and Shareholder Wealth
Authors: ALDERSON MICHAEL J. , CHEN K. C.
Published: April 2012

The ownership of pension assets in a defined benefit pension plan is an unresolved issue in corporate finance. The issue is important because it defines the appropriate investment policy for a pension fund. In this paper, we summarize the ownership debate in the form of two mutually exclusive theories. We then focus on a recently popular event in pension finance, excess asset reversions. Our paper demonstrates the valuation effects associated with this event in a stochastic dominance framework. Under certain conditions, a reversion constitutes an expropriation of wealth from the participants and beneficiaries of the plan to the firm. Using data provided by the Pension Benefit Guaranty Corporation and the Center for Research in Security Prices tape, we examine the returns to the shareholders of 58 companies which conducted excess asset reversions between 1980 and 1984. Our results show that large abnormal returns accrued to these shareholders around the time of the reversion. These findings have implications both for the appropriate investment policy of pension funds and for public policy with respect to plan terminations.
Testing Portfolio Efficiency when the Zero‐Beta Rate is Unknown: A Note
Authors: SHANKEN JAY
Published: April 2012

A lower bound on the distribution function of the likelihood ratio test of portfolio efficiency is derived. An empirical application demonstrates that the bound may sometimes be used to infer rejection of the null hypothesis without appeal to asymptotic statistical approximations. A procedure for incorporating partial information about the zero‐beta intercept, in the multivariate framework, is also developed and applied.
Noise
Authors: BLACK FISCHER
Published: April 2012

The effects of noise on the world, and on our views of the world, are profound. Noise in the sense of a large number of small events is often a causal factor much more powerful than a small number of large events can be. Noise makes trading in financial markets possible, and thus allows us to observe prices for financial assets. Noise causes markets to be somewhat inefficient, but often prevents us from taking advantage of inefficiencies. Noise in the form of uncertainty about future tastes and technology by sector causes business cycles, and makes them highly resistant to improvement through government intervention. Noise in the form of expectations that need not follow rational rules causes inflation to be what it is, at least in the absence of a gold standard or fixed exchange rates. Noise in the form of uncertainty about what relative prices would be with other exchange rates makes us think incorrectly that changes in exchange rates or inflation rates cause changes in trade or investment flows or economic activity. Most generally, noise makes it very difficult to test either practical or academic theories about the way that financial or economic markets work. We are forced to act largely in the dark.
LYON Taming
Authors: McCONNELL JOHN J. , SCHWARTZ EDUARDO S.
Published: April 2012

A Liquid Yield Option Note (LYON) is a zero coupon, convertible, callable, puttable bond. This paper presents a simple contingent claims pricing model for valuing LYONS and uses the model to analyze a specific LYON issue.
Do Demand Curves for Stocks Slope Down?
Authors: SHLEIFER ANDREI
Published: April 2012

Since September, 1976, stocks newly included into the Standard and Poor's 500 Index have earned a significant positive abnormal return at the announcement of the inclusion. This return does not disappear for at least ten days after the inclusion. The returns are positively related to measures of buying by index funds, consistent with the hypothesis that demand curves for stocks slope down. The returns are not related to S & P's bond ratings, which is inconsistent with a plausible version of the hypothesis that inclusion is a certification of the quality of the stock.
Integration vs. Segmentation in the Canadian Stock Market
Authors: JORION PHILIPPE , SCHWARTZ EDUARDO
Published: April 2012

This paper examines the issue of integration versus segmentation of the Canadian equity market relative to a global North American market. We compare the international and domestic versions of the CAPM, and find that integration, or the mean‐variance efficiency of the global market index, is rejected by the data. Segmentation is the preferred model, based on a maximum likelihood procedure correcting for thin trading. We further divide the sample into securities that are interlisted in Canada and the U.S., and those that are not. Integration is rejected for both groups, which indicates that the source of segmentation can be traced to legal barriers based on the nationality of issuing firms.
The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates
Authors: BROWN STEPHEN J. , DYBVIG PHILIP H.
Published: April 2012

The one‐factor version of the Cox, Ingersoll, and Ross model of the term structure is estimated using monthly quotes on U.S. Treasury issues trading from 1952 through 1983. Using data from a single yield curve, it is possible to estimate implied short and long term zero coupon rates and the implied variance of changes in short rates. Analysis of residuals points to a probable neglected tax effect.
An Economic Analysis of Interest Rate Swaps
Authors: BICKSLER JAMES , CHEN ANDREW H.
Published: April 2012

Interest rate swaps, a financial innovation in recent years, are based upon the principle of comparative advantage. An interest rate swap is a useful tool for active liability management and for hedging against interest rate risk. The purpose of this paper is to provide a simple economic analysis of interest rate swaps. Alternative uses of and the appropriate valuation procedure for interest rate swaps are described.
Discrete Expectational Data and Portfolio Performance
Authors: ELTON EDWIN J. , GRUBER MARTIN J. , GROSSMAN SETH
Published: April 2012

In this article we examine the information content in analysts' recommendations which are made on a five‐point buy, hold, or sell scale. Our data set includes data on 10,000 forecasts per month. Unlike most prior studies, our data set does not suffer from selection or survivorship bias. We find information in analysts' changes in recommendations. Approximately 4.5% extra return can be earned by purchasing new buys rather than new sells.
Tax Clienteles and Asset Pricing
Authors: DYBVIG PHILIP H. , ROSS STEPHEN A.
Published: April 2012

Taxation of asset returns can create various clientele effects. If every agent is marginal on all assets, no clientele effects arise. If some (but not every) agent is marginal on all assets, there arises a clientele effect in quantities but none in prices. If no agent is marginal on all assets, there arise clientele effects in both quantities and prices. In the first two cases, standard asset pricing and martingale results extend to analogous aftertax results. In the third case, linear asset pricing works only on subsets of assets, and the standard martingale results become after‐tax supermartingale results.
Futures Options and the Volatility of Futures Prices
Authors: BALL CLIFFORD A. , TOROUS WALTER N.
Published: April 2012

Assuming nonstochastic interest rates, European futures options are shown to be European options written on a particular asset referred to as a futures bond. Consequently, standard option pricing results may be invoked and standard option pricing techniques may be employed in the case of European futures options. Additional arbitrage restrictions on American futures options are derived. The efficiency of a number of futures option markets is examined. Assuming that at‐the‐money American futures options are priced accurately by Black's European futures option pricing model, the relationship between market participants' ex ante assessment of futures price volatility and the term to maturity of the underlying futures contract is also investigated empirically.
Pricing Risk‐Adjusted Deposit Insurance: An Option‐Based Model
Authors: RONN EHUD I. , VERMA AVINASH K.
Published: April 2012

This paper presents a methodology for arriving at empirical estimates of deposit insurance premiums from market data by using isomorphic relationships between equity and a call option, and insurance and a put option. The data utilizes the market value of equity to solve for the asset value and its volatility. Market perceptions of FDIC bailout policies are explicitly modeled so as to eliminate the bias in inverted values of assets and their volatility. Sensitivity analyses are performed to show that rank orderings based on premiums are robust to changes in specification, thus facilitating allocation of aggregate premium across banks.
The Duration of an Adjustable‐Rate Mortgage and the Impact of the Index
Authors: OTT ROBERT A.
Published: April 2012

With the increasing use of adjustable‐rate mortgages for asset/liability management, there exists the need to properly evaluate their price sensitivity to interest rate changes. This paper provides a foundation by deriving the duration of an adjustable‐rate mortgage. The properties of this duration are unique and have some important differences from those of fixed‐rate securities. One important characteristic of an adjustable‐rate mortgage concerns the index used to adjust the mortgage rate. It was found that the index tended to be more important than the adjustment frequency in determining the duration of an adjustable‐rate mortgage.
Callable Bonds: A Risk‐Reducing Signalling Mechanism
Authors: ROBBINS EDWARD HENRY , SCHATZBERG JOHN D.
Published: April 2012

The theory of financial economics has failed to distinguish advantages of callable bonds from those of short‐term debt. This paper shows that either type of borrowing can signal a firm's better prospects but that short‐term debt does so at the cost of weakened risk‐sharing with capital markets. By issuing either equity or long‐term, non‐callable debt, a firm with poor investment opportunities will not pool its prospects with those of a better firm. But equity produces superior risk‐sharing. Perhaps this explains the almost complete absence of long‐term, non‐callable bonds from observed corporate capital structures.
The Pricing of Interest‐Rate Risk: Evidence from the Stock Market
Authors: SWEENEY RICHARD J. , WARGA ARTHUR D.
Published: April 2012

This paper addresses the issue of whether firms are required to pay an ex ante premium to investors for bearing the risk of interest‐rate changes. A two‐factor APT model with the market and changes in the yield on long‐term government bonds as factors is employed. The paper shows that, empirically, most of the interest‐sensitive stocks are in the utility industries, and that there is reasonable evidence that the interest factor is priced in the sense of the APT. Several sources for the interest sensitivity are considered, and regulatory lags are focused on as a likely candidate.
Options, Taxes, and Ex‐Dividend Day Behavior
Authors: KAPLANIS COSTAS P.
Published: April 2012

A novel way of estimating the expected as opposed to the actual share price fall‐off is developed using option prices. This method is applied to the UK Traded Options Market using data from 1979 to 1984. The results show that: (a) the average expected fall‐off implicit in option prices is around 55 to 60% of the dividend and significantly different from it. The fall‐off also varied inversely with the dividend yield, which is consistent with the prediction of the “tax clientele hypothesis.” (b) The estimates of the expected fall‐off were not significantly different from the actual fall‐off. (c) Finally, the results imply that the usual assumption made in valuing options on dividend‐paying stocks, that the fall‐off is equal to the dividend, would lead to downward‐biased estimates of the option value.
Loan Commitment Contracts, Terms of Lending, and Credit Allocation
Authors: MELNIK ARIE , PLAUT STEVEN
Published: April 2012

This paper analyzes the structure of loan commitment contracts and the interrelationships among their component parameters. Lenders offer borrowers a set of loan “packages,” from which the latter may choose that “package” found to be most appealing. Borrowers may “trade off” changes in any loan parameter in exchange for other adjustments. The borrower, at this time, may “purchase” a larger credit ration for a price. Supporting empirical evidence is presented.
Shelf Registrations and Shareholder Wealth: A Comparison of Shelf and Traditional Equity Offerings
Authors: MOORE NORMAN H. , PETERSON DAVID R. , PETERSON PAMELA P.
Published: April 2012

This study examines the effect of issuing common stock on shareholder wealth under two alternative methods of registration, shelf registration under the Securities and Exchange Commission's Rule 415 and the traditional method of registering shares for immediate sale. The stock price reactions accompanying security registrations and offerings over the period from March 1982 through November 1983 are examined for over two hundred issues. A negative price reaction is observed for traditional and shelf registrations for both utility and non‐utility issuers. No statistically significant difference is observed between shelf and traditional registrations. Further negative price reactions precede the offerings of these securities.
Price Movements as Indicators of Tender Offer Success
Authors: SAMUELSON WILLIAM , ROSENTHAL LEONARD
Published: April 2012

This paper examines movements in the prices of target stocks as predictors of the ultimate success or failure of tender offers. An empirical investigation of 100% cash tender offers during the years 1976 to 1981 leads to the conclusion that, with few exceptions, market prices are well‐calibrated, i.e., the current target price during the offer period measures the expected (discounted) stock price at the conclusion date. The market's probability predictions improve monotonically over time.
Mimicking Portfolios and Exact Arbitrage Pricing
Authors: HUBERMAN GUR , KANDEL SHMUEL , STAMBAUGH ROBERT F.
Published: April 2012

We characterize the sets of mimicking positions with returns that can serve in place of factors in an exact K‐factor arbitrage‐pricing relation for a set of N assets. All of the sets are K‐dimensional nonsingular linear transformations of each other. We interpret three examples of such transformations and discuss empirical considerations. We provide conditions under which the mimicking positions can be expressed as portfolios, and we characterize the relation between mimicking portfolios and the minimum‐variance frontier.
Autoregressive Modeling of Earnings‐Investment Causality
Authors: BAR‐YOSEF SASSON , CALLEN JEFFREY L. , LIVNAT JOSHUA
Published: April 2012

The purpose of this paper is to empirically test the relationships between corporate earnings and investment. In particular, the study investigates whether knowledge of past investments improves the prediction of future earnings beyond predictions that are based on past earnings alone. Similarly, it investigates whether knowledge of past earnings improves the prediction of future investments beyond knowledge of past investments alone. This is the empirical definition of Granger causality. The empirical results show that the bivariate past series of earnings and investments is superior to the univariate series in predicting future investments but not in predicting future earnings.
Seasonality in the Risk‐Return Relationship: Some International Evidence
Authors: CORHAY ALBERT , HAWAWINI GABRIEL , MICHEL PIERRE
Published: April 2012

We report evidence of seasonality in the Fama and MacBeth estimate of the CAPM‐based risk premium in four stock exchanges: the NYSE and the London, Paris, and Brussels exchanges. Specifically, we found that, in Belgium and France, risk premia are positive in January and negative the rest of the year. There is no January seasonal in the U.K. risk premium. Instead, we observed in this country a positive April seasonal and a negative average risk premium over the rest of the year. In the U.S., the pattern of risk‐premium seasonality coincides with the pattern of stock‐return seasonality. Both are positive and significant only in January. We also found that the January risk premium in the U.S. is significantly larger than those observed in the European markets. Interestingly, the reported patterns of risk‐premium seasonality in European equity markets do not fully coincide with the observed patterns of stock‐return seasonality in these markets. For example, in the U.K., average stock returns are significant and positive in January and April, whereas the market risk premium is significantly positive only in April. A possible interpretation of this phenomenon is presented in the paper.
The Default Premium and Corporate Bond Experience
Authors: FONS JEROME S.
Published: April 2012

The development of organized markets for speculative‐grade corporate debt has provided financial researchers with an opportunity to examine the pricing of default risk. By incorporating previous work on the default experience of low‐rated corporate debt, this paper presents an introduction to risk‐neutral models of risky‐bond pricing and uses these to examine the relationship between the default premium embodied in bond yields and actual default rates. The contribution of macroeconomic information to the default premium is also examined. The author finds that holders of low‐grade bonds have, on average, been compensated for losses due to default.
Efficient Signalling with Dividends and Investments
Authors: AMBARISH RAMASASTRY , JOHN KOSE , WILLIAMS JOSEPH
Published: April 2012

An efficient signalling equilibrium with dividends and investments or, equivalently, dividends and net new issues of stock is constructed, and its properties are identified. Because corporate insiders can exploit multiple signals, the efficient mix must minimize dissipative costs. In equilibrium, many firms both distribute dividends and deviate from first‐best investment. Also, the impact of dividends on stock prices is positive. By contrast, the announcement effect of new stock is negative for firms with private information primarily about assets in place and positive for firms with inside information mainly about opportunities to invest.