bluuebunny/crossref_metadata_2025 huggingface dataset:
Credit Rationing and Financial Disorder
Authors: GUTTENTAG JACK , HERRING RICHARD
Published: April 2012

We develop a model of lender behavior in the presence of default risk and moral hazard that determines default premiums and identifies the conditions under which borrowers are rationed. A hypothesis regarding a cognitive bias in the formation of expectations provides a dynamic component to our analysis and allows us to explain how an economy becomes vulnerable to a financial crisis and why vulnerability may increase over time.
The Structure of Asset Prices and Socially Useless/Useful Information
Authors: OHLSON JAMES A.
Published: April 2012

This paper relates the value of additional information to asset prices in a pure exchange setting. The price structure of interest revolves around a “pricing‐hypothesis”: the prices in an economy with less information are unbiased estimators of the prices that would obtain in a more informative economy. Two basic results are developed. First, if the incremental information is useless then the pricing‐hypothesis applies. Second, if the pricing hypothesis is assumed valid, then the information is valuable in a weak sense. The results are also considered in the context of empirical research. The case is made for viewing statistical tests of association between prices and signals as tests of the social value of information.
Additional Evidence on the Relation Between Divestiture Announcements and Shareholder Wealth
Authors: ROSENFELD JAMES D.
Published: April 2012

This paper presents estimates of the effect of voluntary divestiture announcements on shareholder wealth. The results show that both spin‐off and sell‐off announcements tend to have a positive influence on the stock prices of the divesting firms, and that the spin‐offs “outperform” the sell‐offs on the day of the event. We also find that the economic gains to the shareholders of the selling and acquiring firms are nearly identical, suggesting that the sell‐off decision is perceived by both investor groups as a positive net present value (NPV) transaction.
A Risk Minimizing Strategy for Portfolio Immunization
Authors: FONG H. GIFFORD , VASICEK OLDRICH A.
Published: April 2012

Consider a fixed‐income portfolio whose duration is equal to the length of a given investment horizon. It is shown that there is a lower limit on the change in the end‐of‐horizon value of the portfolio resulting from any given change in the structure of interest rates. This lower limit is the product of two terms, of which one is a function of the interest rate change only, and the other depends only on the structure of the portfolio. Consequently, this second term provides a measure of immunization risk. If this measure is minimized, the exposure of the portfolio to any interest rate change is the lowest.
New Findings Regarding Day‐of‐the‐Week Returns over Trading and Non‐Trading Periods: A Note
Authors: ROGALSKI RICHARD J.
Published: April 2012

This paper decomposes daily close to close returns into trading day and non‐trading day returns. We discover that all of the average negative returns from Friday close to Monday close documented in the literature for stock market indexes occurs during the non‐trading period from Friday close to Monday open. In addition, average trading day returns (open to close) are identical for all days of the week. January/firm size/turn‐of‐the‐year anomalies are shown to be interrelated with day‐of‐the‐week returns.
Upper and Lower Bounds of Put and Call Option Value: Stochastic Dominance Approach
Authors: LEVY HAIM
Published: April 2012

Applying stochastic dominance rules with borrowing and lending at the risk‐free interest rate, we derive upper and lower values for an option price for all unconstrained utility functions and alternatively for concave utility functions. The derivation of these bounds is quite general and fits any kind of stock price distribution as long as it is characterized by a “nonnegative beta.”

Transaction costs and taxes can be easily incorporated in the model presented here since investors are not required to revise their portfolios continuously. The “price” that is paid for this generalization is that a range of values rather than a unique value is obtained.
The Valuation of Options on Futures Contracts
Authors: RAMASWAMY KRISHNA , SUNDARESAN SURESH M.
Published: April 2012

Rational restrictions are derived for the values of American options on futures contracts. For these options, the optimal policy, in general, involves premature exercise. A model is developed for valuing options on futures contracts in a constant interest rate setting. Despite the fact that premature exercise may be optimal, the value of this American feature appears to be small and a European formula due to Black serves as a useful approximation. Finally, a model is developed to value these options in a world with stochastic interest rates. It is shown that the pricing errors caused by ignoring the location of the interest rate (relative to its long‐run mean) range from −5% to 7%, when the current rate is ±200 basis points from its long‐run value. The role of interest rate expectations is, therefore, crucial to the valuation. Optimal exercise policies are found from numerical methods for both models.
On the Optimality of Portfolio Insurance
Authors: BENNINGA SIMON , BLUME MARSHALL
Published: April 2012

This paper examines the optimality of an insurance strategy in which an investor buys a risky asset and a put on that asset. The put's striking price serves as the insurance level. In complete markets, it is highly unlikely that an investor would utilize such a strategy. However, in some types of less complete markets, an investor may wish to purchase a put on the risky asset. Given only a risky asset, a put, and noncontinuous trading, an investor would purchase a put as a way of introducing a risk‐free asset into the portfolio. If, in addition, there is a risk‐free asset and the investor's utility function displays constant proportional risk‐aversion, then the investor would buy the risk‐free asset directly and not buy a put. In sum, only under the most incomplete markets would an investor find an insurance strategy optimal.
Approximate Factor Structures: Interpretations and Implications for Empirical Tests
Authors: GRINBLATT MARK , TITMAN SHERIDAN
Published: April 2012

This paper provides some new insights about approximate factor structures, as defined by Chamberlain and Rothschild [2], and their implications for empirical tests. First, we show that any economy that satisfies an approximate factor structure can be transformed, in a manner that does not alter the characteristics of investor portfolios, into an economy that satisfies an exact factor structure, as defined by Ross [9]. Second, we show that principal components analysis represents just one of many methods of forming groups of well‐diversified portfolios with no idiosyncratic risk in large samples. Correct factor loadings will be obtained by regressing security returns on any group of these portfolios. Our interpretations of the Chamberlain and Rothschild results also provide additional insights into the testability of the Arbitrage Pricing Theory. We show that securities cannot be repackaged to hide factors in the manner suggested by Shanken [10] without the variance of some of the repackaged securities approaching infinity in large economies.
A VARMA Analysis of the Causal Relations Among Stock Returns, Real Output, and Nominal Interest Rates
Authors: JAMES CHRISTOPHER , KOREISHA SERGIO , PARTCH MEGAN
Published: April 2012

Previous research has documented a negative relation between common stock returns and inflation. Recently, Fama[3]and Geske and Roll[6]have argued that this relation results from a more fundamental one between real activity and expected inflation. Stock returns, they argue, signal changes in real activity, which in turn affect expected inflation. However, unlike Fama, Geske and Roll argue that changes in real activity result in changes in money supply growth, which in turn affect expected inflation. Empirical tests have analyzed separately each link in the proposed causal chain. In this article, we investigate simultaneously the relations among stock returns, real activity, inflation, and money supply changes using a vector autoregressive moving average (VARMA) model. Our empirical results strongly support Geske and Roll's reversed causality model.
A Model for the Determination of “Fair” Premiums on Lease Cancellation Insurance Policies
Authors: SCHALLHEIM JAMES S. , McCONNELL JOHN J.
Published: April 2012

Lease cancellation insurance protects the lessor against early termination of a cancellable operating lease. This paper presents a contingent claims model for determining the “fair” premium for this type of insurance policy. Comparative statics are considered, and some numerical examples are presented to illustrate the model. Among other things, the insurance premium is sensitive to the expected rate of economic depreciation of the leased asset and to the leased asset's systematic and nonsystematic risk.
The Puzzle of Financial Leverage Clienteles
Authors: SARIG ODED , SCOTT JAMES
Published: April 2012

Empirically, it appears that common stock of publicly traded corporations with high‐debt ratios tends to be held by investors with relatively low marginal taxes while the stock in companies with little debt is held by investors in high‐tax brackets. A number of authors have argued that in an equilibrium similar to the one described by Miller [8], these clienteles should exist. We argue that standard portfolio theory does not imply financial leverage clienteles for publicly traded firms. We explain the empirical relationship between investor tax rates and leverage ratios by the existence of dividend clienteles and a positive relationship between dividend yield and leverage ratios.
Implications of the Discreteness of Observed Stock Prices
Authors: GOTTLIEB GARY , KALAY AVNER
Published: April 2012

Stock prices on the organized exchanges are restricted to be divisible by ⅛. Therefore, the “true” price usually differs from the observed price. This paper examines the biases resulting from the discreteness of observed stock prices. It is shown that the natural estimators of the variance and all of the higher order moments of the rate of returns are biased. An approximate set of correction factors is derived and a procedure is outlined to show how the correction can be made. The natural estimators of the “beta” and of the variance of the market portfolio, on the other hand, are “nearly” unbiased.
The Price Elasticity of Demand for Whole Life Insurance
Authors: BABBEL DAVID F.
Published: April 2012

In this study a real price index is created for whole life insurance sold in the United States from 1953 to 1979. New purchases of whole life insurance are shown to be negatively related to changes in this cost index, contrary to what has been widely accepted in the insurance literature, but consistent with economic theory. The existence of strong price elasticity of demand for whole life insurance does not ensure, however, that the insurance industry manifests a high degree of price competition.
Introducing Recursive Partitioning for Financial Classification: The Case of Financial Distress
Authors: FRYDMAN HALINA , ALTMAN EDWARD I. , KAO DUEN‐LI
Published: April 2012

The purpose of this study is to present a new classification procedure, Recursive Partitioning Algorithm (RPA), for financial analysis and to compare it with discriminant analysis within the context of firm financial distress. RPA is a computerized, nonparametric technique based on pattern recognition which has attributes of both the classical univariate classification approach and multivariate procedures. RPA is found to outperform discriminant analysis in most original sample and holdout comparisons. We also observe that additional information can be derived by assessing both RPA and discriminant analysis results.
An Analysis of Mortgage Contracting: Prepayment Penalties and the Due‐on‐Sale Clause
Authors: DUNN KENNETH B. , SPATT CHESTER S.
Published: April 2012

The due‐on‐sale clause contained in most conventional home mortgage contracts is equivalent to a prepayment penalty equal to the difference between the face value and market value of the loan. We analyze a bilateral game with asymmetric information and show that the bank demands the full penalty unless the market value of the loan is sufficiently low. In that case, the bank demands a prepayment penalty which is independent of the market value of the loan in order to induce additional prepayments. We also demonstrate, by a risk‐sharing argument, that the due‐on‐sale clause is optimal in some settings, even though it eliminates some beneficial home sales.
Differential Information and Performance Measurement Using a Security Market Line
Authors: DYBVIG PHILIP H. , ROSS STEPHEN A.
Published: April 2012

An uninformed observer using the tools of mean variance and security market line analysis to measure the performance of a portfolio manager who has superior information is unlikely to be able to make any reliable inferences. While some positive results of a very limited nature are possible, e.g., when there is a riskless asset or when information is restricted to be “security specific,” in general anything is possible. In particular, a manager with superior information can appear to the observer to be below or above the security market line and inside or outside of the mean‐variance efficient frontier, and any combination of these is possible.
Corporate Combinations and Common Stock Returns: The Case of Joint Ventures
Authors: McCONNELL JOHN J. , NANTELL TIMOTHY J.
Published: April 2012

The gain to stockholders from mergers is well documented. However, there is little evidence as to whether the source of the gain is due to synergy or management displacement. Merger is just one of an almost limitless variety of ways in which firms combine resources to accomplish some objective. A joint venture is another. In addition to being of interest as an independent phenomenon, because the original managements of the parent firms remain intact under a joint venture, investigation of wealth gains from joint ventures provides an opportunity to isolate the management displacement hypothesis from the synergy hypothesis as the source of gains in corporate combinations. Our results are 1) there are significant wealth gains from joint ventures, 2) the smaller partner earns a larger excess rate of return while the dollar gains are more equally divided, and 3) the gains, scaled by resources committed, yield “premiums” similar to those in mergers. We are inclined to interpret our results as supportive of the synergy hypothesis as the source of gain from corporate combinations.
Return, Risk, and Yield: Evidence from Ex Ante Data
Authors: ANG JAMES S. , PETERSON DAVID R.
Published: April 2012

The purpose of this study is to investigate the relationship between return and yield in the context of ex ante data from The Value Line Investment Survey and by examining the role of dividends as a proxy for risk. The use of ex ante data should substantially reduce the confounding of tax and information effects that has affected earlier studies. Heteroscedasticity is detected in the after‐tax CAPM and found to be negatively related to yield and positively related to beta. Maximum likelihood methods are used to correct for heteroscedasticity and generate efficient coefficient estimates. Using data for each of the years 1973 through 1983, there is an overall positive relationship between expected return and yield. However, coefficient estimates of yield are highly variable from year to year.
Joint Effects of Interest Rate Deregulation and Capital Requirements on Optimal Bank Portfolio Adjustments
Authors: LAM CHUN H. , CHEN ANDREW H.
Published: April 2012

The 1980 Depository Institution Deregulation and Monetary Control Act (DIDMCA) mandates that Regulation Q be phased out by 1986. With deregulation of interest rate ceilings, the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets. Thus, value‐maximizing bank managers would need to be concerned not only with the internal risk, but also with the external risk in bank portfolio management decisions. Based upon the cash flow version of the capital asset pricing model, this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm.
The Weekly Pattern in Stock Returns: Cash versus Futures: A Note
Authors: CORNELL BRADFORD
Published: April 2012

This paper presents tests designed to determine whether the weekly pattern in stock returns continues after the introduction of futures trading on stock indexes and whether the pattern carries over to the futures market. Using data for the SP500, I find that the “Monday effect” does persist in the cash market, but there is no evidence of a similar pattern in the futures market.
Index Options: The Early Evidence
Authors: EVNINE JEREMY , RUDD ANDREW
Published: April 2012

Index options became the most important traded contracts during their first year of existence. Two contracts, namely those on the S&P100 and the Major Markets Index, have a trading volume which typically surpasses the trading volume in all individual stock option contracts. In this paper, we examine the pricing of the options on the S&P100 and the Major Markets Index. Using intra‐day prices, we find the options frequently violate the arbitrage boundary, put/call parity, and are substantially mispriced relative to theoretical values. Our results suggest that tests of option pricing models may be more difficult than previously realized due to nonsynchronous prices, even using “real‐time” data from the exchanges.
Does the Stock Market Overreact?
Authors: De BONDT WERNER F. M. , THALER RICHARD
Published: April 2012

Research in experimental psychology suggests that, in violation of Bayes' rule, most people tend to “overreact” to unexpected and dramatic news events. This study of market efficiency investigates whether such behavior affects stock prices. The empirical evidence, based on CRSP monthly return data, is consistent with the overreaction hypothesis. Substantial weak form market inefficiencies are discovered. The results also shed new light on the January returns earned by prior “winners” and “losers.” Portfolios of losers experience exceptionally large January returns as late as five years after portfolio formation.
Ripoffs, Lemons, and Reputation Formation in Agency Relationships: A Laboratory Market Study
Authors: DEJONG DOUGLAS V. , FORSYTHE ROBERT , LUNDHOLM RUSSELL J.
Published: April 2012

This paper examines the effect of the moral hazard problem in an agency relationship where the principal cannot observe the level of service provided by the agent. Using data from laboratory markets, we demonstrate that the presence of moral hazard leads to shirking by agents. However, this “lemons” phenomenon occurs only about one‐half of the time. While there is evidence of reputation effects in these markets, seemingly reputable agents are often able to use opportunities for false advertising to their advantage and “ripoff” principals.
Towards a Semigroup Pricing Theory
Authors: GARMAN MARK B.
Published: April 2012

In an arbitrage‐free economy, there will always exist a set of linear operators which map future contingent dividends of securities into their current prices. It happens that such operators will also form an “evolution semigroup” as a consequence of intertemporal analysis of the no‐arbitrage restriction. This paper summarizes some of the major implications of the semigroup properties, but avoids almost all of the technical discussion which underlies them. Instead, several practical examples are presented. Some well‐known continuous‐time results are replicated by this alternative method, and certain new developments are explored.
Risky Debt, Investment Incentives, and Reputation in a Sequential Equilibrium
Authors: JOHN KOSE , NACHMAN DAVID C.
Published: April 2012

The agency relationship of corporate insiders and bondholders is modeled as a dynamic game with asymmetric information. The incentive effect of risky debt on the investment policy of a levered firm is studied in this context. In a sequential equilibrium of the model, a concept of reputation arises endogenously resulting in a partial resolution of the classic agency problem of underinvestment. The incentive of the firm to underinvest is curtailed by anticipation of favorable rating of its bonds by the market. This anticipated pricing of debt is consistent with rational expectations pricing by a competitive bond market and is realized in equilibrium. Some empirical implications of the model for bond rating, debt covenants, and bond price response to investment announcements are explored.
A Micro Model of the Federal Funds Market
Authors: HO THOMAS S. Y. , SAUNDERS ANTHONY
Published: April 2012

This paper demonstrates that valuable insights into the determination of Federal funds rates can be gained through modeling the micro‐decisions of market participants. Fed fund demand functions are derived for different bank valuation functions and several implications are discussed. Specifically, it is: (i) possible to rationalize the observation that large banks are net purchasers and small banks net sellers of Fed funds; (ii) to explain the positive spread of Fed funds rates over other short‐term money market rates; and (iii) to link the size of this spread to the Federal Reserve's underlying monetary policy strategy.
Price Regulation in Property‐Liability Insurance: A Contingent‐Claims Approach
Authors: DOHERTY NEIL A. , GARVEN JAMES R.
Published: April 2012

A discrete‐time option‐pricing model is used to derive the “fair” rate of return for the property‐liability insurance firm. The rationale for the use of this model is that the financial claims of shareholders, policyholders, and tax authorities can be modeled as European options written on the income generated by the insurer's asset portfolio. This portfolio consists mostly of traded financial assets and is therefore relatively easy to value. By setting the value of the shareholders' option equal to the initial surplus, an implicit solution for the fair insurance price may be derived. Unlike previous insurance regulatory models, this approach addresses the ruin probability of the insurer, as well as nonlinear tax effects.
Commercial Bank Portfolio Behavior and Endogenous Uncertainty
Authors: STANHOUSE BRYAN
Published: April 2012

This paper demonstrates how Bayesian information may be analyzed as a variable input in determining an optimal bank portfolio and investigates the impact of information in a way that is statistically satisfactory. A portfolio model is developed, and the impact of information is analyzed. Information is treated as an economic input that is used up to the point where its predicted marginal benefit is exactly equal to its marginal cost, and, from there, the optimal demand for information is derived. A comparative‐static analysis demonstrates that the reaction of optimal portfolio holdings to interest rate changes under variable uncertainty is dramatically different from portfolio behavior when uncertainty is exogenous. Finally, the elasticity of reserves with respect to scale is examined under the assumption of variable uncertainty.
Rights versus Underwritten Offerings: An Asymmetric Information Approach
Authors: HEINKEL ROBERT , SCHWARTZ EDUARDO S.
Published: April 2012

By assuming asymmetric information between investors and firms seeking new equity, we derive a rational expectations, partially revealing information equilibrium in which three forms of equity financing are observed. The highest quality firms employ a standby rights offers, intermediate quality firms signal their true value in the choice of a subscription price in an uninsured rights offer, while low‐quality firms remain indistinguishable to investors by making fully underwritten issues. The model offers justification for many firms using apparently more costly underwritten offers, provides a reason why firms using uninsured rights offers do not set arbitrarily low subscription prices to ensure the success of the issue, and explains the simultaneous existence of the three financing vehicles.
A Utility‐Based Model of Common Stock Price Movements
Authors: LITZENBERGER ROBERT H. , RONN EHUD I.
Published: April 2012

This paper develops and tests a nonlinear utility‐based econometric model of the temporal behavior of aggregate stock price movements based on a constant relative risk aversion utility function and an observable information set consisting of aggregate consumption, aggregate dividends, and past stock prices. The stochastic process derived from time‐series analyses of consumption and dividends measured over annual intervals is used to derive and empirically test a closed‐form solution for stock‐price movements. The endogenization of discount rate changes in the utility‐based model is shown to be more consistent with aggregate stock price movements over a twenty‐year holdout period than constant discount rate models. The model is also used to estimate the representative investor's relative risk aversion. The estimate of 4.22 is consistent with that used by Grossman and Shiller in their perfect foresight model and is significantly higher than the relative risk aversion of 1.0 implied by logarithmic utility.
Stock Price Movements in Response to Stock Issues under Asymmetric Information
Authors: KRASKER WILLIAM S.
Published: April 2012

This paper characterizes the function relating the number of new shares issued by a firm to the resulting change in the firm's stock price, when insiders are asymmetrically informed. We show that, in equilibrium, the stock price will be a decreasing function of the issue size; moreover, the rate of decrease can be so rapid to cause “equity rationing.” We also show that there will be underinvestment relative to the symmetric information case.
Valuation of American Futures Options: Theory and Empirical Tests
Authors: WHALEY ROBERT E.
Published: April 2012

This paper reviews the theory of futures option pricing and tests the valuation principles on transaction prices from the S&P 500 equity futures option market. The American futures option valuation equations are shown to generate mispricing errors which are systematically related to the degree the option is in‐the‐money and to the option's time to expiration. The models are also shown to generate abnormal risk‐adjusted rates of return after transaction costs. The joint hypothesis that the American futures option pricing models are correctly specified and that the S&P 500 futures option market is efficient is refuted, at least for the sample period January 28, 1983 through December 30, 1983.
Does the Stock Market Rationally Reflect Fundamental Values?
Authors: SUMMERS LAWRENCE H.
Published: April 2012

This paper examines the power of statistical tests commonly used to evaluate the efficiency of speculative markets. It shows that these tests have very low power. Market valuations can differ substantially and persistently from the rational expectation of the present value of cash flows without leaving statistically discernible traces in the pattern of ex‐post returns. This observation implies that speculation is unlikely to ensure rational valuations, since similar problems of identification plague both financial economists and would be speculators.
Returns and Risks of U.S. Bank Foreign Currency Activities
Authors: GRAMMATIKOS THEOHARRY , SAUNDERS ANTHONY , SWARY ITZHAK
Published: April 2012

In this paper the risks and returns on U.S. banks' foreign currency positions are analyzed in a portfolio setting when both exchange rate and foreign interest rate risks are present. It is shown that U.S. banks could achieve considerable reductions in risk by optimally selecting their foreign currency positions. Actual foreign currency portfolio returns generated from expected exchange rate changes and exchange rate surprises were positive on average but those generated from interest rate surprises were negative. Although the total portfolio returns were positive, on a risk‐adjusted basis bank return performance was relatively poor. Nevertheless, despite this relatively poor performance, the risk of ruin or failure for a “representative bank” from foreign currency activities was found to be approximately zero when judged in comparison to the capital funds available to large money center banks to cushion such losses.
Asset Price Volatility, Bubbles, and Process Switching
Authors: FLOOD ROBERT P. , HODRICK ROBERT J.
Published: April 2012

Evidence of excess volatilities of asset prices compared with those of market fundamentals is often attributed to speculative bubbles. This study demonstrates that bubbles could in theory lead to excess volatility, but it shows that certain variance bounds tests preclude bubbles as an explanation. The evidence ought to be attributed to model misspecification or inappropriate statistical tests. One important misspecification occurs if a researcher incorrectly specifies the time series properties of market fundamentals. A bubble‐free example economy characterized by a potential switch in government policies produces asset prices that would appear, to an unwary researcher, to contain bubbles.
The Pricing of Futures and Options Contracts on the Value Line Index
Authors: EYTAN T. HANAN , HARPAZ GIORA
Published: April 2012

This paper considers the problems peculiar to the Value Line Index, because of its use of geometric averaging, as regards the pricing of options and futures on that index. The Value Line Composite Index (VLCI) is an equally weighted geometric average index of nearly 1700 stocks. The VLCI futures market has existed since 1982 while the VLCI options market was established in 1985. This paper provides valuation formulas and analyzes the economic properties of these contracts. Because of the geometric averaging in the VLCI, its contingent claims have special properties. For example, the futures price may fall short of the spot price and the value of a VLCI call option may decline when the volatility of the index is increased. VLCI futures are shown to provide a direct means for duplicating an equally weighted portfolio of the underlying stocks.
Benchmark Portfolio Inefficiency and Deviations from the Security Market Line
Authors: GREEN RICHARD C.
Published: April 2012

This paper theoretically evaluates the robustness of the Security Market Line relationship when the market proxy employed is not mean‐variance efficient. The analysis focuses on the behavior of the “benchmark errors,” the deviations of assets and portfolios from the Security Market Line. First, we characterize how the location of an asset in mean‐variance space determines its benchmark error. Then the continuity properties of the benchmark errors are studied. The results indicate that the magnitudes of the errors exhibit continuous but not uniformly continuous behaviors. The relative rankings based on deviations from the Security Market Line, however, exhibit some severe discontinuities. In fact, these can be exactly reversed for two proxies arbitrarily close in mean‐variance space.
Asset Pricing in a Production Economy with Incomplete Information
Authors: DETEMPLE JÉRÔME B.
Published: April 2012

This paper analyzes an economy in which investors operate under partial information about technology‐relevant state variables. It is shown that for Gaussian information structures under incomplete observations, the consumer's problem can be transformed into an equivalent program with a completely observed state: the conditional expectation of the underlying unobservable state variables. A consequence of this transformation is that classic results in finance remain valid under an appropriate reinterpretation of the state variables.
Reserves Announcements and Interest Rates: Does Monetary Policy Matter?
Authors: HARDOUVELIS GIKAS A.
Published: April 2012

The author provides evidence on the perceived existence of strong liquidity effect. The analysis is based on the response of the term structure of interest rates to the weekly Federal Reserve announcements of bank reserves during the post‐October 1979 period. It is shown that unanticipated changes in the mix between borrowed and nonborrowed reserves cause expected real interest rates to change after the announcement because they provide information about a future change in the supply of money. A precise model is developed and tested during subperiods of nonborrowed and borrowed reserves targeting by the Fed.
Managerial Preference, Asymmetric Information, and Financial Structure
Authors: BLAZENKO GEORGE W.
Published: April 2012

If firm performance affects managers' wealth or reputation, preferences of managers dominate firms' financing decisions. When information about real asset investment is symmetric, managers finance exclusively with equity. If managers know more about asset quality than do investors and if managers are sufficiently risk averse, they signal high‐quality projects with debt. Increases in collateral value decrease risky debt use. Increases in interest rates that do not change productive opportunities increase debt use. The explanation for these and further results is based on underpricing of equity and overpricing of debt at the margin.
Corporate Takeover Bids, Methods of Payment, and Bidding Firms' Stock Returns
Authors: TRAVLOS NICKOLAOS G.
Published: April 2012

This study explores the role of the method of payment in explaining common stock returns of bidding firms at the announcement of takeover bids. The results reveal significant differences in the abnormal returns between common stock exchanges and cash offers. The results are independent of the type of takeover bid, i.e., merger or tender offer, and of bid outcomes. These findings, supported by analysis of nonconvertible bonds, are attributed mainly to signalling effects and imply that the inconclusive evidence of earlier studies on takeovers may be due to their failure to control for the method of payment.
A Model of Intertemporal Discount Rates in the Presence of Real and Inflationary Autocorrelations
Authors: BOSSHARDT DONALD I.
Published: April 2012

This paper discusses the pricing of assets in an intertemporal rational‐expectations model when real production and inflation evolve according to first‐order autocorrelated processes. The focus is on the structure of the various intertemporal discount rates (yields) exhibited by this economy. Yield curves are identified for consumption claims, indexed bonds, and nominally riskless bonds and can be extended to any claim that can be approximated by a (finite) linear combination of such securities. The model demonstrates that, if the average term structure for nominally riskless securities is upward sloping, then the yield curve for consumption (market) claims is downward sloping, suggesting that conventional methods for computing long‐term discount rates err by not accounting for maturity factors. The paper also explores the relationship between the intertemporal equilibrium and its embedded single‐period equilibria. The single‐period risk measures in this economy are derived and shown to be (generally) functions of maturity. A model of nominal bond betas is constructed along these lines. It is shown that bond betas that are increasing functions of maturity do not necessarily imply an upward‐sloping term structure.
Time‐Dependent Variance and the Pricing of Bond Options
Authors: SCHAEFER STEPHEN M. , SCHWARTZ EDUARDO S.
Published: April 2012

In this paper, we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond's duration. The resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the Black‐Scholes approach. The paper provides comparisons between option prices computed using this model and those using the Black‐Scholes and Brennan and Schwartz models.
Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets
Authors: DAMMON ROBERT M. , GREEN RICHARD C.
Published: April 2012

In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or “tax arbitrage.” This paper characterizes the joint restrictions on financial‐asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short‐sale constraints. The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then “no‐tax‐arbitrage” prices will exist. They also show that the existence of “no‐tax‐arbitrage” prices ensures the existence of equilibrium prices.
Forward Markets, Stock Markets, and the Theory of the Firm
Authors: MacMINN RICHARD D.
Published: April 2012

This paper models a competitive financial market economy in which there are forward markets as well as stock and bond markets. Although there are separation theorems in the stock and forward markets literatures, this analysis shows that neither separation theorem survives in this integrated financial market economy. Next, the analysis shows that the separation results hold and are equivalent if the manager has an appropriate compensation package. Then the model is modified to allow for depreciation charges and tax credits. A positive theory of hedging is developed that shows that the corporation can preserve deductions and credits by hedging and so increase corporate value.
Stock Return Anomalies and the Tests of the APT
Authors: GULTEKIN MUSTAFA N. , GULTEKIN N. BULENT
Published: April 2012

This paper shows that the empirical tests of the Arbitrage Pricing Theory (APT) model are very sensitive to the anomalies observed in January in the stock returns data. There is a strong seasonal pattern in the estimates of the risk premia from the APT model. The most important implication of the findings in this paper is that the APT model can explain the risk‐return relation mostly for January. Once the January returns are excluded from the data, there is no significant relation between the expected stock returns and the risk measures predicted by the APT model.
Acquisition of Divested Assets and Shareholders' Wealth
Authors: SICHERMAN NEIL W. , PETTWAY RICHARD H.
Published: April 2012

The divesting of corporate assets has become quite popular. Previous studies of divestitures have found conflicting impacts upon shareholders' wealth of the buying firm. This study measures the impacts of product‐line relatedness between the acquiring firm and the divested unit and financial weakness of the selling firm upon the abnormal returns to the acquiring firm. Although the study finds that the impact of financial strength of the seller is ambiguous, the purchase of related assets produces more wealth than does the purchase of unrelated divested units. Further, firms that purchase related divested units have larger proportions of insider ownership.
Components of the Bid‐Ask Spread and the Statistical Properties of Transaction Prices
Authors: GLOSTEN LAWRENCE R.
Published: April 2012

The bid‐ask spread can be decomposed into two parts: one part due to asymmetric information and the other part due to other factors such as monopoly power. The part due to asymmetric information attenuates statistical biases in mean return, variance, and serial covariance. Thus, using spread data to adjust for biases in return moments requires knowing not only the spread but the composition of the spread. Furthermore, any spread‐estimation procedure using transaction prices must estimate two spread components. On the other hand, the appropriateness of some previously suggested statistical corrections is independent of the spread composition.
Orthogonal Frontiers and Alternative Mean‐Variance Efficiency Tests
Authors: LEHMANN BRUCE N.
Published: April 2012

This paper catalogues properties of minimum norm orthogonal portfolios: portfolios which minimize a quadratic objective function and have returns uncorrelated with those of a candidate portfolio that is not mean‐variance efficient. The analysis shows that the dollar versions of these portfolios correspond to estimators of zero beta rates based on alternative statistical criteria and grouping procedures while costless orthogonal portfolios represent candidate mean‐variance efficiency tests. It also develops inference procedures for zero and unit net investment portfolios of individual securities (instead of grouped portfolios) that have zero expected betas. The resulting mean‐variance efficiency tests are reasonably insensitive to the underlying statistical assumptions.
The Choice of Issuance Procedure and the Cost of Competitive and Negotiated Underwriting: an Examination of the Impact of Rule 50
Authors: SMITH RICHARD L.
Published: April 2012

Previous research suggests that firms choose negotiated issuance over competitive despite its apparently higher net interest cost. This result is shown to arise partly from failure to correct for a selectivity bias in the choice of issuance procedures. Two stage analysis is used in a model that includes qualitative and limited dependent variables to re‐estimate the net interest cost difference between competitive and negotiated issues. Results support the hypothesis that the choice of issuance procedure is consistent with shareholder wealth maximization. Examination of debt issues subject to Rule 50 of the Public Utility Holding Company Act indicates that the regulation, as applied, is not effective.
Effects of Capital Gains Taxation on Life‐Cycle Investment and Portfolio Management
Authors: BALCER YVES , JUDD KENNETH L.
Published: April 2012

We examine the impact of capital income taxation, both accrual forms of taxation and taxation of realized capital gains, on total savings and the demand for corporate financial instruments. We find that investors may hold both debt and equity in the face of effective collection of capital gains taxation even in a flat tax system. We also find that the two taxes will have substantially different effects on saving and consumption behavior, making it unlikely that the tax structure can be summarized by any single equivalent accrual tax rate.
Capital Structure, Ownership, and Capital Payment Policy: The Case of Hospitals
Authors: WEDIG GERARD , SLOAN FRANK A. , HASSAN MAHMUD , MORRISEY MICHAEL A.
Published: April 2012

This study examines effects of pertinent features of hospital capital payment policies on hospital capital structure decisions in a one‐period stochastic, value‐maximization model. Separate models are developed for for‐profit and not‐for‐profit hospitals. Hospital debt‐to‐assets ratios are analyzed empirically using a cross‐section of data from the American Hospital Association. Although the effect on capital structure of hospital reliance on cost‐based reimbursement cannot be signed theoretically, in both for‐profit and not‐for‐profit cases, a higher cost‐based share leads to higher leverage. Factors associated with high bankruptcy risk (e.g., earnings volatility) cause hospitals to take on less debt.
Private versus Public Ownership: Investment, Ownership Distribution, and Optimality
Authors: SHAH SALMAN , THAKOR ANJAN V.
Published: April 2012

Examined in this paper is the choice between private and public incorporation of an asset for an entrepreneur (asset owner) who hires a manager with superior information about the asset's return distribution. Public sale of equity is shown to be the preferred alternative when (a) capital market issue costs are low or (b) the assest's idiosyncratic risk is high and the owner is either sufficiently risk averse or sufficiently “optimistic” about the asset's expected return. Thus, those assets deemed most valuable by their owners will tend to be publicly incorporated. The paper also explores the impact of incorporation mode—private versus public—and information structure on the firm's investment policy and ownership distribution.
Optimal Futures Positions for Large Banking Firms
Authors: MORGAN GEORGE EMIR , SHOME DILIP K. , SMITH STEPHEN D.
Published: April 2012

In this paper, we extend earlier work on hedging models so that uncertainty about both deposit supply and loan demand is incorporated as well as random rates of return on loans and CD's. Our model suggests that the optimal forward position is the sum of three ratios that should be estimated simultaneously. Using bank‐specific data, the optimal hedge ratios are estimated in both the pre‐deregulation and deregulation subperiods. Our results show that previous studies of bank hedging with interest rate futures have greatly overstated (a) the volume of short futures positions that banks should take and (b) the degree of homogeneity of optimal hedge ratios across the banking system. Similarly, deregulation has not uniformly affected the interest rate risk borne by different institutions.
Estimation Bias Induced by Discrete Security Prices
Authors: BALL CLIFFORD A.
Published: April 2012

Commonly, equilibrium security prices are modeled by continuous‐state stochastic processes, while observed prices are rounded into discrete units. This paper models the rounding mechanism and examines the probabilistic structure of the resultant rounded process. We provide accurate and simple estimates of the inflation in estimated variance and kurtosis induced by ignoring rounding. In particular, the maximum‐likelihood estimate of security price volatility using rounded prices is developed, and a simulation analysis is performed to examine the small‐sample properties of this estimator. For many practical applications, a simple correction for rounding becomes available.
Time‐Invariant Portfolio Insurance Strategies
Authors: BRENNAN MICHAEL J. , SCHWARTZ EDUARDO S.
Published: April 2012

This paper characterizes the complete class of time‐invariant portfolio insurance strategies and derives the corresponding value functions that relate the wealth accumulated under the strategy to the value of the underlying insured portfolio. Time‐invariant strategies are shown to correspond to the long‐run policies for a broad class of portfolio insurance payoff functions.
Intradaily Price‐Volume Adjustments of NYSE Stocks to Unexpected Earnings
Authors: WOODRUFF CATHERINE S. , SENCHACK A. J.
Published: April 2012

The speed and path of adjustment in stocks to the degree of earnings surprise in their quarterly announcements are studied using price‐volume transactions data. A differential price‐adjustmentp rocess was observed,w ith stocks having large,p ositive earnings surprises experiencing a faster adjustment compared with those stocks with negative earnings surprises. Volume, transaction frequency, and size were found to be directly related to the absolute degree of surprise,b ut very favorablee arnings‐surprises tocks experienced initially a large number of smaller trades while stocks with large unfavorable earnings surprises had relatively fewer transactions but higher volume per trade.
Warrant Exercise, Dividends, and Reinvestment Policy
Authors: SPATT CHESTER S. , STERBENZ FREDERIC P.
Published: April 2012

In this paper, we examine sequential exercise strategies by warrantholders and the gain from hoarding warrants. We analyze several obstacles to acquiring large blocks in order to exploit sequential strategies. First, we identify several reinvestment policies for which sequential exercise is not advantageous, thereby eliminating the gain from hoarding. However, sequential exercise strategies may be advantageous for monopoly or oligopoly warrantholders, even absent dividends, because using exercise proceeds to repurchase stock or to expand the firm's scale increases the riskiness of an equity share. Second, oligopoly warrantholders can receive a smaller warrant value than perfectly competitive warrantholders, suggesting a potential cost to unsuccessful hoarding.