Search

We present the first evidence that initial ratings of commercial paper influence common stock returns. Highly-rated industrial issues of commercial paper, unaccompanied by bank letters of credit, are associated with significantly positive abnormal returns; lower-rated issues are not. The stock price effects of changes in commercial paper ratings also demonstrate the relevance of ratings to the financing of firms. Rating downgrades, especially those that imply an exit from the commercial paper market, produce significantly negative abnormal returns; upgrades have no effects. Initial commercial paper ratings and subsequent reratings appear to help investors sort firms by their future prospects. [ABSTRACT FROM AUTHOR]

This article presents the author's comments on a paper that examined expected returns on stocks. The author suggests that the paper did an excellent job evaluating variance-bound literature; however, he believes that the analysis conducted was partial and failed to highlight the conclusions reached by other prominent researchers on volatility. The author also is skeptical of the conclusion drawn in the paper that suggests turning to nonstandard models for expected returns to explain stock price volatility. The author notes that the field has come a long way in understanding the statistical traps involved with volatility and pushes for more research.

In two papers and in a recent book I have presented theory and evidence which lead to the conclusion that a corporation's share price (or its cost of capital) is not independent of the dividend rate. As you may know, MM (Modigliani and Miller) have the opposite view, and they argued their position at some length in a recent paper.3 Moreover, the tone of their paper made it clear that they saw no reasonable basis on which their conclusion could be questioned. Since they were so sure of their conclusion, it would seem advisable for me to review carefully my thinking on the subject, and this meeting appears to be a good time and place to do so. [ABSTRACT FROM AUTHOR]

This paper analyzes how blockholders can exert governance even if they cannot intervene in a firm's operations. Blockholders have strong incentives to monitor the firm's fundamental value because they can sell their stakes upon negative information. By trading on private information (following the “Wall Street Rule”), they cause prices to reflect fundamental value rather than current earnings. This in turn encourages managers to invest for long-run growth rather than short-term profits. Contrary to the view that the U.S.'s liquid markets and transient shareholders exacerbate myopia, I show that they can encourage investment by impounding its effects into prices. [ABSTRACT FROM AUTHOR]

The article presents commentary from Zhenyu Wang about a paper written by Lubos Pastor and Robert F. Stambaugh (P&S) entitled "The Equity Premium and Structural Breaks," which appeared in the August, 2001 edition of the "Journal of Finance." In that paper P&S combined statistical procedures with economic ideas to estimate the equity premium for stocks in the U.S. The author of the current paper applauds their approach and finds their results sensible. However, he also believes they should incorporate a valuation model based on fundamental economic variables.

This paper tests the tax explanation of the January effect by examining small firm stock returns before the War Revenue Act of 1917. No evidence of a turn-of-the-year effect is found. This paper also extends previous authors' work on the subject to 1918-29. A January effect is found during that period. [ABSTRACT FROM AUTHOR]

The main contribution of my original paper is in pointing out that short-term profit elimination around the ex-dividend day can make the inference of stockholders' marginal tax rates from the behavior of stock prices in that period impossible. This is so because, in the absence of transaction costs and assuming risk neutrality,1 the equilibrium condition for no profit opportunities implies an expected ex-dividend day price drop which, irrespective of stockholders' marginal tax rates, must be equal to the dividend per share. Elton, Gruber, and Rentzler (hereafter EGR) argue that the relevant transaction costs of a short-term trader include the costs associated with the bid and ask spread, clearance, and transfer taxes (for the period of the study). These costs are larger than the minimum transaction costs reported in Table III (p. 1067) of my paper. Consequently, EGR argue that short-term trading around the ex-dividend day is unprofitable and long-term tax rates are determining the price behavior in this period. I agree with EGR that the effective transaction costs of a short-term trader can be larger than the minimum costs reported in my paper. However, below I argue and present evidence that these costs are not large enough to prevent short-term trading at all dividend yield levels. Therefore, as I argued in my original paper, long-term taxes cannot be inferred from the exdividend day behavior of stock prices. [ABSTRACT FROM AUTHOR]

To take a representative sample of Keran's approach to empirical research, consider his equation (7), reproduced as equation II-1 in Table 1 of the H & K paper. This equation purports to show that the "major factors determining stock prices are ... expected corporate earnings and current interest rates" (Keran, p. 31). What it actually shows is an index of stock prices regressed on the current and one lagged value of a long-term interest rate, and on the current and 19 lagged values of corporate profits, with the coefficients constrained to lie along a sixth-order polynomial of the Almon variety. Despite the continual use of the term, "expected corporate earnings," when referring to these lagged values, no attempt is ever made to disentangle the presumed forecasting weights from the presumed explanatory coefficients, nor to validate the expectation by direct predictive tests, nor to compare its predictive performance with other possible proxies. [ABSTRACT FROM AUTHOR]

This paper tests whether the "disposition effect," that is the tendency of investors to ride losses and realize gains, induces "underreaction" to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post-announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event-driven strategy based on this effect yields monthly alphas of over 200 basis points. [ABSTRACT FROM AUTHOR]

The assumption that the market portfolio follows a specified diffusion process implies, in a simple equilibrium framework, that the representative individual must have a certain utility function which is identified in the paper. Not every diffusion process is viable, i.e., can be "endogenized" to be the market portfolio's price process in such an equilibrium model. The paper provides necessary and sufficient conditions for viability which imply that viable diffusion processes constitute a rather restricted family. [ABSTRACT FROM AUTHOR]

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. [ABSTRACT FROM AUTHOR]

This paper, utilizing dealer's "trading book" information, presents some empirical evidence supporting the validity of a dealer pricing model. It shows that much of the transaction prices variation may be explained by the specialist's optimal determination of his bid and ask quotes. Furthermore, it demonstrates that the dealer's bid-ask spread is an important explanatory variable in the observed transaction return. Finally, it indicates that the dealer's inventory level may affect his quotes and thus the transaction prices and order arrivals. The paper provides insights into the relationship between transaction prices and equilibrium prices, which will permit more extensive use of transaction data in empirical investigations. It also provides a better understanding of optimal dealer pricing strategies, suggesting that the proposed empirical model may be used to evaluate a dealer's trading performance. [ABSTRACT FROM AUTHOR]

The effect of personal taxation on stock prices remains controversial. While some researchers have found evidence of a tax effect in the stock market, others have found evidence to the contrary. This paper provides additional empirical evidence on the effect of the differential taxation of dividends and capital gains on stock prices by analyzing stock price changes around the 1971 Canadian Tax Reform and its subsequent amendments in 1977. The results show that changes in the taxation of cash dividends and capital gains affected high-yield and low-yield stocks listed on the Toronto Stock Exchange (TSE) differently. Section I of the paper describes the tax changes. The method used to analyze the tax effect is described in Section II. Section III reports the results, and conclusions are presented in Section IV. [ABSTRACT FROM AUTHOR]

Rate of return regulation in principle suggests strong linkages between interest rates, utility return on book equity (ROE), and stock price/book equity ratios: ceteris paribus, changes in interest rates should be quickly transformed into changes in ROEs, and stock prices should tend toward book value. Absent lags in the process, it also suggests that utility investors are minimally exposed to the risks of unanticipated changes in interest rates, notably those associated with inflation. In this paper we examine the financial implications of electric utility regulation from 1971-1980. Over this period, which was characterized by inflation-related rises in interest rates, we find that the gap between allowed and earned ROEs, on the one hand, and interest rates, on the other hand, increased. Since this outcome is in contradiction of the conceptual model of regulation and investors' exposure to inflation risk, we test the hypothesis that investors respond to the reality of regulation by imposing risk premiums which are functionally related to interest rates. The basic idea is that an ROE shortfall leads to an expectation that regulation will respond in the future with a higher earnings level, but this "IOU" in the implicit social contract is risky. And the question addressed in this paper is whether the degree of riskiness is related to the level of interest rates. Using two valuation models we conclude that at least during the 1970s risk premiums were not related to the level of interest rates. [ABSTRACT FROM AUTHOR]

The article presents commentary about a paper written by Paul Griffen entitled "Competitive Information in the Stock Market: An Empirical Study of Earnings, Dividends and Analysts' Forecasts," which was published in the May, 1976 edition of the "Journal of Finance." The author observes that of the three hypotheses Griffen tests, two are operationally equivalent and none has been supported with adequate evidence. However, he believes that Griffen's investigation of the marginal and joint effects of earnings, dividends, and analysts' forecasts is a worthy endeavor.

This paper by Jack Treynor and Robert Ferguson (TF) is an attempt to demonstrate the usefulness of knowing past price information in making investment decisions. The normative contribution of the paper is the development of a Bayesian probability estimate to assess using past price data whether or not the market has already incorporated some firm-specific information, which has been made available to the investor. The obvious implication is that if the market has not discovered the information, and this can be confirmed with past price data, then the holder of private information can act accordingly. [ABSTRACT FROM AUTHOR]

The article presents commentary about a paper written by Patrick J. Hess entitled "The Ex-Dividend Day Behavior of Stock Returns: Further Evidence on Tax Effects," which appeared in the May, 1982 edition of the "Journal of Finance." The author acknowledges several assumptions made by Hess that Hess believes are missing from a previous paper by Litzenberger and Ramaswamy. However, he believes that Hess' use of daily data introduces certain difficulties, including those associated with distributional assumptions and informational effects.

The article discusses stock valuation and the role of dividends. Theoretical and empirical analysis in the paper focuses on several problems including the determination of the cost of equity capital, the minimization of the cost of capital, and the maximization of the value of stock. These problems are overlapping in that they directly and indirectly concern stock valuation. When speaking of stock valuation one must also discuss the role of dividends. Dividends can influence stock value through capital structure and income splitting.

The article presents discussion regarding the 1982 paper "Do We Really Know Financial Markets are Efficient," by Lawrence H. Summers. The author states that Summers' largest contribution with his paper is the observation that the negative correlation between pricing error and variance of returns can be too small to detect using common techniques. The article states that Summers' paper does not suggest new statistical tests, but does call attention to the deficiencies of past tests. The article supplies a mathematical model of a comparison of values for a monthly versus daily returns which implies that the negative autocorrelation of returns approaches zero as the length of the return interval grows.

A paper that presents us with a paradox has a natural appeal. The paradox in Grossman's paper--that "when a market is a perfect aggregator of information it removes private incentives to collect information" is certainly not trivial from the viewpoint of anyone concerned with the functioning of securities markets. A broader viewpoint is also possible, moreoever, since I find Grossman's problem closely related to an older question in price theory: When every market participant is convinced that the efforts of arbitrageurs ensure that the same good never (for any instant) is offered at different prices at the same time, how can the arbitrage operation that ensures this condition survive? Most price theory texts do not address this problem directly, or at all, although I think they should, and Grossman deserves credit for ably illuminating its counterpart in the theory of efficient securities markets. [ABSTRACT FROM AUTHOR]

This paper compares centralized and fragmented markets, such as floor and telephone markets. Risk-averse agents compete for one market order. In centralized markets, these agents are market makers or limit order traders. They are assumed to observe the quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. We analyze differences in bidding strategies reflecting differences in market structures. The equilibrium number of dealers is shown to be increasing in the frequency of trades and the volatility of the value of the asset. The expected spread is shown to be equal in both markets, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets. [ABSTRACT FROM AUTHOR]

This paper documents that strategies which buy stocks that have performed well in the past and sell stocks that have performed poorly in the past generate significant positive returns over 3- to 12-month holding periods. We find that the profitability of these strategies are not due to their systematic risk or to delayed stock price reactions to common factors. However, part of the abnormal returns generated in the first year after portfolio formation dissipates in the following two years. A similar pattern of returns around the earnings announcements of past winners and losers is also documented. [ABSTRACT FROM AUTHOR]

This paper analyzes the behavior of stock prices around ex-dividend days after the implementation of the 1986 Tax Reform Act that dramatically reduced the difference between the tax treatment of realized long-term capital gains and dividend income in 1987 and completely eliminated the differential in 1988. We shows that this tax change had no effect on the ex-dividend stock price behaviour, which is consistent with the hypothesis that long-term individual investors have no significant effect on ex-day stock prices during this time period. The results indicate that the activity of short-term traders and corporate traders dominates the price determination on the ex-day. [ABSTRACT FROM AUTHOR]

This paper examines the variance of hourly market returns during 1964-1989. Results indicate that return volatility falls from the opening hour until early afternoon and rises thereafter and is significantly greater for intraday versus overnight periods. Market variance is also shown to change significantly over time, rising after NASDAQ began in 1971, rising after trading in stock options began in 1973, falling after fixed commissions were eliminated in 1975, rising after trading in stock index futures was introduced in 1982, and falling after margin requirements for stock index futures became larger in 1988. [ABSTRACT FROM AUTHOR]

In this paper, we investigate the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence shows that the negative stock return-inflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability. [ABSTRACT FROM AUTHOR]

This paper shows that target shareholders can be made better off through the use of certain types of defensive strategies that reduce the value of the target by different amounts for different bidders. In many cases, simply the threat of such strategies can make target shareholders better off. Therefore, empirical tests based on stock price reactions at the adoption of defensive strategies may be underestimating the effect of such strategies. The paper also identifies the necessary characteristics that make these strategies effective and shows that many observed defenses possess similar properties. [ABSTRACT FROM AUTHOR]

This paper investigates the resiliency of the new-issue high-yield bond market by examining the changes in implied default rates of such bonds before and after the largest high-yield bond default, i.e., the LTV bankruptcy. Specifically, the paper compares implied default probabilities of high-yield bonds during the post-LTV period calculated from actual new-issue yields with instrumental default probabilities calculated on the assumption that the default had not occurred. A comparison of these probabilities reveals that the market's perception of default on the high risk segment of the bond market increased significantly after the LTV bankruptcy. However, the effect was transitory, lasting only six months. Thus, the market was resilient to a major default. [ABSTRACT FROM AUTHOR]

The average returns on low-capitalization stocks are unusually high relative to those on large-capitalization stocks in early January, a phenomenon known as the turn-of-the-year effect. This paper finds that the ratio of stock purchases to sales by individual investors displays a seasonal pattern, with individuals having a below-normal buy/sell ratio in late December and an above-normal ratio in early January. Year-to-year variation in the early January buy/sell ratio explains forty-six percent of the year-to-year variation in the turn-of-the-year effect during 1971-1985. [ABSTRACT FROM AUTHOR]

This paper presents empirical evidence comparing two models of trading in equities-the well-known tax-loss-selling hypothesis and "the disposition effect." According to the disposition effect, investors are reluctant to realize losses but are eager to realize gains. This paper distinguishes between the two models with a new methodology that examines the relationship between volume at a given point in time and volume that took place in the past at different stock prices. The evidence overwhelmingly supports the disposition effect not only as a determinant of year-end volume, but also as a determinant of volume levels throughout the year. [ABSTRACT FROM AUTHOR]

Jensen and Meckling were the first to bring attention to the agency costs that arise due to excessive perquisite consumption by the manager and due to the shareholders' incentive to bear unwanted risk. Barnea, Haugen, and Senbet—BHS hereafter—and Haugen and Senbet—HS hereafter—have argued in several publications that (i) the agency problem resulting from excessive perquisite consumption can be resolved by issuing a) convertible debt or b) a package of external equity and managerial stock options, (ii) the agency problems resulting from the shareholders' incentive to bear unwanted risk (also referred to as risk shifting) can be resolved by issuing callable debt, and (iii) welfare loss due to informational asymmetry between insiders and the market can be reduced by issuing callable debt. In this paper, we derive results that contradict these conclusions of BHS and HS. We prove that convertible debt cannot costlessly resolve the agency problem due to excessive perquisite consumption. Farmer and Winter [4] have recently shown that managerial stock options cannot resolve the problem. We also show that convertible debt, in general, does not even mitigate this problem. Next, we show that the argument that callable debt resolves agency problems due to risk shifting and informational asymmetry is incomplete. The paper is organized as follows. Section I deals with the perquisite consumption problem; Section II deals with both risk shifting and informational asymmetry problems since the basis of their resolution in the BHS argument is the same. [ABSTRACT FROM AUTHOR]

This paper examines optimal corporate financing arrangements under asymmetric information for different patterns of temporal resolution of uncertainty in the underlying technology. An agency problem, a signalling problem and an agency-signalling problem arise as special cases. The associated informational equilibria and the optimal financing arrangements are characterized and compared. In the agency-signalling equilibrium the private information of corporate insiders at the time of financing is signalled through capital structure choices which deviate optimally from agency-cost minimizing financing arrangements, which in turn induce risk-shifting incentives in the investment policy. In the pure signalling cue the equilibrium is characterized by direct contractual precommitments to implement investment policies which are riskier than pareto-optimal levels. Empirical implications (or debt covenants and the announcement effect of investment policies and leverage increasing transactions on existing stock and bond prices are explicitly derived. [ABSTRACT FROM AUTHOR]

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. [ABSTRACT FROM AUTHOR]

This paper examines differences in announcement day effects among firms engaged in voluntary sell-offs. While, on average, an initial sell-off announcement results in a significant positive excess return, not all divestiture announcements are accompanied by positive price movements. Dividing the sample into two subsamples based on whether the transaction price is announced shows that the announcement day effect is significantly positive for the price group but not statistically different from zero for the no-price group. In addition, a positive relation is found between the relative size of the sell-off and the announcement day return. [ABSTRACT FROM AUTHOR]

This paper values options on assets whose returns, over a finite interval of time, are generated by a binomial process. It shows that a simple valuation relationship, between the option and the underlying stock, obtains if investors have preference functions that belong to a particular class, even if opportunities to hedge do not exist. One particular application of the theory is in the case where the stock price over a finite interval could increase by an amount, fall by the same amount, or stay at the same level. The results in this paper may be viewed as the foundation of the preference-based approaches to obtaining a risk neutral valuation relationship. [ABSTRACT FROM AUTHOR]

Much of the past work on the money-stock market relationship centered on the question of whether money is a leading indicator of stock prices. Studies by Sprinkel, Homa and Jaffee, and Hamburger and Kochin supported the view that past increases in money lead to increases in equity prices. The implication of this work was that investors could earn above normal profits by using a trading strategy based on the observed behavior of the money stock. This contradicts the efficient markets hypothesis which asserts that current asset prices reflect all available information so that no such trading strategy can exist. Subsequent research by Cooper, Pesando, Rozeff, and Rogalski and Vinso has shown that past money changes do not contain predictive information on stock prices, upholding the efficient markets view. This paper investigates whether the response of common stock prices to weekly money announcements is consistent with the efficient markets hypothesis. Unlike the above research, therefore, the focus is on the very short-run response of stock prices to both anticipated and unanticipated announced changes in money. Recent work by Berkman, Grossman, Urich and Wachtel, and Roley indicates that short-term interest rates respond only to the unexpected component of the announcement, with short-term rates rising when the announced change in money exceeds the expected change. Berkman also examined the reaction of stock prices, finding that an unanticipated increase in the money supply depressed share prices. Lynge found that positive money announcements lowered stock prices, but since he did not distinguish expected from unexpected money growth, his results do not bear directly on the efficient markets issue. This paper has examined the short-run reaction of stock prices to weekly money supply announcements. Several conclusions emerge from this empirical investigation. First, stock prices respond only to the unanticipated change in the money supply as predicted by t... [ABSTRACT FROM AUTHOR]

Stock index futures prices are generally below the level predicted by simple arbitrage models. This paper suggests that the discrepancy between the actual and predicted prices is caused by taxes. Capital gains and losses are not taxed until they are realized. As Constantinides demonstrates in a recent paper, this gives stockholders a valuable timing option. If the stock price drops, the investor can pass part of the loss on to the government by selling the stock. On the other hand, if the stock price rises, the investor can postpone the tax by not realizing the gain. Since this option is not available to stock index futures traders, the futures prices will be lower than standard no-tax models predict. [ABSTRACT FROM AUTHOR]

The article presents commentary about three papers that were published in the May, 1982 issue of the "Journal of Finance," including "Valuation Model Bias and the Scale Structure of Dividend Discount Returns" by Richard O. Michaud and Paul L. Davis (M&D), "Factor-Related and Specific Returns of Common Stocks: Serial Correlation and Market Inefficiency" by Barr Rosenberg and Andrew Rudd (R&R), and "Risk Adjusted Equity Performance Measurement" by John Nagorniak. The author notes the different conclusion each paper reaches concerning the efficiency of capital markets, and believes all constitute a basis for further research.

There have been a number of studies of the price/yield behavior of newly-issued corporate bonds. These studies find that there are systematic differences in yield to maturity between newly-issued bonds and bonds that have been outstanding for some time. Typically, new issues have higher yields and these differences are usually found to persist for some time after issue. Authors realize that such differences are inconsistent with an efficient bond market and usually explain these differences by appeal to various assumed market imperfections, such as a "thin" market in seasoned issues. In this paper we approach the question of differences between new and seasoned issues by concentrating on holding-period returns (coupon plus capital gain) instead of the more usual yield to maturity. That is, we ask whether there are differences in holding period returns between seasoned and unseasoned bonds. The paper is organized as follows: Section I briefly surveys the literature on the seasoning process and develops our approach; Section II develops the hypotheses and describes our test procedure; Section III describes the data used and the results of our tests and Section IV discusses the implications of our findings. [ABSTRACT FROM AUTHOR]

A warrant, like a call option, is a right to buy a share of the firm at a certain price during a given time period. While the call option is issued by an individual, the warrant is issued by the firm and its proceeds are a part of the firm's equity. If a warrant is exercised, it increases the number of outstanding shares of the firm and thus dilutes the equity of its stockholders. Nevertheless, most papers dealing with warrants have overlooked the warrant's potential dilution effect on the firm's equity. In this paper we derive the value of the warrant and the value of the firm that issues warrants. In order to focus on the potential dilution effect of warrants on the current value of the firm, we assume throughout the analysis that the investment policy of the firm is given and is not being affected by its financial decisions. Under this assumption and the assumption of perfect capital markets, the issuance of warrants will not affect the wealth of the current security holders of the firm. However, as will be demonstrated, it may increase the current market value of the firm's future cash inflow, an increase which is offset by the added liability of its securityholders in such a way as to leave their wealth unchanged. [ABSTRACT FROM AUTHOR]

Ball and Watts acknowledge that the findings of their classic study of the time series properties of measured accounting income are somewhat limited because of an ex post sample selection bias against decreases in income [1, pp. 667-668]. They note, however, that the importance of the bias cannot be determined within their own selected sample of firms [1, p. 667]. The first purpose of this paper is to provide some evidence on the importance of their ex post sample selection bias against income decreases by applying some of their procedures to samples of firms which do not possess the same bias. Ball and Watts state that they were not interested in the behavior of the income time series of individual (outlier) firms [1, p. 680]. However, their stated conclusion that a particular single process--a submartingale process--characterizes the measured income series quite well [1, p. 680] implies (perhaps inadvertently) a similarity in the characteristics of the earnings processes of different firms. The second purpose of this paper is to display data which suggests that there may be more diversity than similarity in some of the characteristics of the earnings processes of different firms. [ABSTRACT FROM AUTHOR]

In an earlier paper, I briefly discussed the problem of errors in option pricing due to a misspecification of the stochastic process generating the underlying stock's returns. While there are many ways in which a specification error can be introduced, the particular form chosen in that paper was to compare the option prices arrived at by an investor who believes that the distribution of the unanticipated returns of the underlying stock is lognormal, and hence that he can use the classic Black-Scholes pricing formula, with the "correct" option prices if the true process for the underlying stock is a mixture of a lognormal process and a jump process. This is a particularly important case because the nature of the error is not just one of magnitude, but indeed the qualitiative characteristics of the two processes are fundamentally different. In this paper, I examine the nature and magnitude of the error in a quantitative fashion using simulations. Before discussing the simulations, it is necessary to briefly summarize the option pricing results deduced in the earlier paper. [ABSTRACT FROM AUTHOR]

In this paper we provide an interesting framework of analysis through which the relationship between leverage and the relative stability of stock value can be analyzed. We approach the problem from a unique point of view and, in the process, discover a rather complex relationship between leverage and the stability of common stock prices. The seeds for our ideas were planted in actuarial science through their interest immunization rules for life insurance companies. Later, Grove, apparently unaware of the preceding work in actuarial science, generalizes the concepts to the non-intermediary and makes an important contribution in relating financial leverage to interest rate risk. This paper expands these propositions and demonstrates their sweeping significance for the theory of the finance of the firm. Our analytical framework is based on the work of Hicks and other authors, who have attempted to isolate the theoretical determinants of the risk of equity capital. In this paper we provide an interesting framework of analysis through which the relationship between leverage and the relative stability of stock value can be analyzed. We approach the problem from a unique point of view and, in the process, discover a rather complex relationship between leverage and the stability of common stock prices. The seeds for our ideas were planted in actuarial science through their interest immunization rules for life insurance companies. Later, Grove, apparently unaware of the preceding work in actuarial science, generalizes the concepts to the non-intermediary and makes an important contribution in relating financial leverage to interest rate risk. This paper expands these propositions and demonstrates their sweeping significance for the theory of the finance of the firm. Our analytical framework is based on the work of Hicks and other authors, who have attempted to isolate the theoretical determinants of the risk of equity capital. [ABSTRACT FROM AUTHOR]

The notion of a "hot issue" has been widely discussed and examined in the financial community during the past decade. Hot issues usually refer to particular stock issues that have risen from their offering prices to higher than average premia in the aftermarket. The most well-known investigations of these issues were the Securities and Exchange Commission (SEC) Report on the Special Study of Security Markets (28) and the SEC "hot issue" hearings of 1972. This paper focuses on the prediction of "hot issue" markets. These markets are defined as periods in which the average first month performance (or aftermarket performance) of new issues is abnormally high. Although no other academic research has examined hot issue markets, the predictability of these periods is commonly asserted in the financial community. Furthermore, the SEC has focused on the years 1959-61 and 1968-69 as periods in which an extraordinary number of "hot issues" were allegedly offered. This paper first tests the dependency of new issue premia (and aftermarket performance) in a given month on the premia (and aftermarket performance) of other new issues in past months. Then the relationships between new issue premia, aftermarket performance, the frequency of offerings, and the performance of the market are examined. Finally, implications of these results to investors, issuers, and researchers are analyzed. In particular our findings may help investors and issuers decide when to purchase or issue the securities. Also, we show that the results cast doubt on much of the methodology employed in previous new issue research. [ABSTRACT FROM AUTHOR]

One of the most important problems confronting stock market analysts is the valuation of stocks at any point in time. In fact, the name of the game is to determine whether stocks are selling above or below their real worth. Presumably, "real worth" is synonymous with economic equilibrium based upon the "correct" model of common stock valuation. Deviations from equilibrium will eventually be corrected by the market mechanism and this is the stuff of which profits and losses are made. The purpose of this paper is to extend the work of Malkiel and Cragg since they have apparently opened up a rich vein of exploration in the quest to explain the structure of share prices. The most serious limitation of the Malkiel and Cragg study was its sample size. Unfortunately, the sample was restricted to only 178 corporations. The authors state "... our sample tends to contain the 'blue-chip' group of companies in which investment interest is centered.". Would it be possible to improve the market representativeness and size of the sample and still obtain the excellent results reported by Malkiel and Cragg? In addition to attempting to answer this question, this paper will also consider the role of industrial classification in determining price-earnings ratios holding important financial variables constant. Section II briefly reviews the stock evaluation model. Section III discusses the data source for this study. Section IV reports the regression results while Section V summarizes the findings. [ABSTRACT FROM AUTHOR]

The paper develops a simple model of corporate ownership structure in which costs and benefits of ownership concentration are analyzed. The model compares the liquidity benefits obtained through dispersed corporate ownership with the benefits from efficient management control achieved by some degree of ownership concentration. The paper reexamines the free-rider problem in corporate control in the presence of liquidity trading, derives predictions for the trade and pricing of blocks, and provides criteria for the optimal choice of ownership structure. [ABSTRACT FROM AUTHOR]

Professor Ball's paper reports the results of an extremely detailed and exhaustive study of the effect on security prices of changes in accounting techniques affecting the reported net income figure. His contribution is both substantive, in that it provides further evidence in support of the efficient markets hypothesis, and methodological, in that it proposes refinements to the usual technique used to study the impact of new information on stock prices. I shall discuss these two aspects of his paper separately. The major finding of the paper is that capital markets are efficient to the extent that investors are able to see through the accountant's veil to derive independent estimates of the true economic income of firms. We may conclude from this that annual income reports do nothing to obstruct the flow of information from firm to investor, even if they do relatively little to facilitate it. However, it would be wrong to take this as implying that the principle of consistency in accounting is irrelevant' market efficiency is quite compatible with variations in investor sophistication, and it is possible that changes in accounting techniques lead to wealth transfers from the naive to the sophisticated, which would be widely regarded as undesirable. [ABSTRACT FROM AUTHOR]

This paper develops a model in which investors who are prohibited from short selling agree to disagree on the precision of a publicly observed signal. The model implies that the equilibrium price is a convex function of the public signal. The model predicts that (1) the stock price reacts more to good news than to bad news; (2) the skewness of stock returns is positively correlated with contemporaneous returns, but negatively correlated with lagged returns; (3) short sale constraints increase rather than decrease skewness; and (4) disagreement about information precision increases skewness. Empirical tests conducted find supportive evidence for all these predictions. [ABSTRACT FROM AUTHOR]

This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross-section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity. [ABSTRACT FROM AUTHOR]

The paper argues that the market significantly overvalues firms with severely underfunded pension plans. These companies earn lower stock returns than firms with healthier pension plans for at least 5 years after the first emergence of the underfunding. The low returns are not explained by risk, price momentum, earnings momentum, or accruals. Further, the evidence suggests that investors do not anticipate the impact of the pension liability on future earnings, and they are surprised when the negative implications of underfunding ultimately materialize. Finally, underfunded firms have poor operating performance, and they earn low returns, although they are value companies. [ABSTRACT FROM AUTHOR]

This paper analyzes the impact of changes in monetary policy on equity prices, with the objectives of both measuring the average reaction of the stock market and understanding the economic sources of that reaction. We find that, on average, a hypothetical unanticipated 25-basis-point cut in the Federal funds rate target is associated with about a 1% increase in broad stock indexes. Adapting a methodology due to Campbell and Ammer, we find that the effects of unanticipated monetary policy actions on expected excess returns account for the largest part of the response of stock prices. [ABSTRACT FROM AUTHOR]