Search

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]

This paper tests the Arbitrage Pricing Theory (APT) by estimating the factor loadings that are consistent between two industry groups of securities. One of the pitfalls in the study by Roll and Ross is that the factors estimated in one group may not be the same with the factors estimated in another group. This raises some concerns on the acceptability of their conclusions. For our study, we employ inter-battery factor analysis which enables us to estimate factor loadings by constraining the factors to be the same between two different groups. Our results show that there seem to be five or six inter-group common factors that generate daily returns for two industry groups of securities, and these inter-group common factors do not seem to depend on the size of groups. Also, based on our cross-sectional tests on the risk premia, we conclude that the APT should not be rejected. [ABSTRACT FROM AUTHOR]

This paper presents the mean-Gini (MG) approach to analyze risky prospects and construct optimum portfolios. The proposed method has the simplicity of a mean-variance model and the main features of stochastic dominance efficiency. Since mean-Gini is consistent with investor behavior under uncertainty for a wide class of probability distributions, Gini's mean difference is shown to be more adequate than the variance for evaluating the variability of a prospect. The MG approach is then applied to capital markets and the security valuation theorem is derived as a general relationship between average return and risk. This is further extended to include a degree of risk aversion that can be estimated from capital market data. The analysis is concluded with the concentration ratio to allow for the classification of different securities with respect to their relative riskiness. [ABSTRACT FROM AUTHOR]

This study provides further evidence on the rates of return realized by the shareholders of multinational firms relative to those of purely domestic firms. The results indicate that the risk-adjusted returns realized by the shareholders are identical across the two groups except where the MNC operates in competitive foreign markets. In that case, MNC shareholders experience negative abnormal returns. The study also provides further evidence on the risk-reduction effect of international diversification. The results fail to support the hypothesis that the beta is a convex function of the degree of international involvement. Finally, the paper provides some preliminary evidence on the effect of corporate international diversification on shareholders' returns. It is found that abnormal returns rise by some 18 percent during the 14 months preceding the initial foreign diversification. [ABSTRACT FROM AUTHOR]

We examine abnormal stock returns surrounding contemporaneous earnings and dividend announcements in order to determine whether investors evaluate the two announcements in relation to each other, We find that there is a statistically significant interaction effect. The abnormal return corresponding to any earnings or dividend announcement depends upon the value of the other announcement. This evidence suggests the existence of a corroborative relationship between the two announcements. Investors give more credence to unanticipated dividend increases or decreases when earnings are also above or below expectations, and vice versa. [ABSTRACT FROM AUTHOR]

We examine the hypothesis originally advanced by Roll [12] that observed anomalies in excess returns can be explained by misspecification of the market model used to estimate systematic risk. We find substantial misspecifications in the model systematically related to size and period of listing of the securities in question. There is some evidence that these misspecifications are associated with systemic biases in measured betas used to construct excess returns. [ABSTRACT FROM AUTHOR]

While there has been an abundance of empirical research on the subject of mergers and acquisitions, little research exists on a closely related topic—voluntary corporate selloffs. This study examines the effect on shareholder wealth of the announcement by management of an investment decision to voluntarily sell part of its operations to another firm. Positive abnormal returns are found to occur on the announcement date. However, it is found that such selloffs generally occur after a period of abnormally negative returns, suggesting the announcement is preceded by the release of negative information about the firm. [ABSTRACT FROM AUTHOR]

This paper demonstrates that the Roll and Ross (RR) and other previously published tests of the APT are subject to several basic limitations. There is a general nonequivalence of factor analyzing small groups of securities and factor analyzing a group of securities sufficiently large for the APT model to hold. It is found that as one increases the number of securities, the number of "factors" determined increases. This increase in the number of "factors" with larger groups of securities cannot readily be explained by a distinction between "priced" and "nonpriced" risk factors as it is impermissible to carry out tests on whether a given "risk factor is priced" using factor analytic procedures. [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]

Removing interest rate ceilings on bank deposits or reducing the tax rate applicable to the interest earned on such deposits are alternative means of increasing the after-tax return to depositors. These alternatives, however, have differing impacts on the structure of a competitive banking industry. This paper develops a model which focuses on a bank's choice between paying an explicit interest rate on its deposits and paying a return in the form of services. The model allows banks to differ in their production technologies and depositors in their marginal tax rates and preferences for services. The effects of tax rate changes and a ceiling on the explicit deposit interest rate are analyzed. [ABSTRACT FROM AUTHOR]

The article discusses aspects of international portfolio choice. In international portfolio models nations are defined as zones of common purchasing power units or as subsets of investors who use the same price index in deflating their anticipated monetary returns. Nations may further be separated by sovereignty of taxes and border controls, which constrain private financial transactions between countries. Analysts say nations can be meaningfully distinguished by Purchasing Power Parity deviations. It is reasonable to surmise that investors residing in different countries have different yardsticks for measuring real returns and risks.

The article discusses accounting practices for flotation cost allowances. Flotation costs are incurred when a public utility sells new equity securities. There are two recognized approaches to accounting for flotation costs which have been advocated in regulatory hearings. The first consists of reimbursing the utility in each period for flotation costs actually incurred during that period. The second approach increases the allowed return on equity in all future periods to compensate the equity investor for the erosion of his initial equity contribution, due to flotation costs.

The impact of events on the time series properties of common stock returns has been the subject of numerous articles in the finance literature. Most studies have shown that capital markets are highly efficient in the sense that prices quickly adjust to publicly available information as investors act to receive a return commensurate with the level of perceived risk. This note examines the effect on the stock returns of public utility firms of the Three Mile Island (TMI) nuclear accident. In stock valuation models based on investor rationality, permanent price declines are brought about either by a decline in expected cash flows or by an increase in the rate used to discount future cash flows. Such a nuclear accident may directly affect investors' perceptions of both the expected cash flows of utilities and their risk. These future cash flows are affected because a nuclear accident may cause additional costs due to extended shutdowns or abandonment of nuclear plants, expenses of responding to a nuclear accident, and costs of purchasing replacement power. The response of utility returns to TMI is analyzed at three levels. First, the risk-adjusted returns for the utility experiencing the nuclear accident (General Public Utilities (GPU)) are measured over monthly time periods surrounding TMI. The same analysis is performed on an aggregate sample of electric utility firms to assess the direction and magnitude of TMI's impact on other firms in the industry. Lastly, the sample is divided into utilities with significant nuclear generating capacity at the time of TMI and utilities with no nuclear generating capacity, so that the differential impact of the nuclear accident on nuclear and non-nuclear public utilities may be assessed. Both a single and two index market model are used to estimate risk-adjusted returns. The latter index model includes an interest rate index as well as an equity market index. [ABSTRACT FROM AUTHOR]

This paper has examined the returns behavior of the stocks of bankrupt corporations. Similar to earlier studies, we found evidence of mounting losses sustained by shareholders over long periods prior to bankruptcy. Estimates of average shareholder losses occurring when bankruptcy is announced are the main items of new information presented by this study. Shareholders suffer large losses during the month a bankruptcy occurs, and those losses are especially concentrated into the three trading day interval surrounding a bankruptcy filing. Based upon these findings, we conclude that bankruptcy filings convey important unanticipated information to the market. Attempts were made to see if there were profound differences between (a) Chapter X and Chapter X! bankruptcies and between (b) bankruptcies in which shares became worthless and bankruptcies in which shares retained value. Although some apparent differences were detected, the existence of these differences was not conclusively demonstrated because they were observed in very small samples. [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]

Empirical research indicates that small firms earn higher average rates of return than large firms, even after accounting for beta risk. Roll conjectured that the small firm effect might be attributed to improper estimation of security betas. The evidence shows that while the direction of the bias in beta estimation is consistent with Roll's conjecture, the magnitude of the bias appears to be too small to explain the firm size effect. [ABSTRACT FROM AUTHOR]

GNMA mortgage-backed pass-through securities are supported by pools of amortizing, callable loans. Additionally, mortgagors often prepay their loans when the market interest rate is above the coupon rate of their loans. This paper develops a model for pricing GNMA securities and uses it to examine the impact of the amortization, call, and prepayment features on the prices, risks and expected returns of GNMA's. The amortization and prepayment features each have a positive effect on price, while the call feature has a negative impact. All three features reduce a GNMA security's interest rate risk and, consequently, its expected return. [ABSTRACT FROM AUTHOR]

A mean-variance risk-return tradeoff relationship is derived for the diffusion process limiting case of a state-preference model, with aggregate consumption serving as a pivotal variable. The model is compared to other recent models along the dimensions of generality and tractable implementation. The incorporation of stochastic interest rates in general equilibrium and arbitrage-based valuation models is examined, and an extension to earlier methods is discussed, in connection with the implementation of "robust" general valuation procedures. [ABSTRACT FROM AUTHOR]

This study compares the characteristics of bankrupt and non-bankrupt firms, prior to actual bankruptcy, with respect to various risk and return measures suggested by the capital asset pricing model. In addition, the study suggests an approach to estimating the probability of corporate failure, using capital market data . The conventional measure of the total risk borne by common stockholders is the variability of the rates of return. For the purpose of this study, shifts in the variance of stock returns are used to measure changes in the risk of corporate failure. Extensive cross-sectional and time series analysis indicate that certain risk measures based on market data exhibit significantly different behavior between the two samples examined in the study.

This paper proposes a measure of attitude of individuals towards risk. This measure includes the characteristics of the existing measures as special cases. It enables one to predict how a proportional change in the individual's expected wealth affects his risk premium for a wide range of relationship between the mean wealth and its variance. [ABSTRACT FROM AUTHOR]

The first objective of this paper is to examine how the temporal resolution of uncertainty affects market prices and consumption-investment decisions. We adopt the simplest model that makes possible the analysis of temporal resolution, namely a three period (t = 1, 2, 3) model. Individuals are assumed to act so as to maximize the expected utility of present and future consumption. It is assumed that individuals can trade in the shares of assets which provide uncertain returns and there exists a riskless asset which provides a riskless return over the three periods. Before the beginning of the second period new information arrives. As there is trading at date t = 2, investors will revise their portfolios and prices of the different assets will adjust to the new information. [ABSTRACT FROM AUTHOR]

The authors comment on the article "Investment Decisions, Repetitive Games, and the Unequal Distribution of Wealth" by Markowitz. They state that the distribution of wealth doesn't need to be highly concentrated due to persistent exploitative situations but can instead be deduced from accepted portfolio theory constructs. They present a Monte Carlo game of investment behavior similar to the one in the Markowitz paper that is composed of a series of shorter turns of the wheel that represent definite time periods that establish rewards of the game randomly according to the portfolio assets inherent variances. They state the game reveals that distribution of wealth can be skewed naturally from the participants' behavior in a competitive, private capital market.

The article comments on the paper published within the issue, "The Cost of Equity Capital: A Reconsideration," by M. J. Gordon and L. I. Gould. The author looks at the implications of the mutual dependence of earnings on investment and investment upon earnings under conditions of a constant investment rate and constant earnings growth. The constant growth stock valuation model is looked at as a device for explaining observed stock prices in terms of historical growth rate of dividends as well as a method to determine a firm's optimal investment strategy.

It has long been suggested that the financial structure of a firm communicates information about its returns, and in Ross [1977] some models were developed in which, at an equilibrium, managers would use finance to transmit and validate information about their firms. While these models have the virtue of describing a positive role for finance they are missing some important elements. Perhaps their principal limitation is that they assign no significant function to the manager beyond that of choosing the financial structure. This is in contrast to the neoclassical view of the manager as being concerned solely with activity choice, rather than with irrelevant financial matters. One of the purposes of this paper is to explore the relationship between these two functions. It is not unlikely that in some situations no incentive schedule can be found that simultaneously motivates that manager to make correct activity choices—efficient ones—and to signal the firm's type through the financial structure. Such a structure must reward the manager on the basis of competence while signalling, through finance, the framework of choice faced by the manager. The problem of assessing performance is further complicated by the inability to identify states. In the absence of a complete contingent description of the economy it will always be difficult to separate out the extent to which a particular firm's returns were the consequence of the manager's choices or nature's, i.e., skill or luck. The problems of moral hazard in such a situation are evident; if the manager's productive performance is positively rewarded it is in his interest to bias downward the market's perception of the activity set open to him. This evaluation problem is the second theme of this paper. The first section of the paper introduces the general incentive-signalling-financial (ISF) equilibrium model, and the following section specializes the model to a traditional state-space framework. Here... [ABSTRACT FROM AUTHOR]

In recent years, we have experienced numerous disputes over the rate a public utility should be allowed to earn. More often than not the difference between what a company requests and what the staff of a public utility commission recommends is substantial. Prolonged hearings are held with great costs to both parties. Even when the Commission reaches a decision, it sometimes is appealed to the courts with additional costs and delays. The problem is that the law relating to regulation is subject to ambiguous interpretations in a number of key areas. The purpose of my address is to explore this ambiguity in some detail and to examine an alternative approach to establishing a proper rate of return on equity capital. While this examination is rooted in modern finance theory, the focus of my address is on developing a better understanding of the problem and on policy implications as opposed to extending the theory. We begin by reviewing the legal principles underlying regulation followed by an examination of the rate-making process as it is practiced. The meaning of a "just and reasonable" rate of return to the equity holder is next explored. An alternative approach to regulation and its implications will be discussed in Sections V and VI. Concluding comments appear in the last section. [ABSTRACT FROM AUTHOR]

Many firms face bidding situations in which follow-on contracts are likely, and the firm winning the initial contract is favored to win the follow-on awards. Managers are tempted to bid the initial contract low in anticipation of receiving the lucrative follow-on contract, but quantitative analysis of these situations can be difficult. A technique is presented herein where the expected present value of the margin of the follow-on contract is added to the present value of the margin of the initial contract to achieve an overall expected margin sufficient to meet the management's minimum target ROI levels. [ABSTRACT FROM AUTHOR]

This study demonstrates that the various measures of corporate risk strategic management research has used reflect different risk factors. Factor analysis of nine measures of risk yielded three factors: income stream risk, stock returns risk, and strategic risk. The factors were stable over time. Income stream and strategic risk in a given five-year period reduced firm performance in the next five years; however, the strength of the effect varied across industries and between high- and low-performance firms. Contrary to previous cross-sectional work, performance reduced subsequent income stream uncertainty for high performers and increased income stream risk for low performers. [ABSTRACT FROM AUTHOR]

Recent empirical studies have presented evidence that contradicts the presumed trade-off between changes in market share and profitability. This research attempted to resolve these inconsistent findings and to examine the conditions under which simultaneous increases in market share and profitability are found Contextual and strategic differences were identified among businesses in four dynamic performance situations. [ABSTRACT FROM AUTHOR]

Are there economics benefits to improving customer satisfaction? Many firms that are frustrated in their efforts to improve quality and customer satisfaction are beginning to question the link between customer satisfaction and economic returns. The authors investigate the nature and strength of this link. They discuss how expectations, quality, and price should affect customer satisfaction and why customer satisfaction, in turn, should affect profitability; this results in a set of hypotheses that are tested using a national customer satisfaction index and traditional accounting measures of economic returns, such as return on investment. The findings support a positive impact of quality on customer satisfaction, and, in turn, profitability. The authors demonstrates the economic benefits of increasing customer satisfaction using both an empirical forecast and a new analytical model. In addition, they discuss why increasing market share actually might lead to lower customer satisfaction and provide preliminary empirical support for this hypothesis. Finally, two new findings emerge: First, the market's expectations of the quality of a firm's output positively affects customers' overall satisfaction with the firm; and second, these expectations are largely rational, albeit with a small adaptive component. [ABSTRACT FROM AUTHOR]

The market share-ROI relationship is examined to determine the extent of the causal versus spurious association. By making use of the PIMS data base, it is found that a large proportion of the association is spurious in the sense that both market share and ROI are the joint outcome of some third factor(s). The direct impact of market share on ROI is found to be much smaller than previous studies have indicated. It is suggested that too much emphasis is placed on market share and that more attention needs to be focused on other fundamentals. [ABSTRACT FROM AUTHOR]

The article discusses security market information announcements and what impact these may have on financial market reactions. A content analysis is provided of financial information announcements that companies must make and how this effects the adjustment of the stock market. It is noted that other researchers investigating this subject will need to consider cross-sectional differences in shared value information. The article concludes that the "precision" of earnings statements may indeed effect stock pricing.

This paper provides further evidence of the holiday effect in stock returns and additional insight into the effect. This paper reports abnormally high returns on the trading day before holidays in all three of the major stock markets in the U.S.: the NYSE, AMEX, and NASDAQ. The holiday effect is also present in the U.K. and Japanese stock markets, even though each country has different holidays and institutional arrangements. This study finds that the holiday effects in the U.K. and Japanese stock markets are independent of the holiday effect in the U.S. stock market. Unlike the other seasonal patterns in stock returns, such as January and weekend effects, this investigation of size decile portfolios shows that the size effect is not present in mean returns on preholidays. [ABSTRACT FROM AUTHOR]

Recent research finds that the prior period's worst stock return performers (losers) outperform the prior period's best return performers (winners) in the subsequent period. This potential violation of the efficient markets hypothesis is labeled the "overreaction" phenomenon. This paper shows that the tendency for losers to outperform winners is not due to investor overreaction, but to the tendency for losers to be smaller-sized firms than winners. When losers are compared to winners of equal size, there is little evidence of any return discrepancy, and in periods when winners are smaller than losers, winners outperform losers. [ABSTRACT FROM AUTHOR]

This paper examines the effects of the delivery basis risk embedded in nearly all futures contracts on efficiency tests of these markets. Examining soybean futures contracts, we show that delivery basis risk has important implications for market efficiency tests. Assuming no delivery basis risk, the market efficiency hypothesis is rejected. However, futures prices contain significant time-varying expected delivery basis and time-varying expected delivery risk premiums. Once these expected delivery basis and delivery risk premiums are accounted for, the apparent inefficiency is eliminated. Equilibrium spot prices also contain significant time-varying expected delivery risk premiums. [ABSTRACT FROM AUTHOR]

This paper investigates the effect on shareholder wealth of two events that change management's choice between negotiated and competitive underwritten equity offerings. These two events are the suspension and termination of suspension of Rule 50. (This rule is based on the Public Utility Holding Company Act of 1935 and requires certain utilities to use the competitive method.) The results indicate that the shareholders of the affected utilities experience an abnormal negative return on the announcement of the suspension of Rule 50, and an abnormal positive return on the announcement of the termination of suspension. This evidence is consistent with the joint hypothesis: (i) competitive offerings are less costly than negotiated offerings, and (ii) manager-shareholder agency costs are a determinant of the corporate choice between these two methods of raising equity. [ABSTRACT FROM AUTHOR]

This paper explores the possibility that there were intra-industry impacts that resulted from the nuclear accident that occurred at the Three Mile Island Nuclear Power Plant. The authors investigate what impact this event had on the returns for privately owned electric utilities. The authors' findings suggest that an extensive web of interdepedencies exists in the pricing of equity of electric utilities. They also found that the event at Three Mile Island did lead to a substantial downward price shift among utility companies with a commitment to nuclear power.

Many consumers appear to rationally calculate the net worth of a household investment, but a substantial minority may lack the skills or alertness to perceive an investment opportunity and initiate analysis. Intentions to engage in complementary activities play an important role in the investment decision. [ABSTRACT FROM AUTHOR]

We have raised executive management's awareness, and expectations of the strategic role of information systems technology. Teams of managers are commonly involved in workshops or planning processes designed to identify such applications. Conceptual frameworks to assist in such "idea-generation" sessions are widely cited in the literature and used in practice. Less well understood is the process used to evaluate the sustainability of proposed applications. We present a framework for evaluating sustainability based on the competitor's anticipated response time, differences among competitors, and the potential of the application to preempt competitive responses. Such an analysis is proposed as an evaluation tool for intended strategic applications of information technology. [ABSTRACT FROM AUTHOR]

With the increased availability of computer services over the past few years, the number of articles seeking to evaluate and compare alternative forms of investment in human capital has shown a predictable growth. Unfortunately, a large number of such articles describe the detailed and laborious procedures used to construct net income profiles but then use these profiles to calculate measures of returns that are inappropriately applied as investment criteria. A case in point is the recent article by John J. Siegfried, which compares alternative investments in Ph.D. degrees in economics by method of financing the education and employer type, from the point of view of both society and the individual. The article describes the time-consuming and painstaking calculations performed to arrive at a measure of net benefits for each alternative but then applies inappropriate investment criteria. Before discussing the analytical problems encountered when using internal rates as investment criteria, some potential errors in the construction of net benefits should be described. Siegfried's conclusion that the labor markets for economists in education, government, and business are semiindependent is not supported by the evidence presented on internal rates of return.

The article discusses ways of measuring the benefits of corporate philanthropy. The underlying strategy for many firms is for companies to obtain a tangible return for their charitable contributions. Some businesses have developed a series of cost/benefit analyses to determine long-term returns on philanthropy efforts. The Shell Oil company has identified several social performance planning areas within its strategic management plan. The object is to be responsive to public demands in a proactive rather than a reactive way.

This article surveys the available empirical evidence assessing merger performance; its conclusions are important to the senior management of both potential acquirers and firms seeking to be acquired. The authors examine relative gains to the merging units, changes in their risk characteristics, and changes in the operating results of the merging firms. [ABSTRACT FROM AUTHOR]

It is commonly argued that some Japanese firms enjoy lower capital costs than their U.S. counterparts because of their ability to employ a high degree of debt leveraging. However, since March 1977, several of Japan's major semiconductor manufacturers have made large reductions in their debt-to-equity ratios. This article examines the motivations behind this change, places it in the context of the Japanese financial system, and explores its implications for the relative costs of capital in the United States and Japan. [ABSTRACT FROM AUTHOR]

Do mergers provide real benefits to acquiring firms? If not, as empirical studies completed mostly in the field of finance conclude, then why do firms continue to merge? If mergers do provide real benefits, as the literature of industrial organizations and strategic management suggest, then why haven't the empirical studies found any evidence of real benefits? By integrating the conclusions on mergers from the above three disciplines, these questions are addressed. [ABSTRACT FROM AUTHOR]

It is well documented that expected stock returns vary with the day-of-the-week (the Monday or weekend effect). In this article we show that the well-known Monday effect occurs primarily in the last two weeks (fourth and fifth weeks) of the month. In addition, the mean Monday return of the first three weeks of the month is not significantly different from zero. This result holds for most of the subperiods during the 1962-1993 sampling period and for various stock return indexes. The monthly effect reported by Ariel (1987) and Lakonishok and Smidt (1988) cannot fully explain this phenomenon. [ABSTRACT FROM AUTHOR]

Mutual funds represent one of the fastest growing type of financial intermediary in the American economy. The question remains as to why mutual funds and in particular actively managed mutual funds have grown so fast, when their performance on average has been inferior to that of index funds. One possible explanation of why investors buy actively managed open end funds lies in the fact that they are bought and sold at net asset value, and thus management ability may not be priced. If management ability exists and it is not included in the price of open end funds, then performance should be predictable. If performance is predictable and at least some investors are aware of this, then cash flows into and out of funds should be predictable by the very same metrics that predict performance. Finally, if predictors exist and at least some investors act on these predictors in investing in mutual funds, the return on new cash flows should be better than the average return for all investors in these funds. This article presents empirical evidence on all of these issues and shows that investors in actively managed mutual funds may have been more rational than we have assumed. [ABSTRACT FROM AUTHOR]

We study whether the behavior of stock prices, in relation to size and book-to-market-equity (BE/ME), reflects the behavior of earnings. Consistent with rational pricing, high BE/ME signals persistent poor earnings and low BE/ME signals strong earnings. Moreover, stock prices forecast the reversion of earnings growth observed after firms are ranked on size and BE/ME. Finally, there are market, size, and BE/ME factors in earnings like those in returns. The market and size factors in earnings help explain those in returns, but we find no link between BE/ME factors in earnings and returns. [ABSTRACT FROM AUTHOR]

The predictability of an asset's returns will affect the prices of options on that asset, even though predictability is typically induced by the drift, which does not enter the option pricing formula. For discretely-sampled data, predictability is linked to the parameters that do enter the option pricing formula. We construct an adjustment for predictability to the Black-Scholes formula and show that this adjustment can be important even for small levels of predictability, especially for longer maturity options. We propose several continuous-time linear diffusion processes that can capture broader forms of predictability, and provide numerical examples that illustrate their importance for pricing options. [ABSTRACT FROM AUTHOR]

Consistent with previous research, we fail to find a significant correlation between the abnormal returns of our sample firms with international activities and changes in the dollar. We investigate the possibility that this failure is due to mispricing. Lagged changes in the dollar are a significant variable in explaining current abnormal returns of our sample firms, suggesting that mispricing does occur. A simple trading strategy based upon these results generates significant abnormal returns. Corroborating evidence from returns around earnings announcements as well as errors in analysts' forecasts of earnings is also provided. [ABSTRACT FROM AUTHOR]

In this paper, we find significantly higher preholiday returns in futures contracts compared to nonholiday returns. The findings are consistent with the inventory adjustment hypothesis, since higher preholiday returns associated with lower trading volume are most pronounced for exchange-closed holidays. There is evidence of positive postholiday returns associated with higher trading volume for exchange-open holidays. This is consistent with positive holiday sentiments. The holiday effect is uniquely independent: The magnitude of excess holiday returns is the largest among all seasonal variations. [ABSTRACT FROM AUTHOR]

The underpricing of initial public offerings (IPOs) that has been widely documented appears to be a short-run phenomenon. Issuing firms during 1975-84 substantially underperformed a sample of matching firms from the closing price on the first day of public trading to their three-year anniversaries. There is substantial variation in the underperformance year-to-year and across industries, with companies that went public in high-volume years faring the worst. The patterns are consistent with an IPO market in which (1) investors are periodically overoptimistic about the earnings potential of young growth companies, and (2) firms take advantage of these "windows of opportunity." [ABSTRACT FROM AUTHOR]