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Our article contains three critical elements. First, by way of motivation, we consider active optimal mean-variance portfolios within the confines of a three-risky-asset model (based on common equity, corporate bonds, and long-dated Treasury securities) and a short-term, riskless security. Within that context, our article models and numerically demonstrates the impact of the magnitude and sign of the interest-rate term premium in optimal asset allocation. Then, based on interest-rate survey data, we demonstrate the occurrence of a negative term premium in the Treasury market, and proceed to permit such an occurrence within a model whereby asset returns covary with a market portfolio. Finally, turning to empirics, we document the relationship between the sign of the term premium and the sign of the covariance between Treasury and equity returns. Recognizing the deficiency in using historical data as inputs to active optimal mean-variance portfolios, we seek to obtain forward-looking inputs to render our model prospective (rather than merely retrospective): we design and implement tests for obtaining forward-looking measures of covariation. [ABSTRACT FROM AUTHOR]

The authors document and rationalize the premium paid by bond issuers in the corporate bond markets. Changes in the bond market over the past 30 years have shifted the new-issue pricing risk from investors to banks and back to investors, with large institutional investors acting as a de facto adjunct underwriting group, and this process has required both capital commitment as well as a commitment to taking on unsystematic risk for which investors require compensation. The authors use the superior data prevalent in trades under the TRACE system to compute the new-issue premium (NIP) and relate the magnitude of that premium to predetermined economic variables: the level of the corporate bond spread; the future volatility of swap spreads; the prevailing value of unsystematic risk in the bond markets; the spread of the issuer to the Treasury market at time of issuance; and the tenor of the new bond issue. They then present a model for the required NIP based on compensation for information uncertainty and the bearing of unsystematic risk. In so doing, they also address the issues of oligopolistic pricing and wealth transfer that occur at time of issuance. [ABSTRACT FROM AUTHOR]