This paper introduces an ARCH model (exponential ARCH) that (1) allows correlation between returns and volatility innovations (an important feature of stock market volatility changes), (2) eliminates the need for inequality constraints on parameters, and (3) allows for a straightforward interpretation of the "persistence" of shocks to volatility. In the above respects, it is an improvement over the widely-used GARCH model. The model is applied to study volatility changes and the risk premium on the CRSP Value-Weighted Market Index from 1962 to 1987. Copyright 1991 by The Econometric Society.

Conditional heteroskedasticity in asset returns: a new approach

We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as important in determining the cross- section of capital structure in the U.S. affect firm leverage in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.

What Do We Know About Capital Structure? Some Evidence from International Data

We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as correlated in the cross-section with firm leverage in the United States, are similarly correlated in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.

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What Do We Know about Capital Structure? Some Evidence from International Data

This paper surveys capital structure theories based on agency costs, asymmetric information, product/input market interactions, and corporate control considerations (but excluding tax-based theories). For each type of model, a brief overview of the papers surveyed and their relation to each other is provided. The central papers are described in some detail, and their results are summarized and followed by a discussion of related extensions. Each section concludes with a summary of the main implications of the models surveyed in the section. Finally, these results are collected and compared to the available evidence. Suggestions for future research are provided.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1991.tb03753.x

The Theory of Capital Structure

Offering a unifying theoretical perspective not readily available in any other text, this innovative guide to econometrics uses simple geometrical arguments to develop students' intuitive understanding of basic and advanced topics, emphasizing throughout the practical applications of modern theory and nonlinear techniques of estimation. One theme of the text is the use of artificial regressions for estimation, reference, and specification testing of nonlinear models, including diagnostic tests for parameter constancy, serial correlation, heteroscedasticity, and other types of mis-specification. Explaining how estimates can be obtained and tests can be carried out, the authors go beyond a mere algebraic description to one that can be easily translated into the commands of a standard econometric software package. Covering an unprecedented range of problems with a consistent emphasis on those that arise in applied work, this accessible and coherent guide to the most vital topics in econometrics today is indispensable for advanced students of econometrics and students of statistics interested in regression and related topics. It will also suit practising econometricians who want to update their skills. Flexibly designed to accommodate a variety of course levels, it offers both complete coverage of the basic material and separate chapters on areas of specialized interest.

Estimation and Inference in Econometrics

This paper studies the optimal timing of investment in an irreversible project where the benefits from the project and the investment cost follow continuous-time stochastic processes. The optimal investment rule and an explicit formula for the value of the option to invest are derived, assuming that the option is valued by risk-averse investors who are well diversified. The same analysis is applied to the scrapping decision. Simulations show that this option value can be significant, and that for reasonable parameter values it is optimal to wait until benefits are twice the investment costs.

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The Value of Waiting to Invest

This paper studies the optimal timing of investment in an irreversible project where the benefits from the project and the investment cost follow continuous-time stochastic processes The optimal time to invest and an explicit formula for the value of the option to invest are derived The rule "invest if benefits exceed costs" does not properly account for the option value of waitingSimulations show that this option value can be significant, and that for surprisingly reasonable parameter values it may be optimal to wait until benefits are twice the investment cost Finally, we perform comparative static analysis on the valuation formula and on the rule for when to invest

An important lesson from elementary microeconomics is that a plant should be shut down if operating revenues are less than variable costs. This simple production rule has implications -which have received little attentionfor the initial decision to build the plant.2 This paper develops and studies a methodology for valuing risky investment projects, where there is an option to temporarily and costlessly shut down production (with no effect on future prices and costs) whenever variable costs exceed operating revenues. It is obvious that future revenues or costs must be uncertain if the shut-down option is to affect the investment decision otherwise, it is always known ex ante whether the plant is to be operated. Uncertainty is introduced in this paper by supposing that prices and costs follow a continuous time stochastic process.3 The firm in our model is a risk-neutral, price-taking value maximizer, which is owned by risk-averse investors. Risk aversion thus influences the investment decision by affecting the cost of capital faced by the firm. This is in contrast to the model in Sandmo [1971], in which the firm maximizes the utility of profits.4 Our treatment is descriptive of value-maximizing, publicly-owned firms and is widely used in the finance literature. The economics literature studying the effect of uncertainty on firm behavior has, however, tended to follow Sandhmo. The explicit modelling of the shut-down option and our treatment of risk aversion give us results that differ from those obtained by others who have studied the valuation of risky projects. Our principal results are: 1) Increases in the variance of the output price can either raise or lower the

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Investment and the Valuation of Firms When There is an Option to Shut Down

This paper presents an information-theoretic, infinite horizon model of the equity issue decision. The model predicts that (a) equity issues on average are preceded by an abnormal positive return on the stock, although for some firms the issue is preceded by a loss; (b) equity issues on average are preceded by an abnormal rise in the market; and (c) the stock price drops at the announcement of an issue. The model provides a measure of the welfare cost of asymmetric information; the welfare loss may be small even if the price drop at issue announcement is large. THE ADVERSE SELECTION PROBLEM when firms issue new securities has been the focus of much recent work in corporate finance. Seasoned equity issues have received particular attention, in part because there are striking stock price patterns around the time of equity issues and considerable variation over time in the number of issues. In this paper we present a dynamic, infinite horizon model of the firm's equity issue decision under adverse selection. The model can simultaneously account for each of the following empirical observations about equity issues:' * Stock prices of issuing firms on average exhibit a large and extended positive

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Equity Issues and Stock Price Dynamics

This paper presents an information-theoretic, infinite horizon model of the equity issue decision. The model's predictions about stock price behavior and issue timing explain most of the stylized facts in the empirical literature: (a) equity issues on average are preceded by an abnormal positive return on the stock, although there is considerable variation across firms, (b) equity issues on average are preceded by an abnormal rise in the market, and (c) the stock price drops significantly at the announcement of an issue. In this model, the price drop at issue announcement is uncorrelated with the social cost of suboptimal investment due to asymmetric information; the welfare loss may be small even if the price drop is large.

Robert L. McDonald

Papers

The Value of Waiting to Invest

The Value of Waiting to Invest

Investment and the Valuation of Firms When There is an Option to Shut Down

Equity Issues and Stock Price Dynamics

Equity Issues and Stock Price Dynamics