Showing papers in "Journal of Finance in 1992"
TL;DR: In this paper, Bhandari et al. found that the relationship between market/3 and average return is flat, even when 3 is the only explanatory variable, and when the tests allow for variation in 3 that is unrelated to size.
Abstract: Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market 3, size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in 3 that is unrelated to size, the relation between market /3 and average return is flat, even when 3 is the only explanatory variable. THE ASSET-PRICING MODEL OF Sharpe (1964), Lintner (1965), and Black (1972) has long shaped the way academics and practitioners think about average returns and risk. The central prediction of the model is that the market portfolio of invested wealth is mean-variance efficient in the sense of Markowitz (1959). The efficiency of the market portfolio implies that (a) expected returns on securities are a positive linear function of their market O3s (the slope in the regression of a security's return on the market's return), and (b) market O3s suffice to describe the cross-section of expected returns. There are several empirical contradictions of the Sharpe-Lintner-Black (SLB) model. The most prominent is the size effect of Banz (1981). He finds that market equity, ME (a stock's price times shares outstanding), adds to the explanation of the cross-section of average returns provided by market Os. Average returns on small (low ME) stocks are too high given their f estimates, and average returns on large stocks are too low. Another contradiction of the SLB model is the positive relation between leverage and average return documented by Bhandari (1988). It is plausible that leverage is associated with risk and expected return, but in the SLB model, leverage risk should be captured by market S. Bhandari finds, howev er, that leverage helps explain the cross-section of average stock returns in tests that include size (ME) as well as A. Stattman (1980) and Rosenberg, Reid, and Lanstein (1985) find that average returns on U.S. stocks are positively related to the ratio of a firm's book value of common equity, BE, to its market value, ME. Chan, Hamao, and Lakonishok (1991) find that book-to-market equity, BE/ME, also has a strong role in explaining the cross-section of average returns on Japanese stocks.
14,517 citations
TL;DR: This article analyzed how mutual fund performance relates to past performance and found evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns.
Abstract: This paper analyzes how mutual fund performance relates to past performance. These tests are based on a multiple portfolio benchmark that was formed on the basis of securities characteristics. We find evidence that differences in performance between funds persist over time and that this persistence is consistent with the ability of fund managers to earn abnormal returns.
5,677 citations
TL;DR: In this paper, the authors argue that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun.
Abstract: While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks. ACCORDING TO RECEIVED THEORY, banks reduce the agency costs associated with lending to small and medium growth firms in various ways.' Yet in practice, many such firms diversify away from bank financing even if banks are willing to lend more.2 Why do these firms forsake informed and seemingly more efficient sources of debt finance to borrow from less informed arm's-length sources? While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decision which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's choice of borrowing sources and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.
3,864 citations
TL;DR: In this paper, the authors explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets and use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle.
Abstract: We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. WVhen a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s. How DO FIRMS CHOOSE debt levels, and why do firms or even whole industries sometimes change how much debt they have? Why, for example, have American firms increased their leverage in the 1980s (Bernanke and Campbell (1988), Warshawsky (1990)), and why has this debt increase been the greatest in some industries, such as food and timber? Despite substantial progress in research on leverage, these questions remain largely open. In this paper, we explore an approach to debt capacity based on the cost of asset sales. We argue that the focus on asset sales and liquidations helps clarify the crosssectional determinants of leverage, as well as why debt increased in the 1980s. Williamson (1988) stresses the link between debt capacity and the liquidation value of assets. He argues that assets which are redeployable-have alternative uses-also have high liquidation values. For example, commercial land can be used for many different purposes. Such assets are good candidates for debt finance because, if they are managed improperly, the manager will be unable to pay the debt, and then creditors will take the assets away from him and redeploy them. Williamson thus identifies one important determinant of liquidation value and debt capacity, namely, asset redeploya
2,821 citations
TL;DR: In this article, the authors used the Dow Jones Index from 1897 to 1986 to test two of the simplest and most popular trading rules (moving average and trading range break) by utilizing the bootstrap techniques.
Abstract: This paper tests two of the simplest and most popular trading rules—moving average and trading range break—by utilizing the Dow Jones Index from 1897 to 1986. Standard statistical analysis is extended through the use of bootstrap techniques. Overall, our results provide strong support for the technical strategies. The returns obtained from these strategies are not consistent with four popular null models: the random walk, the AR(1), the GARCH-M, and the Exponential GARCH. Buy signals consistently generate higher returns than sell signals, and further, the returns following buy signals are less volatile than returns following sell signals, and further, the returns following buy signals are less volatile than returns following sell signals. Moreover, returns following sell signals are negative, which is not easily explained by any of the currently existing equilibrium models.
2,236 citations
TL;DR: In this article, the authors compare a variety of continuous-time models of the short-term riskless rate using the Generalized Method of Moments and find that the most successful models are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rates.
Abstract: We estimate and compare a variety of continuous-time models of the short-term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short-term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well-known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.
1,853 citations
TL;DR: In this article, the authors present evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time.
Abstract: This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. I test this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained groups, but is rejected for the others. Do IMPERFECTIONS IN THE financial system play a role in economic fluctuations? Recent research in empirical macroeconomics has directed this question to the area of investment, asking in particular whether firms with free access to capital markets have different investment behavior from those who do not. Emphasis on this question has resulted in part from the theoretical predictions of a recent surge of work in the economics of imperfect information that has explored how violations of the Modigliani-Miller theorem ascribe a role for finanical factors in the investment process. In addition, interest in the question has been spurred by the poor empirical performance of standard optimizing models of investment. For example, tests of the q-theory of investment have found little explanatory power for q, have implied implausibly slow capital stock adjustment speeds, and have been outperformed by simple ad hoc accelerator models.1 One specific hypothesis has been at the center of recent attempts to explore the connection between finance and investment. If a firm has difficulty obtaining outside finance, its investment should display excess sensitivity to the availability of internal funds.2 Moreover, differences in this sensitivity
1,771 citations
TL;DR: In this paper, the authors show that time affects prices, with the time between trades affecting spreads, and that the absence of trades is correlated with volume, and demonstrates how volume affects the speed of price adjustment.
Abstract: This paper delineates the link between the existence of information, the timing of trades, and the stochastic process of prices. We show that time affects prices, with the time between trades affecting spreads. Because the absence of trades is correlated with volume, our model predicts a testable relation between spreads and normal and unexpected volume, and demonstrates how volume affects the speed of price adjustment. Our model also demonstrates how the transaction price series will be a biased representation of the true price process, with the variance being both overstated and heteroskedastic. FEW TOPICS IN FINANCE are of broader interest than the time series properties of security prices. Fundamental to research on such diverse topics as security returns, market efficiency, investor trading strategies, option behavior, and security market design, the stochastic process of prices underlies much of the phenomena studied in financial economics. But how the stochastic process of prices behaves, or even what factors determine the movement between one security price and the next remains unclear. These theoretical questions have spurred extensive research on security price formation, much of it in the large, and growing area of security market microstructure. The microstructure literature investigates how prices evolve by analyzing how traders learn from market data. This focus allows researchers to characterize the time series properties of prices as a function of the information trades reveal to the market. In the standard microstructure models, however, time per se plays no role. In the Kyle (1985) framework, for example, all trades are batched so that wheni individual orders arrive is not relevant (or even known) to the market maker. Similarly, in the Glosten and Milgrom (1985) sequential trade model, orders are assumed to arrive in some probabilistic fashion which is independent of any time parameters. In these models, the timing of trades is irrelevant for the behavior of prices because time itself has no information content.
1,327 citations
TL;DR: In this article, the authors consider a scenario in which an issuer is selling a new security of uncertain value, for example, an initial public offering (IPO) of stock or high-yield debt, through an underwriter.
Abstract: When IPO shares are sold sequentially, later potential investors can learn from the purchasing decisions of earlier investors. This can lead rapidly to "cascades" in which subsequent investors optimally ignore their private information and imitate earlier investors. Although rationing in this situation gives rise to a winner's curse, it is irrelevant. The model predicts that: (1) Offerings succeed or fail rapidly. (2) Demand can be so elastic that even risk-neutral issuers underprice to completely avoid failure. (3) Issuers with good inside information can price their shares so high that they sometimes fail. (4) An underwriter may want to reduce the communication among investors by spreading the selling effort over a more segmented market. CONSIDER A SCENARIO IN which an issuer is selling a new security of uncertain value, for example, an IPO (initial public offering) of stock or high-yield debt, through an underwriter. The S.E.C. has banned variable -price sales. While the value of this new security is highly uncertain to individual market participants, investors hold perfectly accurate information when aggregated. Moreover, there are many (potential) investors, and a small number of these investors can jointly determine the value of the firm (or its project) with high precision. It would seem that in this scenario underpriced offerings would succeed and overpriced offerings would fail. Nevertheless, this paper shows that, if the distribution channels of invest ment banks are limited, underpriced offerings can fail and overpriced offer ings can succeed. With limited distribution channels, it takes the under writer 'time to approach interested investors. Therefore, later investors can observe how well an offering has sold to date -- or at least how successful it has sold relative to offerings previously undertaken by this underwriter.
1,294 citations
TL;DR: In this paper, the authors used a nearly exhaustive sample of mergers between NYSE acquirers and NYSE/AMEX targets and found that stockholders of acquiring firms suffer a statistically significant loss of about 10% over the five-year post-merger period, a result robust to various specifications.
Abstract: The existing literature on the post-merger performance of acquiring firms is divided We re-examine this issue, using a nearly exhaustive sample of mergers between NYSE acquirers and NYSE/AMEX targets We find that stockholders of acquiring firms suffer a statistically significant loss of about 10% over the five-year post-merger period, a result robust to various specifications Our evidence suggests that neither the firm size effect nor beta estimation problems are the cause of the negative post-merger returns We examine whether this result is caused by a slow adjustment of the market to the merger event Our results do not seem consistent with this hypothesis MERGERS ARE ONE OF the most researched areas in finance, yet some basic issues still remain unresolved While most empirical research on mergers focuses on daily stock returns surrounding announcement dates, a few studies also look, in passing, at the long-run performance of acquiring firms after mergers Some conclude that these firms experience significantly negative abnormal returns over one to three years after the merger (for example, Langetieg (1978), Asquith (1983), and Magenheim and Mueller (1988)) These findings led Jensen and Ruback (1983, p '20) to remark: "These post-outcome negative abnormal returns are unsettling because they are inconsistent with market efficiency and suggest that changes in stock prices during takeovers overestimate the future efficiency gains from mergers" Ruback (1988, p 262) later writes: "Reluctantly, I think we have to accept this result-significant negative returns over the two years following a merger-as a fact" However, a conclusion of underperformance is not clearly warranted based on prior research First, the results are not all one-sided Langetieg (1978) finds that post-merger abnormal performance is not significantly different
1,270 citations
TL;DR: The authors show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know, and there can be multiple herding equilibria, and speculators may even choose to study information that is completely unrelated to fundamentals.
Abstract: Standard models of informed speculation suggest that traders try to learn information that others do not have. This result implicitly relies on the assumption that speculators have long horizons, i.e., can hold the asset forever. By contrast, we show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know. There can be multiple herding equilibria, and herding speculators may even choose to study information that is completely unrelated to fundamentals.
TL;DR: In this paper, the authors examined daily excess bond returns associated with announcements of additions to Standard and Poor's Credit Watch List, and to rating changes by Moody's and S&P.
Abstract: This paper examines daily excess bond returns associated with announcements of additions to Standard and Poor's Credit Watch List, and to rating changes by Moody's and Standard and Poor's. Reliably nonzero average excess bond returns are observed for additions to Standard and Poor's Credit Watch List when an expectations model is used to classify additions as either expected or unexpected. Bond price effects are also observed for actual downgrade and upgrade announcements by rating agencies. Excluding announcements with concurrent disclosures weakens the results for downgrades, but not upgrades. The stock price effects of rating agency announcements are also examined and contrasted with the bond price effects. THIS PAPER EXAMINES DAILY excess bond and stock returns associated with two
TL;DR: The authors found that members of the Institutional Investor All-American Research Team supply more accurate earnings forecasts than other analysts when forecasts are matched by the corporation followed and by the date of brokerage house issuance.
Abstract: Members of the Institutional Investor All-American Research Team supply more accurate earnings forecasts than other analysts when forecasts are matched by the corporation followed and by the date of brokerage house issuance. This contemporaneous advantage is complemented by a timing advantage; All-Americans supply forecasts more often than other analysts. Stocks returns immediately following large upward forecast revisions suggest that All-Americans impact prices more than other analysts. However, there is virtually no difference in returns following large downward revisions. Nevertheless, the collective results suggest a positive relation between reputation and performance, and, assuming that All-Americans are better paid, pay and performance.
TL;DR: Schwartz et al. as discussed by the authors examined the behavior of time-weighted bid-ask spreads over the trading day and found that spreads are higher at the beginning and end of the day relative to the interior period.
Abstract: The behavior of time-weighted bid-ask spreads over the trading day are examined. The plot of minute-by-minute spreads versus time of day has a crude reverse J-shaped pattern. Schwartz identifies four determinants of spreads: activity, risk, information, and competition. Using a linear regression model, a significant relationship between these same factors and intraday spreads is demonstrated, but dummy variables for time of day have a reverse J-shape. For given values of the activity, risk, information and competition measures, spreads are higher at the beginning and end of the day relative to the interior period. THIS STUDY HAS A dual focus. First, it extends prior work by examining whether variables previously found to be determinants of spreads using data for intervals of a day or longer also explain spreads during the trading day. Second, the paper furthers previous research concerning intraday patterns in returns, variability, and volume by examining intraday patterns of spreads. Schwartz (1988, pp. 419-420) identifies four classes of variables as determinants of bid-ask spreads: activity, risk, information, and competition. Each of these determinants is considered briefly. Greater trading activity can lead to lower spreads due to economies of scale in trading costs. Using trading cost arguments, previous researchers show that a number of activity variables are significant determinants of bid-ask spreads including: (1) the average number of shares traded (Tinic, 1972), (2) the volume (Tinic and West (1972), Branch and Freed (1977), Stoll (1978)), and (3) the number of transactions (Benston and Hagerman, 1974). Copeland and Galai (1983) model the bid-ask spread as a free straddle option provided by the market maker and show that the bid-ask spread is inversely related to the frequency of trading. Copeland and Galai (1983) note that since less frequent trading usually means lower trading volume, the bid-ask spread is likely to be inversely related to measures of market activity. Inventory control models (Garman (1976), and Ho and Stoll (1980, 1981, 1983)) show that uncertainty in the arrival of buy and sell orders forces dealers away from their optimal inventory position. In the model of Amihud and Mendelson (1980), as the marker-maker approaches the desired inventory position the bid-ask spread is reduced. Hence, if greater
TL;DR: In this paper, the authors developed a two-factor general equilibrium model of the term structure of interest rates and derived closed-form expressions for discount bonds and analyzed the properties of the terms implied by the model.
Abstract: We develop a two-factor general equilibrium model of the term structure. The factors are the short-term interest rate and the volatility of the short-term interest rate. We derive closed-form expressions for discount bonds and study the properties of the term structure implied by the model. The dependence of yields on volatility allows the model to capture many observed properties of the term structure. We also derive closed-form expressions for discount bond options. We use Hansen's generalized method of moments framework to test the cross-sectional restrictions imposed by the model. The tests support the two-factor model. THERE ARE ESSENTIALLY TWO approaches to the modeling of the term structure of interest rates in continuous time. The equilibrium approach pioneered by
TL;DR: In this article, the authors examined whether security analysts underreact or overreact to prior earnings information, and whether any such behavior could explain previously documented anomalous stock price movements, and they concluded that security analysts' behavior is at best only a partial explanation for stock price underreaction to earnings, and may be unrelated to stock price overreactions.
Abstract: This study examines whether security analysts underreact or overreact to prior earnings information, and whether any such behavior could explain previously documented anomalous stock price movements. We present evidence that analysts' forecasts underreact to recent earnings. This feature of the forecasts is consistent with certain properties of the naive seasonal random walk forecast that Bernard and Thomas (1990) hypothesize underlie the well-known anomalous post-earnings-announcement drift. However, the underreactions in analysts' forecasts are at most only about half as large as necessary to explain the magnitude of the drift. We also document that the “extreme” analysts' forecasts studied by DeBondt and Thaler (1990) cannot be viewed as overreactions to earnings, and are not clearly linked to the stock price overreactions discussed in DeBondt and Thaler (1985, 1987) and Chopra, Lakonishok, and Ritter (Forthcoming). We conclude that security analysts' behavior is at best only a partial explanation for stock price underreaction to earnings, and may be unrelated to stock price overreactions.
TL;DR: In this paper, a sample of large acquisitions completed between 1971 and 1982 is studied and the authors characterize the ex post success of the divested acquisitions and consider 34% to 50% of classified divestitures as unsuccessful.
Abstract: This paper studies a sample of large acquisitions completed between 1971 and 1982. By the end of 1989, acquirers have divested almost 44% of the target companies. We characterize the ex post success of the divested acquisitions and consider 34% to 50% of classified divestitures as unsuccessful. Acquirer returns and total (acquirer and target) returns at the acquisition announcement are significantly lower for unsuccessful divestitures than for successful divestitures and acquisitions not divested. Although diversifying acquisitions are almost four times more likely to be divested than related acquisitions, we do not find strong evidence that diversifying acquisitions are less successful than related ones.
TL;DR: In this paper, the authors develop a multi-period auction model in which multiple privately informed agents strategically exploit their long-lived information and show that such traders compete aggressively and cause most of their common private information to be revealed very rapidly.
Abstract: We develop a multi-period auction model in which multiple privately informed agents strategically exploit their long-lived information. We show that such traders compete aggressively and cause most of their common private information to be revealed very rapidly. In the limit as the interval between auctions approaches zero, market depth becomes infinite and all private information is revealed immediately. These results are in contrast to those of Kyle (1985) in which the monopolistic informed trader causes his information to be incorporated into prices gradually, and, when the interval between auctions is vanishingly small, market depth is constant over time. FAMA (1970) DEFINES A "STRONG form" efficient market as one in which security prices fully reflect all available information, including both publicly and privately held information. In a pioneering and influential article, Kyle (1985) develops a model in which a single privately informed trader with long-lived information optimally exploits his monopoly power over time. Kyle's (1985) main results are: (i) the informed trader trades in a gradual manner, so that his information is incorporated into prices at a slow, almost linear rate, and (ii) when auctions are held continuously, the depth of the market is constant over time. However, Kyle's (1985) assumption of a single informed trader is strong, in the sense that in actual financial markets, it is reasonable to expect that at least a few players will have access to private information and will trade in the knowledge that they will face competition with other informed agents in the market. 1 We develop a multi-period auction model in which multiple (strategic) informed traders optimally exploit their long-lived informational advantage. We thus explore the restrictiveness of Kyle's assumption of a single informed trader, and also examine
TL;DR: This article found that the stock market detects the possibility of informed trading and impounds this information into the stock price, and almost half of the pre-announcement stock price run-up observed before takeovers occurs on insider trading days.
Abstract: Whether insider trading affects stock prices is central to both the current debate over whether insider trading is harmful or pervasive, and to the broader public policy issue of how best to regulate securities markets. Using previously unexplored data on illegal insider trading from the Securities and Exchange Commission, this paper finds that the stock market detects the possibility of informed trading and impounds this information into the stock price. Specifically, the abnormal return on an insider trading day averages 3%, and almost half of the pre-announcement stock price run-up observed before takeovers occurs on insider trading days. Both the amount traded by the insider and additional trade-specific characteristics lead to the market's recognition of the informed trading.
TL;DR: In this paper, the authors compared stock price indices across countries in an attempt to explain why they exhibit such disparate behavior, and empirically documented three separate explanatory influences are empirically validated.
Abstract: Stock Price Indices are compared across countries in an attempt to explain why they exhibit such disparate behavior. Three separate explanatory influences are empirically documented. First, part of the behavior can be attributed to a technical aspect of index construction; some indices are more diversified than others. Second, each country's industrial structure plays a major role in explaining stock price behavior. Third, for the majority of countries, a portion of national equity index behavior can be ascribed to exchange rate behavior. Exchange rates explain a significant portion of common currency denominated national index returns, although the amount explained by exchange rates is less than the amount explained by industrial structure for most countries.
TL;DR: In this article, the authors develop and test hypotheses that explain the choice of accounts receivable management policies, focusing on both cross-sectional explanations of policy-choice determinants, as well as incentives to establish captives.
Abstract: This paper develops and tests hypotheses that explain the choice of accounts receivable management policies. The tests focus on both cross-sectional explanations of policy-choice determinants, as well as incentives to establish captives. We find size, concentration, and credit standing of the firm's traded debt and commercial paper are each important in explaining the use of factoring, accounts receivable secured debt, captive finance subsidiaries, and general corporate credit. We also offer evidence that captive formation allows more flexible financial contracting. However, we find no evidence that captive formation expropriates bondholder wealth. FIRMS TYPICALLY SELL MERCHANDISE on credit rather than requiring immediate cash payment. Such credit sales generate accounts receivable. Although credit terms and credit-collection procedures have been studied (see Smith (1980)), there has been little systematic analysis of the organizational and financial structures employed to manage the firm's accounts receivable. These decisions merit more careful attention for two reasons. First, receivables are a substantial fraction of corporate assets; for example, 1986 COMPUSTAT data indicate that accounts receivable are 21.0% of U.S. manufacturing corporations' total assets. Second, we observe substantial diversity in firms' use of specialized contracts and intermediaries in their accounts receivable management policies. Firms can (1) establish a captive finance subsidiary, (2) issue accounts receivable secured debt, (3) factor, (4) employ a credit-reporting firm, (5) retain a credit-collection agency, or (6) purchase a credit-insurance policy.1 In this paper, we demonstrate that accounts receivable management policy offers opportunities for both the development of a robust theory, as well as empirical testing of the theory's implications. Although the data necessary to
TL;DR: In this article, the authors analyzed price formation under two trading mechanisms: a continuous quote-driven system where dealers post prices before order submission and an order driven system where traders submit orders before prices are determined.
Abstract: This paper analyzes price formation under two trading mechanisms: a continuous quote-driven system where dealers post prices before order submission and an order-driven system where traders submit orders before prices are determined. The order-driven system operates either as a continuous auction, with immediate order execution, or as a periodic auction, where orders are stored for simultaneous execution. With free entry into market making, the continuous systems are equivalent. While a periodic auction offers greater price efficiency and can function where continuous mechanisms fail, traders must sacrifice continuity and bear higher information costs.
TL;DR: The authors investigated causal relations and dynamic interactions among asset returns, real activity, and inflation in the postwar United States using a multivariate vector-autoregression (VAR) approach and found that stock returns appear Granger-causally prior and help explain real activity.
Abstract: Using a multivariate vector-autoregression (VAR) approach, this paper investigates causal relations and dynamic interactions among asset returns, real activity, and inflation in the postwar United States. Major findings are (1) stock returns appear Granger-causally prior and help explain real activity, (2) with interest rates in the VAR, stock returns explain little variation in inflation, although interest rates explain a substantial fraction of the variation in inflation, and (3) inflation explains little variation in real activity. These findings seem more compatible with Fama (1981) than with Geske and Roll (1983) or with Ram and Spencer (1983).
TL;DR: In this paper, the authors examine the structure of corporate ownership in a sample of Japanese firms in the mid 1980s and find that ownership concentration in independent Japanese firms is positively related to the returns from exerting greater control over management.
Abstract: I examine the structure of corporate ownership in a sample of Japanese firms in the mid 1980s. Ownership is highly concentrated in Japan, with financial institutions by far the most important large shareholders. Ownership concentration in independent Japanese firms is positively related to the returns from exerting greater control over management. This is not the case in firms that are members of corporate groups (keiretsu). Ownership concentration and the accounting profit rate in both independent and keiretsu firms are unrelated. The results are consistent with the notion that there exist two distinct corporate governance systems in Japan one among independent firms and the other among firms that are members of keiretsu. WHO ARE THE LARGE shareholders of Japanese firms and how much of the firm do they own? How important are financial institutions, nonfinancial corporations, and individuals as large shareholders? How concentrated is corporate ownership in Japan and how does it compare with corporate ownership in the U.S.? Do large shareholders in Japan respond to incentives for corporate control in the same way that they appear to in U.S. firms? Does the structure of ownership and the behavior of large shareholders differ between firms in keiretsu groups and those that are independent of such groups? Does the ownership structure of a Japanese firm have any bearing on its profitability? This paper attempts to answer these questions by analyzing the ownership structure of a sample of large Japanese firms in the mid 1980s. Many of these questions were addressed by Demsetz and Lehn (1985) and Morck, Shleifer, and Vishny (1988) for U.S. firms, and this paper borrows from both works in terms of methodology. The interest in addressing these questions for Japan stems from three factors. First, Japan differs from the U.S. because the legal and regulatory environment of Japanese financial institutions permits them to be what Jensen (1989) has termed "active investors" to a much greater extent in corporations. Institutional investors in
TL;DR: In this paper, the authors used the predictability of monthly excess returns on U.S. and Japanese equity portfolios over the period 1971-1990 to study the integration of long-term capital markets in these two countries.
Abstract: This paper uses the predictability of monthly excess returns on U.S. and Japanese equity portfolios over the U.S. Treasury bill rate to study the integration of long-term capital markets in these two countries. During the period 1971-1990 similar variables, including the dividend-price ratio and interest rate variables, help to forecast excess returns in each country. In addition, in the 1980's U.S. variables help to forecast excess Japanese stock returns. There is some evidence of common movement in expected excess returns across the two countries, which is suggestive of integration of long-term capital markets. IF CAPITAL MARKETS ARE integrated, then financial assets traded in different markets, but with identical risk characteristics, will have identical expected returns. Alternatively, in segmented capital markets, barriers to arbitrage may allow assets traded in different markets to have different expected returns even when their risk characteristics are the same. This study explores the extent to which U.S. and Japanese stock markets can be described
TL;DR: The authors examine whether greater futures-trading activity (volume and open interest) is associated with greater equity volatility and find no evidence of a relation between the futures life cycle and spot equity volatility.
Abstract: We examine whether greater futures-trading activity (volume and open interest) is associated with greater equity volatility. We partition each trading activity series into expected and unexpected components, and document that while equity volatility covaries positively with unexpected futures-trading volume, it is negatively related to forecastable futures-trading activity. Further, though futures-trading activity is systematically related to the futures contract life cycle, we find no evidence of a relation between the futures life cycle and spot equity volatility. These findings are consistent with theories predicting that active futures markets enhance the liquidity and depth of the equity markets.
TL;DR: In this paper, option replication is discussed in a discrete-time framework with transaction costs, and a simple Black-Scholes type approximation for the option prices is derived for plausible parameter values.
Abstract: Option replication is discussed in a discrete-time framework with transaction costs The model represents an extension of the Cox-Ross-Rubinstein binomial option pricing model to cover the case of proportional transaction costs The method proceeds by constructing the appropriate replicating portfolio at each trading interval Numerical values of these prices are presented for a range of parameter values The paper derives a simple Black-Scholes type approximation for the option prices with transaction costs and demonstrates numerically that it is quite accurate for plausible parameter values
TL;DR: In this article, the authors characterize the predictable components in excess rates of returns on major equity and foreign exchange markets using lagged excess returns, dividend yields, and forward premiums as instruments.
Abstract: The paper first characterizes the predictable components in excess rates of returns on major equity and foreign exchange markets using lagged excess returns, dividend yields, and forward premiums as instruments. Vector autoregressions (VARs) demonstrate one-step-ahead predictability and facilitate calculations of implied long-horizon statistics, such as variance ratios. Estimation of latent variable models then subjects the VARs to constraints derived from dynamic asset pricing theories. Examination of volatility bounds on intertemporal marginal rates of substitution provides summary statistics that quantify the challenge facing dynamic asset pricing models.
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TL;DR: For example, this article found that 50.9% of 167 NYSE firms with losses during 1980-1985 reduced dividends, versus 1.0% of 440 firms without losses.
Abstract: An annual loss is essentially a necessary condition for dividend reductions in firms with established earnings and dividend records: 50.9% of 167 NYSE firms with losses during 1980–1985 reduced dividends, versus 1.0% of 440 firms without losses. As hypothesized by Miller and Modigliani, dividend reductions depend on whether earnings include unusual items that are likely to temporarily depress income. Dividend reductions are more likely given greater current losses, less negative unusual items, and more persistent earnings difficulties. Dividend policy has information content in that knowledge that a firm has reduced dividends improves the ability of current earnings to predict future earnings.
TL;DR: In this article, the authors analyzed insider trading in the 1982 tender offer for Campbell Taggart, an NYSE-traded baking company, by Anheuser-Busch, the nation's largest brewer.
Abstract: Trading by corporate insiders and their tippees is analyzed in Anheuser-Busch's 1982 tender offer for Campbell Taggart. Court records that identify insider transactions are used to disentangle the individual insider trades from liquidity trades. Consistent with previous studies, insider trading was found to have had a significant impact on the price of Campbell Taggart. However, the impact of informed trading on the market is complicated. Trading volume net of insider purchases rose. Contrary to the broad implications of adverse selection models, Campbell Taggart's liquidity improved when the insiders were active in the market, and the insiders received superior execution for their orders. THIS PAPER EXAMINES INSIDER trading surrounding the 1982 acquisition of Campbell Taggart, an NYSE-traded baking company, by Anheuser-Busch, the nation's largest brewer. News of the impending acquisition was leaked by one of the Anheuser-Busch directors and sequentially transmitted to a small group of individuals that proceeded to purchase a large amount of Campbell Taggart stock. During the criminal and civil litigation that followed this event, insider purchases were identified. We use the court records to isolate individual insider transactions from the flow of background trading, permitting analysis of the market's reaction to the onset of informed trading.1 Because the insider trading was not revealed to other market participants, the Campbell Taggart incident presents a unique laboratory for studying the dissemination and incorporation of private inside information into market