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Showing papers in "Journal of Financial and Quantitative Analysis in 2001"


Journal ArticleDOI
TL;DR: In contrast to previous empirical work, out tests explicitly account for the fact that firms may face impediments to movements toward their target ratio, and that the target ratio may change over time as the firm's profitability and stock price change as mentioned in this paper.
Abstract: When firms adjust their capital structures, they tend to move toward a target debt ratio that is consistent with theories based on tradeoffs between the costs and benefits of debt. In contrast to previous empirical work, out tests explicitly account for the fact that firms may face impediments to movements toward their target ratio, and that the target ratio may change over time as the firm's profitability and stock price change. A separate analysis of the size of the issue and repurchase transactions suggests that the deviation between the actual and the target ratios plays a more important role in the repurchase decision than in the issuance decision.

1,969 citations


Journal ArticleDOI
TL;DR: This article used intraday data from the interdealer government bond market to investigate the effects of scheduled macroeconomic announcements on prices, trading volume, and bid-ask spreads, and found that 17 public news releases, as measured by the surprise in the announced quantity, have a significant impact on the price of at least one of the following instruments: a three-month bill, a two-year note, a 10-year notes, and a 30-year bond.
Abstract: This paper uses intraday data from the interdealer government bond market to investigate the effects of scheduled macroeconomic announcements on prices, trading volume, and bid-ask spreads. We find that 17 public news releases, as measured by the surprise in the announced quantity, have a significant impact on the price of at least one of the following instruments: a three-month bill, a two-year note, a 10-year note, and a 30-year bond. These effects vary significantly according to maturity. Public news can explain a substantial fraction of price volatility in the aftermath of announcements, and the adjustment to news generally occurs within one minute after the announcement. We document significant and persistent increases in volatility and trading volume after the announcements. Bidask spreads, on the other hand, widen at the time of the announcements, but then revert to normal values after five to 15 minutes. The effects that we document have relevant implications for yield curve modeling and for the microstructure of bond markets.

897 citations


Journal ArticleDOI
TL;DR: In this paper, the authors explore the effect of exclusionary ethical investing on corporate behavior in a risk-averse, equilibrium setting and show that it leads to polluting firms being held by fewer investors since green investors eschew polluting stocks.
Abstract: This paper explores the effect of exclusionary ethical investing on corporate behavior in a risk-averse, equilibrium setting. While arguments exist that ethical investing can influence a firm's cost of capital, and so affect investment, no equilibrium model has been presented to do so. We show that exclusionary ethical investing leads to polluting firms being held by fewer investors since green investors eschew polluting firms' stock. This lack of risk sharing among non-green investors leads to lower stock prices for polluting firms, thus raising their cost of capital. If the higher cost of capital more than overcomes a cost of reforming (i.e., a polluting firm cleaning up its activities), then polluting firms will become socially responsible because of exclusionary ethical investing. A key determinant of the incentive for polluting firms to reform is the fraction of funds controlled by green investors. In our model, empirically reasonable parameter estimates indicate, that more than 20 % green investors are required to induce any polluting firmss to reform. Existing empirical evidence indicates that at most 10% of funds are invested by green investors.

861 citations


Journal ArticleDOI
TL;DR: In this paper, the authors provide evidence that the documented abnormal returns and changes in short interest around option listings are consistent with the mitigation of short sale constraints resulting from the option introduction, and that both the abnormal return and short interest changes around listing dates can be predicted using ex ante characteristics of the underlying stock.
Abstract: Early studies find that option introductions tend to raise the price of underlying stocks. More recent research indicates that post-1980 option introductions are associated with negative abnormal returns in underlying stocks. Other studies document increased short sale activities following option listing. This paper provides evidence that the documented abnormal returns and changes in short interest around option listings are consistent with the mitigation of short sale constraints resulting from the option introduction, and that both the abnormal returns and short interest changes around listing dates can be predicted using ex ante characteristics of the underlying stock.

378 citations


Journal ArticleDOI
TL;DR: The authors investigated whether firms systematically reduce or increase their riskiness with derivatives and found that firms that use derivatives display few, if any, measurable differences in risk that are associated with the use of derivatives.
Abstract: Public discussion about corporate use of derivatives focuses on whether firms use derivatives to reduce or increase firm risk. In contrast, em- pirical, academic studies of corporate derivatives-use take it for granted that firms hedge with derivatives. Using data from financial statements of 425 large u.s. corporations, we investigate whether firms systematically reduce or increase their riskiness with derivatives. We find that many firms manage their exposures with large derivatives positions. Nonetheless, compared to firms that do not use financial derivatives, firms that use derivatives display few, if any, measurable differences in risk that are associated with the use of derivatives.

372 citations


Journal ArticleDOI
TL;DR: In this paper, the authors examined different hypotheses about stock splits and found that stock splits attract uninformed traders and that informed trading increases, resulting in no appreciable change in the information content of trades.
Abstract: Extending an empirical technique developed in Easley, Kiefer, and O'Hara (1996), (1997a), we examine different hypotheses about stock splits. In line with the trading range hypothesis, we find that stock splits attract uninformed traders. However, we also find that informed trading increases, resulting in no appreciable change in the information content of trades. Therefore, we do not find evidence consistent with the hypothesis that stock splits reduce information asymmetries. The optimal tick size hypothesis predicts that stock splits attract limit order trading and this enhances the execution quality of trades. While we find an increase in the number of executed limit orders, their effect is overshadowed by the increase in the costs of executing market orders due to the larger percentage spreads. On balance, the uninformed investors' overall trading costs rise after stock splits.

273 citations


Journal ArticleDOI
TL;DR: In this article, the authors used daily returns to examine how mutual funds actively alter the risk of their portfolios in response to past performance and found that daily returns produce much more efficient estimates of fund volatility, which give vastly different inferences about the behavior of fund managers.
Abstract: Daily returns are used to examine how mutual funds actively alter the risk of their portfolios in response to past performance. Compared to monthly data, daily returns produce much more efficient estimates of fund volatility, which give vastly different inferences about the behavior of fund managers. In particular, monthly results consistent with under-performers increasing their risk relative to better performing funds disappear with daily data. The differences in the monthly and daily results arise from biases in the monthly volatility estimates attributable to daily return autocorrelation.

251 citations


Journal ArticleDOI
TL;DR: In this paper, the authors show that zero-cost collars and equity swaps provide insiders with the opportunity to hedge the risk associated with their personal holdings in the company's equity, and they suggest that increasing the transparency of these transactions may provide valuable information to investors.
Abstract: Zero-cost collars and equity swaps provide insiders with the opportunity to hedge the risk associated with their personal holdings in the company's equity. Consequently, their use has important implications for incentive-based contracting and for understanding insider trading behavior. Our analysis indicates that these transactions generally involve high-ranking insiders and effectively reduce their ownership by about 25%, on average. Given the potential of these financial instruments to substantially alter the incentive alignment between managers and shareholders, we suggest that increasing the transparency of these transactions may provide valuable information to investors.

217 citations


Journal ArticleDOI
TL;DR: The authors examined the impact of manager replacement on subsequent fund performance and found evidence supporting the presence of strategic risk shifting in the fund portfolios prior to replacement, consistent with the notion of win? dow dressing.
Abstract: I examine the impact of mutual fund manager replacement on subsequent fund perfor? mance. Using a sample of 393 domestic equity and bond fund managers that were replaced over the 1979-1991 period, for the underperformers, I document significant improvements in post-replacement performance relative to the past performance of the fund. On the other hand, the replacement of overperforming managers results in deterioration in postreplacement performance. I find evidence supporting the presence of strategic risk shifting in the fund portfolios prior to replacement. Furthermore, consistent with the notion of win? dow dressing, I document that the level of portfolio turnover activity decreases significantly in the post-replacement period. Lastly, the replacement of poor performers is preceded by significant decreases in net new inflows in the fund.

155 citations


Journal ArticleDOI
TL;DR: In this article, the authors consider a market microstructure model in which the rates of public and private informa? tion arrival are probabilistic, and the latter depends on the availability of private information that is stochastically changing over time.
Abstract: I consider a market microstructure model in which the rates of public and private informa? tion arrival are probabilistic. The latter depends on the availability of private information that is stochastically changing over time. In equilibrium, traders estimate the availability of private information using past periods' trading volume and use this information to adjust their strategies. The time-series properties include contemporaneous correlation between price variability and volume and autocorrelation in price variability (similar to GARCH). The model explains why trading volume contains useful information for predicting volatil? ity and provides predictions on the limit and market order placement strategies of traders.

152 citations


Journal ArticleDOI
TL;DR: In this paper, a link between market structure and the resulting market characteristics was proposed, namely, tick size, bid-ask spreads, quote clustering, and market depth, and it was shown that market charateristics are endogenous to the market structure.
Abstract: We propose a link between market structure and the resulting market characteristics—tick size, bid-ask spreads, quote clustering, and market depth. We analyze transactions data of stocks traded on the London Stock Exchange, a dealer market. We conclude that market charateristics are endogenous to the market structure. The London dealer market does not have a mandated tick size, and it exhibits higher spreads, higher quote clusterings, and higher market depth than the NYSE auction market. Clustering of trade prices is similar in London and New York.

Journal ArticleDOI
TL;DR: In this paper, a simple fair pricing mechanism was proposed to correct net asset values for stale prices of open-end international mutual funds. But, the mechanism was limited to a sample of 391 U.S.-based international mutual fund companies.
Abstract: Daily pricing of mutual funds provides liquidity to investors but is subject to valuation errors due to the inability to observe synchronous, fair security prices at the end of the trading day. This mayhurt fund investor if speculatior strategiclly seek to exploit mispricing or if the net flow of money into funds is correlated with these pricing eerrors. We show that mutual funds are exposed to speculative traders by using a simple day trading rule that yields large profits in a sample of 391 U.S.-based open-end international mutual funds. We propose a simple “fair pricing” mechanism that alleviated these concerns by correcting net asset values for stale prices. We argue that fund companies and regulatiors should look at alternatives that allow funds to offer fair prciing to investors, which, in turn, decreases the need to resort to monitoring for day traders and redemption penalties.

Journal ArticleDOI
TL;DR: In this article, the authors examined long-run performance and insider trading around canceled and completed seasoned equity offerings (SEOs) and found that insider selling increases prior to competed and canceled SEOs, but declines afferward only for canceled offerings.
Abstract: This paper provides evidence on managerial motives for raising equity by examining long-run performance and insider trading around canceled and completed seasoned equity offerings (SEOs). Insider selling increases prior to competed and canceled SEOs, but declines afferward only for canceled offerings. For completed SEOs, pre-filing insider trading is related to long-run performance after completion. For Canceled sEOs, pre-filing insider trading is related to stock performance between filing and cancellation. Finally, changes in dence is consistent with insiders exploiting windows of opportunity by attempting to issue overvalued equity and by canceling the issue when the market reaction to the announcement eliminates the overvaluation.

Journal ArticleDOI
TL;DR: This article found that firms with greater levels of international activity have better credit ratings and that the cost of debt financing is inversely related to the degree of firm internationalization beyond that incorporated in credit ratings.
Abstract: Recent research suggests that firm internationalization is associated with greater exchange rate risk and a higher cost of equity capital. However, there is no research on the relation between the level of firm international activity and the cost of debt financing. This study of? fers the first such empirical evidence using non-provisional public debt. Based on a sample of 2,194 U.S. firm year observations, we find that firms with greater levels of international activity have better credit ratings. We also find that the cost of debt financing is inversely related to the degree of firm internationalization beyond that incorporated in credit ratings. These results suggest that rating agencies do not fully incorporate firm international activ? ity in their analysis resulting in a downward bias in credit ratings for international firms. In aggregate, the results imply that failing to incorporate firm international activity in debt pricing leads to potential omitted variable problems.

Journal ArticleDOI
TL;DR: In this article, the extent of information-motivated trading conditional on trade size in the options and stock markets was investigated, and it was shown that the options market is the primary venue for information trading only for small investors, whereas large investors do not necessarily trade options rather than stocks when they are informed.
Abstract: This study investigates the extent of information-motivated trading conditional on trade size in the options and stock markets. We find envidence that the options market is the primary venue for information trading only for small investors, whereas large ivestors do not necessarily trade options rather than stocks when they are informed. With different trading mechanisms in the stock and options markets, this finding implies that investors, when facing different impediments to information-related trading, select different vehicles to exploit their information. We also show that the adverse selection component of the bid-ask spread decreases with option delta, implying that options with greater finanical leverage attract more informed investors. Overall, our results reinforce the notion that the options market is a venue for information-motivated trading.

Journal ArticleDOI
TL;DR: The authors examined the stock price reaction to earnings announcements in the five years following seasoned equity offerings (SEOs) and found that on average, post-SEO earnings announcements are met with a significantly negative abnormal stock price response.
Abstract: We examine the stock price reaction to earnings announcements in the five years following seasoned equity offerings (SEOs). On average, post-SEO earnings announcements are met with a significantly negative abnormal stock price reaction. Although this negative reaction accounts for a disproportionately large portion of long-run post-SEO abnormal stock returns, on average, abnormal stock price reactions to post-seo earnings announcements are reliably negative only within the smallest quartile of equity issuers. For small firms, therefore, these findings are broadly consistent with the hypothesis that firms issue equity when the market overestimates the firm's future earnings perfomance.

Journal ArticleDOI
TL;DR: In this paper, the authors examine whether the market demand curve for equities is dawnward sloping, and they find that equity fund flows seem to be influenced by the performance of the stock market and investors try to forecast fundamentals of firms and change their demand for stocks accordingly.
Abstract: We examine whether the market demand curve for equities is dawnward sloping. Unlike previous studies that examine individual stocks' demand curves, we look at the aggregate demand curve. As a proxy for aggregate demand, we employ equity mutual fund flows. Unlike previous studies that focus on events that are unlikely to convey new information to the market, we devise an empirical framework that disentangles the price-pressure effect and the information effect. We do not find evidence for the price-pressure effect that equity fund flows directly affect stock market prices in the presence of fundamentals of firms. Instead, we find that equity fund flows seem to be influenced by the performance of the stock market and that investors try to forecast fundamentals of firms and change their demand for stocks accordingly. Overall, these findings are with a horizontal market demand curve for equities.

Journal ArticleDOI
TL;DR: In this paper, the authors determine whether each bid (ask) quote reflects the trading interest of the specialist, limit order traders, or both for a sample of NYSE stocks in 1991.
Abstract: In this paper, we determine whether each bid (ask) quote reflects the trading interest of the specialist, limit order traders, or both for a sample of NYSE stocks in 1991. We then compare Nasdaq spreads with NYSE spreads that reflect the trading interest of the specialist. Our empirical results show that the average Nasdaq spread is significantly larger than the average NYSE specialist spread. We find that, on average, 49% of the difference between Nasdaq and specialist spreads is due to the differential use of even-eighth quotes between Nasdaq dealers and NYSE specialists. We also find that the NYSE specialist spread is significantly larger than the limit order spread, although NYSE specialists and limit order traders are similiar in their use of even-eighth quotes.

Journal ArticleDOI
TL;DR: The authors examined investors' reaction to quarterly earnings announcements over a five-year period following the offering for a large sample of seasoned equity issuing firms and found that investors are not disappointed by earnings announcements that follow seasoned equity offerings.
Abstract: The leading explanation for the post-issue long-run stock return underperformance of sea? soned equity offering firms is that investors have optimistic expectations regarding future earnings and the underperformance occurs as these expectations are corrected over time. To directly test this hypothesis, we examine investors' reaction to quarterly earnings an? nouncements over a five-year period following the offering for a large sample of seasoned equity issuing firms. In general, our evidence suggests that investors are not disappointed by earnings announcements that follow seasoned equity offerings. This result is not sen? sitive to widening the window over which earnings announcement returns are computed. This result also holds true for subsets of equity issuing firms classified as glamour issuing firms, Nasdaq listed issuing firms, and hot market issuing firms. The choice of these three subsets is predicated by extant evidence that these firms are likely to convey relatively more unfavorable information through their earnings announcements. Overall, our findings are inconsistent with the optimistic expectations hypothesis.

Journal ArticleDOI
TL;DR: In this paper, the negative abnormal stock returns of about 1% occur near record dates of stock splits and the lower the returns, the more positive the ex-date returns and when-issued premi? ums.
Abstract: Negative abnormal stock returns of about 1% occur near record dates of stock splits Fur? ther, the lower the returns, the more positive are ex-date returns and when-issued premi? ums A possible explanation of these related phenomena is that trading hindrances asso? ciated with record dates create trading inconvenience that is reflected in lower prices near record dates In turn, anomalous positive ex-date returns arise in part from the abnormally low prices of unsplit shares caused by the negative record date returns

Journal ArticleDOI
TL;DR: The authors examined the effect of the chain of events that led to the disagreement between the White House and Congress over the increase of the federal debt limit from mid-October 1995 to March 1996 caused a default potential for Treasury securities.
Abstract: The chain of events that led to the disagreement between the White House and Congress over the increase of the federal debt limit from mid-October 1995 to March 1996 caused a default potential for Treasury securities. We examine the effect of this event chain on the yield spread between commercial paper and Treasury bills and find that both the threeand six-month yield spreads were reduced during the event period. The results suggest that the market charged a default risk premium to the Treasury securities. There is no evidence that these events had a sustained effect on T-bill rates since the yield spread during the post-event period resumed its pre-event level.

Journal ArticleDOI
TL;DR: In this paper, a tradeoff between the risk-shifting and hedging incentives of firms is discussed and conditions under which each dominates in a multi-period context, even if no such incentive exists in a single-period one.
Abstract: This paper demonstrates a tradeoff between the risk-shifting and hedging incentives of firms and identifies conditions under which each dominates. A firm may have the incentive to hedge in a multi-period context, even if no such incentive exists in a single-period one. Unrestricted access to swaps in the presence of asymmetric information about firm type and the swapping motive would lead to unbounded speculation resulting in breakdowns in swap and debt markets. Price-based methods are unable to control this and market makers have to rely upon additional exposure information or credit enhancement devices to preserve equilibrium.

Journal ArticleDOI
TL;DR: The authors examined the role of conditioning information in dynamic term structure models and found that the truncation bias causes the drift of these models to have a nonlinear structure, and used the theory of enlargement of filtrations to estimate the extent of this bias.
Abstract: We examine an impartant aspect of emprical estimation of term structure models; the role of conditioning information in dynamic term structure models. The use of both real world or simulated data implicitly incorporates conditioning information. We examine the bias created in estimating the drift by a specific form of conditioning, namely truncation. Using the theory of enlargement of filtrations we provide estimates of the extent of this truncation bias for commonly used short rate models. We find that this truncation bias causes the drift of these models to have a nonlinear structure.

Journal ArticleDOI
TL;DR: In this article, the authors show that the threat of takeover may divert managerial effort from productive to defensive activities, and that, when this is considered, takeovers may, in fact, be excessive.
Abstract: Existing theory suggests that, in an unregulated market for corporate control, the level of takeovers is suboptimal because shareholders do not receive the full benefit from them. However, existing theory neglects that the threat of takeover may divert managerial effort from productive to defensive activities. This paper shows that, when this is considered, takeovers may, in fact, be excessive.

Journal ArticleDOI
TL;DR: In this article, the authors decompose the profit of an option into two basic components: (i) mispricing of the option relative to the asset at the time of purchase; and (ii) profit from subsequent fortuitous changes of the underlying asset.
Abstract: This paper shows how to decompose the dollar profit earned from an option into two basic components: i) mispricing of the option relative to the asset at the time of purchase; and ii) profit from subsequent fortuitous changes or mispricing of the underlying asset. This separation hinges on measuring the "true relative value" of the option from its realized payoff. The payoff from any one option has a huge standard error about this value that can be reduced by averaging the payoff from several independent option positions. Simulations indicate that 95% reductions in standard errors can be further achieved by using the payoff of a dynamic replicating portfolio as a Monte Carlo control variate. In addition, the paper shows that these low standard errors are robust to discrete rather than continuous dynamic replication and to the likely degree of misspecification of the benchmark formula used to implement the replication. Option mispricing profit can be further decomposed into profit due to superior esti? mation of the volatility (volatility profit) and profit from using a superior option valuation formula (formula profit). To make this decomposition reliably, the benchmark formula used for the attribution needs to be similar to the formula implicitly used by the market to price options. If so, then simulation indicates that this further decomposition can be achieved with low standard errors. Basic component ii) can be further decomposed into profit from a forward contract on the underlying asset (asset profit) and what I term pure option profit. The asset profit indicates whether the investor was skillful by buying or selling options on mispriced underlying assets. However, asset profit could also simply be just compensation for bearing risk?a distinction beyond the scope of this paper. Al? though simulation indicates that the attribution procedure gives an unbiased allocation of the option profit to this source, its standard error is large?a feature common with others' attempts to measure performance of assets.