Showing papers in "Journal of Financial Research in 1989"

Holiday closings and security returns

Abstract: This paper documents unusual return patterns for securities around holiday closings. Returns for trading days immediately before holiday closings (pre-holiday trading days) are unusually high regardless of weekday, year, or holiday closing. Returns for trading days following holiday closings (post-holiday trading days) are high only if they occur at the end of the week. Tests indicate that pre-holiday returns do not respond to a closing effect, and that the post-holiday returns do not result from a time-diffusion process. Holiday trading day returns question the tax-loss selling explanation of the turn-of-the-year effect and display a significant small firm effect outside of January.

Skewness and kurtosis in japanese equity returns: empirical evidence

Abstract: In this paper, the distribution of equity returns on the Tokyo Stock Exchange is examined from 1965 to 1984, and significant and persistent skewness and kurtosis are found. The deviation of security returns from normality declines with increasing portfolio size and appears to be greater than the non-normality evidenced in U.S. security returns. Further, these deviations from normality persist even after controlling for January and firm size effects.

The underpricing of “second” initial public offerings

Abstract: The underpricing of initial public offerings (IPOs) of equity represents a well-documented empirical phenomenon. One prominent explanation for this underpricing relies on the uncertainty investors feel about the value of the issuer. In this paper, this asymmetric information hypothesis is tested by examining the underpricing of IPOs of seventy-four firms for which the uncertainty about the value of the firm is likely to be substantially reduced. These firms were once publicly owned, then taken private, and subsequently returned to public ownership. Findings show that the IPOs of these “reverse leveraged buyouts” are significantly less underpriced than typical IPOs. These results support the asymmetric information hypothesis.

Restricted voting shares, ownership structure, and the market value of dual‐class firms

Abstract: In this study, financial implications of differential voting right/multiple ordinary share class capitalizations are examined using data from British dual-class firms Positive wealth effects are observed after announcements of plans to issue restricted voting (RV) shares, and also after announcements of RV share enfranchisement plans The two share classes are usually created through large, noncash stock dividends or recapitalizations and, although corporate insiders hold about three times as large a fraction of superior voting (SV) shares, their RV shareholdings average a nontrivial 101 percent Finally, compensation is usually paid to SV shareholders when RV shares are enfranchised

Impacts of relative size and industrial relatedness on returns to shareholders of acquiring firms

Abstract: The premise of this paper is that in mergers the manageability of acquisitions significantly affects the wealth of shareholders of acquiring firms. Specifically, the relative size of partners as well as the industrial relatedness of the two firms are examined. The test period allows for the determination of announcement, interim, and consummation effects of the mergers on shareholder wealth. It is found that acquisitions of relatively large firms from unrelated industries lead to significant declines in the wealth of shareholders of acquiring firms, and that this result is most pronounced when the period is extended beyond the announcement through the effective dates.

Determinants of valuation effects for security offerings of commercial bank holding companies

Abstract: In this study, the impact of security issuance by bank holding companies is examined in light of two hypotheses: the regulation or asymmetry reduction hypothesis and the bank capital hypothesis. Announcements of the issuance of common stock are associated with a significant negative effect, and the magnitude of this effect is similar to that found previously for utilities and smaller than that found for industrial firms. The market does not appear to treat subordinated debt announcements as similar to equity, although the debt qualifies as “capital” for regulatory purposes. Cross-sectional regressions do not support asymmetric information models where all unexpected external announcements are viewed negatively. Rather, the type of security being issued is an important determinant of the announcement effect.

A note on the behavior of security returns: a test of stock market overreaction and efficiency

Abstract: Researchers have debated stock market efficiency for years and have found several apparent anomalies, among them the overreaction investment strategy. In a sample of virtually all AMEX and NYSE stocks over twenty-one years, it is demonstrated that abnormal returns earned in one year are positively related to the abnormal returns earned in the next year. This evidence is contrary to the overreaction investment philosophy.

A bias‐correcting procedure for beta estimation in the presence of thin trading

Abstract: In this paper, an alternative technique is developed for obtaining consistent estimates of beta in the presence of thin trading. The new estimator is tested on simulated data and the results are compared with those obtained from the Dimson [4] Scholes and Williams [9] techniques. The new estimator is found to have approximately the same bias as the others, but it has a considerably lower variance.

On stochastic dominance analysis of day‐of‐the‐week return patterns

Abstract: Studies show that significant differences exist among return distributions of days of the week. While these results are ubiquitous, their validity depends on the robustness of statistical procedures used. Virtually every day-of-the-week study has used mean/variance analysis despite it being well documented that daily return distributions are nonnormal. This study uses stochastic dominance analysis, which is not distribution dependent, to test for a day-of-the-week effect. Results indicate that the day-of-the-week effect is robust and that previous findings are not artifacts deriving from violations of distributional assumptions.

An examination of the yield spread between insured and uninsured debt

Abstract: Currently, municipal bonds insured by major insurance firms receive the highest credit rating from rating agencies. The interest rates on regular triple-A municipal bonds, however, have been persistently below those of insured bond issues. The yield spread between insured and uninsured triple-A bonds in the tax-exempt market is examined here, and it is shown that the yield spread may be attributable to split ratings and default-related risks.

THE COST OF CAPITAL, MACAULAY'S DURATION, AND TOBIN'S q

Abstract: It is shown empirically that the cost of equity capital estimated from the dividend discount model and Tobin's q are negatively related. The theoretical relationship between these variables is exploited to determine alternative estimates of the cost of equity capital and Macaulay's duration without having to estimate the growth rate g in the conventional manner. This new approach can readily be implemented for large firms reporting SFAS No. 33 data.

The relationship between the variability of inflation and stock returns: an empirical investigation

Abstract: Several researchers find a negative correlation between the rate of inflation and stock returns. This phenomenon may be explained by the variability hypothesis, which posits that the negative correlation is caused by the combination of a positive relation between the rate of inflation and the variability of inflation and a negative relation between the variability of inflation and stock returns. An autoregressive conditional heteroscedastic model of inflation is used to measure the variability of inflation. Empirical results do not support the ability of the variability hypothesis to explain the negative correlation between stock returns and inflation.

Earnings forecast revisions associated with stock split announcements

Abstract: Recent studies document abnormal stock returns at stock split announcements. Three hypotheses related to expected future earnings—the trading range, attention, and signaling hypotheses—have been offered as explanations. Evidence has also been provided that splitting firms have greater postannouncement earnings growth than control nonsplitting firms. Using earnings expectation data from the Institutional Brokers Estimate System, significantly greater forecast revisions are found in this study for split firms than for control nonsplit firms. The difference is significantly related to abnormal stock returns of splitting firms.

Basis volatility: implications for hedging

Abstract: Most hedges placed in futures markets must be lifted before contract expiration, which necessitates incurring “basis risk.” The focus of this paper is on quantifying such risk as a function of the timing of a hedge, its duration, distance from contract expiration, hedge life, and other market-observable variables. The development of basis-risk profiles provides a hedger with estimates of hedging risks that reasonably can be expected before the actual placement of hedges, thus serving as a useful input in the hedging decision.

Risk and return on newly listed stocks: the post-listing experience

Abstract: Researchers consistently find that newly listed stocks underperform in the post-listing period. It has been suggested that this anomalous finding may, in part, be explained away if the risk during this period is lower than at other times. Evidence is presented here that the riskiness of newly listed stocks undergoes a seasoning process. Instead of lower risk, riskiness is found to be greater immediately after listing than in later periods. This suggests that the post-listing anomaly is actually worse than has been previously recognized.

An analysis of the january effect in stocks and interest rates under varying monetary regimes

Abstract: In this paper the meaning of the January effect is clarified. The early literature indicates that differing views on the existence of such an effect were based on different data sets, various time periods, and different measurement tools. A model is formulated to test the January effect hypothesis with seven assets from 1871 to 1986, including tests performed for subperiods corresponding to different monetary regimes. The hypothesis tests incorporate an unbiased estimator to avoid the biases caused by heteroscedasticity and autocorrelation. Findings suggest that asset return behavior differs among assets and regimes.

The risk behavior of equity of firms approaching bankruptcy

Abstract: The risk behavior of financially distressed companies is studied using the shifting regimes regression model originally suggested by Brown, Durbin, and Evans. In addition, the presence of nonsynchronous trading is detected and the regression model is adjusted accordingly using Dimson's technique. The results reveal that the behavior of systematic risk as firms approach bankruptcy depends to some degree on appropriate identification of periods over which beta is constant and adjusting for nonsynchronous trading. The results also lend support to the importance of skewness and to some extent beta but not unsystematic risk in explaining the security returns of firms approaching bankruptcy. Finally, the behavior of equity risk is examined according to the outcome of the bankruptcy filing.

Regulatory and procedural effects on the underpricing of initial public offerings

Abstract: In this paper, the pricing of initial public offerings (IPOs) is examined from the underwriter's point of view. It is shown that because of the regulations and procedures governing the underwriting and pricing of IPOs, underwriters can maximize expected income by underpricing IPOs. Thus, it is argued that in addition to other feasible explanations of the underpricing phenomenon (e.g., compensation to uninformed investors, insurance against legal liability, etc.), regulatory and procedural factors contribute to the underpricing of IPOs. This is shown to be true both when uninformed investors are present and absent from the market for IPOs.

Moral hazard and capital budgeting

Abstract: In this paper, the effect of moral hazard on capital budgeting is examined. It is shown that moral hazard may change project rankings based on net present value under perfect information. It is also shown that in certain agency relationships moral hazard increases managerial contracting costs more for projects with slower paybacks, thus producing a bias in favor of projects with faster paybacks. This effect manifests itself only under specific conditions.

The informational content of forward rates: further evidence

Abstract: Using single-equation estimation techniques, researchers have generally found that forward rates have little ability to predict future spot rates In this paper, Generalized Least Squares is used to estimate simultaneously the forecastive ability of multiple forward rates It is discovered that current forward rates significantly predict future spot rates for various rate maturities up to twelve months ahead Also found are instances in which the Treasury bill market does not conform to the weak form of market efficiency

The effect of a sinking fund on the reoffering yields of new public utility bonds

Abstract: In this study, empirical tests are conducted to determine the impact of a sinking fund on reoffering yields of a sample of new public utility bonds sold between January 1977 and March 1982. The findings of the regression analysis are consistent with the hypotheses that the value of the sinking fund varies with the default risk of the issuer and with market expectations of future interest rate movements, and that the sinking fund improves the liquidity of a bond issue.

The cost of including a call provision in municipal debt contracts

Abstract: Municipal bond market studies testing for the effect of a call provision on new-issue borrowing cost fail to examine if the cost of the call provision is sensitive to expected changes in interest rates. This may explain why some studies find that the presence of a call provision increases municipal borrowing costs while others find no effect. Another possible reason for the contradictory findings may be a failure to correct for a self-selection bias that results when some issuers choose to include a call provision and others do not. To correct for the potential self-selection problem, a two-stage probit switching regression technique is used here to estimate the cost of a call provision to municipal issuers. Results indicate municipal issuers pay a premium for the call privilege at the time of issue and that the size of the premium is sensitive to expected changes in interest rates.

Financing and house prices

Abstract: Recent empirical evidence on the effect of below-market financing on house prices has suffered from estimation and interpretation problems. In this paper, a methodology is developed to solve these problems. Using data for mortgage revenue bonds, the methodology is tested with results indicating that all financing subsidy is capitalized into house prices.

Optimum corporate leverage with risky debt: a demand approach

Abstract: Traditional models of corporate interior optimum leverage rely on institutional schemes such as taxes, bankruptcy, and agency costs. Theories of leverage indifference in the presence of risky debt depend on various features of perfect and complete markets and on the assumption that all investors hold a uniform portfolio. In the model developed here, corporate interior optimum leverage is obtained as a result of a fundamental risk-return trade-off for investors who hold nonuniform portfolios of risky equity and debt claims in the absence of market mechanisms, forcing leverage indifference. The dynamic optimization solution accommodates bankruptcy costs and specialized institutional factors but does not rely on their presence.

Estimation and selection bias in mean‐variance portfolio selection

Abstract: Much research has focused on the problem of selecting portfolios without the benefit of parametric measures of risk and return. In this paper, a Monte Carlo technique is used to isolate the extent and nature of the problems introduced by this practice. The technique is employed in the context of classical statistical methodology without permitting short sales. It is shown that using estimators of expected return and risk not only obscures parametric values, but also affects portfolio composition in the Markowitz framework. In this study, these two components of bias are isolated and measured.

Direct tests of the divergence of opinion hypothesis in the market for racetrack betting

Abstract: The “divergence of opinion” hypothesis suggests predictable pricing effects in markets where assumptions of homogeneous investor expectations and unrestricted short selling do not hold. Direct tests of the hypothesis in traditional financial markets do not exist apparently because of the severity of several requirements, including that measurement of divergent ex-ante expectations be unambiguously paired with associated ex-post results. This and remaining conditions are met in direct tests of the hypothesis in a pricing arena where divergence of opinion influences are likely to be present: racetrack betting. Results provide no statistically significant support for the divergence of opinion hypothesis.

The coupon effect on term premiums

Abstract: Monthly holding period returns for U.S. Treasury bills and notes of identical maturity indicate a significant coupon effect upon term premiums. Hotelling's T2 test of the vectors of mean term premiums indicates that term premiums are not statistically significant for notes but are significant for bills. Mean-variance and stochastic dominance criteria indicate an investment preference for bills over notes on a pretax basis. Because the data set is Treasury bills and notes, which are identical except for coupon level, these results are evidence of a coupon effect on term premiums.

The effect of market proxy rebalancing policies on detecting abnormal performance

Abstract: In this paper, effects on the measured abnormal performance of test portfolios are compared against market proxies having the same or different rebalancing policies. Results show that the common practice of comparing buy-and-hold test portfolios with equally weighted market proxies produces lower Jensen [7] alphas and lower alpha t-values. Comparing buy-and-hold test portfolios with value-weighted market proxies produces higher portfolio betas and alphas, but lower alpha t-values. Finally, comparing buy-and-hold test portfolios with buy-and-hold market proxies produces the most powerful tests of abnormal performance.

The risk implications of forecast errors of bank earnings, 1976–1986

Abstract: The forecast errors arising from security analysts' predictions of commercial bank earnings are investigated here and compared with the earnings forecast errors associated with savings and loans, other financial services organizations, and a random sample of nonfinancial firms from 1976 to 1986. Although bank earnings forecast errors did increase over 1976–1986, analyses suggest that the rise was less than at other industries considered in the study. The increase in forecast errors appears to be centered at multinational banking organizations, with only limited increases in earnings forecast errors at regional banks.

Intrinsic uncertainty and common-knowledge priors in financial economics

Abstract: This article introduces the concept of intrinsic uncertainty, which occurs in the absence of common knowledge, and its relation to the standard homogeneous beliefs assumption of finance theory. When individuals in an informed environment have homogeneous beliefs (common priors), they objectively agree; however, they can agree without knowing they agree. With homogeneous beliefs, individuals still face intrinsic uncertainty over unknown beliefs of others. If two people have homogeneous beliefs and their informed posteriors for an event E are common knowledge, then—contrary to the widely held view—these posteriors may be unequal. The two people can agree to disagree. Consensus over the probabilities of the possible states requires an agreed common-knowledge priors assumption.