Showing papers in "Review of Financial Studies in 1994"
TL;DR: In this paper, the authors studied the large premium attributed to voting shares on the Milan Stock Exchange and found that the premium varies according to the ownership structare and the concentration of the voting rights, and can be rationalized in the presence of enormous private benefits of control.
Abstract: I study the large premium (82 percent) attributed to voting shares on the Milan Stock Exchange The premium varies according to the ownership structare and the concentration of the voting rights, and it can be rationalized in the presence of enormous private benefits of control A case study seems to indicate that in Italy private benefits of control can easily be worth more than 60 percent of the value of nonvoting equity A tentative explanation for these findings is provided Traditional finance theory disregards the value of voting rights in pricing common stock In most cases this omission does not seem harmful Many studies of differential voting stocks in different countries have indicated that voting rights are generally worth between 10 percent and 20 percent of the value of common stock’ The Italian evidence I present differs sharply from this view In Italy voting shares that have inferior dividend rights trade at an average premium
986 citations
TL;DR: This paper investigated empirically how returns and volatilities of stock indices are correlated between the Tokyo and New York markets using intradaily data that define daytime and overnight returns for both markets, and found that Tokyo (New York) daytime returns are correlated with New York (Tokyo) overnight returns.
Abstract: This article investigates empirically how returns and volatilities of stock indices are correlated between the Tokyo and New York markets. Using intradaily data that define daytime and overnight returns for both markets, we find that Tokyo (New York) daytime returns are correlated with New York (Tokyo) overnight returns. We interpret this result as evidence that information revealed during the trading hours of one market has a global impact on the returns of the other market. In order to extract the global factor from the daytime returns of one market, we propose and estimate a signal-extraction model with GARCH processes. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
948 citations
TL;DR: This article showed that the positive volatility-volume relation documented by numerous researchers actually reflects the positive relation between volatility and the number of transactions, and that it is the occurrence of transactions per se, and not their size, that generates volatility; trade size has no information beyond that contained in the frequency of transactions.
Abstract: We show that the positive volatility-volume relation documented by numerous researchers actually reflects the positive relation between volatility and the number of transactions. Thus, it is the occurrence of transactions per se, and not their size, that generates volatility; trade size has no information beyond that contained in the frequency of transactions. Our results suggest that theoretical research needs to entertain scenarios in which (1) both the frequency and size of trades are endogenously determined, yet (2) the size of trades has no information content beyond that contained in the number of transactions. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
921 citations
TL;DR: In this paper, it was shown that analysts exhibit herding behavior, whereby they release forecasts similar to those previously announced by other analysts, even when this is not justified by their information.
Abstract: The use of analyst forecasts as proxies for investors' earnings expectations is commonplace in empirical research. An implicit assumption behind their use is that they reflect analysts' private information in an unbiased manner. As demonstrated here, this assumption is not necessarily valid. There is shown to be a tendency for analysts to release forecasts closer to prior earnings expectations than is appropriate, given their information. Further, analysts exhibit herding behavior, whereby they release forecasts similar to those previously announced by other analysts, even when this is not justified by their information. These results are shown to have interesting empirical implications. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
911 citations
TL;DR: The authors show that in markets where investors know a priori that they do not have to compete with informed investors, IPOs are not underpriced and also show that IPOs underwritten by reputable investment banks experience significantly less underpricing and perform significantly better in the long run.
Abstract: We test the empirical implications of several models of IPO underpricng. Consistent with the winner’s-curse hypothesis, we show that in markets where investors know a priori that they do not have to compete with informed investors, IPOs are not underpriced. We also show that IPOs underwritten by reputable investment banks experience significantly less underpricing and perform significantly better in the long run. We do not find empirical support for the signaling models that try to explain why firms underprice. In fact, we find that (1) firms that underprice more return to the reissue market less frequently, and for lesser amounts, than firms that underprice less, and (2) firms that underprice less experience higher earnings and pay higher dividends, contrary to the models’ predictions.
775 citations
TL;DR: In this article, the authors test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk and find that the empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and equity returns are negatively correlated with domestic inflation.
Abstract: We test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk. The empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and equity returns are negatively correlated with domestic inflation. We then develop a model of international portfolio choice and equity market equilibrium that integrates inflation risk and deadweight costs. Using this model we estimate the levels of costs required to generate the observed home bias in portfolios consistent with different levels of risk aversion. For a level of risk aversion consistent with standard estimates of the domestic equity market risk premium, these costs are about a few percent per annum, greater than observable costs such as withholding taxes. Thus, the home bias cannot be explained by either inflation hedging or direct observable costs of international investment unless investors have very low levels of risk aversion. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
752 citations
TL;DR: In this paper, the authors model firms' choice between bank loans and publicly traded debt, allowing for debt renegotiation in the event of financial distress, and demonstrate that banks' desire to acquire a reputation for making the "right" renegotiation versus liquidation decision provides them an endogenous incentive to devote a larger amount of resources than bondholders toward such evaluations.
Abstract: We model firms’ choice between bank loans and publicly traded debt, allowing for debt renegotiation in the event of financial distress. Entrepreneurs, with private information about their probability of financial distress, borrow from banks (multiperiod players) or issue bonds to implement projects. If a firm is in financial distress, lenders devote a certain amount of resources (unobservable to entrepreneurs ) to evaluate whether to liquidate the firm or to renegotiate its debt. We demonstrate that banks’ desire to acquire a reputation for making the “right” renegotiation versus liquidation decision provides them an endogenous incentive to devote a larger amount of resources than bondholders toward such evaluations. In equilibrium, bank loans dominate bonds from the point of view of minimixing inefficient liquidation; however, firms with a lower probability of financial distress choose bonds over bank loans.
693 citations
TL;DR: In this article, a cross-sectional discrete spread model is estimated by using intraday stock quotation spread frequencies, and the results are used to project $1/16 spread usage frequencies given a $ 1/16 tick.
Abstract: Exchange minimum price variation regulations create discrete bid-ask spreads. If the minimum quotable spread exceeds the spread that otherwise would be quoted, spreads will be wide and the number of shares offered at the bid and ask may be large. A cross-sectional discrete spread model is estimated by using intraday stock quotation spread frequencies. The results are used to project $1/16 spread usage frequencies given a $1/16 tick. Projected changes in quotation sizes and in trade volumes are obtained from regression models. For stocks priced under $10, the models predict spreads would decrease 38 percent, quotation sizes would decrease 16 percent, and daily volume would increase 34 percent. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
686 citations
TL;DR: In this paper, the authors reexamine the autocorrelation patterns of short-horizon stock returns and provide support for a market efficiency-based explanation of the evidence.
Abstract: This article reexamines the autocorrelation patterns of short-horizon stock returns. We document empirical results which imply that these autocorrelations have been overstated in the existing literature. Based on several new insights, we provide support for a market efficiency-based explanation of the evidence. Our analysis suggests that institutional factors are the most likely source of the autocorrelation patterns.
394 citations
TL;DR: In this paper, the authors derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to result in an (unique) equilibrium outcome.
Abstract: A firm must decide what security to sell to raise external capital to finance a profitable investment opportunity. There is ex ante asymmetry of information regarding the probability distribution of cash flow generated by the investment. In this setting, we derive necessary and sufficient conditions for a security to be optimal (uniquely optimal), that is, for pooling at this security to be an (the unique) equilibrium outcome. Using these conditions we show that the debt contract is (uniquely) optimal if and only if cash flows are ordered by (strict) conditional stochastic dominance. Finally, we derive an equivalence relationship between optimal security designs and designs that minimize mispricing.
355 citations
TL;DR: In this paper, a two-equation econometric model of quote revisions and transaction returns is developed and used to identify the relative importance of different microstructure theories and to make predictions.
Abstract: To what extent are the empirical regularities implied by market microstructure theories useful in predicting the short-run behavior of stock returns A two-equation econometric model of quote revisions and transaction returns is developed and used to identify the relative importance of different microstructure theories and to make predictions. Microstructure variables and lagged stock index futures returns have in-sample and out-of-sample predictive power based on data observed at five-minute intervals. The most striking microstructure implication of the model, confirmed by the empirical results, specifies that the expected quote return is positively related to the deviation between the transaction price and the quote midpoint while the expected transaction return is negatively related to the same variable. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this article, the authors analyzed the effect of insider trading on information revelation and risk sharing in the stock market and found that the option mitigates the market breakdown problem created by the combination of market incompleteness and asymmetric information.
Abstract: We analyze the introduction of a nonredundant option, which completes the markets, and the effects of this on information revelation and risk sharing. The option alters the interaction between liquidity and insider trading. We find that the option mitigates the market breakdown problem created by the combination of market incompleteness and asymmetric information. The introduction of the option has ambiguous consequences on the informational efficiency of the market. One the one hand, by avoiding market breakdown, it enables trades to occur and convey information. On the other hand, the introduction of the option enlarges the set of trading strategies the insider can follow. This can make it more difficult for the market makers to interpret the information content of trades and consequently can reduce the informational efficiency of the market. The introduction of the option also has an ambiguous effect on the profitability of insider trades, which can either increase or decrease depending on parameter values. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, the authors show that S&P 500 stock betas are overstated and non-S&P500 stock bets are understated because of liquidity price effects caused by the S&Ps 500 trading strategies.
Abstract: this paper shows that S&P 500 stock betas are overstated and the non-S&P 500 stock betas are understated because of liquidity price effects caused by the S&P 500 trading strategies The daily and weekly betas of stocks added to the S&P 500 index during 1985-1989 increase, on average, by 0211 and 0130 The difference between monthly betas of otherwise similar S&P 500 and non-S&P 500 stocks also equals 0125 during this period Some of these increases can be explained by the reduced nonsynchroneity of S&P 500 stock prices, but the remaining increases are explained by the price pressure or excess volatility caused by the S&P500 trading strategies I estimate that theprice pressures accountfor 85 percent of the total variance of daily returns of a value-weighted portfolio of NYSE/AMEX stocks The negative own autocorrelations in S&P 500 index returns and the negative cross autocorrelations between S&P 500 stock returns provide further evidence consistent with the price pressure hypothesis
TL;DR: In this article, the authors examined common stock prices around ex-dividend dates and predicted that such mixing will result in a nonlinear relation between percentage price drop and dividend yield, not the commonly assumed linear relation.
Abstract: This study examines common stock prices around ex-dividend dates. Such price data usually contain a mixture of observations--some with and some without arbitrageurs and/or dividend capturers active. Our theory predicts that such mixing will result in a nonlinear relation between percentage price drop and dividend yield--not the commonly assumed linear relation. This prediction and another important prediction of theory are supported empirically. In a variety of tests, marginal price drop is not significantly different from the dividend amount. Thus, over the last several decades, one-for-one marginal price drop has been an excellent (average) rule of thumb. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, the authors consider the multi-period relationship between a client and a portfolio manager and explore the optimal retention policy of the client and find that the optimal initial set of contracts features a smaller performance based fee component paid to the manager than in a first-best contract, and the contract choice elicits only partial information about the manager.
Abstract: We consider the multiperiod relationship between a client and a portfolio manager and the resulting problem of motivating a manager of unknown ability to acquire valuable information. We explore the contractual forms and the optimal retention policy of the client and find that the optimal initial set of contracts features a smaller performance based fee component paid to the manager than in a first-best contract, and the contract choice elicits only partial information about the manager. As a result, ex post performance measurement is critical to future recontracting. In general, managers are retained only if the returns on their portfolio exceed the benchmark by an appropriate amount. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this article, the authors examine a model in which an insider/manager allocates resources on the basis of his private information and outside information conveyed through the secondary market price of the firm's shares.
Abstract: We show that entrepreneurs may prefer to allow insider trading even when it is not socially optimal. We examine a model in which an insider/manager allocates resources on the basis of his private information and outside information conveyed through the secondary-market price of the firm's shares. If the manager is allowed to trade, he will compete with informed outsiders, reducing the equilibrium quality of outside information. While the benefits to production of outside information are the same for society and entrepreneurs, we show that the social and private costs are different. Thus, entrepreneurs and society may disagree on the conditions under which insider trading restrictions should be imposed. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: This paper used 40 years of hourly Dow Jones 65 Composite price index data to estimate transitory volatility throughout the trading day and found that transitory price volatility is greater at the open of trading than at the close.
Abstract: Prior analyses of prices of the NYSE and other exchanges find that transitory price volatility is greater at the open of trading than at the close. We extend this line of research by using 40 years of hourly Dow Jones 65 Composite price index data to estimate transitory volatility throughout the trading day. Our results indicate that transitory volatility steadily declines during the trading day. We find a similar intraday decline in transitory volatility for a 2 1/2-year sample of the individual firms in the Dow Jones 30 Industrials Index. The results are consistent with the hypothesis that trading aids price formation and do not support the argument that particular trading mechanisms are the source of greater volatility at the open of trading. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In an infinitely repeated version of the Diamond and Dybvig (1983) model, intergenerational transfers enable a bank to achieve interest rate smoothing and to provide depositors with liquidity insurance as mentioned in this paper.
Abstract: In an infinitely repeated version of the Diamond and Dybvig (1983) model, intergenerational transfers enable a bank to achieve interest rate smoothing and to provide depositors with liquidity insurance without Diamond and Dybvig's assumption of no side trades. The bank is subject to runs that may result from either excessive withdrawals or the lack of new deposits. The latter cause, which cannot occur in Diamond and Dybvig's one-generation model, implies that suspension of convertibility may not prevent bank runs. Government intervention may be necessary to maintain bank stability. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: The authors examined the capital expenditures of a sample of 700 takeover targets and firms that went private over the period 1972-1987 and did not find evidence that takeover targets increase their capital expenditures over the four-year period before the acquisition or that they overinvest in capital expenditures relative to several benchmarks.
Abstract: I examine the capital expenditures of a sample of 700 takeover targets and firms that went private over the period 1972-1987. For the complete sample, I do not find evidence that takeover targets increase their capital expenditures over the four-year period before the acquisition or that they overinvest in capital expenditures relative to several benchmarks. Subsample results provide some evidence of overinvestment in oil and gas firms and large firms. There is no evidence of overinvestment, however, for firms acquired in a hostile takeover or firms that went private. In general, these results are not consistent with the conjecture that takeovers are motivated by the need to reduce excess investment in capital expenditures in target firms. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, the authors found that program trading and intraday changes in the S&P 500 Index are correlated. But they did not find that program trades in this 1989-1990 sample did not seem to have created major shortterm liquidity problems.
Abstract: Program trading and intraday changes in the S&P 500 Index are correlated. Future prices and, to a lesser extent, cash prices lead program trades. Index arbitrage trades are followed by an immediate change in the cash index, which ultimately reverses slightly. No reversal follows nonarbitrage trades. The cumulative index changes associated with buy-and-sell trades and with arbitrage and nonarbitrage trades all are similar. Price decompositions suggest that the results are not due to microstructure effects. Program trades in this 1989-1990 sample do not seem to have created major short-term liquidity problems. The results are stable within the sample. Many practitioners, regulators, and public commentators have expressed concerns about potential destabilizing effects of program trading. They argue that program trades–especially index arbitrage programs–increase intraday volatility and decrease
TL;DR: In this paper, the authors show that the stock price reaction to a repurchase announcement is positively related to previous period's dividends and to earnings innovations, and that when their stock is sufficiently undervalued, firms distribute all accumulated cash through stock repurchases.
Abstract: We propose that it is precisely because firms' repurchases of their own stock through tender offers are associated with large stock-price increases that repurchases are unattractive as a means of distributing cash. As a result, firms distribute some cash in the form of dividends--despite the tax disadvantage--and carry the rest to future periods. However, when their stock is sufficiently undervalued, firms distribute all accumulated cash through stock repurchases. We show that dividends are smoothed and are positively related both to earnings innovations and to previous period's dividends. Also, the stock-price reaction to a repurchase announcement, of a given size, is increasing in the previous period's dividends. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In a model with asymmetric information and external equity financing, it is impossible to achieve socially optimal investment because of renegotiation possibilities as mentioned in this paper, and no other compensation contract that would induce the manager to invest efficiently survives renegotiation.
Abstract: In a model with asymmetric information and external equity financing, it is impossible to achieve socially optimal investment because of renegotiation possibilities. The contractual solution suggested by Dybvig and Zender (1991) is not dynamically consistent--the manager's contract would be renegotiated, resulting in inefficient investment. Moreover, no other compensation contract that would induce the manager to invest efficiently survives renegotiation. Contracts that pay the manager based on the stock price, while producing suboptimal investment as in Myers and Majluf (1984), are robust to renegotiation. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: The authors proposed alternative generalized method of moments (GMM) tests that are analytically solvable in many econometric models, yielding in particular analytical GMM tests for asset pricing models with time-varying risk premiums.
Abstract: We propose alternative generalized method of moments (GMM) tests that are analytically solvable in many econometric models, yielding in particular analytical GMM tests for asset pricing models with time-varying risk premiums. We also provide simulation evidence showing that the proposed tests have good finite sample properties and that their asymptotic distribution is reliable for the sample size commonly used. We apply our tests to study the number of latent factors in the predictable variations of the returns on portfolios grouped by industries. Using data from October 1941 to September 1986 and two sets of instrumental variables, we find that the tests reject a one-factor model but not a two-factor one. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this article, the effect of cross-holdings on market capitalization and return measures as well as their implications for econometric testing of asset pricing theories are analyzed and the implications for risk-return estimates in equilibrium asset pricing models.
Abstract: Cross-holding occurs when listed corporations own securities issued by other corporations. We analyze the effect of cross-holdings on market capitalization and return measures as well as implications for econometric testing of asset pricing theories. We show that cross-holdings generally distort standard market return and risk measures The magnitudes of such distortions are calculated for simulated economies by using a variety of crossholding patterns. In addition, cross-holdings are shown to induce nonstationarity in the covariance matrix of security returns. We examine the effect of this nonstationarity for estimating efficient frontiers and factor structures. We also discuss the implications for risk-return estimates in equilibrium asset pricing models. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, the effect of changes in output uncertainty on the price of aggregate capital and on the prices of levered claims on capital was examined, and it was shown that increased risk was responsible for the U.S. stock market decline of the 1970s.
Abstract: We examine the effect of changes in output uncertainty on the price of aggregate capital and on the prices of levered claims on capital. The relation between the volatility of the marginal product of capital and the price of capital depends on the level of capital adjustment costs and the elasticity of intertemporal substitution. For available estimates of this elasticity, the value of capital and risks are directly related while the value of levered equity claims on capital may be decreasing in risk. We use these results to analyze the argument that increased risk was responsible for the U.S. stock market decline of the 1970s. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, a mixed jump-diffusion model was used to estimate the effect of information surprise and strategic trading around corporate events, and they found that for more than 93 percent of the firms in their sample the mixed jump diffusion model is statistically superior to the pure diffusion model in describing stock returns.
Abstract: I present a methodology that uses the mixed jump-diffusion model for stock returns to estimate the separate effects of information surprises and strategic trading around corporate events. Using simulation techniques, I show that for events with multiple announcements spread over a long time, the estimators derived from the mixed jump-diffusion model are more powerful compared to the traditional cumulative abnormal return estimators. The new methodology is used to study the separate effects of information surprises and strategic trading associated with blockholdings and subsequent targeted repurchases. I find that for more than 93 percent of the firms in our sample the mixed jump-diffusion model is statistically superior to the pure diffusion model in describing stock returns. More important, I find a statistically significant negative effect due to trading, while the average effect around announcements is statistically insignificant. In contrast, the standard cumulative abnormal return is not statistically different from zero. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
TL;DR: In this paper, Kandel and Stambaugh provide the rejection regions in sample mean-variance space for likelihood ratio tests of various asset-pricing models when no riskless asset exists.
Abstract: In Kandel and Stambaugh (1989), we provide the rejection regions in sample mean-variance space for likelihood ratio tests of various asset-pricing models. When a riskless asset exists, we note that, in some cases, there can be no rejection region to construct in sample mean-variance space. That is, there can be samples in which no portfolio would produce a likelihood-ratio test statistic above the critical value for a given significance level (see Propositions 1 and 4). [This possibility was first noted in Kandel and Stambaugh (1987).] What we failed to observe is that a similar phenomenon can arise when no riskless asset exists. It is possible in that case as well to have samples in which there are no portfolios that produce a likelihood ratio test-statistic above the critical value. Specifically, WA, the transformation of the likelihood ratio (defined on page 135 of our article) has an upper bound equal to D/L (where D and L are defined on page 129). As a result, there is no rejection region ex post whenever the critical value for WA exceeds DIL. The critical parabolas given in Propositions 2, 3, and 5 are therefore defined only when, in each proposition, the argument of 6, ( ) and 62 ( ) is less than DIL. Although this outcome does not occur in any of the