Showing papers in "The Journal of Business in 2006"
TL;DR: In this paper, a class of discontinuous processes exhibiting a jump-reversion component was introduced to properly represent these sharp upward moves shortly followed by drops of similar magnitude, which allows to capture both the trajectorial and the statistical properties of electricity pool prices.
Abstract: This paper analyzes the special features of electricity spot prices derived from the physics of this commodity and from the economics of supply and demand in a market pool. Besides mean-reversion, a property they share with other commodities, power prices exhibit the unique feature of spikes in trajectories. We introduce a class of discontinuous processes exhibiting a jump-reversion component to properly represent these sharp upward moves shortly followed by drops of similar magnitude. Our approach allows to capture - for the first time to our knowledge - both the trajectorial and the statistical properties of electricity pool prices. The quality of the fitting is illustrated on a database of major US power markets.
454 citations
TL;DR: The authors studied the effect of loan portfolio focus versus diversification on the return and the risk of 105 Italian banks over the period 1993-99 using data on bank-by-bank exposures to different industries and sectors.
Abstract: We study the effect of loan portfolio focus versus diversification on the return and the risk of 105 Italian banks over the period 1993–99 using data on bank‐by‐bank exposures to different industries and sectors. We find that diversification is not guaranteed to produce superior performance and/or greater safety for banks. For high‐risk banks, diversification reduces bank return while producing riskier loans. For low‐risk banks, diversification produces either an inefficient risk‐return trade‐off or only a marginal improvement. Our results are consistent with a deterioration in the effectiveness of bank monitoring at high risk‐levels and upon lending expansion into newer or competitive industries.
454 citations
TL;DR: In this paper, the authors model an IPO company's optimal response to the presence of sentiment investors, and generate refutable predictions regarding the extent of long-run underperformance, offer size, flipping, and lockups.
Abstract: We model an IPO company’s optimal response to the presence of sentiment investors. “Regular” investors are allocated stock that they subsequently sell to sentiment investors. Because sentiment demand may disappear prematurely, carrying IPO stock in inventory is risky, so for regulars to break even the stock must be underpriced. The issuer still gains as the offer price capitalizes part of the regulars’ expected trading gain. This resolves the empirical puzzle that issuers do not appear to price their stock aggressively in hot markets. The model generates new refutable predictions regarding the extent of long‐run underperformance, offer size, flipping, and lockups.
418 citations
TL;DR: This article developed a method to generate estimates of higher frequency covariances when one variable is observed at lower frequencies (e.g., quarterly changes in institutional ownership and monthly stock returns).
Abstract: Although the relation between quarterly changes in institutional investor ownership and contemporaneous stock returns is well documented, the source of the relation remains unclear because institutional ownership data are unavailable at higher frequencies. In this study, we develop a method to generate estimates of higher frequency covariances when one variable is observed at lower frequencies (e.g., quarterly changes in institutional ownership and monthly stock returns). Our method provides evidence that institutional trading has both temporary and permanent price effects and that the latter is associated with information effects.
386 citations
TL;DR: In this article, the authors investigate why individual stocks become more volatile over the 1976-2000 period, during which quarterly accounting data are available at the firm level, and investigate the relationship between stock return volatility and corporate earnings.
Abstract: We investigate why individual stocks become more volatile over the 1976–2000 period, during which quarterly accounting data are available at the firm level. On average, corporate earnings have deteriorated and their volatilities have increased over the sample period. This is more evident for newly listed stocks than for existing stocks. The stock return volatility is negatively related to the return‐on‐equity and positively related to the volatility of the return‐on‐equity in cross‐sections. The upward trend in average stock return volatility is fully accounted for by the downward trend in the return‐on‐equity and the upward trend in the volatility of the return‐on‐equity.
383 citations
TL;DR: This article explored various hypotheses to explain accruals' predictive power, such as extrapolative biases about future growth, and underreaction to changes in business conditions, and provided checks for robustness using within industry comparison and data on U.K. stocks.
Abstract: An exclusive focus on bottom‐line income misses important information contained in accruals (the difference between accounting earnings and cash flow) about the quality of earnings. Earnings increases that are accompanied by high accruals, suggesting low‐quality earnings, are associated with poor future returns. We explore various hypotheses—earnings manipulation, extrapolative biases about future growth, and underreaction to changes in business conditions—to explain accruals’ predictive power. Checks for robustness using within‐industry comparisons and data on U.K. stocks are also provided.
372 citations
TL;DR: In this paper, a detailed data set on Thai firms before the Asian crisis of 1997 was used to examine whether business connections predicted preferential access to long-term bank credit, and they found that firms with connections to banks and politicians had greater access to a longterm debt than firms without such ties.
Abstract: We used a detailed data set on Thai firms before the Asian crisis of 1997 to examine whether business connections predicted preferential access to long‐term bank credit. We found that firms with connections to banks and politicians had greater access to long‐term debt than firms without such ties. Connected firms needed less collateral, obtained more long‐term loans, and appeared to use fewer short‐term loans than those without connections. We found no connections between banks and firms reducing asymmetric information problems. This is consistent with research implicating weak corporate governance in the extent and severity of the crisis.
348 citations
TL;DR: This article investigated the link between a firm's competitive environment and the idiosyncratic volatility of its stock returns and found that firms enjoying high market power, or established in concentrated industries, have lower volatility.
Abstract: We investigate the link between a firm’s competitive environment and the idiosyncratic volatility of its stock returns. We find that firms enjoying high market power, or established in concentrated industries, have lower idiosyncratic volatility. We posit that competition affects volatility in two distinct ways. Market power works as a hedging instrument that smoothes out idiosyncratic fluctuations. Also, market power lowers information uncertainty for investors and therefore return volatility. We find strong support for both effects. Our results contribute to the understanding of recent trends of idiosyncratic volatility and confirm the link between stock performance and firm's competitive environment.
327 citations
TL;DR: In this paper, the authors present theory and evidence of stock price manipulation, showing that manipulators trade in the presence of other traders seeking information about the stock's true value, making it easier for manipulators to trade and potentially worsening market efficiency.
Abstract: We present theory and evidence of stock price manipulation. Manipulators trade in the presence of other traders seeking information about the stock’s true value. More information seekers imply greater competition for shares, making it easier for manipulators to trade and potentially worsening market efficiency. Data from SEC enforcement actions show that manipulators typically are plausibly informed parties (insiders, brokers, etc.). Manipulation increases volatility, liquidity, and returns. Prices rise throughout the manipulation period and fall postmanipulation. Prices and liquidity are higher when manipulators sell than when they buy. When manipulators sell, prices are higher when liquidity and volatility are greater.
308 citations
TL;DR: This paper examined whether the 1990s also were characterized by increased stock market integration and found that, as forward interest differentials against Germany and inflation differentials benchmarked against the three best performing states shrank toward zero, stock markets converged toward full integration.
Abstract: The launch of the single currency in Europe in January 1999 was preceded by a period of regulatory harmonization, convergence in bond yields and inflation rates, and strict fiscal policy across the Eurozone countries. We examine whether the 1990s also were characterized by increased stock market integration. The results indicate that, as forward interest differentials benchmarked against Germany and inflation differentials benchmarked against the three best performing states shrank toward zero, stock markets converged toward full integration. The United Kingdom, a country that chose not to enter the Eurozone, shows no such increase in stock market integration.
298 citations
TL;DR: In this article, a simple Glosten-Milgrom type equilibrium model is presented to analyze the decision of informed traders on whether to use limit or market orders, and it is shown that informed traders do prefer limit orders to market orders and that limit orders are indeed more informative.
Abstract: We present a simple, Glosten-Milgrom type equilibrium model to analyze the decision of informed traders on whether to use limit or market orders. We show that even after incorporating an order’s price impact, not only may informed traders prefer to use limit orders, but the probability that they submit limit orders can be so high that limit orders convey more information than market orders. We further show that the horizon of the private information is critical for this decision and is positively related to the use of limit orders. Our empirical analysis using TORQ suggests that informed traders do prefer limit orders to market orders and that limit orders are indeed more informative. Our model is in contrast to the literature that assumes that informed traders use market orders only and the literature that examines the limit order versus the market order decision of uninformed traders.
TL;DR: This article examined the effects of the Riegle-Neal branching deregulation in the 1990s on banking market structure, service, and performance and found that a significant portion of the observed increase in branch networks can be traced to the deregulation, allowing consumers to enjoy larger fee free networks locally and regionally.
Abstract: The paper examines the effects of the Riegle-Neal branching deregulation in the 1990s on banking market structure, service, and performance. While concentration at the regional level has increased, deregulation has left almost intact the structure of metropolitan markets, which have between two and three dominant banks—controlling over half of market deposits—both at the beginning and the end of the sample. A significant portion of the observed increase in branch networks can be traced to the deregulation, allowing consumers to enjoy larger fee-free networks locally and regionally. Costs, service fees, and credit risk increase, spreads fall, and profits are unaffected.
TL;DR: In this paper, the authors relate the value of growth options in a firm's investment opportunity set to the level of debt in the firm's capital structure, which implies that book leverage should fall with the addition of growth option.
Abstract: We relate the value of growth options in the firm's investment opportunity set to the level of debt in the firm's capital structure. Underinestment costs of debt increase and free cash flow benefits fall with additional growth options. Thus, if debt capacity is defined as the amount of debt the firm optimally adds for an incremental project, then the debt capacity of growth options is negative. This result implies that book leverage should fall with the addition of growth options. Our tests, using a large sample of industrial firms, confirm this prediction.
TL;DR: In this article, the authors study how the market prices the default and liquidity risks incorporated into interest rate swap spreads, and they jointly model the Treasury, repo, and swap term structures using a five-factor affine framework and estimate the model by maximum likelihood.
Abstract: We study how the market prices the default and liquidity risks incorporated into interest rate swap spreads. We jointly model the Treasury, repo, and swap term structures using a five‐factor affine framework and estimate the model by maximum likelihood. The credit spread is driven by a persistent liquidity process and a rapidly mean‐reverting default intensity process. The credit premium for all but the shortest maturities is primarily compensation for liquidity risk. The term structure of liquidity premia increases steeply, while that of default premia is almost flat. Both liquidity and default premia vary significantly over time.
TL;DR: In this article, the authors explore factors that affect portfolio size among a sample of venture capital financing data from 214 Canadian funds and find decreasing returns to scale in the number of entrepreneurial firms financed by a venture capital fund.
Abstract: This paper explores factors that affect portfolio size among a sample of venture capital financing data from 214 Canadian funds. Four categories of factors affect portfolio size: (1) the venture capital funds’ characteristics, including the type of fund, fund duration, fund‐raising, and the number of venture capital fund managers; (2) the entrepreneurial firms’ characteristics, including stage of development, technology, and geographic location; (3) the nature of the financing transactions, including staging, syndication, and capital structure; and (4) market conditions. The data further indicate decreasing returns to scale in the number of entrepreneurial firms financed by a venture capital fund.
TL;DR: The authors examined the effect of mergers on bidding firms' stock prices and found evidence of merger momentum: bidder stock prices are more likely to increase when a merger is announced if recent mergers by other firms have been received well (a “hot” merger market) or if the overall stock market is doing better.
Abstract: This paper examines the effects of mergers on bidding firms’ stock prices. We find evidence of merger momentum: bidder stock prices are more likely to increase when a merger is announced if recent mergers by other firms have been received well (a “hot” merger market) or if the overall stock market is doing better. However, there is long run reversal. Long-run bidder stock returns are lower for mergers announced when the either merger or stock markets were hot at the time of the merger than for those announced at other times.
TL;DR: This article examined momentum and reversals in international stock market indices and found that country stock indices exhibit momentum during the first year after the portfolio formation date and reversal during the subsequent two years.
Abstract: This study examines momentum and reversals in international stock market indices. We find that country stock indices exhibit momentum during the first year after the portfolio formation date and reversals during the subsequent 2 years. Positive currency momentum predicts low stock index returns in the future, thereby weakening momentum and strengthening reversals in U.S. dollar‐denominated stock index returns. Cross‐sectional regression tests involving individual stock indices confirm the portfolio findings. Our results are consistent with a key prediction of recent behavioral theories, that initial momentum should be accompanied by subsequent reversals.
TL;DR: In this article, the authors examine Regulation FD's impact on the accuracy and dispersion of sell-side analysts' earnings forecasts and uncover two main sets of findings: individual and consensus forecasts become less accurate post-FD, particularly for early forecasts and for smaller companies.
Abstract: We examine Regulation FD’s impact on the accuracy and dispersion of sell‐side analysts’ earnings forecasts. Using a large sample of quarterly forecasts made over a nearly 10‐year period surrounding FD’s adoption, we uncover two main sets of findings. First, individual and consensus forecasts become less accurate post‐FD, particularly for early forecasts and for smaller companies. Second, forecast dispersion increases post‐FD. This effect is stronger for early forecasts and has increased with the passage of time. These results, which are quite robust to alternative empirical methodologies, suggest that there has been a reduction in both selective guidance and forecast quality post‐FD.
TL;DR: In this paper, the authors examined the relationship between the stock and futures markets in terms of lead-lag relationship, correlation, and the hedge ratio using wavelet analysis and found that there is a feedback relationship between stock and stock markets regardless of time scales, wavelet correlation between two markets varies over investment horizons but remains very high.
Abstract: This paper examines the relationship between the stock and futures markets in terms of lead‐lag relationship, correlation, and the hedge ratio using wavelet analysis. Empirical results show that (1) there is a feedback relationship between the stock and futures markets regardless of time scales, (2) wavelet correlation between two markets varies over investment horizons but remains very high, and (3) hedge ratio and the effectiveness of hedging strategies increase as the wavelet time scale increases. Simulation for utility comparisons shows that hedging effectiveness depends not only on the time scale but also on the risk aversion coefficient of an individual investor.
TL;DR: In this paper, a range-based covariance estimator motivated by a key financial economic consideration, the absence of arbitrage, in addition to statistical considerations, is proposed for multivariate volatility estimation.
Abstract: We extend range-based volatility estimation to the multivariate case. In particular, we propose a range-based covariance estimator motivated by a key financial economic consideration, the absence of arbitrage, in addition to statistical considerations. We show that this estimator is highly efficient yet robust to market microstructure noise arising from bid-ask bounce and asynchronous trading.
TL;DR: In this article, the authors use industry commodity flows information to measure vertical relations in completed mergers from 1962 to 1996 and find that almost one third of the mergers display vertical relatedness.
Abstract: We use industry commodity flows information to measure vertical relations in completed mergers from 1962 to 1996. Almost one‐third of the mergers display vertical relatedness. Vertical merger activity is more intensive in the 1980s and 1990s and less so in the 1960s and the 1970s. Vertical mergers generate positive wealth effects that are significantly larger than those for diversifying mergers; the wealth effects in vertical mergers are comparable to those in pure horizontal mergers.
TL;DR: In this paper, the authors present a model of online music sharing that incorporates economic and technological incentives to sample, purchase, and pirate, and find that lowering the cost of sampling music will propel more consumers to purchase music online as the total cost of evaluation and acquisition decreases.
Abstract: We present a model of online music sharing that incorporates economic and technological incentives to sample, purchase, and pirate. Contrary to conventional wisdom, we find that lowering the cost of sampling music will propel more consumers to purchase music online as the total cost of evaluation and acquisition decreases. Attempts to prevent sampling will be counterproductive in the long run. Sharing technologies erode the superstar phenomenon widely prevalent in the music business. Extensive empirical investigations, based on surveys and Billboard ranking charts, lend support to the economic model and validate the key results.
TL;DR: In this paper, the importance of the information contained in sector investment growth rates for explaining the cross section of equity returns was examined and an empirical specification that outperforms the capital asset pricing model and Cochrane's (1996) model was proposed.
Abstract: We examine the importance of the information contained in sector investment growth rates for explaining the cross section of equity returns. We propose an empirical specification that outperforms the capital asset pricing model and Cochrane’s (1996) model and performs at least as well as the Fama‐French (1993) and Lettau‐Ludvigson (2001) models in explaining the 25 Fama‐French size‐sorted and book‐to‐market‐sorted portfolios, as well as other sets of test assets.
TL;DR: In this article, the authors compared four signaling strategies that sellers of higher-quality products or securities employ to differentiate their products: development of a reputation for quality, third-party certification, warranties, and information disclosure.
Abstract: Signaling strategies that sellers of higher-quality products or securities employ to differentiate their products include (1) development of a reputation for quality, (2) third-party certification, (3) warranties, and (4) information disclosure. These signaling strategies are compared using data from the online auction market for classic comic books. This market's advantages include that (1) the information asymmetry is substantial, (2) good measures of reputation are available, and (3) all four signals are common. We explore which signals are strongest and why, which are substitutes or complements, and how choice among the other three strategies depends on the reputation of the seller.
TL;DR: The authors analyzed the risk management policies of 44 companies in the gold mining industry and found that firms tend to decrease hedging as prices move against them, contrary to that predicted by risk management theory.
Abstract: We analyze the corporate risk management policies of 44 companies in the gold mining industry. Firms tend to decrease hedging as prices move against them—behavior contrary to that predicted by risk management theory. These results, along with new survey evidence, suggest that firms attempt to time market prices, so‐called selective hedging. Although estimates show a statistically significant ability of producers to favorably adjust hedge ratios, this can be attributed to sample‐specific negative autocorrelation in gold prices. Economic gains to selective hedging are small, and no evidence suggests that selective hedging leads to superior operating or financial performance.
TL;DR: The authors showed that adding a set of systematic comoments (but not standard moments) of order 3-10 reduces the explanatory power of the Fama-French factors to insignificance in almost every case.
Abstract: A growing literature contends that, since returns are not normal, higher‐order comoments matter to risk‐averse investors. Fama and French (1993, 1995) find that nonmarket risk factors based on size and book‐to‐market ratio are priced by investors. We test the hypothesis that the Fama‐French factors simply proxy for the pricing of higher‐order comoments. Using portfolio returns over various time horizons, we show that adding a set of systematic comoments (but not standard moments) of order 3–10 reduces the explanatory power of the Fama‐French factors to insignificance in almost every case.
TL;DR: In this paper, the authors derived a model for the subjective and objective values of incentive options, where the subjective value is the cost to the firm of issuing the option and lies between the market and subjective values.
Abstract: Owners of incentive options invariably hold undiversified portfolios. This paper derives a model for the subjective and objective values of such options. The subjective value—the value to the holder—is less than the market value because the option is held in an undiversified portfolio and because it is exercised suboptimally from the market perspective. The objective value is the cost to the firm of issuing the option and lies between the market and subjective values. This value recognizes the suboptimal exercise but not the undiversified discount. The model, which is the Black‐Scholes model with modified parameters, is simple to use.
TL;DR: This article examined whether the decline in the number of dividend payers is purely a U.S. phenomenon or is part of a global trend and concluded that a shift in catering incentives appears most likely explain these recent changes in U.K. payout policies.
Abstract: We examine whether the decline in the number of dividend payers is purely a U.S. phenomenon or is part of a global trend. Focusing on the United Kingdom, a capital market comparable in maturity and sophistication to that of the United States, we find that the number of U.K. firms paying dividends declines from 75.9% to 54.5%. After controlling for firm size and profitability, we find a declining propensity to pay dividends over the 1998–2002 subperiod. We conclude that a shift in catering incentives appears most likely explain these recent changes in U.K. payout policies.
TL;DR: The authors study optimal bank capital choice as a dynamic trade-off between the opportunity cost of equity, the loss of franchise value following a regulatory minimum capital violation, and the cost of recapitalization.
Abstract: We study optimal bank capital choice as a dynamic trade‐off between the opportunity cost of equity, the loss of franchise value following a regulatory minimum capital violation, and the cost of recapitalization. We introduce a recapitalization delay that results in a strictly positive probability of capital adequacy violation. We calibrate the model to bank accounting return data and evaluate the model’s ability to explain observed bank capital ratios. Differences in return volatility explain a significant fraction of the cross‐sectional variation in bank capital ratios. Differences in the level of capital market imperfections across banks constitute a secondary explanation.
TL;DR: In this article, substantial variation in the prices of common stocks in U.S. markets due to firms selecting particular price ranges for their shares was found to explain roughly two-thirds of the variation in share prices.
Abstract: We document substantial variation in the prices of common stocks in U.S. markets due to firms selecting particular price ranges for their shares. Cross‐sectional evidence indicates that variables consistent with Merton’s model of capital market equilibrium explain roughly two‐thirds of this variation in share prices. In addition, measures of trading range and share price appreciation predict stock splits, and the “investor base” of firms that split their stock increases compared to other firms. We conclude that firms manage share price levels to increase the value of the firm.