Showing papers on "Market liquidity published in 1993"

Market Liquidity and Performance Monitoring

Abstract: This paper studies the value of the stock market as a monitor of managerial performance. It shows that the stock price incorporates performance information that cannot be extracted from the firm's current or future profit data. The additional information is useful for structuring managerial incentives. The amount of information contained in the stock price depends on the liquidity of the market. Concentrated ownership, by reducing market liquidity, reduces the benefits of market monitoring. Integration is associated with weakened managerial incentives and less market monitoring. This may explain why shares of divisions of a firm are rarely traded. The model offers a reason why market liquidity and monitoring have both a private and a social value, a feature missing in standard finance models. This is used to study the equilibrium size of the stock market as a function of investor preferences and the available amounts of long- and short-term capital.

Credit Market Constraints, Consumption Smoothing and the Accumulation of Durable Production Assets in Low-Income Countries: Investments in Bullocks in India

Abstract: In this paper we formulate and estimate a finite-horizon, structural dynamic model of agricultural investment behavior that incorporates the major features of low-income agricultural environments: income uncertainty, constraints on borrowing and rental markets, and the use of investment assets to generate income and smooth consumption. The model is fit to longitudinal Indian household data on farm profits, bullock stocks, and pump sets. The estimated structural parameters are used to assess the effects on the life cycle accumulation of bullocks, agricultural profits, and welfare associated with complete markets and bullock liquidity and with second-best policies that provide assured sources of income to farmers and weather insurance.

Sticking It Out: Entrepreneurial Survival and Liquidity Constraints

Abstract: We examine why some individuals survive as entrepreneurs and others do not. In addition. we analyze the growth of entrepreneurial enterprises, conditional on surviving. Our focus is on the role of access to capital--to what extent do liquidity constraints increase the likelihood of entrepreneurial failure? The empirical strategy is based on the following logic: If entrepreneurs cannot borrow to attain their profit-maximizing levels of capital, then those entrepreneurs who have substantial personal financial resources will be more successful than those who do not. The data consist of the 1981 and 1985 federal individual income tax returns of a group of people who received inheritances. These data allow us to identify those individuals who were sole proprietors in 1981, and to determine the extent to which the decision to remain a sole proprietor was influenced by the magnitude of the inheritance-induced increase in liquidity. The results are consistent with the notion that liquidity constraints exert a noticeable ifluence on the viability of entrepreneurial enterprises. For example, a $150,000 inheritance increases the probability that an individual will continue as a sole proprietor by 1.3 percentage points, and conditional on surviving, the receipts of the enterprise increase by almost 20 percent.

Limited market participation and volatility of asset prices

Abstract: Traditional asset-pricing theories assume complete market participation, despite considerable empirical evidence that most investors participate in a limited number of markets. The authors show that once the participation decision is endogenized, market properties change dramatically. First, limited market participation can amplify the effect of liquidity trading relative to full participation; under certain circumstances, an arbitrarily small aggregate liquidity shock can cause significant price volatility. Second, there exist multiple equilibria with very different participation regimes and levels of asset-price volatility. Third, under plausible conditions the equilibria can be Pareto-ranked; the Pareto-preferred equilibrium is characterized by greater participation and lower volatility. Copyright 1994 by American Economic Association.

The Trades of Market Makers: An Empirical Analysis of NYSE Specialists

Abstract: This paper presents a transaction-level empirical analysis of the trading activities of New York Stock Exchange specialists. The main findings of the analysis are the following. Adjustment lags in inventories vary across stocks, and are in some cases as long as one or two months. Decomposition of specialist trading profits by trading horizon shows that the principal source of these profits is short term. An analysis of the dynamic relations among inventories, signed order flow, and quote changes suggests that trades in which the specialist participates have a higher immediate impact on the quotes than trades with no specialist participation. THE IMPORTANCE OF LIQUIDITY in securities markets motivates strong interest in the trading behavior of dealers. Dealers seek to provide liquidity in an ongoing manner and they can influence the short-run dynamics of securities prices through their trading behavior. Not surprisingly, many academic studies examine dealers' trading activities and their role in price determination. Because of the difficulty in obtaining detailed data, most (but not all) of this work is theoretical. Several important empirical issues, therefore, remain unresolved. This paper analyzes inventory adjustment, price determination, and trading profits for one important class of dealers, New York Stock Exchange (NYSE) specialists.'

Price Formation and Equilibrium Liquidity in Fragmented and Centralized Markets

Abstract: This paper compares centralized and fragmented markets, such as floor and telephone markets. Risk-averse agents compete for one market order. In centralized markets, these agents are market makers or limit order traders. They are assumed to observe the quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. We analyze differences in bidding strategies reflecting differences in market structures. The equilibrium number of dealers is shown to be increasing in the frequency of trades and the volatility of the value of the asset. The expected spread is shown to be equal in both markets, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets. THIS PAPER ANALYZES FRAGMENTED markets and compares them to centralized markets. Telephone dealer markets such as NASDAQ, SEAQ, the foreign exchange market, and the Treasury bonds market are fragmented. Examples of centralized markets are the stock and futures exchanges, such as the NYSE or the CBOT. In the latter, all the orders are addressed to the same location so that market participants can observe all the quotes and trades and take them into account in their strategies. In the former, deals are the outcome of bilateral negotiations that other market participants cannot observe. Consequently information about market conditions is more readily available in centralized markets than in fragmented markets. This difference in market structures affects the behavior of the agents who provide liquidity to the market. Suppliers of liquidity, i.e., market makers, dealers, or limit order traders can be seen as bidders in the auction for the order flow from market order traders. The bids are the ask and bid quotes. There are two determinants of the quotes. First, they depend on the agents' private valuations of the asset. In the present paper, the agents are assumed to have the same information about the final value of the asset, but they are

Asymmetric information, liquidity constraints, and Canadian investment

Abstract: A new theoretical literature has suggested that the Modigliani-Miller Theorem may not hold under imperfect information and that liquidity may affect a firm's investment spending. This paper provides three original tests for such capital market imperfections, based on predicted differences in investment between firms in different informational positions with respect to potential creditors or investors. The empirical tests suggest that information asymmetries have a large effect on investment behaviour. The form of the tests reduces the likelihood of biases due to problems of endogeneity. The paper also examines the effect of differential measurement error on the tests. Information asymetrique, contraintes de liquidite et investissements au Canada. Une nou- velle litterature theorique suggere qu'il se pourrait que le theoreme Modigliani-Miller ne soit pas verifie quand l'information est imparfaite, et que le niveau de liquidite puisse affecter les depenses d'investissement d'une firme. Ce memoire propose trois tests originaux des effets de telles imperfections du marche du capital fondes sur les differences predites dans l'investissement entre firmes qui ont des positions informationnnelles differentes par rapport aux investisseurs potentiels. Les tests empiriques suggerent que les asymetries d'information ont un effet important sur les comportements d'investissement. La forme de ces tests reduit la possibilite de biais attribuables aux problemes d'endogeneite. Le memoire examine aussi les effets de l'erreur differentielle de mesure sur les tests.

Separating the likelihood and timing of bank failure

Abstract: We use a split-population survival-time model to separate the determinants of bank failure from the factors influencing the survival time of failing banks. Basic indicators of a bank's condition, such as capital, troubled assets, and net income, are important in explaining the timing of bank failure. However, many of the other variables typically included in bank failure models, such as measures of bank liquidity, are not associated with the time to failure. The results also suggest that the closure of large banks is not delayed relative to the closure of small banks.

Accounting measures of corporate liquidity, leverage, and costs of financial distress

Abstract: Liquid assets such as cash and marketable securities constitute a considerable portion of total assets, say 6.3% to 9.6%, of manufacturing firms. Financial managers pay a lot of attention to the measurement and management of corporate liquidity. It has also been recognized that a consequence of severe shortage of liquidity is financial distress. This study analyzes the relationship of the costs of financial distress to the level of corporate liquidity maintained and leverage.

The Effect of Public Information and Competition on Trading Volume and Price Volatility

Abstract: In a one-period model of market making with many exogenously informed traders, we first show that the variance of prices and expected.trading volume depend on the public information released at the start of trading. This is accomplished by representing beliefs with elliptically countoured distributions, for which the form of optimal decision rules does not depend on the specific distribution used. Second, if the model is altered so that the decision to become informed is made endogenous, then the decision rules of the market-maker and infomed traders depend on the public information. Third, in a multiperiod model with many informed traders and long-lived private information, recursion formulas similar to those of Kyle (1985) hold for all elliptically contoured distributions, trading volume is autocorrelated, and, unless per period liquidity trading is bounded.away from zero as new trading periods are added, informed traders' profits vanish. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

The Effect of Borrowing Constraints on Consumer Liabilities

Abstract: This paper explores the effects of liquidity constraints on consumer liabilities. While much empirical evidence attests to the importance of liquidity constraints in the U.S. economy, evidence about the effects of borrowing constraints on consumer balance sheets is scarce. Using the 1983 Survey of Consumer Finances data we estimate desired borrowing for unconstrained households. We then evaluate the gap between predicted.and observed debt for the sample of liquidity constrained consumers. Predicted debt is 75 percent higher than actual debt in the liquidity constrained sample. Thus, the effect of removing borrowing constraints has quantitatively important implications for the allocation of debt in the household portfolio. The removal of borrowing constraints would raise aggregate household liabilities by 9 percent. Copyright 1993 by Ohio State University Press.

Consumer response to the timing of income: Evidence from a change in tax withholding

Abstract: In 1992, the income tax withholding tables were adjusted so that withholding was reduced. A typical worker received an extra $28.80 in take-home pay per month in March through December 1992, to be offset by a lower tax refund in 1993. The change in withholding amounted to 0.5 percent of GDP. President Bush, who proposed this change in his State of the Union address, intended that it provide a temporary stimulus to demand. But the policy change involved only the timing of income, so, under the life-cycle/permanent-income model, it would be predicted to have a negligible effect on consumption and aggregate demand. This paper reports consumers' responses to the change in withholding. The results are based on a survey taken shortly after it went into effect. Forty-three percent of consumers report spending the extra take-home pay--substantially more than the zero percent predicted by the standard models, but substantially less than the one hundred percent upon which the policy was predicated. The decision to save the income is not explained by expected income growth. Therefore, while behavior of many households is not fully consistent with the life-cycle/permanent-income model, liquidity constraints do not appear to account for this behavior.

Output Collapse in Eastern Europe: The Role of Credit

Abstract: Real bank credit in Eastern European countries after their recent stabilization programs is shown to have fallen sharply, except in the case of Hungary. The meaning of the fall is discussed from the present value and liquidity perspectives. Moreover, it is shown that the hypothesis that the output contraction may partly owe to a credit contraction cannot be ruled out. The hypothesis is tested on a sample of 85 branches of industry in Poland. Also analyzed are the rationale for expecting a connection between credit and output and the policy options available to mitigate the liquidity crunch in postsocialist economies.

Cash conversion cycle and firm size: a study of retail firms

Abstract: Many businesses are faced with liquidity problems for various reasons This is especially true for small businesses, since most must operate with fewer sources of both short and long term financing than larger firms Where less financing is available, more assets must be held in liquid form to meet daily transactions and emergency requirements Larger firms, that have better access to both the money and capital markets, can afford to hold fewer current assets and meet cash requirements just as quickly and efficiently through borrowing

The Effect Of Borrowing Constraints On Consumer Liabilities

Abstract: This paper explores the liquidity constraint on consumer liabilities. While much empirical evidence attests to the importance of liquidity constraints in the U.S. economy, evidence about the effects of borrowing constraints on consumer balance sheets is scarce. Using the 1983 Survey of Consumer Finances data we estimate desired borrowing for unconstrained households. We then evaluate the gap between predicted and observed debt for the sample of liquidity-constrained consumers. Predicted debt is 75 percent higher than actual debt in the liquidity constrained samples. Thus, the effect of removing borrowing constraints has quantitatively important implications for the allocation of debt in the household portfolio. The removal of borrowing constraints would raise aggregate household liabilities by 9 percent.

Liquidity as a Choice Variable: A Lesson from the Japanese Government Bond Market

Abstract: In Japan, almost identical government bonds can be trade at large price differentials. Motivated by this phenomenon, we examine the issue of the value of liquidity in markets for riskless securities. We develop a model of an issuer of bonds, a market maker, and heterogeneous investors trading in an incomplete market. We show not only that divergent prices for similar securities can be sustained in a rational expectations equilibrium, but also that this divergnece may be optimal from the perspective of the issuer. Price segmentation is possible because agents have a desire to trade, but shortsale restrictions limit their trading strategies and prevent them from forcing bond prices to be equal. Restricting the form of market making to exclude price competition and unregulated profit maximization is also necessary to sustain price segmentation. The optimality of segmentation from the issuer's standpoint arises because of the issuer's standpoint arises because of the issuer's ability to charge for the liquidity services provided to the investors. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Network Economics with Application to Finance

Abstract: Networks are common in financial services. Perfect competition does not decentralize optimality on a network, and coordination of participants expectations and investments is crucial for success. Financial exchange networks exhibit two kinds of externalities: liquidity enhancement by size expansion, and underpriced provision of market price information to outside rivals. We discuss the interaction of these externalities in alternative exchange network structures.

Sticking it Out: Entrepreneurial Survival and Liquidity Constraints

Abstract: This paper analyzes the role of liquidity constraints in the formation of new entrepreneurial enterprises. The basic empirical strategy is to determine whether an individual's wealth affects the probability of becoming an entrepreneur, and the conditional amounts of depreciable assets, ceteris paribus. If so, liquidity constraints are likely to be present. To be successful, such a research strategy requires a measure of asset variation that is both precisely measured and exogenous to the entrepreneurial decision. Our data are uniquely well-suited for this purpose. The sample consists of the 1981 and 1985 federal income tax returns of a group of people who received inheritances in 1982 and 1983, along with information on the size of those inheritances from a matched set of estate tax returns. Hence, we can examine how the exogenous receipt of capital affects the decision to become an entrepreneur and important financial characteristics of new enterprises. Our results suggest that the size of the inheritance has a substantial effect on the probability of becoming an entrepreneur, and that conditional on becoming an entrepreneur, the size of the inheritance has a statistically significant and quantitatively important effect on the amount of capital employed. These findings are consistent with the presence of liquidity constraints.

Effect Of Liquidity On Firms' R&D Spending

Abstract: The effect of firms financial condition on their R&D investment is explored using a relatively long panel data set for five high-technology industries. We find that financial condition, whether measured as cash flow, the stock of liquid assets or the ratio of liquid assets to current liabilities, does affect the R&D spending of small firms. The effect persists after controlling for unobserved permanent firm effects, and the pattern of significance of lagged effects supports the interpretation of causality running from liquidity to R&D. For larger firms, there is no evidence of such an effect. Using these data, we cannot say whether the absence of an effect in larger firms results from better access to capital markets or from higher adjustment costs in R&D.

A Primer on Tax Evasion

Abstract: Tax evasion is universal. It depends on the economic and tax structures, types of income, and social attitudes. The theory of tax evasion has limitations since it rests solely on attitudes toward risk, with full information regarding the tax administration's behavior. Methodologies for estimating tax evasion include estimating the underground economy and comparing declared taxes with potential tax revenue calculated from national accounts. Measures to address tax evasion include use of withholding, presumptive and minimum taxes, selective auditing, penalties, and cross checks between taxes.

Franchising, liquidity constraints and entry

Abstract: The short- and long-run incentives to franchise are considered. While monitoring problems due to geographic dispersion ensure that franchising is an efficient organizational form in the long run, entry costs suggest that franchising is an efficient solution to the formidable problems posed by entry in the short run. This explains the intensive use of franchising in the early growth stages, followed by a greater proportion of company-owned outlets as the system matures.

Liquidity Effects of the Introduction of the S&P 500 Index Futures Contract on the Underlying Stocks

Abstract: This study examines bid-ask spreads in the stock market around the introduction of the Standard and Poor's (S&P) 500 index futures contract and tests the following competing hypotheses: (1) stock spreads may widen as uninformed traders migrate to futures and (2) spreads may narrow because specialists can hedge better. The authors' analysis suggests that, after controlling for changes in other spread determinants, average spreads of S&P 500 stocks increased significantly. Though an additional test suggests an increase in the adverse-selection component of the spread in the postfutures period, this increase is not reliably different from zero. Copyright 1993 by University of Chicago Press.

Finance and development: issues and experience: Finance and development: the case of Southern Italy

Abstract: We look at the role of the financial sector in the context of the relatively backward regions of Southern Italy (the so-called Mezzogiorno). Commercial banks in the South typically have higher operating costs and charge higher interest rates than Northern banks. Econometric analysis on a large set of individual loan contracts suggests that borrowers in the South are considerably riskier than those elsewhere in Italy. It also indicates, however, that risk accounts for only half of the 200 basis points average North-South interest differential. The rest is largely accounted for by differences in operating costs. We argue that these findings reflect a situation in which Southern banks have a monopoly of information concerning local firms, with outside banks forced to resort to rationing practices to avoid attracting the worse borrowers. To support this interpretation, we analyse loan contracts of Southern firms who borrow at the same time from local and external banks. We also show that geographical proximity tends to raise interest rates in the South. We then turn to the issue of allocative efficiency and argue that Southern banks tend to perform their screening function less efficiently than banks in the rest of Italy. We finally show that in the South, risk exerts a significantly larger effect on borrowing and that Southern firms whose earnings are more variable are more likely to be liquidity constrained in their investment decision.

Price Competition between Market Makers

Abstract: The paper explicitly models price competition in financial markets in which prices are quoted by competing dealers before future demand is observed. The strategic behaviour of informed insiders and uninformed liquidity traders implies that a growing number of market makers leads to a higher risk exposure for the individual market maker which induces higher individual bid-ask-spreads and higher transaction costs for the liquidity traders. Under certain conditions liquidity traders would prefer a monopolistic market maker rather than several competing market makers. The results hold under various assumptions on the strategy space of the market makers.

Further evidence on managerial motives for stock splits

Abstract: This field research study uses the responses from a 1991 mail survey to examine managerial motives for issuing stock splits. The sample consists of 251 NYSE and AMEX firms that issued stock splits of at least 25 percent between January 1, 1987 and December 31, 1990. Based on survey data from 136 responding firms, the evidence suggests that the main motive of a split is moving the stock price into a better trading range, followed by improving trading liquidity. The results also show that the mean preferred trading range of stock split firms is from $20 to $35, but differs between firms with small (< 2-for-l) versus large (22-for-l) stock splits.

The Role of Liquidity in Futures Market Innovations

Abstract: I characterize the optimal design of a new futures market (an innovation) by an exchange in the presence of market frictions. Futures markets am characterized by both the contract and the level of trader participation both can be determined by an exchange. A game in which exchanges simultaneously design markets is c onsidered, and a particular equilibrium (not necessarily unique) is constructed. A game in which exchanges sequentially design markets (and incur design costs) is also considered and the (generically unique) equilibrium is constructed. The nature of equilibrium with multiple exchanges is discussed in these simultaneous and sequential settings, illustrating the role played by liquidity considerations both in market design and in the nature of competition between exchanges.

Fundamentals of small business financial management for start up, survival, growth, and changing economic circumstances

Abstract: In the life of a business, the lack of adequate liquidity to meet current obligations when they come due frequently results in problems which, more often than desirable, result in the failure of the enterprise. A common cause of such small business failures at various stages in the business's life cycle is poor financial planning. One planning deficiency which results in early failure is under capitalization. Under capitalization results from several errors made during the initial stages of financial planning and implementation. Cash flow problems are a common symptom among businesses with this problem.