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Contents
Cross-Hedging with Currency Options and Futures
Eric C. Chang and Kit Pong Wong
The Performance of Multi-Factor Term Structure Models for Pricing and
Hedging Caps and Swaptions
Joost Driessen, Pieter Klaassen, and Bertrand Melenberg
Is There Really a When-Issued Premium?
John R. Ezzell, James A. Miles, and J. Harold Mulherin
Market Structure and Trader Anonymity: An Analysis of Insider Trading
Jon A. Garfinkel and M. Nimalendran
The Impact of Minimum Trading Units on Stock Value and Price Volatility
Shmuel Hauser and Beni Lauterbach
Financial Advisors and Shareholder Wealth Gains in Corporate Takeovers
Jayant R. Kale, Omesh Kini, and Harley E. Ryan, Jr.
Reputation and the Market for Distressed Firm Debt
Thomas H. Noe and Michael J. Rebello
On the Impossibility of Weak-Form Efficient Markets
Steve L. Slezak
The Clustering of IPO Gross Spreads: International Evidence
Sami Torstila
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Abstracts
Cross-Hedging with Currency Options and Futures
Eric C. Chang and Kit Pong Wong
This paper develops an expected utility model of a multinational firm
facing exchange rate risk exposure to a foreign currency cash flow.
Currency derivative markets do not exist between the domestic and foreign
currencies. There are, however, currency futures and options markets
between the domestic currency and a third currency to which the firm has
access. Since a triangular parity condition holds among these three
currencies, the available, yet incomplete, currency futures and options
markets still provide a useful avenue for the firm to indirectly hedge
against its foreign exchange risk exposure. This paper offers analytical
insights into the optimal cross-hedging strategies of the firm. In
particular, the results show the optimality of using options in
conjunction with futures in the case of currency mismatching, even though
cash flows appear to be linear.
The Performance of Multi-Factor Term Structure Models for Pricing and
Hedging Caps and Swaptions
Joost Driessen, Pieter Klaassen, and Bertrand Melenberg
We empirically compare a wide range of term structure models used in the
pricing and, in particular, hedging of caps and swaptions. We analyze the
influence of the number of factors on the hedging and pricing results, and
investigate the type of data— interest rate or derivative
price— in combination with the estimation technique that should be
used to obtain the best hedging and pricing results. We use data on
interest rates, and cap and swaption prices from 1995–1999. The
empirical results show that, if the number of hedge instruments is equal
to the number of factors, multi-factor models outperform one-factor models
in hedging caps and swaptions. However, if one uses a large set of hedge
instruments, one-factor models perform as well as multi-factor models. We
find that models with two or three factors imply better out-of-sample
predictions of cap and swaption prices than one-factor models. Estimation
on the basis of current derivative prices leads to more accurate
out-of-sample prediction of cap and swaption prices than estimation on the
basis of interest rate data.
Is There Really a When-Issued Premium?
John R. Ezzell, James A. Miles, and J. Harold Mulherin
We use a unique set of equities in the when-issued market to provide new
tests of the law of one price in financial markets. We compare the prices
of when-issued and regular way shares of publicly traded subsidiaries and
their parents around the time the subsidiaries are fully divested and we
find that the when-issued shares of the subsidiary trade at a discount.
Pricing differences stem from measurement factors such as exchange
location and bid-ask clustering that bias the observed when-issued pricing
differential away from zero. The remaining difference is due to asymmetric
movements in bid and ask quotes in the two markets. We also find evidence
of temporary price pressures on the date of execution of the spinoff of
the subsidiary firms that bear resemblance to the pricing in the
when-issued market. We interpret the evidence as consistent with the law
of one price in the presence of transaction costs and microstructure
phenomena.
Market Structure and Trader Anonymity: An Analysis of Insider
Trading
Jon A. Garfinkel and M. Nimalendran
This paper examines the degree of anonymity—the extent to which a
trader is recognized as informed—on alternative market structures.
We find evidence that is consistent with less anonymity on the NYSE
specialist system compared to the NASDAQ dealer system. Specifically, when
corporate insiders trade medium-sized quantities (500–9,999 shares
inclusive), NYSE listed stocks exhibit larger changes in proportional
effective spreads than NASDAQ stocks. Taken together, these findings are
consistent with Barclay and Warner's (1993) contention that stealth
(medium-sized) trades are more likely based on private information and
insider trades are more transparent on the NYSE specialist system relative
to the NASDAQ dealer system. The results support the hypothesis by
Benveniste, Marcus, and Wilhelm (1992) that the unique relationship
between specialists and floor brokers on the NYSE leads to less
anonymity.
The Impact of Minimum Trading Units on Stock Value and Price
Volatility
Shmuel Hauser and Beni Lauterbach
We study how minimum trading unit changes on the Tel-Aviv Stock Exchange
impact a stock's trading activity, price volatility, and value. The value
effects are consistent with Merton's (1987) model, i.e., an increase in
the investor base (trading volume) and a decrease in price noisiness
affect stock value positively. Our results extend Amihud, Mendelson, and
Uno's (1999) tests of Merton by demonstrating a clear relation between
price noisiness changes and stock value changes, and by showing that the
response to a minimum trading unit decrease becomes less favorable (and
arguably even negative) in the thinnest trading stocks.
Financial Advisors and Shareholder Wealth Gains in Corporate Takeovers
Jayant R. Kale, Omesh Kini, and Harley E. Ryan, Jr.
We examine the effect of financial advisor reputation on wealth gains in
corporate takeovers. In view of the adversarial nature of a takeover, we
construct a measure of the relative reputation of the advisor. We document
that the absolute wealth gain as well as the share of the total takeover
wealth gain accruing to the bidder (target) increases (decreases) as the
reputation of the bidder's advisor increases relative to that of the
target. We also find that the total wealth created in the takeover is
positively related to the reputation of bidder and target advisors. While
bidder advisor reputation is positively related to the probability of bid
success in our sample, we also present some evidence to suggest that
bidders with better advisors are more likely to withdraw from potentially
value-destroying takeovers.
Reputation and the Market for Distressed Firm Debt
Thomas H. Noe and Michael J. Rebello
Our analysis explains how vulture investors (vultures) can maintain and
exploit their reputations for toughness. Vultures leverage their
reputations to extract concessions from stockholders in debt
restructurings. To profit from these concessions, vultures must first
acquire debt from incumbent bondholders. Buying only the tranches most
likely to render them marginal creditors maximizes vulture leverage in
debt-purchase negotiations. Vulture profits are proportional to the degree
of uncertainty regarding the identity of the marginal debt class.
On the Impossibility of Weak-Form Efficient Markets
Steve L. Slezak
Recent theoretical models show that irrational expectations can generate
return predictability consistent with apparent violations of weak-form
market efficiency documented in the empirical literature. These behavioral
models constrain rational investors' ability to exploit inter-temporal
predictability by assuming that rational agents face high transactions
costs, are myopic, or are non-existent. This paper presents a model in
which there are two types of irrational expectations, one that causes
momentum and another that creates reversals. I investigate whether these
types of predictability will persist in the presence of fully rational
agents who face no transactions costs, are long lived, and trade
dynamically to optimally exploit any predictability due to irrational
mispricings. I show that weak-form market efficiency will be violated
under two very weak conditions: rational investors are risk averse and the
fundamental value of the asset is risky. The paper also investigates the
accumulation of wealth by trader type and shows that irrational agents
will survive under a large set of parameters.
The Clustering of IPO Gross Spreads: International Evidence
Sami Torstila
Patterns of clustering in IPO gross spreads can be identified not only in
the U.S., but also in many other markets across the world. The evidence
indicates, however, that these clustering patterns are not necessarily
collusive. Clustering is widespread in many countries with low gross
spreads. In fact, the amount of clustering observed is negatively related
to the gross spread level of a country. Additionally, an analysis of
abnormal gross spreads following Hansen (2001) indicates that few clusters
contain abnormal positive surpluses.
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