ContentsCommon Factors and Local Factors: Implications for Term Structures and Exchange RatesDong-Hyun Ahn
Does Insider Trading Impair Market Liquidity? Evidence from IPO Lockup Expirations
A Yen is Not a Yen: TIBOR/LIBOR and the Determinants of the Japan Premium
Demographics, Stock Market Flows, and Stock Returns
Minority Shareholder Protections and the Private Benefits of Control for Swedish Mergers
Confidence in the Familiar: An International Perspective
Changing Risk, Return, and Leverage: The 1997 Asian Financial Crisis
Discounting and Clustering in Seasoned Equity Offering Prices
Sharpe Ratios and Alphas in Continuous Time
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Abstracts
Common Factors and Local Factors: Implications for Term Structures and
Exchange Rates This paper studies a multi-factor, two-country term structure and exchange rate model when a diversification effect for an international bond portfolio is expected. It shows that the diversification gain calls upon certain restrictions on the process of the stochastic discount factor in a factor-structured economy. Existence of local factors is shown to be a necessary condition for the gains from investing in foreign bonds. Further, the exchange rate risk premia are shown to be a function of the differentials of the risk premia of the factors in bond returns. Empirical results reveal the tendency for investors to respond sensitively to rare shocks, which is shown to be a potential solution to the forward premium puzzle.
Does Insider Trading Impair Market Liquidity? Evidence from IPO Lockup
Expirations We test the hypothesis that insider trading impairs market liquidity by analyzing intraday trades and quotes around 1,497 IPO lockup expirations in the period 1995-1999. We find that, while lockup expirations are associated with considerable insider trading for some IPO firms, they have little effect on effective spreads. By contrast, two other liquidity measures, quote depth and trading activity, improve substantially. In the 23% of lockup expirations where insiders disclose share sales, spreads actually decline. These findings indicate that a large body of well-informed, blockholding insider traders can enter a market from which they had previously been absent, and substantially change trading volume and share price without impairing market liquidity.
A Yen is Not a Yen: TIBOR/LIBOR and the Determinants of the Japan Premium Pricing in the euroyen market is based on LIBOR, the London Interbank Offered Rate, set at 11:00am London time or TIBOR, the Tokyo Interbank Offered Rate, set at 11:00am Tokyo time. The changing TIBOR-LIBOR spread reflects the credit risk associated with Japanese banks or the "Japan premium." The spread is modeled as a function of determinants of bank default and firm value. Systematic variation in the spread can be explained by interest rate and stock price effects along with public information flows of good and bad news regarding Japanese banking, with a separate role for bank credit downgrades and upgrades.
Demographics, Stock Market Flows, and Stock Returns This paper studies the link between population age structure, net outflows (dividends plus repurchases less net issues) from the stock market, and stock market returns in an overlapping generations framework. I find support for the traditional lifecycle models - the outflows from the stock market are positively correlated with the changes in the fraction of old people (65 and over) and negatively correlated with the changes in the fraction of middle-aged people (45 to 64). Changes in population age structure also add significant explanatory power to equity premium regressions. The population structure adds to the predictive power of regressions involving the investment/savings rate for the U.S. economy. Finally, international demographic changes have some power in explaining international capital flows.
Minority Shareholder Protections and the Private Benefits of Control for
Swedish Mergers Sweden has a high degree of separation of ownership from control through pyramids, dual-class shares, and cross-holdings. This increases the potential for private benefits of control. However, Sweden's extralegal institutions - tax compliance and newspaper circulation - are consistent with greater shareholder protection. Using data on Swedish mergers we find limited evidence of shareholder expropriation. Apparently, Sweden's extralegal institutions offset the drawback of weak corporate governance.
Confidence in the Familiar: An International Perspective One striking feature of international portfolio investment is the extent to which equity portfolios are concentrated in the domestic equity market of the investor - the home bias puzzle. I examine the role of investors' perception of foreign investment risk on their portfolio choices. The expected returns and risk of foreign investment are specified through an asset pricing model with the home portfolio being the benchmark asset - Pastor's (2000) domestic CAPM\@. The model serves as a reference point around which investors can center their prior beliefs. I focus on investors' prior beliefs that are consistent with the literature on confidence in the familiar - foreign equities, in terms of both expected returns and risk, being viewed less favorably than domestic equities. These prior beliefs are then combined with the data on G7 equities, and the revised beliefs are used to obtain the global optimal asset allocation. To hold predominantly domestic equities, each G7 investor has to believe that the risk of foreign investment is several times higher than the actual risk. The home bias is more of a puzzle for a U.S. investor during the 1970s. Specifying investors' prior beliefs around the world CAPM does not help resolve the puzzle.
Changing Risk, Return, and Leverage: The 1997 Asian Financial Crisis This paper explores risk and return relations in six Asian equity markets affected by the 1997 Asian financial crisis. After the start of the crisis, national equity betas increased and average returns fell substantially. Beta increases due to leverage linked to exchange rates. The increase in expected return needed to accompany this rise in beta is made possible through the creation of capital losses that lower average returns. We propose a new probability-based asset pricing model that captures leverage effects using valuation ratios. Results show the role of leverage in explaining the likelihood of the financial crises. Cross-sectional evidence supports time-series findings.
Discounting and Clustering in Seasoned Equity Offering Prices An analysis of 4,814 SEOs during 1986-1999 indicates that the average offering of new shares is priced at a discount of 3% from the closing price on the day before the issue. Discounts have risen steadily over time, sharply increasing the indirect costs of issuing seasoned equity. There is evidence of increased clustering of offer prices at integers, and of greater importance in the analyst coverage provided by underwriters. Adjusting for other factors, we find that issues with integer offer prices, and underwriters with highly regarded analysts, are increasingly associated with larger discounts. The rise in discounts is consistent with an increased ability of investment bankers to extract rents from issuing firms.
Sharpe Ratios and Alphas in Continuous Time This paper proposes modified versions of the Sharpe ratio and Jensen's alpha, which are appropriate in a simple continuous-time model. Both are derived from optimal portfolio selection. The modified Sharpe ratio equals the ordinary Sharpe ratio plus half of the volatility of the fund. The modified alpha also differs from the ordinary alpha by a second-moment adjustment. The modified and the ordinary Sharpe ratios may rank funds differently. In particular, if two funds have the same ordinary Sharpe ratio, then the one with the higher volatility will rank higher according to the modified Sharpe ratio. This is justified by the underlying dynamic portfolio theory. Unlike their discrete-time versions, the continuous-time performance measures take into account that it is optimal for investors to change the fractions of their wealth held in the fund vs. the riskless asset over time.
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