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Contents
The Performance of Alternative Interest Rate Risk Measures and
Immunization Strategies under a Heath-Jarrow-Morton Framework
Senay Agca
Survival, Look-Ahead Bias, and Persistence in Hedge Fund
Performance
Guillermo Baquero, Jenke ter Horst, and Marno Verbeek
The Information Content of Institutional Trades on the London Stock Exchange
Aslihan Bozcuk and M. Ameziane Lasfer
Lockups Revisited
James C. Brau, Val E. Lambson, and Grant McQueen
Signaling Managerial Optimism through Stock Dividends and Stock Splits:
A Reexamination of the Retained Earnings Hypothesis
Dean Crawford, Diana R. Franz, and Gerald J. Lobo
Pricing European and American Derivatives under a Jump-Diffusion Process: A
Bivariate Tree Approach
Jimmy E. Hilliard and Adam Schwartz
Packaging Liquidity: Blind Auctions and Transaction Efficiencies
Kenneth A. Kavajecz and Donald B. Keim
Information Quality, Learning, and Stock Market Returns
George Li
Information vs. Entry Costs: What Explains U.S. Stock Market Evolution?
Joel Peress
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Abstracts
The Performance of Alternative Interest Rate Risk Measures and
Immunization Strategies under a Heath-Jarrow-Morton Framework
Senay Agca Using a Monte Carlo simulation, this study addresses the question of how
traditional risk measures and immunization strategies perform when the term
structure evolves in a Heath-Jarrow-Morton (1992) manner. The results suggest
that, for immunization purposes, immunization strategies and portfolio
formation strategies are more important than interest rate risk measures.
The performance of immunization strategies depends more on the transaction
costs and the holding period than on the risk measures. Moreover, the
immunization performance of bullet and barbell portfolios is not very
sensitive to interest rate risk measures.
Survival, Look-Ahead Bias, and Persistence in Hedge Fund
Performance
Guillermo Baquero, Jenke ter Horst, and Marno Verbeek We analyze the performance persistence in hedge funds
taking into account look-ahead bias (multi-period sampling bias).
We model liquidation of hedge funds by analyzing how it depends upon
historical performance. Next, we use a weighting procedure that eliminates
look-ahead bias in measures for performance persistence. In contrast to
earlier results for mutual funds, the impact of look-ahead bias is
exacerbated for hedge funds due to their greater level of total risk. At
the four-quarter horizon, look-ahead bias can be as much as 3.8%,
depending upon the decile of the distribution. We
find positive persistence in hedge fund quarterly returns after correcting for
investment style. The empirical pattern at the annual level is also
consistent with positive persistence, but its statistical significance is
weak.
The Information Content of Institutional Trades on the London Stock Exchange
Aslihan Bozcuk and M. Ameziane Lasfer We construct a unique data set that includes all reported institutional block trades
on the London Stock Exchange and analyze the market
reaction to buy and sell trades. We find that the type of investors
behind the trade and the combination of the trade's size and the
trader's resulting level of ownership are the major determinants of the
information effects and the asymmetry between price impacts of buy and sell
trades. In particular, large trades undertaken by fund managers, the
most active investors in our sample, have strong information content, while,
for the remaining trades, we report limited support for the information
and the price impact asymmetry hypotheses. These results hold even after
accounting for trade complexity and volatility effects in the regressions.
Lockups Revisited
James C. Brau, Val E. Lambson, and Grant McQueen Lockups are agreements made by insiders of stock-issuing firms to abstain from
selling shares for a specified period of time after the issue. Brav and
Gompers (2003) suggest that lockups are a bonding solution to a moral
hazard problem and not a signaling solution to an adverse selection problem.
We challenge this conclusion theoretically and empirically. In our model,
insiders of good firms signal by putting and keeping (locking up) their money where their
mouths are. Our model yields two comparative statics: lockups should be
shorter when a firm is i) more transparent and/or ii) more risky. Using a
sample of 4,013 initial public offerings and 3,279 seasoned equity offerings
between 1988 and 1999, we find empirical support for our theoretical
predictions.
Signaling Managerial Optimism through Stock Dividends and Stock Splits:
A Reexamination of the Retained Earnings Hypothesis
Dean Crawford, Diana R. Franz, and Gerald J. Lobo The retained earnings hypothesis predicts that stock distributions accounted
for by reducing retained earnings are a more credible signal of managerial
optimism than stock distributions that do not reduce retained earnings. This
study examines the costs of false signaling that are a necessary
pre-condition for the hypothesis and finds them to be generally very small,
calling the validity of
the hypothesis into question for most firms. However, prior studies
report broad-based market evidence consistent with the
hypothesis. To resolve this apparent inconsistency, the study replicates
and extends tests of the retained earnings hypothesis contained in three
prior studies, and shows that the findings in support of the retained
earnings hypothesis can be attributed to specification and measurement
choices that bias the results in favor of the hypothesis. The support for
the retained earnings hypothesis is weaker when the sources of the bias are
removed. However, some support for the hypothesis remains for a limited set
of distributing firms.
Pricing European and American Derivatives under a Jump-Diffusion Process: A
Bivariate Tree Approach
Jimmy E. Hilliard and Adam Schwartz We develop a straightforward procedure to price derivatives by a bivariate
tree when the underlying process is a jump-diffusion. Probabilities and jump
sizes are derived by matching higher order moments or cumulants. We give comparisons
with other published results along with convergence proofs and
estimates of the order of convergence. The bivariate tree approach is
particularly useful for pricing long-term American options and long-term real
options because of its robustness and flexibility. We illustrate the pedagogy in an application involving a long-term investment project.
Packaging Liquidity: Blind Auctions and Transaction Efficiencies
Kenneth A. Kavajecz and Donald B. Keim The costs of implementing investment strategies represent a significant drag
on the performance of mutual funds and other institutional investors. It is
the responsibility of institutional investors, and in the interests of the
individual investors they represent, to seek market mechanisms that mitigate
trading costs. We investigate an example of one such liquidity provision
mechanism whereby liquidity demanders auction a set of trades as a package
directly to potential liquidity providers. A critical feature of the auction
is that the identities of the securities in the package are not revealed to
the bidder. We demonstrate that this mechanism provides a transactions cost
savings relative to more traditional trading mechanisms for the liquidity
demander as well as an efficient way for liquidity suppliers to obtain order
flow. We argue that the cost savings afforded this new mechanism are due to
the potential for low cost crosses with the bidder's existing inventory
positions and through the longer trading horizon, and superior trading
ability, of the bidders. This research suggests that the ability to innovate
via new liquidity provision mechanisms can provide market participants with
transaction cost savings that cannot be easily duplicated on more
traditional exchanges.
Information Quality, Learning, and Stock Market Returns
George Li This paper studies how the precision of noisy
public information that investors receive about the expected aggregate
dividend growth rate affects stock market returns. I show that less precise
information can increase the risk premium and stock return volatility. The
numerical results from my calibrated model also show that noisy information
can significantly increase the risk premium and stock return volatility. My
finding implies that the presence of noisy information may help explain the large
average risk premium and return volatility in the U.S. financial market.
In addition, my finding suggests it is optimal for firms to disclose to investors more precise
information to reduce the cost of equity capital.
Information vs. Entry Costs: What Explains U.S. Stock Market Evolution?
Joel Peress I investigate whether changes in stock market participation costs can
explain the long-term increase in the number of U.S. stockholders. I
separate these costs into two components: an information cost (the cost of
collecting market information), and an entry cost (all other costs,
including commissions and fees), and disentangle their general equilibrium
implications in a noisy rational expectations economy. While a falling information
cost cannot explain the observed increase in stock market participation,
a falling entry cost can account for this plus
several other features of the U.S. economy, including the falling equity premium,
rising return variances, and the boom in passive
relative to active investing.
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