Abstracts
Equilibrium Pricing in Incomplete Markets
Abdelhamid Bizid and Elyès Jouini
Given the exogenous price process of some assets, we
constrain the price process of other assets that are characterized by
their final payoffs. We deal with an incomplete market framework in a
discrete-time model and assume the existence of the equilibrium. In this
setup, we derive restrictions on the state-price deflators. These
restrictions do not depend on a particular choice of utility function. We investigate numerically a
stochastic volatility model as an example. Our
approach leads to an interval of admissible prices that is more robust than the
arbitrage pricing interval.
Trade Credit and the Effect of Macro-Financial Shocks: Evidence from U.S. Panel Data
Woon Gyu Choi and Yungsan Kim
Using disaggregated panel data, we examine how firms change trade credit in
response to a monetary tightening. We find that both accounts payable and
accounts receivable increase with tighter monetary policy, implying that
trade credit helps firms absorb the effect of a credit contraction. Further,
both S&P 500 firms and a comparison group of smaller firms
increase {net} trade credit (accounts receivable minus payable), making up for
the reduced liquidity associated with tighter policy. However, we find no evidence that
large firms play this role more actively than smaller firms.
Opening and Closing the Market: Evidence from the London Stock Exchange
Andrew Ellul, Hyun Song Shin, and Ian Tonks
We investigate the performance of call markets at the open and close using a unique natural experiment provided by the London Stock Exchange where traders can choose between a call and an off-exchange dealership system. Although the call market dominates dealers in terms of price discovery, it suffers from a high failure rate to open and close trading especially when trading conditions are difficult. The call's trading costs increase with asymmetric information, slow trading, order flow imbalances, and uncertainty. Traders' resort to use of call auctions is negatively correlated with firm size, implying that the call may not be the optimal method for opening and closing trading of medium and small sized stocks.
Long-Run Investment Decisions, Operating Performance, and Shareholder Value
Creation of Firms Adopting Compensation Plans Based on Economic Profits
Chris E. Hogan and Craig M. Lewis
For firms that adopted economic profit plans between 1983 and
1996, we document changes in investment behavior that lead to improvements
in operating performance and growth opportunities relative to these firms' past
performance. The improvements, however, are similar to those realized by a
set of non-adopting control firms that are selected on the basis of a
logistic regression model of adoption choice. We then consider the
possibility that some firms are better candidates for economic profit plans
than others and classify adopters according to whether they make anticipated
or surprising choices based on the adoption choice model. We find that
anticipated adopters make changes in investment behavior that reduce
invested capital and allow them to become more profitable than a sample of
control firms that were expected to adopt but chose to continue using a
traditional plan. A similar analysis of surprise adopters does not reveal
significant performance differences relative to a sample of anticipated
non-adopters. The classification analysis suggests that economic profit plans
work best for firms that are expected to adopt such plans based on
pre-adoption operating, organizational, financial, and compensation
characteristics.
Bayesian Analysis of Stochastic Betas
Gergana Jostova and Alexander Philipov
We propose a mean-reverting stochastic process for the market
beta. In a simulation study, the proposed model generates
significantly more precise beta estimates than GARCH betas, betas
conditioned on aggregate or firm-level variables, and
rolling regression betas, even when the true betas are generated
based on these competing specifications. Our model significantly
improves out-of-sample hedging effectiveness. In asset pricing
tests, our model provides substantially stronger support for the
conditional CAPM relative to competing beta models and helps
resolve asset pricing anomalies such as the size, book-to-market,
and idiosyncratic volatility effects in the cross section of stock
returns.
Stock Splits, Broker Promotion, and Decimalization
Palani-Rajan Kadapakkam, Srinivasan Krishnamurthy, and Yiuman Tse
Stock split ex-dates are associated with both an increased intensity of
small investor buying and a positive abnormal return. The broker promotion
hypothesis suggests that the increase in relative spread after a split
induces brokers to promote splitting stocks to small investors. The trading
inconvenience hypothesis ascribes the ex-split effects to inconveniences
such as investors' aversion to dealing with due bills, which is unrelated to
relative spreads. The reduction in the bid-ask spread due to decimalization
allows us to disentangle these two hypotheses. During the 1/8{th} pricing
period, we show that after the ex-date, the relative spread increases
significantly. The average buy order size decreases and the frequency of small
transactions increases after the split. After decimalization, these changes
are smaller in magnitude. We observe significant positive abnormal returns
around the ex-date during the 1/8th pricing period, but not in the
decimal pricing period. These results support the broker promotion
hypothesis.
Does Corporate Governance Matter to Bondholders?
Mark S. Klock, Sattar A. Mansi, and William F. Maxwell
We examine the relation between the cost of debt financing and a governance
index that contains various antitakeover and shareholder protection
provisions. Using firm-level data from the Investors Research Responsibility
Center for the period 1990–2000, we find that antitakeover
governance provisions lower the cost of debt financing. Segmenting the data
into firms with the strongest management rights (strongest antitakeover
provisions) and firms with the strongest shareholder rights (weakest
antitakeover provisions), we find that strong antitakeover provisions are
associated with a lower cost of debt financing while weak antitakeover
provisions are associated with a higher cost of debt financing, with a
difference of about 34 basis points between the two groups.
Overall, the results suggest that antitakeover governance provisions,
although not beneficial to stockholders, are viewed favorably in the bond
market.
The Volatility Risk Premium Embedded in Currency Options
Buen Sin Low and Shaojun Zhang
This study employs a non-parametric approach to investigate the volatility
risk premium in the over-the-counter currency option market. Using a large
database of daily delta-neutral straddle quotes in four major currencies—the British pound, the euro, the Japanese yen, and the Swiss franc—we
find that volatility risk is priced in all four currencies across different
option maturities. We find that the volatility risk premium is negative, with the premium decreasing in
maturity. Finally, we also find evidence that jump risk may be priced in the currency
option market.
Security Fungibility and the Cost of Capital: Evidence from Global Bonds
Darius P. Miller and John J. Puthenpurackal
This paper examines the potential benefits of security
fungibility by conducting the first comprehensive analysis of global bonds.
Unlike other debt securities, global bonds' fungibility allows them to be
placed simultaneously in bond markets around the world; they trade, clear,
and settle efficiently within as well as across markets. We test the impact
of issuing these securities on firms' cost of capital, issuing costs,
liquidity, and shareholder wealth. Using a sample of 230 global bond issues
by 94 companies from the U.S. and abroad over the period 1996–2003, we find
that firms lower their cost of (debt) capital by issuing these
fungible securities. We also document that the stock price reaction to the
announcement of global bond issuance is positive and significant, while
comparable domestic and eurobond issues over the same time period are
associated with insignificant changes in shareholder wealth.