Contents

Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market
Warren Bailey and Y. Peter Chung

Under-Diversification and Retention Commitments in IPOs
Lucie Courteau

Cointegration, Error Correction, and Price Discovery on Informationally-Linked Security Markets
Frederick H. deB. Harris, Thomas H. McInish, Gary L. Shoesmith, and Robert A. Wood

Single Factor Heath-Jarrow-Morton Term Structure Models Based on Markov Spot Interest Rate Dynamics
Andrew Jeffrey

Daily and Intradaily Tests of European Put-Call Parity
Avraham Kamara and Thomas W. Miller, Jr.

Investment Under Uncertainty: The Case of Replacement Investment Decisions
David C. Mauer and Steven H. Ott

The Informative role of the Value Line Investment Survey: Evidence from Stock Highlights
David R. Peterson

Abstracts

This paper evaluates the conjecture that excess stock returns that have been documented around the announcement of corporate spin-offs represent, at least in part, the re-creation of value destroyed at the time of an earlier acquisition. We evaluate this question with a sample of spin-offs that originated as earlier acquisitions. At the time of the original acquisition, on average, announcement period returns to the bidder and the combined bidder and target firm are negative and significant. Additionally, announcement period returns at the time of the spin-off are negatively and significantly correlated with acquisition announcement period returns.

Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market
Warren Bailey and Y. Peter Chung

We study the impact of exchange rate fluctuations and political risk on the risk premiums reflected in cross-sections of individual equity returns from Mexico, a country which has experienced significant monetary and political turbulence. Indicators from Mexico's currency and sovereign debt markets are employed as proxies for exchange rate and political risks. We find some evidence of equity market premiums for exposure to these risks. The results suggest common factors in emerging market equity, currency, and sovereign debt markets, and have several implications for corporate and portfolio management and for the use of emerging market data by researchers.

Under-Diversification and Retention Commitments in IPOs
Lucie Courteau

This study is an extension of Leland and Pyle's (1977) signaling model. It introduces, in addition to the retained ownership, the length of the holding period to which she commits in the prospectus as a signal of firm value. The length of the holding period is found to be a signaling mechanism that complements ownership retention. Depending on the information structure of the firm, the entrepreneur may prefer to commit to a holding period longer than the minimum required by securities regulations.

Cointegration, Error Correction, and Price Discovery on Informationally-Linked Security Markets
Frederick H. deB. Harris, Thomas H. McInish, Gary L. Shoesmith, and Robert A. Wood

Using synchronous transactions data for IBM from the New York, Pacific and Midwest Stock Exchanges, we estimate an error correction model to investigate whether each of the exchanges is contributing to price discovery. Johansen's test yields two cointegrating vectors which together verify the expected long-run equilibrium of equal prices across the three exchanges. Two error correction terms specified as the differences from IBM prices on the NYSE indicate that adjustments maintaining the long-run cointegration equilibrium take place on all three exchanges. That is, IBM prices on the NYSE adjust toward IBM prices on the Midwest and Pacific Exchanges, just as Midwest and Pacific prices adjust to the NYSE.

Single Factor Heath-Jarrow-Morton Term Structure Models Based on Markov Spot Interest Rate Dynamics
Andrew Jeffrey

This paper considers the class of Heath-Jarrow-Morton term structure models where the spot interest rate is Markov and the term structure at time t is a function of time, maturity and the spot interest rate at time t. A representation for this class of models is derived and I show that the functional forms of the forward rate volatility structure and the initial forward rate curve cannot be arbitrarily chosen. I provide necessary and sufficient conditions indicating which combinations of these functional forms are allowable. I also derive a partial differential equation representation of the term structure dynamics which does not require explicit modeling of both the market price of risk and the drift term for the spot interest rate process. Using the analysis presented in this paper a class of intertemporal term structure models is derived.

Daily and Intradaily Tests of European Put-Call Parity
Avraham Kamara and Thomas W. Miller, Jr.

Existing empirical studies of the put-call parity condition report frequent, substantial violations. An important problem in interpreting these results is that these studies all investigate American options. While some of these studies attempt to reduce the effects of possible early exercise on their tests, they have not fully accounted for the effect of early exercise. Therefore, it is not possible to conclude from these studies whether, or to what extent, observed PCP violations are due to market inefficiency or due to the value of early exercise. We avoid the early exercise problem by testing put-call parity using European options. We find violations that are much less frequent and smaller than the studies using American options. Moreover, these violations reflect premia for liquidity (immediacy) risk.

Investment Under Uncertainty: The Case of Replacement Investment Decisions
David C. Mauer and Steven H. Ott

We analyze the determinants of replacement investment decisions in a contingent claims model with maintenance and operation cost uncertainty. We find that the optimal time between replacements is increasing in the volatility of cost, the purchase price of a new asset and the corporate tax rate; and is decreasing in the systematic risk of cost, the salvage value of the asset and the investment tax credit. The optimal time between replacements can either increase or decrease with an increase in the depreciation rate. Extensions of the model to examine the effects of technological and tax policy uncertainty on replacement investment decisions give intuitive, but striking results. Uncertainty about the arrival of a technological innovation that would decrease maintenance and operation cost results in a significant decrease in replacement investment. Uncertainty in a tax law change that would encourage investment, decreases current investment; and uncertainty in a tax law change that would discourage investment, increases current investment.

The Informative role of the Value Line Investment Survey: Evidence from Stock Highlights
David R. Peterson

I examine abnormal stock returns associated with "stock highlights" published by the Value Line Investment Survey. At the time of their publication, stock highlights elicit strong positive abnormal returns. They also have positive abnormal returns at the time of the earnings announcement preceding stock highlight publications. Post-earnings-announcement drift is present but is much too small to explain abnormal returns at the time of the publication of stock highlights. Thus, Value Line stock highlights provide useful information to investors. This information is rapidly reflected in stock prices, consistent with market efficiency.