Knowledge that Transforms

Different continuous-time models for interest rates coexist in the literature. We test parametric models by comparing their implied parametric density to the same density estimated nonparametrically. We do not replace the continuous-time model by discrete approximations, even though the data are recorded at discrete intervals. The principal source of rejection of existing models is the strong non-linearity of the drift. Around its mean, where the drift is essentially zero, the spot rate behaves like a random walk. The drift then mean-reverts strongly when far away from the mean. The volatility is higher when away from the mean.

This paper studies the shareholder wealth effects associated with 875 new security issues in Japan from January 1, 1985 to May 31, 1991. The sample includes public equity, private equity, rights offerings, straight debt, warrant debt and convertible debt issues. Contrary to the U.S., the announcement of convertible debt issues is accompanied by a significant positive abnormal return of 1.05%. The announcement of equity issues has a positive abnormal return ofO.45%, significant at the 0.10 level, but this positive abnormal return can be attributed to one year in our sample and is offset by a negative issue date abnormal return of -1.01%. The abnormal returns are negatively related to firm size, so that for equity issues (but not for convertible debt issues), large Japanese firms have significant negative announcement abnormal returns. Our evidence is consistent with the view that Japanese managers decide to issue shares based on different considerations than American managers.

We present two ways in which trading in a replicatable option can affect the price process of the underlying asset. In the first situation, trading an option that each investor views as pay off redundant breaks a non-fully revealing equilibrium that exists when the option market is absent. The second situation involves a market that is dynamically complete without options, but in which introducing an option market allows self-confirming conjectures of additional uncertainty about the future price of the underlying asset. Heterogeneous beliefs play important though different roles in both situations.

Financially intermediated and stock market consumption-investment allocations, with and without governmental interventions, are compared in a welfare sense in overlapping generation economies with (and without) shocks to agents’ intertemporal preferences. We first show that, in economies with preference shocks, governmental interventions subject to the same information requirements as those imposed on financial intermediaries, lead to stock market allocations that are not inferior to those attained under financial intermediation. Second, we argue that the necessary interventions are qualitatively no different from those required to implement stationary optimal allocations in OLG models without shocks to agents’ intertemporal consumption preferences.

Mortgage originators offer borrowers various combinations of “points”—loan fees—and coupon: high points and low coupon or low points and high coupon. In this article points are interpreted as a device serving to separate borrowers with high prepayment probabilities from those with low prepayment probabilities. Borrowers and lenders are treated symmetrically: both are risk neutral and both have complete and frictionless access to credit markets (implying that borrowers can finance points if they wish), except that borrowers’ prepayment speeds are private knowledge. Equilibria are derived, both when borrowers cannot prepay voluntarily and when they can.

This article focuses on the difference between market makers and limit orders in their role as suppliers of liquidity. For both sources of liquidity I analyze the price behavior of stocks and options around large option trades and I estimate the premium paid by the initiator of the large trade. My findings suggest that limit orders for options are "picked off" after adverse changes in the underlying stock price. Furthermore, I find that for these transactions there is a permanent change in quotations in the direction of the transaction. After transactions where market makers supply liquidity, quotes tend to return to their pretrade level.

This article investigates the hypothesis that dividend changes are determined by changes in some measure of permanent earnings. The analysis employs two measures of permanent earnings and takes into account the nonstationarity of dividend and earnings series. This study finds that dynamic dividend behavior is accounted for primarily by changes in permanent earnings. dividends respond strongly to permanent changes in earnings without any significant overreaction, whereas they respond little, if at all, to transitory changes in earnings. The findings also suggest that the partial adjustment hypothesis, which assumes managers partially adjust dividends to a target dividend, performs better when the target dividend level is proportional to permanent earnings than when it is proportional to current earnings.

Within the past few years several articles have suggested that returns on large equity portfolios may contain a significant predictable component at horizons 3 to 6 years. Subsequently, the tests used in these analyses have been criticized (appropriately) for having widely misunderstood size and power, rendering the conclusions inappropriate. This criticism however has not focused on the data, it addressed the properties of the tests. In this article we adopt a subjectivist analysis – treating the data as fixed – to ascertain whether the data have anything to say about the permanent/temporary decomposition. The data speak clearly and they tell us that for all intents and purposes, stock prices follow a random walk.

We show how the efficiency of reorganization is affected by the distribution of control rights under the U.K. insolvency code. Control rights raise particular problems when creditors have different incentives to keep the firm as a going concern. Such differences may arise from the possession of private benefits by particular creditors which are lost if the debtor firm is liquidated. The incidence of inefficient liquidations is influenced by the size and seniority of creditors’ claims. The current U.K. code is widely thought to give rise to inefficient liquidations. We show, however, that inefficiency depends upon the debt structure and whether the controlling creditor in formal bankruptcy has private benefits.

We analyze a competitive model in which different information signals get reflected in value at different points in time. If investors are sufficiently risk averse, we obtain an equilibrium in which all investors focus exclusively on the short term. In addition, we show that increasing the variance of informationless trading increases market depth but causes a greater proportion of investors to focus on the short-term signal, which decreases the informativeness of prices about the long run. Finally, we also explore parameter spaces under which long-term informed agents wish to voluntarily disclose their information.