Knowledge that Transforms

This paper presents simple closed-form expressions for volatility futures and option prices and examines their implications for the characteristics of these securities. We show that the properties of these volatility derivatives are fundamentally different from those of conventional option and futures contracts. This analysis also provides insights into the role that volatility derivatives may play in managing and hedging volatility risk in financial markets.

I use the stochastic cost frontier approach to investigate efficiency of banks operating in the Third Federal Reserve District, accounting for the quality and riskiness of bank output. In addition to the mean and mode of the conditional distribution of the one-sided error term, I calculate confidence intervals for the inefficiency measures based on the conditional distribution. The results indicate that Third District banks are operating at cost-efficient output levels and product mixes, but are not efficiently using their inputs. The second part of the article relates the inefficiency measures to several correlates.

This paper investigates the capital and portfolio risk decisions of property-liability insurance firms. A theoretical model based on option pricing theory is developed which predicts a positive relationship between insurer capital and risk, as firms balance these two factors to achieve their desired overall insolvency risk. The implications of the model are then tested empirically using a simultaneous equations methodology. The results support the predictions of the model. They also provide evidence that managerial incentives play a role in determining capital and risk in insurance markets. The findings have significant implications for insurance solvency regulation.

The relative prices of shares that differ only in their voting rights are modelled. In our model, voting rights become valuable when a control contest is decided through takeover bids for outside votes. The study shows how the value of the voting right depends on the initial ownership distribution, the share structure, and the ability of the incumbent manager versus a rival for control. Empirical support for the model is provided using Swedish stock market data.

In the absence of information regarding whether a trade is buyer or seller initiated, many researchers have employed the ‘tick’ rule as a proxy. These researchers have been supported in their endeavours by the work of Lee and Ready (1991) which suggests that the tick rule is 90% accurate. Unfortunately, the difficulty of securing data on this issue has made Lee and Ready's paper somewhat unique in that there have been few attempts to confirm their result in US markets and no attempts in other markets. The purpose of this work is to test the robustness of their result in the Australian securities market. Using cleaner intra-day data we mimic the Lee and Ready study to cast some doubt upon the robustness of their findings in different markets. Our results suggest an overall accuracy of approximately 74% as opposed to Lee and Ready's 90%. However, accuracy in excess of 90% is documented when zero ticks are excluded. Further analysis provides evidence that a volatile or trending market will decrease the accuracy of the tick rule. It is also demonstrated that the tick rule is less likely to accurately classify seller initiated trades and small buyer initiated trades.

The purpose of this paper is to specify a formal model that rationalizes the intercorporate shareholdings observed in the Japanese equity market as a mechanism for mutual commitment and risk sharing that creates greater possibilities to resolve managerial myopic problems caused by the threat of external takeovers. We show that, under certain conditions, all agents including the existing shareholders of the firm are strictly better off when participating in an implicit contract associated with intercorporate shareholdings. The results also suggest that intercorporate ownership raises the stock prices of the member firms.

We examine the effects of thin trading on the specification of event study tests. Simulations of upper and lower tail tests are reported with and without variance increases on the event date across levels of trading volume. The traditional standardized test is misspecified for thinly traded samples. If return variance is unlikely to increase, then Corrado's rank test provides the best specification and power. With variance increases, the rank test is misspecified. The Boehmer et al. standardized cross-sectional test (Event-study methodology under conditions of event-induced variance, Journal of Financial Economics 30, pp. 253–272) is properly specified, but not powerful, for upper-tailed tests. Lower-tailed alternative hypotheses can best be evaluated using the generalized sign test.

This paper examines the lending patterns of 34 commercial banks during alternate periods of minority and non-minority ownership in the 1980s and early 1990s. The principal finding, obtained using a partial adjustment analysis of bank lending and bank capital, is that loan growth is slower when banks are owned by minorities compared to when they are owned by non-minorities.

Calls of in-the-money convertible preferred stock typically induce dividend savings for the firm, since preferred dividends exceed common stock dividends. Prior research finds that these savings are negatively related to stock returns at call announcement and argues that the market expects managers to abuse the increased free cash flow. This paper finds that dividend savings are closely related to call size, suggesting other explanations. Larger calls experience a more negative announcement reaction. Consistent with temporary liquidity effects, there is a price reversal during the conversion period, which is greater for larger calls.

This paper describes the exercise behavior of over 50,000 employees who hold longterm options on employer stock at eight corporations. Employees typically exercise options years before expiration, commonly sacrificing half of the Black-Scholes value. Exercise is strongly associated with recent stock price movements, the market-to-strike ratio, proximity to vesting dates, time to maturity, volatility, and the employee's level within the company. These findings have implications for compensation planners, the FASB as it develops a new accounting standard for options, and financial statement users and preparers who apply and interpret the new FASB standard.