Abhay Abhyankar, Devraj Basu, Does Conditioning Information Matter in Estimating Continuous Time Interest Rate Diffusions?, The Journal of Financial and Quantitative Analysis, Vol. 36, No. 3 (Sep., 2001), pp. 335-344

Abstract In this paper we study the economic value and statistical significance of asset return predictability, based on a wide range of commonly used predictive variables. We assess the performance of dynamic, unconditionally efficient strategies, first studied by Hansen and Richard (1987) and Ferson and Siegel (2001), using a test that has both an intuitive economic interpretation and known statistical properties. We find that using the lagged term spread, credit spread, and inflation significantly improves the risk-return trade-off. Our strategies consistently outperform efficient buy-and-hold strategies, both in and out of sample, and they also incur lower transactions costs than traditional conditionally efficient strategies.

Stochastic discount factor bounds provide a useful diagnostic tool for testing asset pricing models by specifying a lower bound on the variance of any admissible discount factor. In this paper, we provide a unified derivation of such bounds in the presence of conditioning information, which allows us to compare their theoretical and empirical properties. We find that, while the location of the ‘unconditionally efficient (UE)’ bounds of [Ferson, W., Siegel, A., 2001. The efficient use of conditioning information in portfolios. Journal of Finance 56 (3), 967–982] is statistically indistinguishable from the (theoretically) optimal bounds of [Gallant, R., Hansen, L., Tauchen, G., 1990. Using conditional moments of asset payoffs to infer the volatility of intertemporal marginal rates of substitution. Journal of Econometrics 45 (1), 141–179] (GHT), the former exhibit better sampling properties. We demonstrate that the difference in sampling variability of the UE and GHT bounds is due to the different behavior of the efficient return weights underlying their construction.

We study the cross-section of expected corporate bond returns using an inter-temporal CAPM (ICAPM) with three-factors: innovations in future excess bond returns, future real interest rates and future expected inflation. Our test assets are a broad range of corporate bond market index portfolios. We find that two factors – innovations about future inflation and innovations about future real interest rates – explain the cross-section of expected corporate bond returns in our sample. Our model provides an alternative to the ad hoc risk factor models used, for example, in evaluating the performance of bond mutual funds.

We examine the wealth effects of the announcement of issues of different types of convertible securities by UK firms and find significant negative effects on shareholder wealth. We however, also find that when the sample is partitioned by method of issue, privately placed convertible bonds, in contrast to previous research, exhibit a negative impact on firm wealth. Further, we also find negative wealth effects for firms that issue convertible securities to refinance previous debt or finance specific acquisitions. However announcements of convertible bond issues, for the purpose of financing capital expenditure schemes, show significant positive wealth effects. Finally, we find mixed support for testable predictions of the main theoretical models relating cross-sectional firm characteristics of convertible bond issuers to abnormal returns.

Abstract Momentum profits depend mainly on the short leg and therefore on barriers to short sales. Our research indicates that the decline in momentum profitability in the past 2 decades is driven partly by a contemporaneous growth in stock options trading. Stock options offer an alternative to short selling, augmenting the stock lending market, and thereby contributing to improved pricing efficiency. The resulting reduction in barriers to short sales contributes to lower returns to momentum trading from the short leg. Our results persist after matching stocks with and without options based on different firm-level characteristics.