Currency carry trades exploiting violations of uncovered interest rate parity in G10 currencies deliver significant excess returns with annualized Sharpe ratios equal to or greater than those of equity market factors (1990–2012). Using data on out-of-the-money foreign exchange options, I compute returns to crash-hedged portfolios and demonstrate that the high returns to carry trades are not due to peso problems. A comparison of the returns to hedged and unhedged trades indicates crash risk premia account for at most one-third of the excess return to currency carry trades.

We evaluate whether, and under what circumstances, corporate tax aggressiveness influences audit pricing. Using a compound measure of two long-run effective tax rates, we find that tax-aggressive firms pay higher fees for external audit services after controlling for factors related to earnings management. The fee premium increases with management’s uncertainty about the sustainability of tax positions if audited by tax authorities (i.e., disclosed tax reserves). Further, the provision of auditor-provided tax services may create knowledge spillovers that alleviate the fee premium for tax aggressiveness, unless tax uncertainty is high. Finally, an accounting firm’s industry expertise in auditing is associated with higher audit fees independent of tax aggressiveness, whereas industry expertise in taxation leads to a fee premium only for tax-aggressive clients. Overall, the evidence implies firms’ aggressive tax behavior, tax services provider, and auditor expertise interact to influence the pricing of audit engagements.

We examine changes in banks’ market-to-book ratios over the last decade, focusing on the dramatic and persistent declines witnessed during the financial crisis. The extent of the decline and its persistence cannot be explained by the delayed recognition of losses on existing financial instruments. Rather, it is declines in the values of intangibles – including customer relationships and other intangibles related to business opportunities – along with unrecognized contingent obligations that account for most of the persistent decline in market-to-book ratios. These shifts reflect a combination of changed economic circumstances (e.g., low interest rates reduce the value of core deposits; meager growth opportunities reduce the value of customer relationships) and changed regulatory policies. Together, these changes in the business environment since the financial crisis have led investors to associate little value with intangibles. For example, changing market perceptions of the consequences of leverage have affected the way investors value banks; prior to the crisis, higher leverage, ceteris paribus, was associated with greater value (reflecting the high relative cost of equity finance), but during and after the crisis, as default risk and regulatory concerns came to the fore, lower leverage was associated with greater value. Reflecting the rising importance of regulatory risks (e.g., the uncertain consequences of the Volcker Rule), after controlling for other influences, dividend payments (a signal of management and regulatory perceptions of the persistence of financial strength) matter for market prices much more after the crisis, while increases in recurring fee income matter less.

Abstract How does the market value “toxic” structured-credit securities? We study the valuation of what is possibly the most toxic of all toxic assets: the equity tranche of a collateralized debt obligation (CDO). In theory, CDO equity should be similar in nature to bank stock since both represent residual claims on a portfolio of loans. We find CDO equity returns are much more related to stock returns than to fixed-income returns. CDO equity returns track the returns of financial stocks much more closely than any other industry. Nearly two-thirds of the variation in CDO returns can be explained by fundamentals.

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We use the unique regulatory environment of the pharmaceutical industry to examine how potential competition affects generic drug pricing. Our identification strategy exploits a provision of the Hatch-Waxman Act that awards 180 days of marketing exclusivity to the first valid generic drug applicant against the holder of a branded drug patent. In smaller drug markets, we find that price falls in response to an increase in potential competition. We also find that few manufacturers enter these markets, indicating this price reduction is an effective deterrent. In contrast, we find that generic incumbents accommodate entry in larger drug markets.

While stock options are commonly used in managerial compensation to provide desirable incentives, they can create adverse incentives to distort the choice of investment risk. Relative to the risk level that maximizes firm value, call options in a compensation contract can induce too much or too little corporate risk-taking, depending on managerial risk aversion and the underlying investment technology. We show that inclusion of lookback call options in compensation packages has desirable countervailing effects on managerial choice of corporate risk policies and can induce risk policies that increase shareholder wealth. We argue that lookback call options are analogous to the observed practice of option repricing.

This paper introduces a new confidence interval (CI) for the autoregressive parameter (AR) in an AR(1) model that allows for conditional heteroskedasticity of a general form and AR parameters that are less than or equal to unity. The CI is a modification of Mikusheva's (2007a) modification of Stock's (1991) CI that employs the least squares estimator and a heteroskedasticity-robust variance estimator. The CI is shown to have correct asymptotic size and to be asymptotically similar (in a uniform sense). It does not require any tuning parameters. No existing procedures have these properties. Monte Carlo simulations show that the CI performs well in finite samples in terms of coverage probability and average length, for innovations with and without conditional heteroskedasticity.

In the 1980s, many US cities initiated programs reserving a proportion of government contracts for minority-owned businesses. The staggered introduction of these set-aside programs is used to estimate their impacts on the self-employment and employment rates of African American men. Black business ownership rates increased significantly after program initiation, with the black-white gap falling 3 percentage points. The evidence that the racial gap in employment also fell is less clear as it depends on assumptions about the continuation of preexisting trends. The black gains were concentrated in industries heavily affected by set-asides, and they mostly benefited the better educated.