[A general approach to testing serial dependence restrictions implied from financial models is developed. In particular, we discuss joint serial dependence restrictions imposed by random walk, market microstructure, and rational expectations models recently examined in the literature. This approach incorporates more information from the data by explicitly modeling dependencies induced by the use of overlapping observations. Because the estimation problem is sufficiently simple in this framework, the test statistics have simple representations in terms of only a few unknown parameters. As a result, relatively good size properties are attained in small samples. In addition, the benefit to overlapping observations and the advantage of examining multiperiod time series are explicitly quantified.]

This paper addresses the problem of testing financial models in the presence of market microstructure effects. The moment restrictions implied by the financial and market microstructure models are jointly tested using Hansen’s (1982) GMM approach. To illustrate the methodology, I consider the random walk model in combination with the bid-ask price effect model of Blume and Stambaugh (1983). Within this sufficiently simple framework, I obtain closed-form expressions for the estimators, standard errors of the estimators, and the test statistic, which affords an opportunity to examine the precision of the estimators and the power of the test as the return interval increases. I show that apparent rejections of the random walk model cannot be sustained when tests of the model are adjusted for market microstructure effects, and I discuss other applications of the methodology.

[In this paper, we use call option prices to identify synergies and news from merger and acquisition (M&A) transaction announcements. We find that M&A announcements result in large and approximately equal gains to the bidder and the target on average, with the combined gains being large enough to justify the premium paid to target shareholders. On average, M&A announcements release good news about targets, but bad news about bidders. This suggests that market prices understate true synergy gains, and helps reconcile the generally negative market-based evidence on value-creation in takeovers with their continued prominence in everyday business strategy.]

The development of asset pricing models that rely on instrumental variables together with the increased availability of easily accessible economic time-series have renewed interest in predicting security returns. Evaluating the significance of these new research findings, however, is no easy task. Because these asset pricing theory tests are not independent, classical methods of assessing goodness-of-fit are inappropriate. This study investigates the distribution of the maximal R-square when k of m regressors are used to predict security returns. The authors provide a simple procedure that adjusts critical R-square values to account for selecting variables by searching among potential regressors.

Matthew Richardson, Tom Smith, A Direct Test of the Mixture of Distributions Hypothesis: Measuring the Daily Flow of Information, The Journal of Financial and Quantitative Analysis, Vol. 29, No. 1 (Mar., 1994), pp. 101-116

We provide a formal test of the liquidity preference hypothesis (LPH), that is, the monotonicity of ex ante term premiums, using nonparametric estimates that do not require a structural model for conditional expected returns. Although the point estimates of the term premiums are consistent with previous conclusions in the literature regarding violations of the LPH, the test statistics are generally insignificant, even when powerful conditioning information is used. These results illustrate the importance of correctly accounting for correlations across maturities and of formally testing the inequality restrictions implied by the LPH.

A general approach to testing serial dependence restrictions implied from financial models is developed. In particular, we discuss joint serial dependence restrictions imposed by random walk, market microstructure, and rational expectations models recently examined in the literature. This approach incorporates more information from the data by explicitly modeling dependencies induced by the use of overlapping observations. Because the estimation problem is sufficiently simple in this framework, the test statistics have simple representations in terms of only a few unknown parameters. As a result, relatively good size properties are attained in small samples. In addition, the benefit to overlapping observations and the advantage of examining multiperiod time series are explicitly quantified.

We examine the transmission of international monetary policy shocks via the bank lending channel. Exploiting a panel of regulatory data on foreign banks operating in Australia, we show that the supply of credit is vulnerable to the international pass-through of monetary policy, with banks headquartered in Asia demonstrating high elasticity. Household and non-financial corporate loans are the most susceptible channels to policy shocks, while higher-margin lending, non-lending assets, and reservable liabilities are insensitive. We demonstrate that although banks curtail lending in the face of tighter monetary policy, they increase their non-reservable borrowing, suggesting an increased reliance on capital markets. Finally, we show that unconventional monetary policies have a muted effect compared to traditional measures. • We study the transmission of monetary policy shocks via the bank lending channel. • We exploit Australian regulatory bank data to test for the presence of the BLC. • Household and corporate loans are found to be the most susceptible channels. • Asian banks demonstrate the highest degree of lending elasticity. • Unconventional policies have a muted effect compared to traditional measures.

This paper develops tests of inequality restrictions implied by conditional asset pricing models. The methodology is easy to implement, requires little knowledge of the conditional distribution of asset returns, and is valid under fairly weak assumptions. As an application, we test whether the ex ante risk premium is always positive. We report reliable evidence that the ex ante risk premium is negative in some states of the world; these states are related to periods of high expected inflation and especially to downward-sloping term structures.

The need to understand and measure the determinants of market maker bid/ask spreads is crucial in evaluating the merits of competing market structures and the fairness of market maker rents. This study develops a simple, parsimonious model for the market maker's spread that accounts for the effects of price discreteness induced by minimum tick size, order-processing costs, inventory-holding costs, adverse selection, and competition. The inventory-holding and adverse selection cost components of spread are modeled as an option with a stochastic time to expiration. This inventory-holding premium embedded in the spread represents compensation for the price risk borne by the market maker while the security is held in inventory. The premium is partitioned in such a way that the inventory-holding and adverse selection cost components, as well as the probability of an informed trade, are identified. The model is tested empirically using Nasdaq stocks in three distinct minimum tick size regimes and is shown to perform well both in an absolute sense and relative to competing specifications.