We examine the stock market reaction to announcements of formal supervisory actions. We find that the variation in the quality and timeliness of disclosure by U.S. banks explains much of the variation in the market's reactions. We also find that these announcements can cause spillover effects. However, rather than representing contagion, these spillover effects are consistent with enhanced transparency. Only banks in the same region as the announcing bank, with similar exposures, are affected. Thus, enhanced disclosure can improve the allocation of resources in the banking system. Journal of Economic Literature Classification Numbers: G21, G28.

Dealers enter nonbinding expressions of interest during the Nasdaq preopening to promote price discovery and ease stock inventory management when the market opens. But does this practice of “indicating ahead” constitute best execution for an individual customer? Arguments in favor of the practice rely on the notion that best execution is a general condition as opposed to a concept applicable on a trade-by-trade basis. Some customers must sacrifice in individual instances to improve the functioning of the overall market. But the practice of indicating ahead violates the dealer agent's duty of loyalty to her individual customer. Moreover, the dealer's financial self-interest is best served by indicating ahead. Journal of Economic Literature Classification Numbers: G10, G18, K22.

Abstract In this article, I use the principal‐agent framework to examine the incentives of risk‐and work‐averse agents to work on projects that are long‐term, multistage, and subject to abandonment. Periodic applications of effort by the agent are required. The agent also obtains private information as the project evolves, and he decides whether the project should be abandoned or continued. The principal not only seeks to provide incentives to induce the agent to take up such risky investments and work hard at them, but also seeks to provide incentives for the agent to abandon the project if the profit prospect is low. We show that the agent's decision to continue is not always aligned with the principal's desire. The result provides an economic rationale for the sunk cost phenomenon. There also exist conditions under which the agent chooses to prematurely abandon the project.

Abstract Guenther and Trombley (1994) and Jennings, Simko, and Thompson (1996) document a negative association between a firm's last‐in, first‐out (LIFO) reserve and the market value of its equity. In this paper, we test a deferred tax explanation of this negative association. Specifically, we argue that investors, conditional on adjusting inventory to as‐if first‐in, first‐out (FIFO), estimate a firm's future LIFO liquidation tax burden as its LIFO reserve multiplied by the appropriate corporate tax rate and include this tax‐adjusted LIFO reserve in the valuation of a LIFO firm's net assets. On the basis of this argument, the tax‐adjusted LIFO reserve is in effect an estimate of an off‐balance‐sheet deferred tax liability and, as a result, we predict a negative association between the tax‐adjusted LIFO reserve and market value of equity. We test our deferred tax explanation by estimating a valuation model in which a firm's market value of equity is expressed as a function of the firm's assets, liabilities, deferred tax liability, and tax‐adjusted LIFO reserve; the model is estimated separately in years preceding and following the reduction of tax rates mandated by the US Tax Reform Act of 1986. Test results provide strong support for the deferred tax explanation of the negative association between a firm's LIFO reserve and the market value of its equity.

Forward rate dynamics are modeled as a random field. In contrast to multifactor models, random field models offer a parsimonious description of term structure dynamics, while eliminating the self-inconsistent practice of recalibration. The form of the drift of the instantaneous forward rate process necessary to preclude arbitrage under the risk-neutral measure is obtained. Forward risk-adjusted measures are identified and used to price a bond option when the forward volatility structure depends on the square root of the current spot rate. Several classes of tractable random field models are presented.

Forward rate dynamics are modeled as a random field. In contrast to multifactor models, random field models offer a parsimonious description of term structure dynamics, while eliminating the self-inconsistent practice of recalibration. The form of the drift of the instantaneous forward rate process necessary to preclude arbitrage under the risk-neutral measure is obtained. Forward risk-adjusted measures are identified and used to price a bond option when the forward volatility structure depends on the square root of the current spot rate. Several classes of tractable random field models are presented.

This paper focuses on pricing and hedging options on a zero-coupon bond in a Heath-Jarrow-Morton (1992) framework when the value and/or functional form of forward interest rates volatility is unknown, but is assumed to lie between two fixed values. Due to the link existing between the drift and the diffusion coefficients of the forward rates in the Heath, Jarrow and Morton framework, this is equivalent to hedging and pricing the option when the underlying interest rate model is unknown. We show that a continuous range of option prices consistent with no arbitrage exist. This range is bounded by the smallest upper-hedging strategy and the largest lower-hedging strategy prices, which are characterized as the solutions of two non-linear partial differential equations. We also discuss several pricing and hedging illustrations.

This study compares the market value of firms that reorganize in bankruptcy with estimates of value based on management's published cash flow projections. We estimate firm values using models that have been shown in other contexts to generate relatively precise estimates of value. We find that these methods generally yield unbiased estimates of value, but the dispersion of valuation errors is very wide-the sample ratio of estimated value to market value varies from less than 20% to greater than 250%. Cross-sectional analysis indicates that the variation in these errors is related to empirical proxies for claimholders' incentives to overstate or understate the firm's value.

We examine research and development (R&D) agreements between government agencies and other organizations. Consistent with theories of contractual “hold up,” contracts are longer and more complete when the parties envision a joint product as opposed to when they merely plan to share information. Contracts are less complete when the parties have an ongoing business relationship, suggesting an interaction between reputation and explicit contracting. While our experiment cannot dismiss the possibility that these empirical regularities simply reflect the nature of the parties' joint investment, the findings are consistent with arguments that theories of contracting for tangible inputs also pertain to R&D.

This paper investigates tax effects in the Canadian government bond market during the period 1964—1986. Unlike previous studies, we apply both statistical and nonstatistical teststo analyze clientele effects and market equilibria. The results divide the sample into two distinct periods of time, with the end of 1976 marking the division. We find that tax effects are almost nonexistent in the Canadian government bond market before the end of 1976, but are predominant in the post-1976 period. Non-segmented market equilibria cannot be rejected before 1977, but are strongly rejected after 1976. In fact, segmented equilibria with clientele effects in both quantities and prices characterize the entire five year period from 1982 to 1986. These findings are consistent with tax reforms, government deficit financing and interest rate fluctuations in Canada during our sample period.