Knowledge that Transforms

We use cross‐sectional regressions to study how a firm's value is related to dividends and debt. With a good control for profitability, the regressions can measure how the taxation of dividends and debt affects firm value. Simple tax hypotheses say that value is negatively related to dividends and positively related to debt. We find the opposite. We infer that dividends and debt convey information about profitability (expected net cash flows) missed by a wide range of control variables. This information about profitability obscures any tax effects of financing decisions.

We examine the effects of bank–firm relationships on firm performance in Japan. When access to capital markets is limited, close bank–firm ties increase the availability of capital to borrowing firms, but do not lead to higher profitability or growth. The cost of capital of firms with close bank ties is higher than that of their peers. This indicates that most of the benefits from these relationships are appropriated by the banks. Finally, the slow growth rates of bank clients suggest that banks discourage firms from investing in risky, profitable projects. However, liberalization of financial markets reduces the banks' market power.

Empirical evidence suggests that banking panics are related to the business cycle and are not simply the result of “sunspots.” Panics occur when depositors perceive that the returns on bank assets are going to be unusually low. We develop a simple model of this. In this setting, bank runs can be first‐best efficient: they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios. However, if costly runs or markets for risky assets are introduced, central bank intervention of the right kind can lead to a Pareto improvement in welfare.

Several studies suggest that a firm distress risk factor could be behind the size and the book‐to‐market effects. A natural proxy for firm distress is bankruptcy risk. If bankruptcy risk is systematic, one would expect a positive association between bankruptcy risk and subsequent realized returns. However, results demonstrate that bankruptcy risk is not rewarded by higher returns. Thus, a distress factor is unlikely to account for the size and book‐to‐market effects. Surprisingly, firms with high bankruptcy risk earn lower than average returns since 1980. A risk‐based explanation cannot fully explain the anomalous evidence.

Implicit in the prices of traded financial assets are Arrow–Debreu prices or, with continuous states, the state‐price density (SPD). We construct a nonparametric estimator for the SPD implicit in option prices and we derive its asymptotic sampling theory. This estimator provides an arbitrage‐free method of pricing new, complex, or illiquid securities while capturing those features of the data that are most relevant from an asset‐pricing perspective, for example, negative skewness and excess kurtosis for asset returns, and volatility “smiles” for option prices. We perform Monte Carlo experiments and extract the SPD from actual S&P 500 option prices.

This paper investigates the informational role of transactions volume in options markets. We develop an asymmetric information model in which informed traders may trade in option or equity markets. We show conditions under which informed traders trade options, and we investigate the implications of this for the linkage between markets. Our model predicts an important informational role for the volume of particular types of option trades. We empirically test our model's hypotheses with intraday option data. Our main empirical result is that negative and positive option volumes contain information about future stock prices.

This paper provides a detailed characterization of the volatility in the deutsche mark–dollar foreign exchange market using an annual sample of five‐minute returns. The approach captures the intraday activity patterns, the macroeconomic announcements, and the volatility persistence (ARCH) known from daily returns. The different features are separately quantified and shown to account for a substantial fraction of return variability, both at the intraday and daily level. The implications of the results for the interpretation of the fundamental “driving forces” behind the volatility process is also discussed.

Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) hypothesize that asset return volatility is a deterministic function of asset price and time, and develop a deterministic volatility function (DVF) option valuation model that has the potential of fitting the observed cross section of option prices exactly. Using S&P 500 options from June 1988 through December 1993, we examine the predictive and hedging performance of the DVF option valuation model and find it is no better than an ad hoc procedure that merely smooths Black–Scholes (1973) implied volatilities across exercise prices and times to expiration.

This paper analyzes the incentives of large shareholders to monitor public corporations. We investigate the hypothesis that a liquid stock market reduces large shareholders' incentives to monitor because it allows them to sell their stocks more easily. Even though this is true, a liquid market also makes it less costly to hold larger stakes and easier to purchase additional shares. We show that this fact is important if monitoring is costly: market liquidity mitigates the problem that small shareholders free ride on the effort of the large shareholder. We find that liquid stock markets are beneficial because they make corporate governance more effective.

We find that the underperformance of IPO stocks relative to the market over a three‐year holding period is less severe for IPOs handled by more prestigious underwriters. Consistent with prior studies, we also find that IPOs managed by more reputable underwriters are associated with less short‐run underpricing. Among the various existing proxies for underwriter reputation, the Carter–Manaster measure is the most significant in the context of initial returns and also in the context of the three‐year performance of IPOs. The study also provides an updated list of the Carter–Manaster measure for various underwriters.