Knowledge that Transforms

Empirical analysis of rates of return in finance implicitly condition on the security surviving into the sample. We investigate the implications of such conditioning on the time series of rates of return. In general this conditioning induces a spurious relationship between observed return and total risk for those securities that survive to be included in the sample. This result has immediate implications for the equity premium puzzle. We show how these results apply to other outstanding problems of empirical finance. Long‐term autocorrelation studies focus on the statistical relation between successive holding period returns, where the holding period is of possibly extensive duration. If the equity market survives, then we find that average return in the beginning is higher than average return near the end of the time period. For this reason, statistical measures of long‐term dependence are typically biased towards the rejection of a random walk. The result also has implications for event studies. There is a strong association between the magnitude of an earnings announcement and the postannouncement performance of the equity. This might be explained in part as an artefact of the stock price performance of firms in financial distress that survive an earnings announcement. The final example considers stock split studies. In this analysis we implicitly exclude securities whose price on announcement is less than the prior average stock price. We apply our results to this case, and find that the condition that the security forms part of our positive stock split sample suffices to explain the upward trend in event‐related cumulated excess return in the preannouncement period.

As a centralized, computerized, limit order market, the Paris Bourse is particularly appropriate for studying the interaction between the order book and order flow. Descriptive methods capture the richness of the data and distinctive aspects of the market structure. Order flow is concentrated near the quote, while the depth of the book is somewhat larger at nearby valuations. We analyze the supply and demand of liquidity. For example, thin books elicit orders and thick books result in trades. To gain price and time priority, investors quickly place orders within the quotes when the depth at the quotes or the spread is large. Consistent with information effects, downward (upward) shifts in both bid and ask quotes occur after large sales (purchases).

This article examines the representation of venture capitalists on the boards of private firms in their portfolios. If venture capitalists are intensive monitors of managers, their involvement as directors should be more intense when the need for oversight is greater. I show that venture capitalists' representation on the board increases around the time of chief executive officer turnover, while the number of other outsiders remains constant. I also show that distance to the firm is an important determinant of the board membership of venture capitalists, as might be anticipated if the oversight of local firms is less costly than more distant businesses.

Substantially revised and updated second edition of Terry Mills' best-selling graduate textbook The Econometric Modelling of Financial Time Series. The book provides detailed coverage of the variety of models that are currently being used in the empirical analysis of financial markets. Covering bond, equity and foreign exchange markets, it is aimed at scholars and practitioners wishing to acquire an understanding of the latest research techniques and findings, and also graduate students wishing to research into financial markets. This second edition includes a great deal of new material, and also provides a more in-depth treatment of two crucial, and related, areas: the theory of integrated processes and cointegration. The new material discusses the distributional properties of asset returns and more recent and novel techniques of analysing and interpreting vector autoregressions that contain integrated and possibly cointegrated variables. Data appendix available online at www.lboro.ac.uk/departments/ec/cup.

This paper examines the robustness of the evidence on predictability of US stock returns, and addresses the issue of whether this predictability could have been historically exploited by investors to earn profits in excess of a buy-and-hold strategy in the market index. We find that the predictive power of various economic factors over stock returns changes through time and tends to vary with the volatility of returns. The degree to which stock returns were predictable seemed quite low during the relatively calm markets in the 1960's, but increased to a level where, net of transaction costs, it could have been exploited by investors in the volatile markets of the 1970's.

Most discussions of corporate capital structure effectively assume that all debt is the same. Yet debt differs by maturity, covenant restrictions, conversion rights, call provisions, and priority. Here, we examine priority structure across a sample of 4995 COMPUSTAT industrial firms from 1981 to 1991. We analyze the variation in the use of capital leases, secured debt, ordinary debt, subordinated debt, and preferred stock both as a fraction of the firm's market value and as a fraction of total fixed claims. Our evidence provides consistent support for contracting cost hypotheses, mixed support for tax hypotheses, and little support for the signaling hypothesis.

In this article, we develop relative pricing (APT) models that are successful in explaining expected returns in the bond market. We utilize indexes as well as unanticipated changes in economic variables as factors driving security returns. An innovation in this article is the measurement of the economic factors as changes in forecasts. The return indexes are the most important variables in explaining the time series of returns. However, the addition of the economic variables leads to a large improvement in the explanation of the cross‐section of expected returns. We utilize our relative pricing models to examine the performance of bond funds.

This article provides a new methodology for pricing and hedging derivative securities involving credit risk. Two types of credit risks are considered. The first is where the asset underlying the derivative security may default. The second is where the writer of the derivative security may default. We apply the foreign currency analogy of Jarrow and Turnbull (1991) to decompose the dollar payoff from a risky security into a certain payoff and a spot exchange rate. Arbitrage-free valuation techniques are then employed. This methodology can be applied to corporate debt and over the counter derivatives, such as swaps and caps.

We use the term structure of futures prices to test whether investors anticipate mean reversion in spot asset prices. The empirical results indicate mean reversion in each market we examine. For agricultural commodities and crude oil the magnitude of the estimated mean reversion is large; for example, point estimates indicate that 44 percent of a typical spot oil price shock is expected to be reversed over the subsequent eight months. For metals, the degree of mean reversion is substantially less, but still statistically significant. We detect only weak evidence of mean reversion in financial asset prices.