Knowledge that Transforms

This paper models a competitive financial market economy in which there are forward markets as well as stock and bond markets. Although there are separation theorems in the stock and forward markets literatures, this analysis shows that neither separation theorem survives in this integrated financial market economy. Next, the analysis shows that the separation results hold and are equivalent if the manager has an appropriate compensation package. Then the model is modified to allow for depreciation charges and tax credits. A positive theory of hedging is developed that shows that the corporation can preserve deductions and credits by hedging and so increase corporate value.

The purpose of this paper is to empirically test the relationships between corporate earnings and investment. In particular, the study investigates whether knowledge of past investments improves the prediction of future earnings beyond predictions that are based on past earnings alone. Similarly, it investigates whether knowledge of past earnings improves the prediction of future investments beyond knowledge of past investments alone. This is the empirical definition of Granger causality. The empirical results show that the bivariate past series of earnings and investments is superior to the univariate series in predicting future investments but not in predicting future earnings.

This paper studies the impact that margin requirements have on both the existence of arbitrage opportunities and the valuation of call options. In the context of the Black‐Scholes economy, margin restrictions are shown to exclude continuous‐trading arbitrage opportunities and, with two additional hypotheses, still to allow the Black‐Scholes call model to apply. The Black‐Scholes economy consists of a continuously traded stock with a price process that follows a geometric Brownian motion and a continuously traded bond with a price process that is deterministic.

This paper considers the pricing of options with default risk. The comparative statics of such options can differ from those of ordinary options, and early exercise of such American call options can be optimal. Several examples of options with default risk are considered.

The tools provided by option‐pricing theory are used to examine the wealth effects of interfirm cash tender offers. The analysis provides evidence consistent with the “synergy” theory of corporate takeovers and has implications concerning the economic effects of regulations of cash tender offers. The analysis further suggests that the market prices information uncertainty in a manner not captured by the standard Capital Asset Pricing Model. The study introduces a technique for unbundling the prices of a primary asset and a contingent claim when only the prices of the combination are observed.

In this paper, we implement a methodology to identify and measure premia in the pricing of forward foreign exchange. The methodology involves application of signal-extraction techniques from the engineering literature. Diagnostic tests indicate that these methods are quite successful in capturing the essence of the time-series properties of premium terms. The estimated premium models indicate that premia show a certain degree of persistence over time and that more than half the variance in the forecast error that results from the use of current forward rates as predictors of future spot rates is accounted for by variation in premium terms. The methodology can be applied straightforwardly to the measurement of unobservables in other financial markets.

This paper develops a model in which managers can signal their firms' true values by using either a dividend or a stock repurchase or both. The authors explain a number of stylized facts about these cash-disbursement mechanisms, particularly those concerning the relative magnitudes of stock price responses to dividends and repurchases. Most importantly, they explain why a stock repurchase elicits a significantly higher price response, on average, than a dividend announcement.