Knowledge that Transforms

The APT is represented as a multivariate regression model with across‐equations restrictions. Both observed and unobserved (latent) macroeconomic factors are included, thus generalizing and unifying two previous strands of literature. Large portfolios representing unobserved factors are treated as endogenous, and nonlinear 3SLS estimates are shown to differ sharply from estimates that ignore this endogeneity. Using monthly stock returns and six factors, we cannot reject January effects. The following results are invariant with respect to the inclusion of January effects: we reject the CAPM in favor of the APT; however, we cannot reject the APT restrictions on the linear factor model.

This research empirically investigates the relation between common stock and call option trading volumes. The paper hyothesizes and tests a sequential flow of information between the stock and option markets. If information trading for CBOE‐listed firms is predominantly accomplished through option trading, then existing research methodologies may be biased against finding any significant economic consequences in those instances where option listing is an important variable. Results indicate that trading in call options leads trading in the underlying shares, with a one‐day lag.

The authors investigate the term structure of interest rates when the underlying state variables and production technologies follow the jump‐diffusion processes. Even in some cases where the traditional expectations theory about the term structure is consistent with general equilibrium under diffusion processes, the traditional theory is not consistent under jump‐diffusion processes. It is shown that bond prices are strictly higher under jump risks than otherwise and that consumers with logarithmic utility functions will develop hedge portfolios in the presence of jump diffusion.

This paper presents empirical evidence comparing two models of trading in equities—the well‐known tax‐loss‐selling hypothesis and “the disposition effect.” According to the disposition effect, investors are reluctant to realize losses but are eager to realize gains. This paper distinguishes between the two models with a new methodology that examines the relationship between volume at a given point in time and volume that took place in the past at different stock prices. The evidence overwhelmingly supports the disposition effect not only as a determinant of year‐end volume, but also as a determinant of volume levels throughout the year.

A thorough understanding of internal incentive structures is critical to developing a viable theory of the firm, since these incentives determine to a large extent how individuals inside an organization behave. Many common features of organizational incentive systems are not easily explained by traditional economic theory—including egalitarian pay systems in which compensation is largely independent of performance, the overwhelming use of promotion-based incentive systems, the absence of up-front fees for jobs and effective bonding contracts, and the general reluctance of employers to fire, penalize, or give poor performance evaluations to employees. Typical explanations for these practices offered by behaviorists and practitioners are distinctly uneconomic—focusing on notions such as fairness, equity, morale, trust, social responsibility, and culture. The challenge to economists is to provide viable economic explanations for these practices or to integrate these alternative notions into the traditional economic model.

In this paper, we explore the relationship between real exchange rates and real interest rate differentials in the United States, Germany, Japan, and the United Kingdom. Contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant, we find little evidence of a stable relationship between real interest rates and real exchange rates. We consider both in-sample and out-of-sample tests. One hypothesis that is consistent with our findings is that real disturbances (such as productivity shocks) may be a major source of exchange rate volatility.

This is a summary and interpretation of some of the literature on stock price volatility that was stimulated by Leroy and Porter [28] and Shiller [40] . It appears that neither small‐sample bias, rational bubbles nor some standard models for expected returns adequately explain stock price volatility. This suggests a role for some nonstandard models for expected returns. One possibility is a “fads” model in which noise trading by naive investors is important. At present, however, there is little direct evidence that such fads play a significant role in stock price determination.

This paper considers a model where banks may improve the returns on loans by monitoring borrowers. Bank regulation, together with competitive deposit and equity financing, can give banks an incentive to sell loans, but the extent of their loan selling is limited by a moral-hazard problem. A solution is given for the optimal design of the bank-loan buyer contract that alleviates this moral-hazard problem. An explanation is also given as to why some banks might buy loans and why loan sales volume has recently increased.

This paper presents empirical tests of market rationality using data from the point spread betting market on National Football League games. Data from this market avoid many common pitfalls of tests of rationality in conventional financial markets. The authors test for rationality with two types of tests, statistical and economic. Results of the tests reveal that the statistical tests cannot reject market rationality while the economic tests do reject market rationality.