Knowledge that Transforms

We estimate and compare a variety of continuous-time models of the short-term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short-term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well-known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.

Acknowledgments. Introduction: The Revolution in the Wealth of Nations. PART I: SETTING THE SCENE. Chapter 1. Are Stock Prices Predictable? PART II: THE WHOLE AND THE PARTS. Chapter 2. Fourteen Pages to Fame. Chapter 3. The Interior Decorator Fallacy. Chapter 4. The Most Important Single Influence. PART III: THE DEMON OF CHANCE. Chapter 5. Illusions, Molecules, and Trends. Chapter 6. Anticipating Prices Properly. Chapter 7. The Search for High P.Q. PAR IV: WHAT ARE STOCKS WORTH? Chapter 8. The Best at the Price. Chapter 9. The Bombshell Assertions. Chapter 10. Risky Business. Chapter 11. The Universal Financial Device. PART V: FROM GOWN TO TOWN. Chapter 12. The constellation. Chapter 13. The Accountant for Risk. Chapter 14. The Ultimate Invention. PART VI: THE FUTURE. Chapter 15. The View form the Top of the Tower. Notes. Bibliography and Other Sources. Name Index. Subject Index.

This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. I test this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained groups, but is rejected for the others.

We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s.

The paper first characterizes the predictable components in excess rates of returns on major equity and foreign exchange markets using lagged excess returns, dividend yields, and forward premiums as instruments. Vector autoregressions (VARs) demonstrate one‐step‐ahead predictability and facilitate calculations of implied long‐horizon statistics, such as variance ratios. Estimation of latent variable models then subjects the VARs to constraints derived from dynamic asset pricing theories. Examination of volatility bounds on intertemporal marginal rates of substitution provides summary statistics that quantify the challenge facing dynamic asset pricing models.

This paper uses the predictability of monthly excess returns on U.S. and Japanese equity portfolios over the U.S. Treasury bill rate to study the integration of long‐term capital markets in these two countries. During the period 1971–1990 similar variables, including the dividend‐price ratio and interest rate variables, help to forecast excess returns in each country. In addition, in the 1980's U.S. variables help to forecast excess Japanese stock returns. There is some evidence of common movement in expected excess returns across the two countries, which is suggestive of integration of long‐term capital markets.

Using a multivariate vector‐autoregression (VAR) approach, this paper investigates causal relations and dynamic interactions among asset returns, real activity, and inflation in the postwar United States. Major findings are (1) stock returns appear Granger‐causally prior and help explain real activity, (2) with interest rates in the VAR, stock returns explain little variation in inflation, although interest rates explain a substantial fraction of the variation in inflation, and (3) inflation explains little variation in real activity. These findings seem more compatible with Fama (1981) than with Geske and Roll (1983) or with Ram and Spencer (1983) .

I examine the structure of corporate ownership in a sample of Japanese firms in the mid 1980s. Ownership is highly concentrated in Japan, with financial institutions by far the most important large shareholders. Ownership concentration in independent Japanese firms is positively related to the returns from exerting greater control over management. This is not the case in firms that are members of corporate groups (keiretsu). Ownership concentration and the accounting profit rate in both independent and keiretsu firms are unrelated. The results are consistent with the notion that there exist two distinct corporate governance systems in Japan —one among independent firms and the other among firms that are members of keiretsu.

This paper develops and tests hypotheses that explain the choice of accounts receivable management policies. The tests focus on both cross‐sectional explanations of policy‐choice determinants, as well as incentives to establish captives. We find size, concentration, and credit standing of the firm's traded debt and commercial paper are each important in explaining the use of factoring, accounts receivable secured debt, captive finance subsidiaries, and general corporate credit. We also offer evidence that captive formation allows more flexible financial contracting. However, we find no evidence that captive formation expropriates bondholder wealth.

Stock Price Indices are compared across countries in an attempt to explain why they exhibit such disparate behavior. Three separate explanatory influences are empirically documented. First, part of the behavior can be attributed to a technical aspect of index construction; some indices are more diversified than others. Second, each country's industrial structure plays a major role in explaining stock price behavior. Third, for the majority of countries, a portion of national equity index behavior can be ascribed to exchange rate behavior. Exchange rates explain a significant portion of common currency denominated national index returns, although the amount explained by exchange rates is less than the amount explained by industrial structure for most countries.