Markets have an allocational role; even in the absence of news about payoffs, prices change to facilitate trade and allocate resources to their best use. Allocational price changes create noise in the signal extraction process, and markets where such trading is important are markets in which we may expect to find a failure of informational efficiency. An important source of allocational trading is the use of dynamic trading strategies caused by the incomplete equitization of risks. Incomplete equitization causes trade. Trade implies the inefficiency of passive strategies, thus requiring investors to determine whether price changes are informational or allocational.
The capital asset pricing model implies that the market portfolio is efficient and expected returns are linearly related to betas. Many do not view these implications as separate, since either implies the other, but the authors demonstrate that either can hold nearly perfectly while the other fails grossly. If the index portfolio is inefficient, then the coefficient and R[squared] from an ordinary least squares regression of expected returns on betas can equal essentially any values and bear no relation to the index portfolio's mean-variance location. That location does determine the outcome of a mean-beta regression fitted by generalized least squares.
This article presents evidence suggesting that the relationship that existed between the partnership of J. P. Morgan and its client firms partially resolved the latter's external financing problems by diminishing the principal-agent and asymmetric information problems. The author estimates and compares investment regression equations for a sample of Morgan-affiliated companies and a control group of nonaffiliated companies. The econometric results seem to indicate that companies not affiliated to the house of Morgan were liquidity constrained.
This article finds evidence consistent with the hypothesis that managers consider personal risk when making decisions that affect firm risk. The author finds that chief executive officers (CEOs) with more personal wealth vested in firm equity tend to diversify. CEOs who are specialists at the existing technology tend to buy similar technologies. When specialists have many years vested, they tend to diversify, however. Poor performance in the existing lines of business is associated with movements into new lines of business.
This article compares the market value of highly leveraged transactions to the discounted value of their corresponding cash flow forecasts. For the authors' sample of 51 highly leveraged transactions completed between 1983 and 1989, the valuations of discounted cash flow forecasts are within 10 percent on average of the market values of the completed transactions. Their valuations perform at least as well as valuation methods using comparable companies and transactions. The authors also invert their analysis by estimating the risk premia implied by transaction values and forecast cash flows and relating those risk premia to firm and industry betas, firm size, and firm book-to-market ratios.
In this article, the authors develop relative pricing (APT) models that are successful in explaining expected returns in the bond market. They 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. The authors utilize their relative pricing models to examine the performance of bond funds.
We develop a simple approach to valuing risky corporate debt that incorporates both default and interest rate risk. We use this approach to derive simple closed-form valuation expressions for fixed and floating rate debt. The model provides a number of interesting new insights about pricing and hedging corporate debt securities. For example, we find that the correlation between default risk and the interest rate has a significant effect on the properties of the credit spread. Using Moody's corporate bond yield data, we find that credit spreads are negatively related to interest rates and that durations of risky bonds depend on the correlation with interest rates. This empirical evidence is consistent with the implications of the valuation model.
This study examines differences in finance research productivity and influence across 661 academic institutions over the five-year period from 1989 through 1993. The authors find that forty institutions account for over 50 percent of all articles published by sixteen leading journals over the five-year period; sixty-six institutions account for two-thirds of the articles. Influence is more skewed, with as few as twenty institutions accounting for 50 percent of all citations to articles in these journals. The number of publications and publication influence increase with faculty size and academic accreditation. Prestigious business schools are associated with high publication productivity and influence. Coauthors are Robert J. Bricker, Kelly R. Brunarski, and Betty J. Simkins.
This article examines the robustness of the evidence on predictability of U.S. 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 1960s but increased to a level where, net of transaction costs it could have been exploited by investors in the volatile markets of the 1970s.