Knowledge that Transforms

This article examines the predictable variation in long-maturity government bond returns in six countries. A small set of global instruments can forecast 4 to 12 percent of monthly variation in excess bond returns. The predictable variation is statistically and economically significant. Moreover, expected excess bond returns are highly correlated across countries. A model with one global risk factor and constant conditional betas can explain international bond return predictability if the risk factor is proxied by the world excess bond return but not if it is proxied by the world excess stock return.

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, the authors examine priority structure across a sample of 4995 COMPUSTAT industrial firms from 1981 to 1991. They 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. The authors' evidence provides consistent support for contracting cost hypotheses, mixed support for tax hypotheses, and little support for the signaling hypothesis.

This article establishes efficient lattice algorithms for pricing American interest-sensitive claims in the Heath, Jarrow, and Morton paradigm under the assumption that the volatility structure of forward rates is restricted to a class that permits a Markovian representation of the term structure. The class of volatilities that permits this representation is quite large and imposes no severe restrictions on the structure for the spot rate volatility. The algorithm exploits the Markovian property of the term structure and permits the efficient computation of all types of interest rate claims. Specific examples are provided.

This paper examines the structure of staged venture capital investments when agency and monitoring costs exist. Expected agency costs increase as assets become less tangible, growth options increase, and asset specificity rises. Data from a random sample of 794 venture-capital-backed firms support the predictions. Venture capitalists concentrate investments in early stage and high technology companies where informational asymmetries are highest. Decreases in industry ratios of tangible assets to total assets, higher market-to-book ratios, and greater R&D intensities lead to more frequent monitoring. Venture capitalists periodically gather information and maintain the option to discontinue funding projects with little probability of going public.

We propose a measure of capital market integration arising from a conditional regime-switching model. Our measure allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. We find that a number of emerging markets exhibit time-varying integration. Some markets appear more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets. While there is a perception that world capital markets have become more integrated, our country-specific investigation suggests that this is not always the case.

Oil futures prices are often below spot prices. This phenomenon, known as strong backwardation, is inconsistent with Hotelling's theory under certainty that the net price of an exhaustible resource rises over time at the rate of interest. The authors introduce uncertainty and characterize oil wells as call options. They show that production occurs only if discounted futures are below spot prices, production is nonincreasing in the riskiness of future prices, and strong backwardation emerges if the riskiness of future prices is sufficiently high. The empirical analysis indicates that U.S. oil production is inversely related and backwardation is directly related to implied volatility.

How marketability affects security prices is one of the most important issues in finance. The authors derive a simple analytical upper bound on the value of marketability using option-pricing theory. They show that discounts for lack of marketability can potentially be large even when the illiquidity period is very short. This analysis also provides a benchmark for assessing the potential costs of exchange rules and regulatory requirements restricting the ability of investors to trade when desired. Furthermore, these results provide new insights into the relation between discounts for lack of marketability and the length of the marketability restriction.

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).

Regulatory authorities set capital requirements to cover the position risk of securities firms and to protect against losses arising from fluctuations in the value of their holdings. The requirements may be set using the comprehensive approach required by the U.S. Securities and Exchange Commission, the building-block approach required by the European Community, or the portfolio approach required by the United Kingdom. We compare these three alternatives using a large sample of U.K. equity trading books. The portfolio approach systematically specifies larger requirements for riskier books, and vice versa. It is more efficient than the building-block approach, and far more efficient than the comprehensive approach.