Knowledge that Transforms

This paper examines the relation between the interest rate sensitivity of common stock returns and the maturity composition of the firm's nominal contracts. Using a sample of actively traded commerical banks and stock savings and loan associations, common stock returns are found to be correlated with interest rate changes. The co-movement of stock returns and interest rate changes is positively related to the size of the maturity difference between the firm's nominal assets and liabilities.

Upper and lower bounds are derived for call options traded at discrete intervals. These bounds are independent of assumptions on the stock price distribution other than a restriction satisfied by the stock being “non‐negative beta.” The development of the bounds relies on the single‐price law and arbitrage arguments. Both single‐period and multiperiod results are produced, and put option bounds follow by extension. The bounds exist as equilibrium values given a consensus on stock price distribution; they are also valid for empirical studies, being adjustable for dividends and commissions.

A number of investigators have reported that January stock returns in the U.S. exceed returns for other months of the year. This paper documents a similar finding for Canadian stocks over the period 1951–1980. However, Canada did not introduce a capital gains tax until 1973 and the paper reports that January returns in Canada exceed returns for other months of the year before and after this date. Thus, these data do not support the tax‐loss‐selling‐pressure hypothesis as the entire explanation for the turn‐of‐the‐year effect in stock returns, nor, by implication, do they support the tax‐loss‐selling‐pressure hypothesis as the complete explanation for the “small firm” effect in U.S. stocks returns.

Consider a fixed‐income portfolio whose duration is equal to the length of a given investment horizon. It is shown that there is a lower limit on the change in the end‐of‐horizon value of the portfolio resulting from any given change in the structure of interest rates. This lower limit is the product of two terms, of which one is a function of the interest rate change only, and the other depends only on the structure of the portfolio. Consequently, this second term provides a measure of immunization risk. If this measure is minimized, the exposure of the portfolio to any interest rate change is the lowest.

This paper derives a stronger version of Huberman's recent “preference free” pricing theorem. This pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model. It must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals. This result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under Huberman's bound. Some applications to empirical tests and performance measurement are also discussed.

We examine abnormal stock returns surrounding contemporaneous earnings and dividend announcements in order to determine whether investors evaluate the two announcements in relation to each other. We find that there is a statistically significant interaction effect. The abnormal return corresponding to any earnings or dividend announcement depends upon the value of the other announcement. This evidence suggests the existence of a corroborative relationship between the two announcements. Investors give more credence to unanticipated dividend increases or decreases when earnings are also above or below expectations, and vice versa.