Knowledge that Transforms

This paper provides empirical support for the notion that autoregressive conditional heteroskedasticity in daily stock return data reflects time dependence in the process generating information flow to the market. Daily trading volume, used as a proxy for information arrival time, is shown to have significant explanatory power regarding the variance of daily returns, which is an implication of the assumption that daily returns are subordinated to intraday equilibrium returns. Furthermore, autoregressive conditional heteroskedasticity effects tend to disappear when volume is included in the variance equation.

Measuring the total return variation explained by shocks to expected cash flows, time-varying expected returns, and shocks to expected returns is one way to judge the rationality of stock prices. Variables that proxy for expected returns and expected-return shocks capture 30 percent of the variance of annual NYSE value-weighted returns. Growth rates of production, used to proxy for shocks to expected cash flows, explain 43 percent of the return variance. Whether the combined explanatory power of the variables–about 58 percent of the variance of annual returns–is good or bad news about market efficiency is left for the reader to judge.

This paper is a report on seventy-two firms that went public since 1983, but previously underwent a full or divisional levereged buy-out. Accounting measures of performance reveal significant improvements in profitability, which resulted mainly from these firms' ability to reduce costs. Firms experience dramatic increases in leverage at the levereged buyout, but the leverage ratios are gradually reduced. The evidence is consistent with the hypothesis that the change in the governance structure of these firms towards more concentrated residual claims created a new organizational structure that is more efficient than its predecessor.

This paper investigates the existence of equilibria with information-based black trading in a multiperiod market when no investor is constrained to block trade. Attention is restricted to equilibria in which a strategic uninformed institution (i.e., one which is forced to rebalance its portfolio, but is free to choose an optimal rebalancing strategy) is willing to trade a block rather than "break up" the block into a series of smaller trades. Examples of such equilibria are found and analyzed.

This paper examines the returns earned by subscribing to initial public offerings of equity. K. Rock (1986) suggests that initial public offerings of equity returns are required by uninformed investors as compensation for the risk of trading against superior information. The authors show that initial public offerings of equity with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of "informed" activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with initial public offerings of equity that have lower returns.

This paper demonstrates how the incentive of manager-equityholders to substitute toward riskier assets, commonly referred to as the "asset substitution problem," is related to the level of observable risk in the firm. When observable and unobservable risks are sufficiently positively correlated, increases (decreases) in observable risk generate the incentive for manager-equityholders to increase (decrease) unobservable risk. Thus, credible commitments to hedge observable risk can benefit the firm's manager-equityholders by reducing the incentive to shift risk and the associated agency cost of debt. This provides a positive rationale for hedging diversifiable risk at the firm level.

This paper reexamines the evidence on purchasing power parity in the long run. Previous studies have generally been unable to reject the hypothesis that the real exchange rate follows a random walk. If true, this implies that purchasing power parity does not hold. In contrast, this paper casts serious doubt on this random walk hypothesis. The results follow from more powerful estimation techniques, applied in a multilateral framework. Deviations from purchasing power parity, while substantial in the short run, appear to take about three years to be reduced in half.

In this paper, the authors examine the profitability of insider trading in firms whose securities trade in the OTC/NASDAQ market. Although the evidence suggests timing and forecasting ability on the part of insiders, high transaction costs (especially bid-ask spreads) appear to eliminate the potential for positive abnormal returns from active trading. By implication, outside investors who mimic the trading of insiders are also precluded from earning abnormal profits. In addition, the authors provide evidence on the determinants of insiders' profits. The data suggest that insiders closer to the firm trade on more valuable information than insiders removed from the firm.

The assumption that the market portfolio follows a specified diffusion process implies, in a simple equilibrium framework, that the representative individual must have a certain utility function that is identified in the paper. Not every diffusion process is viable, i.e., can be "endogenized" to be the market portfolio's price process in such an equilibrium model. The paper provides necessary and sufficient conditions for viability that imply that viable diffusion processes constitute a rather restricted family.