Knowledge that Transforms

This paper presents a general framework for pricing contingent claims under interest rate and asset price uncertainty. The framework extends Ho and Lee's (1986) valuation framework by allowing not only future interest rates but also future asset prices to depend on the current term structure of interest rates. The approach is shown to provide risk-neutral valuation relationships that are consistent with the initial term structure of interest rates and can be applied to valuation of a broad class of assets including stock options, convertible bonds, and junk bonds.

This paper hypothesizes and tests the argument that a defeasance transaction initiates a wealth transfer from stockholders to bondholders. Our empirical tests provide compelling evidence of bondholder gains, but no support for shareholder losses when a firm defeases debt. We speculate that the insignificance of the loss to shareholders is primarily due to the size disparity between the value of defeased debt and the market value of outstanding equity, since the suggested economic merits of defeasance appear unfounded. Although we cannot prove an agency motivation for defeasance, we find a very high correlation between compensation tied to earnings and defeasing debt at a book gain.

This paper examines dynamic information losses associated with loan terminations. We assume that the aggregated returns of current borrowers contain information about the mean returns to future borrowers. In a competitive loan market, the value of this information is not fully internalized by individual borrowers and lenders, and loan decisions fail to be first best. Introducing heterogeneous borrowers, who know their own risk characteristics better than lenders, safer borrowers are less willing to borrow when risk premia rise. As they cease borrowing, the information generated in credit markets becomes noisier and this tends to increase risk premia. The model produces alternating and persistent periods of “tight” and “loose” credit.

Over the last decade much attention has been focused upon strategic factors influencing corporate financing decisions, especially those relating to informational problems.The results of this research have primarily been suggestive--proposing possible explanations of phenomena, but not providing specific methods for incorporating the strategic factors into quantitative valuation techniques and models.Quantitative models of financial variables have primarily been developed for cases of perfect competition or similar special cases in which the strategic factors are not central.In this paper we provide a model in which the estimation of the value of strategic factors is the objective and for a relationship between prices across time which is at the center of finance theory.This paper develops the use of an auction model to value long-term forward contracts for the purchase of commodities.Recent theoretical and empirical research has emphasized the danger of ex-post opportunistic bargaining as a primary motivation for the use of long-term forward contracts in preference to a dependence upon spot markets.However, this literature has not developed an operational procedure for assessing the value to the firm of using a forward contract to eliminate this ex-post bargaining problem.Traditional arbitrage methods for valuing forward contracts sold on the organized exchanges ignore the bargaining problem, that is.they assume a competitive market in which the strategic factors creating the bargaining problem and motivating the use of long-term contracts are not present.We demonstrate how auction models can be used to assign a value to the strategic advantage of long-term contracts.This value is shown to depend primarily upon the number of potential buyers in the relevant market and the relation between the lower end of the range of reservation prices of these buyers and the fixed costs of installing the capacity to supply the commodity.Problems with assigning a value to the strategic advantage of long-term contracts are discussed and other important strategic features of long-term contracts which need to be valued are identified.RECEJVED1 .

The end of favorable tax treatment for long-term capital gains caused investors to reassess traditional tax-induced trading strategies. This study compares trading behavior in December 1986 and January 1987 with previous years. Our results indicate that these tax code changes had a powerful effect on trading behavior. Relative trading volume was considerably higher in December 1986 for long-term winners but not significantly lower for long-term losers. Results also indicate altered trading patterns based on short-term gains in December 1986 and for long-term winners in January 1987.

Eric L. Mais, William T. Moore, Ronald C. Rogers, A Re-Examination of Shareholder Wealth Effects of Calls of Convertible Preferred Stock, The Journal of Finance, Vol. 44, No. 5 (Dec., 1989), pp. 1401-1410

We develop a multiperiod rational expectations model of securities market equilibrium in which equilibrium prices may move between periods even though it is common knowledge that no new information has arrived about ultimate security payoffs. This happens because investors know they have imperfect information about the endowments of other investors and this knowledge affects their probability beliefs about the prices that will prevail at the intermediate trading date. These beliefs are reflected in the equilibrium at the initial trading date when investors focus on the probabilities of intermediate capital gains and losses, rather than ultimate payoffs.