The behavior of competing dealers in securities markets is analyzed. Securities are characterized by stochastic returns and stochastic transactions. Reservation bid and ask prices of dealers are derived under alternative assumptions about the degree to which transactions are correlated across stocks at a given time and over time in a given stock. The conditions for interdealer trading are specified, and the equilibrium distribution of dealer inventories and the equilibrium market spread are derived. Implications for the structure of securities markets are examined.
This paper presents estimates of the effect of a voluntary spin‐off announcement on shareholder wealth. The results show that spin‐off announcements have a positive influence on stock prices and that the relative increase in share price is greater for large spin‐offs than for small ones.
This paper develops a new option pricing formula that pushes the underlying source of risk back to the risk of individual assets of the firm. The formula simultaneously encompasses differential riskiness of the assets of the firm, their relative weights in determining the value of the firm, the effects of firm debt, and the effects of a dividend policy with both constant and random components. Although this setting considerably generalizes the Black‐Scholes [1] analysis, it nonetheless produces a formula via riskless arbitrage arguments that, given estimated inputs, is as easy to use as the Black‐Scholes formula.
This study finds shortcomings in empirical tests of the capital structure irrelevance hypothesis. The alternative hypothesis is that firms choose value maximizing mixes of debt and equity on account of bankruptcy costs and the tax deductibility of interest payments. Based upon the cross‐sectional implications of the tax shelter‐bankruptcy cost hypothesis, an alternative test of the irrelevance hypothesis is performed. The test examines the relationship between failure rates and leverage ratios for 36 lines of business. The results are inconsistent with the irrelevance hypothesis.
In order to supply additional empirical evidence of the effect of wealth on relative risk aversion, this study investigates households' demand for risky assets, using analysis of covariance techniques applied to the asset holdings of Canadian individual households. The extent and pattern of life‐cycle effects are also examined. Results generally point to decreasing relative risk aversion when housing is either excluded from the definition of wealth or treated as a riskless asset. The investor's life‐cycle plays a prominent role in portfolio selection behavior, with risk aversion increasing uniformly with age. Tax differentials do not seem to be an important element in investment decisions with respect to risk. When the sample and wealth definitions are censored in order to approximate those of previous empirical studies, their findings on relative risk aversion are generally corroborated.
We estimate the parameters of Ross's Arbitrage Pricing Theory (APT). Using daily return data during the 1963–78 period, we compare the evidence on the APT and the Capital Asset Pricing Model (CAPM) as implemented by market indices and find that the APT performs well. The theory is further supported in that estimated expected returns depend on estimated factor loadings, and variables such as own variance and firm size do not contribute additional explanatory power to that of the factor loadings.
This paper develops a theory of financial intermediation that highlights the contribution of intermediaries as informed agents in a market with imperfect information. We consider a venture capital market where the entrepreneurs select the qualities of projects and their perquisite consumptions, about which the investors are imperfectly informed. It is shown that when all investors have positive search costs, the entrepreneurs are induced to offer the unacceptable inferior projects (“lemons” only), and the investors will not enter the venture capital market, but put their funds in other low return investments–an undesirable allocation of resources. Beginning with an initial undesirable situation, the financial intermediaries may evolve as informed agents that induce a Pareto‐preferred allocation, leading the investors to a higher welfare state. We focus our analysis on the existence of intermediation equilibra when the market for intermediation services is competitive. The distribution of returns on projects, the fees charged by intermediaries, and the fraction of institutional holdings are all endogenous in equilibrium. It is shown that (i) there cannot be a competitive intermediation equilibrium with very high institutional holdings, and (ii) in other cases multiple equilibra may exist, but the one with the highest institutional holdings dominates the others in a Pareto sense.