Knowledge that Transforms

Diversified firms have different values from comparable portfolios of single‐segment firms. These value differences must be due to differences in either future cash flows or future returns. Expected security returns on diversified firms vary systematically with relative value. Discount firms have significantly higher subsequent returns than premium firms. Slightly more than half of the cross‐sectional variation in excess values is due to variation in expected future cash flows, with the remainder due to variation in expected future returns and to covariation between cash flows and returns.

A Sunday New York Times article on a potential development of new cancer‐curing drugs caused EntreMed's stock price to rise from 12.063 at the Friday close, to open at 85 and close near 52 on Monday. It closed above 30 in the three following weeks. The enthusiasm spilled over to other biotechnology stocks. The potential breakthrough in cancer research already had been reported, however, in the journal Nature , and in various popular newspapers (including the Times ) more than five months earlier. Thus, enthusiastic public attention induced a permanent rise in share prices, even though no genuinely new information had been presented.

Over half of money fund managers voluntarily waive fees they have a contractual right to claim. Moreover, as a consequence of fee waivers, funds on average collect one half of reported expense ratios. Variation in fee waivers is significant and relates to differences in relative performance. Both low‐performing retail and institutional funds waive fees to improve their net performance. More interestingly, high‐performing retail, but not institutional, funds use fee waivers to strategically adjust net performance to increase expected fund flows. Despite fund flow incentives, high‐performing institutional funds do not waive more because they cannot significantly improve their relative performance.

This paper studies a dynamic model of a financial market with a strategic trader. In each period the strategic trader receives a privately observed endowment in the stock. He trades with competitive market makers to share risk. Noise traders are present in the market. After receiving a stock endowment, the strategic trader is shown to reduce his risk exposure either by selling at a decreasing rate over time or by selling and then buying back some of the shares sold. When the time between trades is small, the strategic trader reveals the information regarding his endowment very quickly.

A global trend towards automated trading systems raises the important question of whether execution costs are, in fact, lower than on trading floors. This paper compares the trade execution costs of similar stocks in an automated trading structure (Paris Bourse) and a floor‐based trading structure (NYSE). Results indicate that execution costs are higher in Paris than in New York after controlling for differences in adverse selection, relative tick size, and economic attributes across samples. These results suggest that the present form of the automated trading system may not be able to fully replicate the benefits of human intermediation on a trading floor.

Numerous studies report that standard volatility models have low explanatory power, leading some researchers to question whether these models have economic value. We examine this question by using conditional meanm‐variance analysis to assess the value of volatility timing to short‐horizon investors. We find that the volatility timing strategies outperform the unconditionally efficient static portfolios that have the same target expected return and volatility. This finding is robust to estimation risk and transaction costs.

We relate the organizational form of investment banking syndicates to moral hazard in team production. Although syndicates are dissolved upon deal completion, membership stability across deals represents a barrier to entry that enables the capture of quasirents. This improves incentives for individual bankers to cultivate investor relationships that translate into greater expected proceeds. Reputational concerns of lead bankers amplify the effect. We derive conditions under which restricted entry and designation of a lead banker strictly Pareto dominate, in which case it is also strictly Pareto dominant for the syndicate's fee to be greater than members' cost of participation.

We study equilibrium firm‐level stock returns in two economies: one in which investors are loss averse over the fluctuations of their stock portfolio, and another in which they are loss averse over the fluctuations of individual stocks that they own. Both approaches can shed light on empirical phenomena, but we find the second approach to be more successful: In that economy, the typical individual stock return has a high mean and excess volatility, and there is a large value premium in the cross section which can, to some extent, be captured by a commonly used multifactor model.

We study standard mutual fund performance measures, using simulated funds whose characteristics mimic actual funds. We find that performance measures used in previous mutual fund research have little ability to detect economically large magnitudes (e.g., three percent per year) of abnormal fund performance, particularly if a fund's style characteristics differ from those of the value‐weighted market portfolio. Power can be substantially improved, however, using event‐study procedures that analyze a fund's stock trades. These procedures are feasible using time‐series data sets on mutual fund portfolio holdings.