Knowledge that Transforms

Using an improved measure of a common stock's annualized dividend yield, we document that risk‐adjusted NYSE stock returns increase in dividend yield during the period from 1963 to 1994. This relation between return and yield is robust to various specifications of multifactor asset pricing models that incorporate the Fama–French factors. The magnitude of the yield effect is too large to be explained by a “tax penalty” on dividend income and is not explained by previously documented anomalies. Interestingly, the effect is primarily driven by smaller market capitalization stocks and zero‐yield stocks.

This paper studies thirty‐one highly leveraged transactions (HLTs) that become financially, not economically, distressed. The net effect of the HLT and financial distress (from pretransaction to distress resolution, market‐ or industry‐adjusted) is to increase value slightly. This finding strongly suggests that, overall, the HLTs of the late 1980s created value. We present quantitative and qualitative estimates of the (direct and indirect) costs of financial distress and their determinants. We estimate financial distress costs to be 10 to 20 percent of firm value. For a subset of firms that do not experience an adverse economic shock, financial distress costs are negligible.

We find that option listings are associated with a decrease in the variance of the pricing error, a decrease in the adverse selection component of the spread, and an increase in the relative weight placed by the specialist on public information in revising prices for the underlying stocks. We also find that there is a decrease in the spread and increases in quoted depth, trading volume, trading frequency, and transaction size after option listings. Overall, our results suggest that option listings improve the market quality of the underlying stocks.

Default, loss severity, and average loss rates for a large sample of privately placed bonds are presented and compared with loss experience for publicly issued bonds. The chance of very large portfolio losses is estimated and some determinants of such losses are analyzed. Results show ex ante riskier classes of private debt perform better on average than public debt. Both diversification and the riskiness of individual portfolio assets influence the bad tail of the portfolio loss distribution. Private placements are similar to corporate loans in that both are monitored private debt. The results are thus relevant to management and securitization of private debt portfolios generally.

This paper studies the exposure of North American gold mining firms to changes in the price of gold. The average mining stock moves 2 percent for each 1 percent change in gold prices, but exposures vary considerably over time and across firms. As predicted by valuation models, gold firm exposures are significantly negatively related to the firm's hedging and diversification activities and to gold prices and gold return volatility, and are positively related to firm leverage. Simple discounted cash flow models produce useful exposure predictions but they systematically overestimate exposures, possibly due to their failure to reflect managerial flexibility.

This paper studies the term structure of real rates, expected inflation, and inflation risk premia. The analysis is based on new estimates of the real term structure derived from the prices of index‐linked and nominal debt in the U.K. I find strong evidence to reject both the Fisher Hypothesis and versions of the Expectations Hypothesis for real rates. The estimates also imply the presence of time‐varying inflation risk premia throughout the term structure.

We provide an explanation for hedging as a means of allocating rather than reducing risk. We argue that when increases in total risk are costly, firms optimally allocate risk by reducing (increasing) exposure to risks that provide zero (positive) economic rents. Our evidence shows that mutual thrifts that convert to stock institutions increase total risk following conversion, consistent with their increased abilities and incentives for risk taking. They achieve this increase by hedging interest‐rate risk and increasing credit risk. We provide some evidence that risk‐management activities are related to growth capacity and management compensation structure attained at conversion.

This paper develops static hedges for several exotic options using standard options. The method relies on a relationship between European puts and calls with different strike prices. The analysis allows for constant volatility or for volatility smiles or frowns.

Why does stock volatility increase when output declines? The theory of investment under uncertainty implies that political uncertainty may simultaneously increase volatility and reduce output. Though cause and effect are typically hard to separate, the transition from Imperial to Weimar Germany offers a natural experiment because major political events left clear traces on stock prices. Current and past increases in volatility are associated with output declines, consistent with U.S. experience. However, political events are more clearly the source of volatility, and the results support the view that the relationship between volatility and output reflects the joint effects of political factors.

Venture capital distributions, a legal form of insider trading, provides an ideal arena for examining the share price impact of transactions by informed parties. These sales, which occur after substantial run‐ups in share value, generate a substantial price reaction immediately around the event. In the months after distribution, returns apparently continue to be negative. When the short‐ and long‐run reactions are decomposed, they are consistent with the view that venture capitalists use inside information to time stock distributions: Distributions of firms brought public by lower quality underwriters and of less seasoned firms have more negative price reactions.