Knowledge that Transforms

Since an underwriter sets an IPO's offer price without knowing its market value, investors can acquire information about its value and avoid overpriced deals (“lemon‐dodge”). To mitigate this well‐known risk, the bank enters into a repeat game with a coalition of investors who do not lemon‐dodge in exchange for on‐average underpriced shares. We (i) derive and test a quantitative IPO pricing rule (showing that tech IPOs were not excessively underpriced during the boom of the 1990s); and (ii) analyzing a unique multibank data set, find strong support for the conjecture that a bank preferentially allocates shares to its coalition.

A German broker's clients place similar speculative trades and therefore tend to be on the same side of the market in a given stock during a given day, week, month, and quarter. Aggregate liquidity effects, short sale constraints, the systematic execution of limit orders (coordinated through price movements) or the correlated trading of other investors who pick off retail limit orders do not fully explain why retail investors trade similarly. Correlated market orders lead returns, presumably due to persistent speculative price pressure. Correlated limit orders also predict subsequent returns, consistent with executed limit orders being compensated for accommodating liquidity demands.

We study the rivalry between Euronext and the London Stock Exchange (LSE) in the Dutch stock market to test hypotheses about the effect of market fragmentation. As predicted by our theory, the consolidated limit order book is deeper after entry of the LSE. Moreover, cross‐sectionally, we find that a higher trade‐through rate in the entrant market coincides with less liquidity supply in this market. These findings imply that (i) fragmentation of order flow can enhance liquidity supply and (ii) protecting limit orders against trade‐throughs is important.

We develop a model that endogenizes dynamic financing, investment, and cash retention/payout policies in order to analyze the effect of financial flexibility on firm value. We show that the value of financing flexibility depends on the costs of external financing, the level of corporate and personal tax rates that determine the effective cost of holding cash, the firm's growth potential and maturity, and the reversibility of capital. Through simulations, we demonstrate that firms facing financing frictions should simultaneously borrow and lend, and we examine the nature of dynamic debt and liquidity policies and the value associated with corporate liquidity.

Over March and April 2000, Internet stocks lost 56%, or $700 billion. This sudden collapse has been attributed to an increasing supply of shares from lockup expirations and equity offerings. I show that Internet stocks collapsed in this period regardless of whether their lockups expired. Furthermore, daily Internet stock portfolio returns were almost unaffected by the number or dollar amount of lockup expirations that day, or by the amount of stock offered in IPOs or SEOs. Most of the Internet stock decline is explained by poor marketwide returns, particularly for growth stocks.

I present a simple model of informed trading in which asset values are derived from imperfectly competitive product markets and private information events occur at individual firms. The model predicts that informed traders may have incentives to make information‐based trades in the stocks of competitors, especially when events occur at firms with large market shares. In the context of 759 earnings announcements, I use intraday transactions data to test the hypothesis that net order flow and returns in the stocks of nonannouncing competitors have information content for announcing firms.

In 1970 the New York Stock Exchange relaxed rules that prohibited the public incorporation of member firms. Investment banking concerns went public in waves, with Goldman Sachs the last of the bulge bracket banks to float. We explain the pattern of investment bank flotations. We argue that partnerships foster the formation of human capital and we use technological advances that undermine the role of human capital to explain the partnership's going‐public decision. We support our theory using a new data set of investment bank partnership statistics.

We argue that the implied cost of capital (ICC), computed using earnings forecasts, is useful in capturing time variation in expected stock returns. First, we show theoretically that ICC is perfectly correlated with the conditional expected stock return under plausible conditions. Second, our simulations show that ICC is helpful in detecting an intertemporal risk–return relation, even when earnings forecasts are poor. Finally, in empirical analysis, we construct the time series of ICC for the G–7 countries. We find a positive relation between the conditional mean and variance of stock returns, at both the country level and the world market level.

This paper establishes a causal relation between an individual's decision whether to own stocks and average stock market participation of the individual's community. We instrument for the average ownership of an individual's community with lagged average ownership of the states in which one's nonnative neighbors were born. Combining this instrumental variables approach with controls for individual and community fixed effects, a broad set of time‐varying individual and community controls, and state‐year effects rules out alternative explanations. To further establish that word‐of‐mouth communication drives this causal effect, we show that the results are stronger in more sociable communities.

When ambiguity‐averse investors process news of uncertain quality, they act as if they take a worst‐case assessment of quality. As a result, they react more strongly to bad news than to good news. They also dislike assets for which information quality is poor, especially when the underlying fundamentals are volatile. These effects induce ambiguity premia that depend on idiosyncratic risk in fundamentals as well as skewness in returns. Moreover, shocks to information quality can have persistent negative effects on prices even if fundamentals do not change.