This paper considers the maturity intermediation and intertemporal lending decisions of risk‐averse financial intermediaries. In particular, the maturity mismatch problem and the fixed‐versus‐variable‐rate lending decision are modeled when the major source of risk involves uncertain future interest rates. The results imply that the strategy of matching the maturity of assets and liabilities is not generally optimal or even minimum risk. This is due primarily to the “built‐in” hedge that the intermediary has as a result of rolling over short‐term loans while continuing to finance long‐term loans. Intertemporal dependencies between loan demand and costs (or both) also have an effect on the optimal degree of maturity mismatching and provide one rationale for making loans at rates below current marginal cost.
A firm must issue common stock in order to undertake a new investment, and the firm's manager‐owners can value the firm more accurately than the market. The ability of the manager‐owners to trade in the firm's shares during the issue (a) reduces the investments that are foregone because of the market's mispricing the firm's shares, (b) changes the size and direction of the stock price change when the firm announces a new stock issue, and (c) changes the market value of the firm before and after the issue announcement, whether or not it decides to issue.
In this paper, we examine leasing as a tax‐arbitrage instrument. Analysis of a sample of UK leases presented in this paper suggests that lessors earn large positive NPVs. Our theoretical model seeks to explain these positive NPVs in terms of a market price for a scarce resource that we identify as scarce taxable earnings. Using these prices, the model permits a lessor to determine whether the profitability of a proposed set of lease contracts can be improved by writing a different set of contracts that makes better use of the lessor's taxable earnings. There may be two reasons why an initial portfolio of contracts may be suboptimal. Either there may be clienteles or the leasing market may be inefficient. Subsequently, we discuss reasons why the leasing market may be characterized by clienteles, and, using two different samples of leases, we test whether the leasing market is segmented and efficient.
In this paper, we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond's duration. The resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the Black-Scholes approach. The paper provides comparisons between option prices computed using this model and those using the Black-Scholes and Brennan and Schwartz models.
We report evidence of seasonality in the Fama and MacBeth estimate of the CAPM-based risk premium in four stock exchanges: the NYSE and the London, Paris, and Brussels exchanges.Specifically, we found that, in Belgium and France, risk premia are positive in January and negative the rest of the year.There is no January seasonal in the U.K. risk premium.Instead, we observed in this country a positive April seasonal and a negative average risk premium over the rest of the year.In the U.S., the pattern of risk-premium seasonality coincides with the pattern of stock-return seasonality.Both are positive and significant only in January.We also found that the January risk premium in the U.S. is significantly larger than those observed in the European markets.Interestingly, the reported patterns of risk-premium seasonality in European equity markets do not fully coincide with the observed patterns of stock-return seasonality in these markets.For example, in the U.K., average stock returns arc significant and positive in January and April, whereas the market risk premium is significantly positive only in April.A possible interpretation of this phenomenon is presented in the paper.THE SEASONAL BEHAVIOR of stock market returns has been documented in several studies.Rozeff and Kinney [24], Keim [16], and Roll [23] report that U.S. stock market returns are, on average, higher in January than during the remaining eleven months of the year.This January seasonal is not restricted to U.S. common stocks.Gultekin and Gultekin [9] and others have observed the same phenomenon in most stock exchanges around the world. 1 More to the point, however, is the fact that the U.S. January seasonal is not confined to stock market returns.Recent contributions by Tinic and West [28,29] indicate the presence of a January seasonal in the coefficients of the estimated relationship between average portfolio returns and systematic risk.Their results reveal, "The positive relationship between return and risk is unique to January.The risk premiums during the remaining eleven months are not significantly different from zero" ([28], p. 561). 2 The purpose of this paper is to examine the relationship between average returns and risk in the United States, the United Kingdom, France, and Belgium and to find out whether the estimated coefficients of the risk-return relationship exhibit a January seasonal similar to that observed in the U.S. equity market.The examination of stock price behavior in markets other than the United States is of interest for at least three reasons.First, it provides additional evidence in support of or against the validity of security-pricing models such as the two-parameter capital asset pricing model (CAPM).3 Second, it allows us to compare the pattern of risk-premium seasonality across national stock markets.Third, looking at non-U.S.data may help us in understanding why the market risk premium exhibits seasonalities.In particular, we seek to find out whether risk-premium seasonality is linked to return seasonality.If this were the case, then, any potential explanation of return seasonality could also be a possible explanation of risk-premium seasonality.For example, if return seasonality could be explained by the so-called tax-loss selling hypothesis, 4 which predicts that stock returns will be higher in the first month of the fiscal year, then the tax-loss selling hypothesis could have something to do with riskpremium seasonality.Consider the following empirical result reported in Section II.In January, and only in January, average stock returns and the market risk premium are positive in the United States.They are not significantly different from zero during the rest of the year.Now, based on the U.S. evidence, we may be tempted to link the January seasonal in stock returns to the January seasonal in the risk premium.But a look at the evidence from other countries reveals that these two phenomena may not be related.Indeed, in the United Kingdom, France, and Belgium, the evidence is not consistent with the linkage hypothesis.Specifically, we present below evidence indicating that, in Belgium and France, the CAPM-based risk
In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or "tax arbitrage."This paper characterizes the joint restrictions on financial-asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short-sale constraints.The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then "no-tax-arbitrage" prices will exist.They also show that the existence of "no-tax-arbitrage" prices ensures the existence of equilibrium prices. THE EFFECTS OF DIFFERENTIAL taxation on the equilibrium prices of financial assets have attracted much attention from financial economists in recent years.Otherwise identical securities that contribute to taxable income to different degrees will, in general, be valued differently by taxable investors.As a result, tax considerations have been useful in helping explain the effect of dividend yield on stock returns,' the effect of coupon levels and term to maturity on bond prices,2 the timing of investors' portfolio transactions,3 and the observed capital structures of firms.4While a rich set of observed behaviors can be better understood by reference to differential taxation, there are well-known difflculties in dealing with taxes in a general-equilibrium setting.To clear markets, relative prices must reflect the marginal rates of substitution of all agents simultaneously.When tax rates differ across investors, however, this condition can be impossible to achieve.To illustrate, consider a world of perfect certainty with two assets: a tax-exempt municipal bond and a taxable government bond.To equate marginal rates of substitution, the rate of return on the government bond, rg, must equal that on the municipal, rm, "grossed up" by one minus the investor's marginal tax rate, ti; that is, rg = rm/( 1 -ti).If there are investors in more than one tax bracket, this condition will obviously be impossible to satisfy for all of them simultaneously.