Empirical evidence of time varying term premia in bond returns is frequently interpreted as evidence against the Expectations Hypothesis. This paper shows that the Expectations Hypothesis can actually imply time varying term premia if the time frame for which the Expectations Hypothesis holds differs from the return measurement period. Furthermore, many of the properties of these term premia are consistent with those of observed term premia. These results are important because they imply that the case against the Expectations Hypothesis is weaker than claimed in the empirical literature.
This paper presents our investigation of the factors that determine secondary market prices of developing country syndicated loans. Trading volume in this market has almost doubled yearly from 1985 to 1988 while average market prices declined from 73% to 41% of par value during the same period. We find that loan values depend on a country's solvency rather than its liquidity and show that a country's adoption of a debt conversion program significantly decreases its loans' market prices. Furthermore, the debt moratoria by Brazil and Peru, as well as the developing-country-specific provisions made by U.S. banks, impact loan prices negatively.
We examine empirical implications of models of differential information that formalize the following intuition: securities for which there is relatively little information are perceived as relatively more risky because of the greater uncertainty surrounding the exact parameters of their return distributions. The implication that beta risk for low information firms should decline as information increases is confirmed with several data sets. We find such a decline over the first several periods subsequent to initial public offerings and initial listings. There is also an abrupt risk decline at the first annual earnings announcement.
We assume a world like the one that gives the capital asset pricing model, but with many goods and many countries. We assume that investors in a given country have homothetic utility functions with the same weights, and a currency that has a sure end-of-period value using a price index with those weights. Siegel's paradox (derived from Jensen's inequality) makes investors want a positive amount of exchange risk. When average risk tolerance is the same across countries, every investor will hold the same mix of market risk (through the world market portfolio of all assets) and exchange risk (in a diversified basket of foreign currencies). In fact, the ratio of exchange risk to market risk is equal to the average investor's risk tolerance. We can write the ratio of exchange risk to market risk (and the fraction of the market's exchange risk that investors hedge) as depending on an average of world market risk premia, an average of world market volatilities, and an average of exchange rate volatilities. The weights in these averages are the same as the weights of the different countries in the currency basket. Given these averages, the ratio (and the fraction hedged) will not depend directly on exchange rate means or covariances. In equilibrium, we can use the ratio of exchange risk to market risk to measure average risk tolerance: in this model, risk tolerance is observable.
This paper investigates the effects of seniority rules and restrictive dividend convenants on the over- and under-investment incentives associated with risky debt. We show that increasing seniority of new debt decreases the incidence of under-investment but increases over-investment, and vice versa. Under symmetric information, the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets (i.e., project financing). Under asymmetric information, the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project's cash flow in the same rate. If this is not possible, the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large. With regard to dividend convenants, we show that their effect depends on whether or not dividend payments are conditioned on future investments. When they are unconditioned, allowing more dividends increases the under-investment incentive. In contrast, conditional dividends decrease the underinvestment incentive and increase the over-investment incentive.
This paper uses a sample of over 25,000 daily warrant prices to empirically investigate potential problems with the commonly used warrant pricing model proposed by Black and Scholes as an extension of their call option model. One problem seems to be especially important: the constant variance assumption of the dilution adjusted Black-Scholes model appears to cause biases in model prices for almost all warrants and over the entire sample period. We show that more accurate price forecasts are obtained with a specific form of the constant elasticity of variance model.
This paper develops a theory of choice among alternative procedures for distributing cash from corporations to shareholders. Despite the preferential tax treatment of capital gains for individual investors, it is shown that a majority of a firm's shareholders may support a dividend payment for small distributions. For larger distributions an open market stock repurchase is likely to be preferred by a majority of shareholders, and for the largest distributions tender offer repurchases dominate.
For homothetic time and state separable preferences, the coefficient of relative risk aversion (CRRA) is equal to the reciprocal of the elasticity of intertemporal substitution (EIS). This paper shows that, when the growth rate of consumption is i.i.d., asset pricing models based upon preferences in which the CRRA and the EIS are no longer linked do not have more explanatory power. Further, in these stochastic environments, estimates of the CRRA in the standard preferences are measures of the true CRRA and not the EIS. These results are fairly accurate descriptions of economies calibrated using United States annual data.