This paper reexamines the anomalous evidence concerning the efficiency of the listed options exchanges. We focus on the structure of trading costs in that market, and note several costs which generally have been ignored, the largest of which is the bid-ask spread. When we adjust the published trading rules for our estimates of these trading costs, the reported abnormal returns are eliminated.
This study considers the impact of capital structure change announcements on security prices. Statistically significant price adjustments in firms' common stock, preferred stock and debt related to these announcements are documented and alternative causes for these price changes are examined. The evidence is consistent with both corporate tax and wealth redistribution effects. There is also evidence that firms make decisions which do not maximize stockholder wealth. In addition, a new approach to testing the significance of public announcements on security returns is presented.
A definition of market adjustment is proposed in terms of the time it takes market attributes to reflect new information. Properties of the proposed definition are discussed. In order to operationalize the concept, a statistical method is introduced to estimate the adjustment times. Empirical examples are used to illustrate the proposed method. Some possible economic interpretations are given. The properties of the estimator are also investigated by simulation and analytical methods.
A model of the tax structure of interest rates is developed and simple approximate expressions relating yield to coupon are derived. The effect on these simple expressions of alternative assumptions about holding period length, expectations of future interest rates, and other factors, is evaluated. It is shown that with recent U.S. yield averages the new-seasoned yield spread varies with the new-seasoned coupon spread as the theory prescribes. It is concluded that new issue yield averages should provide a more reliable measure of the cost of debt capital than is provided by seasoned yield averages.
With risky debt outstanding, stockholder actions aimed at maximizing the value of their equity claim can result in a reduction in the value of both the firm and its outstanding bonds. We examine ways in which debt contracts are written to control the conflict between bondholders and stockholders. We find that extensive direct restrictions on production/investment policy would be expensive to employ and are not observed. However, dividend and financing policy restrictions are written to give stockholders incentives to follow a firm-value-maximizing production/investment policy. Taking into account how contracts control the bondholder- stockholder conflict leads to a number of testable propositions about the specific form of the debt contract that a firm will choose.
Casual observers of the New York Stock Exchange are often dumbfounded by the frenetic behavior of its participants. If asked how such chaos generates accurate prices many academicians would reply that the ability to transact frequently is a virtue since it promotes prompt information dissemination and therefore market efficiency. However, in contrast to the NYSE where, during trading hours, trades may be consumated almost continuously, the Paris Stock Exchange trades each security only a handful of times a day. This continental contrast in market structure led us to reexamine the role of speed in markets. We have discovered that if sufficient uncertainty surrounds the dissemination of information, frequent transacting may be deleterious to market efficiency. In fact, in our paradigm we are able to show that our measure of market efficiency may be maximized when there is a unique, non-zero time interval between consecutive trades. The measure of efficiency used throughout the paper is minus the mean squared error. This measure was chosen to focus upon the information content of prices at times when they are posted (i.e., at times of tâtonnements). For this purpose we ignore costs of illiquidity and costs associated with obsolete information that would occur between tâtonnements. In this restricted sphere, maximazation of our efficiency measure is consistent with maximizing Social Pareto Optimality.
Recent work by Richard Roll has challenged the worth of portfolio performance measures based on the capital asset pricing model. This paper demonstrates that Roll's conclusions are due to his focusing on a ‘truly’ ex-ante efficient index. Using a choice and information theoretic framework, we show that an appropriate index is efficient relative to the probabilities assessed by the ‘market’. Residual analyses and portfolio performance tests, using such an index, yield meaningful results for a wide class of information structures. Roll's primary criticisms, however, relate to tests of the asset pricing model itself. We argue that these criticisms are vastly overstated.