Knowledge that Transforms

In monthly U.S. data for 1959–1979 and 1979–1983, the state of the term structure of interest rates predicts excess stock returns, as well as excess returns on bills and bonds. This paper documents this fact and uses it to examine some simple asset pricing models. In 1959–1979, the data strongly reject a single-latent-variable specification of predictable excess returns. There is considerable evidence that conditional variances of excess returns change through time, but the relationship between conditional mean and conditional variance is reliably positive only at the short end of the term structure.

This paper examines possible motives for and consequences of voluntary corporate liquidations. Specifically, the procedural and tax differences between voluntary liquidations and other control-changing transaction devices are analyzed. An empirical investigation of successful liquidations shows that the announcement of liquidation reduces the risk of liquidating shares, that the shareholders receive substantial gains from successful liquidations, and that the average gains to the acquiring shareholders are not significantly different from zero. These findings suggest that the liquidating firms' assets have been underutilized before liquidation and that voluntary liquidations lead to higher-valued reallocations of corporate resources.

This paper examines the relation between stock returns and stock market volatility. We find evidence that the expected market risk premium (the expected return on a stock portfolio minus the Treasury bill yield) is positively related to the predictable volatility of stock returns. There is also evidence that unexpected stock market returns are negatively related to the unexpected change in the volatility of stock returns. This negative relation provides indirect evidence of a positive relation between expected risk premiums and volatility.

This paper presents evidence regarding the two quantifiable components of the costs of going public: direct expenses and underpricing. Together, these costs average 21.22% of the realized market value of the securities issued for firm commitment offers and 31.87% for best efforts offers. For a given size offer, the direct expenses are of the same order of magnitude for both contract types, but the underpricing is greater for best efforts offers. An explanation of why some firms choose to use best efforts offers in spite of their apparent higher total costs is given.

This study investigates the anomalous findings of the previous insider trading studies that any investor can earn abnormal profits by reading the Official Summary. Availability of abnormal profits to insiders, availability of abnormal profits to outsiders who imitate insiders, determinants of insiders' predictive ability, and effect of insider trading on costs of trading for other investors are examined by using approximately 60,000 insider sale and purchase transactions from 1975 to 1981. Implications for market efficiency and evaluation of abnormal profits to active trading strategies are discussed.

Several predetermined variables that reflect levels of bond and stock prices appear to predict returns on common stocks of firms of various sizes, long-term bonds of various default risks, and default-free bonds of various maturities. The returns on small-firm stocks and low-grade bonds are more highly correlated in January than in the rest of the year with previous levels of asset prices, especially prices of small-firm stocks. Seasonality is found in several conditional risk measures, but such seasonality is unlikely to explain, and in some cases is opposite to, the seasonal found in mean returns.

This paper develops and tests two propositions. We demonstrate that there is a monotone relation between the (expected) underpricing of an initial public offering and the uncertainty of investors regarding its value. We also argue that the resulting underpricing equilibrium is enforced by investment bankers, who have reputation capital at stake. An investment banker who ‘cheats’ on this underpricing equilibrium will lose either potential investors (if it doesn't underprice enough) or issuers (if it underprices too much), and thus forfeit the value of its reputation capital. Empirical evidence supports our propositions.

The paper examines the allocation of consumption and investment in a three-date binomial model in order to determine the sign of the real term structure premium in general equilibrium. When production functions are concave, markets are complete, and future production possibilities are the same irrespective of which state of the world occurs, the term structure premium will be positive. In incomplete markets, constant or increasing absolute risk aversion is sufficient to guarantee a positive term structure premium, although in the (more likely) case of decreasing absolute risk aversion a negative premium cannot be ruled out.

Evidence presented here indicates that the relationship between stock returns and unexpected inflation differs systematically across firms. The differences are shown to be consistent with cross-sectional variation in firms' nominal contracts (monetary claims and depreciation tax shields). The differences are also partially explained by proxies for underlying firm characteristics that could create interaction between unexpected inflation and operating profitability. Finally, much if not most of the differences appear to arise because unexpected inflation is correlated with changes in expected aggregate real activity, the effects of which tend to vary across firms according to their systematic risk.

We examine the effects of market making and intermittent trading on estimates of stock price volatility. When observed price changes are correctly tied to a stock's true price dynamics, it is found that non-trading per se causes a loss of efficiency but no bias in traditional volatility estimates. Non-trading induces substancial inefficiency in the extreme value estimator of volatility which it biases downward. Market making's effects add to the non-trading induced inefficiency in the traditional estimator, while information trading causes a downward bias, and liquidity trading a potentially removable upward bias, in that estimator.