This paper tests models of mutual fund market timing that allow the manager's payoff function to depend on returns in excess of a benchmark, and distinguish timing based on publicly available information from timing based on finer information. We simultaneously estimate parameters which describe the public information environment, the manager's risk aversion, and the precision of the fund's market-timing signal. Using a sample of more than 400 U.S. mutual funds for 1976–94, our findings suggest that mutual funds behave as highly risk averse, benchmark investors. Conditioning on public information improves the model specification. After controlling for the public information, we find no evidence that funds have significant market-timing ability.

This paper argues that corporations may use convertible bonds as an indirect way to get equity into their capital structures when adverse-selection problems make a conventional stock issue unattractive. Unlike other theories of convertible bond issuance, the model here highlights: 1) the importance of call provisions on convertibles and 2) the significance of costs of financial distress to the information content of a convertible issue.

The validity of the classic Black-Scholes option pricing formula depends on the capability of investors to follow a dynamic portfolio strategy in the stock that replicates the payoff structure to the option. The critical assumption required for such a strategy to be feasible, is that the underlying stock return dynamics can be described by a stochastic process with a continuous sample path. In this paper, an option pricing formula is derived for the more-general case when the underlying stock returns are generated by a mixture of both continuous and jump processes. The derived formula has most of the attractive features of the original Black-Scholes formula in that it does not depend on investor preferences or knowledge of the expected return on the underlying stock. Moreover, the same analysis applied to the options can be extended to the pricing of corporate liabilities.

We show that analyst coverage proxies contain information about expected returns. We decompose analyst coverage into abnormal and expected components using a simple characteristic-based model and show that firms with abnormally high analyst coverage subsequently outperform firms with abnormally low coverage by approximately 80 basis points per month. We also show abnormal coverage rises following exogenous shocks to underpricing and predicts improvements in firms’ fundamental performance, suggesting that return predictability stems from analysts more heavily covering underpriced stocks. Our findings highlight the usefulness of analysts’ actions in expected return estimations, and a potential inference problem when coverage proxies are used to study information asymmetry and dissemination.

This paper examines the price effect of institutional stock trading, using a unique data set that reports the transactions (large and small) of 37 large institutional money management firms. The direction of each trade and the identity of the management firm behind each trade are known. Although institutional trades are associated with some price pressure, we find that the average effect is small. There is also a marked asymmetry between the price impact of buys versus sells. We relate our findings to various hypotheses on the elasticity of demand for stocks, the cost of executing transactions, and the determinants of market impact. Although market capitalization and relative trade size influence the market impact of a trade, the dominant influence is the identity of the money manager behind the trade.

The fallacy that a many-period expected-utility maximizer should maximize (a) the expected logarithm of portfolio outcomes or (b) the expected average compound return of his portfolio is now understood to rest upon a fallacious use of the Law of Large Numbers. This paper exposes a more subtle fallacy based upon a fallacious use of the Central-Limit Theorem. While the properly normalized product of independent random variables does asymptotically approach a log-normal distribution under proper assumptions, it involves a fallacious manipulation of double limits to infer from this that a maximizer of expected utility after many periods will get a useful approximation to his optimal policy by calculating an efficiency frontier based upon (a) the expected log of wealth outcomes and its variance or (b) the expected average compound return and its variance. Expected utilities calculated from the surrogate log-normal function differ systematically from the correct expected utilities calculated from the true probability distribution. A new concept of ‘initial wealth equivalent’ provides a transitive ordering of portfolios that illuminates commonly held confusions. A non-fallacious application of the log-normal limit and its associated mean-variance efficiency frontier is established for a limit where any fixed horizon period is subdivided into ever more independent sub-intervals. Strong mutual-fund Separation Theorems are then shown to be asymptotically valid.

What makes an asset institutional quality? This paper proposes that one reason is the existing concentration of delegated investors in a market through a liquidity channel. Consistent with this intuition, it documents differences in investor composition across US cities and shows that delegated investors concentrate their investments in cities with higher turnover. It then estimates a search model showing how heterogeneity in liquidity preferences makes some markets more liquid, even when assets have identical cash flows. The paper provides evidence for clientele equilibria arising in frictional asset markets and suggests that a liquidity channel may explain divergent paths in city development.

We empirically evaluate the predictions of the mispricing hypothesis with limits-to-arbitrage suggested by Shleifer and Vishny (1997) and the q-theory with investment frictions proposed by Li and Zhang (2010) on the negative relation between asset growth and average stock returns. We conduct cross-sectional regressions of returns on asset growth on subsamples split by a given measure of limits-to-arbitrage or investment frictions. We show that: (i) proxies for limits-to-arbitrage and proxies for investment frictions are often highly correlated; (ii) the evidence based on equal-weighted returns shows significant support for both hypotheses, while the evidence from value-weighted returns is weaker; and (iii) in direct comparisons, each hypothesis is supported by a fair and similar amount of evidence.

This article investigates predictors and benefits of corporate adaptation to crisis, adding a new dimension to studies of flexibility and resilience based on ex ante characteristics. We produce a unique sample of work-from-home announcements scraped from company websites during Covid-19. The announcers’ valuations increased by 3%–5% and risk declined versus matches, consistent with real-options theory under asymmetric information. We estimate characteristics, including subtle textual topics from 10-Ks, that predicted adaptation, show faster price response following Bloomberg coverage, and real advantages in subsequent operating performance. Corporate adaptation to crisis adds value and reduces risk, beyond information in firm characteristics.

We document that gold mining firms have consistently realized economically significant cash flow gains from their derivatives transactions. We conclude that these cash flows have increased shareholder value since there is no evidence of an offsetting adjustment in firms’ systematic risk. This finding contradicts a central assumption in the risk management literature that derivatives transactions have zero net present value, and highlights an important motive for firms to use derivatives that the literature has hitherto ignored. Although we find considerable evidence of selective hedging in our sample, the cash flow gains from selective hedging appear to be small at best.