Knowledge that Transforms

There is a significant foreign influence on the risk premium for U.S. assets. Using a bivariate GARCH-in-mean process, we find that the conditional expected excess return on U.S. stocks is positively related to the conditional covariance of the return of these stocks with the return on a foreign index but is not related to its own conditional variance. Further, we are unable to reject the international version of the CAPM. We present evidence for different model specifications, multiple-day returns, and alternative proxies for foreign stock returns.

It seems plausible that an increase in stock market volatility raises required stock returns, and thus lowers stock prices. We develop a formal model of this volatility feedback effect using a simple model of changing variance (a quadratic generalized autoregressive conditionally heteroskedastic, or QGARCH, model). Our model is asymmetric and helps to explain the negative skewness and excess kurtosis of U.S. monthly and daily stock returns over the period 1926–1988. We find that volatility feedback normally has little effect on returns, but it can be important during periods of high volatility.

We estimate the conditional distribution of trade-to-trade price changes using ordered probit, a statistical model for discrete random variables. This approach recognizes that transaction price changes occur in discrete increments, typically eighths of a dollar, and occur at irregularly-spaced time intervals. Unlike existing models of discrete transactions prices, ordered probit can quantify the effects of other economic variables like volume, past price changes, and the time between trades on price changes. Using 1988 transactions data for over 100 randomly chosen U.S. stocks, we estimate the ordered probit model via maximum likelihood and use the parameter estimates to measure several transaction-related quantities, such as the price impact of trades of a given size, the tendency towards price reversals from one transaction to the next, and the empirical significance of price discreteness.

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.

This paper uses new data on the holdings of 769 tax-exempt (predominantly pension) funds, to evaluate the potential effect of their trading on stock prices. We address two aspects of trading by these money managers: herding, which refers to buying (selling) simultaneously the same stocks as other managers buy (sell), and positive-feedback trading, which refers to buying past winners and selling past losers. These two aspects of trading are commonly a part of the argument that institutions destabilize stock prices. The evidence suggests that pension managers do not strongly pursue these potentially destabilizing practices.

We examine post-acquisition performance for the 50 largest U.S. mergers between 1979 and mid-1984. Merged firms show significant improvements in asset productivity relative to their industries, leading to higher operating cash flow returns. This performance improvement is particularly strong for firms with highly overlapping businesses. Mergers do not lead to cuts in long-term capital and R&D investments. There is a strong positive relation between postmerger increases in operating cash flows and abnormal stock returns at merger announcements, indicating that expectations of economic improvements underlie the equity revaluations of the merging firms.