Knowledge that Transforms

We test six term structure models in the Heath, Jarrow, and Morton (1992) class using Eurodollar futures and options data from 1987∗1992. We study the time series of implied interest rate volatilities from these models. Using one-day lagged implied volatilities, our one-and two-parameter models simultaneously price an average of 18.5 options each day with an average absolute error of one-and-a-half to two basis points. Although the models fit well, we document systematic strike- price and time-to-maturity biases for all models. We also implement simple trading strategies to test whether the models identify genuine biases.

We rationalize the cross-holdings of debt and equity within the Japanese keiretsu as a contingent governance mechanism through which internal discipline is sustained over time. The reciprocal allocation of control rights supports cooperation and mutual monitoring among managers through a coalition-enforced threat of removal from control. In financial distress this threat is less effective, and the governance mode shifts to hierarchical enforcement under main bank leadership. The model is consistent with the capital structure, the distribution of claims, the extent of intragroup trading, and patterns of investor intervention within the groups.

This paper estimates real term structures from cross-sections of British government index-linked (‘realrd) bond prices. The Cox, Ingersoll, and Ross (1985) model is then fitted to the same data; the model closely approximates the shapes of the directly-estimated term structures. In contrast to similar studies of the nominal term structure, the long-term zero-coupon yield is quite stable, as the CIR model predicts, and in common with previous studies, the level of implied short rate volatility corresponds well with time series estimates. The other parameters, however, are often highly correlated and intertemporal parameter stability is rejected.

We investigate contagion effects in the stock returns of life insurance companies at the time of announcements by First Executive and Travelers of significant problems in their investment portfolios. We first demonstrate that investments in junk bonds or commercial mortgages are important for the shareholder wealth effects of other life insurance companies. We then directly link the shareholder wealth effects to characteristics of firms' customers. Our evidence shows that effects on shareholder wealth are larger for companies with significant junk bond/commercial mortgage assets and readily mobile customers as represented by guaranteed investment contracts (GICs).

We develop evidence on the finite sample properties of the Generalized Method of Moments (GMM) in an asset pricing context. The models imply nonlinear, cross-equation restrictions on predictive regressions for security returns. We find that a two-stage GMM approach produces goodness-of-fit statistics that reject the restrictions too often. An iterated GMM approach has superior finite sample properties. The coefficient estimates are approximately unbiased in simpler models, but their asymptotic standard errors are understated. Simple adjustments for the standard errors are partially successful in correcting the bias. In more complex models the coefficients and their standard errors can be highly unreliable. The power of the tests to reject a single-premium model is higher against a two-premium, fixed-beta alternative than against a conditional Capital Asset Pricing Model with time-varying betas.

This study uses intraday when-issued rate quotes to examine the rewards and risks of the Treasury coupon auctions for bidders who face different tradeoffs between the winner's curse and quantity risk. The data indicate that markups of auction average rates over bid when-issued rates at auction times average 3/8 basis point. I also find that when-issued rates react as strongly to bidding aggressiveness at auctions before the auction results are announced as theydo afterward, and that quantity risk is as important as the winner's curse.

This study provides the first large-sample analysis of the stock-market reactions to interfirm litigation. When a suit is filed, the common stock of the typical defendant declines by about 1%, while the plaintiff experiences no significant gains. For the average pair of firms, the combined drop in value upon filing is $21 million. Much of the loss is regained if the suit is settled. The findings suggest that bargaining among firm claimants sometimes leads to very inefficient outcomes. Part of the leakage is explained by the costs of increased financial distress imposed on the defendant.

This paper examines the timing of initial public offerings and private financings by venture capitalists. Using a sample of 350 privately held venture-backed biotechnology firms between 1978 and 1992, I show that these companies go public when equity valuations are high and employ private financings when values are lower. Seasoned venture capitalists appear to be particularly proficient at taking companies public near market peaks. The results are robust to a variety of controls and alternative explanations.

Suppose that a firm receives a cash windfall which does not change its investment opportunity set or, equivalently, its marginal Tobin's Q. What will this firm do with the money? We provide empirical answers to this question using a sample of eleven firms with such windfalls in the form of a won or settled lawsuit. We examine a variety of decisions of the firm to shed light on alternative theories of corporate financing and investment. Our evidence is broadly inconsistent with the perfect capital markets model. The results need to be stretched considerably to fit the asymmetric information model in which managers act in the interest of shareholders. The evidence supports the agency model of managerial behavior, in which managers try to ensure the long-run survival and independence of the firms with themselves at the helm.

This paper updates Kaplan (1989) by comparing Federated Department Stores' value before its purchase by Campeau Corporation to its post-bankruptcy value. The post-bankruptcy value includes all direct and indirect costs of bankruptcy and financial distress. Federated's assets increased in value by 3.1 billion in 1992 dollars(or 1.6 billion in 1987 dollars). This increase is only slightly below that in Kaplan (1989), suggesting that net bankruptcy costs were modest, and, possibly, nonexistent. The Federated purchase illustrates that a highly-leveraged transaction can increase value, but still be unable to meet its debt obligations; and bankruptcy (and financial distress) need not be costly.