Knowledge that Transforms

This paper hypothesizes that the relation between stock returns and inflation is caused by the equilibrium process in the monetary sector. More importantly, these relations vary over time in a systematic manner depending on the influence of money demand and supply factors. Post-war evidence from the United States, Canada, the United Kingdom and Germany indicates that the negative stock return-inflation relations are caused by money demand and counter-cyclical money supply effects. On the other hand, pro-cyclical movements in money, inflation, and stock prices during the 1930's lead to relations which are either positive or insignificant.

Empirical tests of Euler equations relating security returns and consumption usually appear to reject the model. Using a common specification of aggregate preferences and instrumental variables, this paper examines some potential reasons for rejections. The evidence indicates that maintained stationarity assumptions of previous tests fail for post-war U.S. quarterly and monthly data. Shifts in model parameters are found across policy regimes (pre-1951 and post-1979) and across stages of the business cycle (recession versus non-recession). Controlling for some of these factors, less evidence is found against a simple consumption-based asset pricing model in non-recession periods.

This paper numerically solves the call option valuation problem given a fairly general continuous stochastic process for return volatility. Statistical estimators for volatility process parameters are derived, and parameter estimates are calculated for several individual stocks and indices. The resulting estimated option values do not differ dramatically from Black-Scholes values in most cases, although there is some evidence that for longer-maturity index options, Black-Scholes overvalues out-of-the-money calls in relation to in-the-money calls.

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 models effects of short-sale constraints on the speed of adjustment (to private information) of security prices. Constraints eliminate some informative trades, but do not bias prices upward. Prohibiting traders from shorting reduces the adjustment speed of prices to private information, especially to bad news. Non-prohibitive costs can have the reverse effect, but this is unlikely. Implications are developed about return distributions on information announcement dates. Periods of inactive trade are shown to impart a downward bias to measured returns. An unexpected increase in the short-interest of a stock is shown to be bad news.

In this paper we examine the Henriksson-Merton test of market timing and its potential usefulness in evaluating investment advice. The paper proposes a natural extension of the test that is valid under more general assumptions about the distribution of asset returns. We show that the Henriksson-Merton test and its more general counterpart are special cases of standard tests of market rationality and efficiency. Both tests are applied to a group of foreign exchange advisory services.

Investment decisions and outlays are often made sequentially. For example, the rate at which construction proceeds is usually flexible and can be adjusted with the arrival of new information. Traditional discounted cash flow methods which treat the pattern of investment as fixed ignore this flexibility and understate the value of the project. This paper uses contingent claims analysis to derive optimal decision rules and to value such investments. We determine the effects of time to build, opportunity cost and uncertainty on the investment decision. For reasonable parameter values, we show how a simple NPV rule can lead to gross errors.

This study tests hypotheses about the valuation of leasing contracts. We examine the determinants of the yields of a relatively large, reasonably heterogeneous, and nationally representative sample of financial leases. We find lease yields to be significantly related to treasury bond yields and our proxies for the systematic risk of the leased asset's residual value and the transaction and information costs associated with the lease. There is also some evidence of a relationship between lease yields and the default-risk of the lessee.

This paper tests an information-signaling hypothesis as a potential explanation for corporate convertible bond call policies and for the negative share price reaction to the announcement of the calls. We test this hypothesis by trying to ascertain whether the information signaled is realized. Our results show an unexpected decline in the firm's performance subsequent to the call. We also find significant negative cumulative returns during a sixty-month period following the calls.

Antitakeover amendments (shark repellents) restrict the transfer of corporate control. On average, the public announcement of antitakeover amendments by 600 firms in the period 1979–1985 has an insignificant effect on the value of announcing firms' shares. However, different types of amendments have varying effects. Non-fair-price amendments have an average significant negative effect of 2.95% on share prices, while fair-price amendments have an insignificant effect. The more harmful amendments have larger insider holdings and lower institutional holdings, suggesting a partial explanation of why shareholders approve these amendments.