We develop a specification test and a sequence of model selection procedures for non-nested, overlapping, and nested models based on the second Hansen-Jagannathan distance, which requires a good asset pricing model to not only have small pricing errors but also be arbitrage free. Our methods have reasonably good finite sample performances and are more powerful than existing ones in detecting misspecified models with small pricing errors but are not arbitrage-free and in differentiating models that have similar pricing errors of a given set of test assets. Using the Fama and French size and book-to-market portfolios, we reach dramatically different conclusions on model performances based on our approach and existing methods.

This paper investigates the effectiveness of using securities class action lawsuits in monitoring defendant firms by institutional lead plaintiffs from two aspects: (1) immediate litigation outcomes, including the probability of surviving the motion to dismiss and the settlement amount, and (2) subsequent governance improvement such as changes in board independence. Using a large sample of securities lawsuits from 1996 to 2005, we show that institutional investors are more likely to serve as the lead plaintiff for lawsuits with certain characteristics. After controlling for these determinants of having an institutional lead plaintiff, we show that securities class actions with institutional owners as lead plaintiffs are less likely to be dismissed and have larger monetary settlements than securities class actions with individual lead plaintiffs. This effect exists for various types of institutions including public pension funds. We also find that, after the lawsuit filings, defendant firms with institutional lead plaintiffs experience greater improvement in their board independence than defendant firms with individual lead plaintiffs. Our study suggests that securities litigation is an effective disciplining tool for institutional owners.

We develop a reduced-form approach for valuing callable corporate bonds by characterizing the call probability via an intensity process. Asymmetric information and market frictions justify the existence of a call-arrival intensity from the market's perspective. Our approach both extends the reduced-form model of Duffie and Singleton (1999) for defaultable bonds to callable bonds and captures some important differences between call and default decisions. A comprehensive empirical analysis of callable bonds using both our model and the more traditional American option approach for valuing callable bonds shows that the reduced-form model fits callable bond prices well and that it outperforms the traditional approach both in- and out-of-sample.