Knowledge that Transforms

When shareholders have different plans to sell their shares, they will, in general, have different preferences concerning the firm's decision to pay out cash using dividends or share repurchase. We illustrate these different preferences and explore a model of payout policy that highlights the adverse selection costs of repurchases when managers have superior information about the value of the firm. We show that, in the absence of fixed costs to repurchasing shares, there is a separating equilibrium in which managers use taxable dividends to signal the quality of the firm, with better firms paying lower dividends, using repurchases for the remainder of the payout. With fixed costs to repurchasing, small payouts are made via dividend and large payouts are divided between repurchases and dividends, as in the no-fixed cost case. In both cases, the percentage of shares repurchased increases with the size of the payout and larger repurchases are better news.

Suppose the ICAPM governs asset prices and there is a total of S state variables that might be of hedging concern to investors. Can we determine which state variables are, in fact, of hedging concern? What does it mean to say that these state variables are priced, that is, that they give rise to special risk premiums in expected returns? The goal of this paper is to formulate this problem clearly and show when it can and cannot be solved. Ignoring estimation problems, it is possible to find the set of priced state variables when the state variables are identified (named). When we know the number of state variables, but not their names, confident conclusions about even the number of them that produce special risk premiums are probably impossible, unless the number is zero, so the ICAPM collapses to the CAPM.

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Elazar Berkovitch, Ronen Israel, Jaime F. Zender, The Design of Bankruptcy Law: A Case for Management Bias in Bankruptcy Reorganizations, The Journal of Financial and Quantitative Analysis, Vol. 33, No. 4 (Dec., 1998), pp. 441-464

Jongmoo Jay Choi, Takato Hiraki, Nobuya Takezawa, Is Foreign Exchange Risk Priced in the Japanese Stock Market?, The Journal of Financial and Quantitative Analysis, Vol. 33, No. 3 (Sep., 1998), pp. 361-382

This paper identifies various components of stock prices and examines the response of stock prices to different types of shocks: permanent and temporary changes in earnings and dividends, changes in discount factors, and non-fundamental factors. The analysis is conducted in a log-linear structural VAR framework. I find that about half of the yearly variation in prices is not related to either earnings or dividend changes. Time-varying interest rates do not help explain the remaining price movements. However, time-varying excess stock returns (i.e., risk premiums) account for much of the remaining variation in stock prices, in particular, in the postwar period. As a result, the deviation of stock prices from these fundamentals reduces to about 10% of stock price movements and tends to persist for a while before it declines eventually. This finding seems more compatible with a fad rather than a bubble interpretation.

Paul D. Childs, Steven H. Ott, Alexander J. Triantis, Capital Budgeting for Interrelated Projects: A Real Options Approach, The Journal of Financial and Quantitative Analysis, Vol. 33, No. 3 (Sep., 1998), pp. 305-334

John M. Bizjak, Christopher J. Marquette, Are Shareholder Proposals All Bark and No Bite? Evidence from Shareholder Resolutions to Rescind Poison Pills, The Journal of Financial and Quantitative Analysis, Vol. 33, No. 4 (Dec., 1998), pp. 499-521

We consider the general n-factor Heath, Jarrow, and Morton model (1992) and provide a sufficient condition on the volatility structure for the spot rate process to be Markovian with 2n state variables. The price of a discount bond is also Markovian with the same state variables and, hence, claims against the term structure can be efficiently priced using standard simulation techniques. Our results extend earlier works such as Ritchken and Sankarasubramanian (1995) where the one-factor model is treated, and Carverhill (1994), where the volatility structure is non-random. Numerical experiments show that our model can explain the volatility smile observed in the interest rate options market and also overcome the biases noted by Flesaker (1993).

Kristian R. Miltersen, Eduardo S. Schwartz, Pricing of Options on Commodity Futures with Stochastic Term Structures of Convenience Yields and Interest Rates, The Journal of Financial and Quantitative Analysis, Vol. 33, No. 1 (Mar., 1998), pp. 33-59