Knowledge that Transforms

Empirical studies of dual class shares indicate that superior voting shares (SVS) sell at a premium relative to their counterpart restricted shares (RVS). This paper uses Toronto Stock Exchange data to show that SVS price premium over RVS reflects the expected takeover premium paid to shareholders outside the control block. Thus, marginal shareholders pay a higher SVS price in anticipation of receiving a differential takeover bid as suggested by the extra merger hypothesis. Further analysis indicates that voting power increases the price premium while ownership, size, and the higher trading liquidity of RVS are inversely related to the premium.

Kalok Chan, Y. Peter Chung, Herb Johnson, The Intraday Behavior of Bid-Ask Spreads for NYSE Stocks and CBOE Options, The Journal of Financial and Quantitative Analysis, Vol. 30, No. 3 (Sep., 1995), pp. 329-346

Existing empirical studies of the put-call parity condition report frequent, substantial violations. An important problem in interpreting these results is that these studies all investigate American options. While some of these studies attempt to reduce the effects of possible early exercise on their tests, they cannot fully account for the effect of early exercise. Therefore, it is not possible to conclude from these studies whether, or to what extent, observed put-call parity violations are due to market inefficiency or due to the value of early exercise. We avoid the early exercise problem by testing put-call parity using European options. We find violations that are much less frequent and smaller than the studies using American options. Moreover, these violations reflect premia for liquidity (immediacy) risk.

This paper analyzes the relationship between tax heterogeneity and the behavior of stock prices and volume around the ex-dividend day within an equilibrium framework.We conclude that, even in a world without transaction costs, the price drop on the ex-day need not be equal to the dividend amount.The model allows us to account for higher market trading volume around the ex-day.The market trading volume is shown to be a positive function of tax heterogeneity among traders.We show that the volume of trade around the ex-day contains information about investors' tax preferences above and beyond the information contained in the ex-day price alone.Consistent with the model's predictions, our empirical analysis reveals that as the risk associated with the ex-dividend day increases, or tax heterogeneity decreases, trading volume decreases.constant), the abnormal volume of trade significantiy decreases.Using the period around the 1986 TRA, we are also able to show that a change in the degree of tax heterogeneity affects both prices and volume around the ex-dividend day.Our analysis shows that unless a perfect tax clientele exists, it is not possible to infer tax rates from price alone.[By a perfect tax clientele we mean that each tax group hold different securities, and all trading is intra-group trading.See Miller and Modigliani (1961) and Elton and Gruber (1970)].However, the crosssectional distribution of tax rates can be inferred by using both price and volume data.This point can be illustrated using the following stylized example.Assume that there are three groups of traders in the marketplace with a marginal rate of substitution between dividends and capital gains income of 0.75, 1.0, and 1.25, respectively.Assume further that the average price drop relative to the dividend amount is 1.0.Using the standard analysis, we may conclude that the second group dominates the ex-dividend day price determination.However, this may not be the case.For example, suppose that 50% of the traders are from the first group, 50%

We study the impact of exchange rate fluctuations and political risk on the risk premiums reflected in cross-sections of individual equity returns from Mexico, a country that has ex? perienced significant monetary and political turbulence. Indicators from Mexico's currency and sovereign debt markets are employed as proxies for exchange rate and political risks. We find some evidence of equity market premiums for exposure to these risks. The results suggest common factors in emerging market equity, currency, and sovereign debt markets, and have several implications for corporate and portfolio management and for the use of emerging market data by researchers.

Andrew Jeffrey, Single Factor Heath-Jarrow-Morton Term Structure Models Based on Markov Spot Interest Rate Dynamics, The Journal of Financial and Quantitative Analysis, Vol. 30, No. 4 (Dec., 1995), pp. 619-642

We analyze the determinants of replacement investment decisions in a contingent claims model with maintenance and operation cost uncertainty. We find that the optimal time between replacements is increasing in the volatility of cost, the purchase price of a new asset, and the corporate tax rate; and is decreasing in the systematic risk of cost, the salvage value of the asset, and the investment tax credit. The optimal time between replacements can either increase or decrease with an increase in the depreciation rate. Extensions of the model to examine the effects of technological and tax policy uncertainty on replacement investment decisions give intuitive, but striking results. Uncertainty about the arrival of a technological innovation that would decrease maintenance and operation cost results in a significant decrease in replacement investment. Uncertainty in a tax law change that would encourage investment decreases current investment; and uncertainty in a tax law change that would discourage investment increases current investment.

We examine how prices in interest rate and foreign exchange futures markets adjust to the new information contained in scheduled macroeconomic news releases in the very short run. Using 10-second returns and tick-by-tick data, we find that prices adjust in a series of numerous small, but rapid, price changes that begin within 10 seconds of the news release and are basically completed within 40 seconds of the release. There is some evidence that prices overreact in the first 40 seconds but that this is corrected in the second or third minute after the release. While volatility tends to be higher than normal just before the news release, there is no evidence of information leakage. In our analysis, we correct for the biases created by bid-ask spreads and tick-by-tick data.

Robin J. Brenner, Kenneth F. Kroner, Arbitrage, Cointegration, and Testing the Unbiasedness Hypothesis in Financial Markets, The Journal of Financial and Quantitative Analysis, Vol. 30, No. 1 (Mar., 1995), pp. 23-42

Prior theoretical work on estimation risk generally has been restricted to single-period, returns-based models in which the investor must estimate the vector of expected returns but the covariance matrix is known. This paper extends the literature on parameter uncertainty in several ways. First, we analyze asymmetric parameter uncertainty in a model based on payoffs. Second, we explore the effects of both symmetric and asymmetric estimation risk on equilibrium asset prices when the covariance matrix for payoffs must also be estimated. Finally, we investigate the effects on equilibrium of asymmetric parameter uncertainty in a simple multiperiod model.