Knowledge that Transforms

Enrico C. Perotti, Ernst-Ludwig von Thadden, Strategic Transparency and Informed Trading: Will Capital Market Integration Force Convergence of Corporate Governance?, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 1 (Mar., 2003), pp. 61-85

In this paper we investigate the claim that hedge funds offer investors a superior risk-return trade-off. We do so using a continuous time version of Dybvig's (1988a, 1988b) payoff distribution pricing model. The evaluation model, which does not require any assumptions with regard to the return distribution of the funds in question, is applied to the monthly returns of 77 hedge funds and 13 hedge fund indices over the period May 1990 - April 2000. The results show that as a stand-alone investment hedge funds do not offer a superior risk-return profile. We find 12 indices and 72 individual funds to be inefficient, with the average efficiency loss amounting to 2.76% per annum for indices and 6.42% for individual funds. Part of the inefficiency cost of individual funds can be diversified away. Funds of funds, however, are not the preferred vehicle for this as their performance appears to suffer badly from their double fee structure. Looking at hedge funds in a portfolio context results in a marked improvement in the evaluation outcomes. Seven of the 12 hedge fund indices and 58 of the 72 individual funds classified as inefficient on a stand-alone basis are capable of producing an efficient payoff profile when mixed with the S&P 500. The best results are obtained when 10-20% of the portfolio value is invested in hedge funds.

We study the effect of trading consolidation by examining the response of liquidity and stock price to the exercise of deep in-the-money corporate warrants. This enables a relatively clean test of the value of trading consolidation. The exercise at the warrant expiration is fully anticipated and has no information content. An effect can come from the value of trading consolidation that improves liquidity. Indeed, we find that liquidity and stock prices both increase significantly at warrant expiration. Further, the price increase is positively related to the pre-exercise extent of fragmentation, to post-exercise improvement in stock liquidity, and to the proportional increase in the number of shares following the warrant exercise.

This paper develops an expected utility model of a multinational firm facing exchange rate risk exposure to a foreign currency cash flow. Currency derivative markets do not exist between the domestic and foreign currencies. There are, however, currency futures and options markets between the domestic currency and a third currency to which the firm has access. Since a triangular parity condition holds among these three currencies, the available, yet incomplete, currency futures and options markets still provide a useful avenue for the firm to indirectly hedge against its foreign exchange risk exposure. This paper offers analytical insights into the optimal cross-hedging strategies of the firm. In particular, the results show the optimality of using options in conjunction with futures in the case of currency mismatching, even though cash flows appear to be linear.

Patterns of clustering in IPO gross spreads can be identified not only in the U.S., but also in many other markets across the world. The evidence indicates, however, that these clustering patterns are not necessarily collusive. Clustering is widespread in many countries with low gross spreads. In fact, the amount of clustering observed is negatively related to the gross spread level of a country. Additionally, an analysis of abnormal gross spreads following Hansen (2001) indicates that few clusters contain abnormal positive surpluses.

Does more leverage always worsen the debt agency problem? This paper presents a unified analysis that accounts for both risk-shifting and under-investment debt agency problems. For firms with positive marginal volatility of investment (defined as the change in cash flow volatility corresponding to a change of investment scale), equity holders' risk-shifting incentive will mitigate the under-investment problem. This implies that, contrary to conventional views, the total agency cost of debt does not uniformly increase with leverage. This model further predicts that, for high growth firms in which the under-investment problem is severe, the optimal debt ratio is positively related to the marginal volatility of investment. Empirical results support this prediction.

Recent research has examined the performance of stocks held by U.S. mutual funds and found they realize abnormal returns. The result is significant as it stands in contrast to the general consensus from traditional performance studies that mutual funds do not possess superior information. Employing a unique dataset, I examine the performance of the monthly stock holdings and trades of a sample of Australian fund managers. When stock holdings are observable, performance measures can be constructed that are more precise than traditional fund manager performance measures. I find the stocks held by fund managers realize abnormal returns consistent with some stock selection ability across fund managers. Examining the performance of their individual trades, I find that the stocks they buy realize abnormal returns whereas for sell trades I find no evidence of abnormal returns. Overall, the results suggest fund managers have the ability to select stocks that realize positive abnormal returns thus providing out-of-sample support for similar recent findings for U.S. mutual funds.

Joost Driessen, Pieter Klaassen, Bertrand Melenberg, The Performance of Multi-Factor Term Structure Models for Pricing and Hedging Caps and Swaptions, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 3 (Sep., 2003), pp. 635-672

John T. Scruggs, Paskalis Glabadanidis, Risk Premia and the Dynamic Covariance between Stock and Bond Returns, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 2 (Jun., 2003), pp. 295-316

Wei-Ling Song, Samuel H. Szewczyk, Does Coordinated Institutional Investor Activism Reverse the Fortunes of Underperforming Firms?, The Journal of Financial and Quantitative Analysis, Vol. 38, No. 2 (Jun., 2003), pp. 317-336