Knowledge that Transforms

Abstract We investigate the pricing of 4,989 equity IPOs with offer dates between 1981 and 2000. Approximately three-fourths of these IPOs have integer offer prices. Average initial returns for IPOs with integer offer prices are significantly higher (24.5%) than those priced on the fraction of the dollar (8.1%). This result is robust through time and after conditioning for other effects known to influence initial returns. We hypothesize that integer vs. fractional dollar IPOs are the result of negotiations between the issuing firm and underwriter. Under this negotiation hypothesis, the frequency of integer pricing should be an increasing function of the offer price and the degree of uncertainty surrounding the value of the firm. Empirical evidence, supportive of the negotiation hypothesis, is presented.

Abstract This paper investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets endogenously modifies the participation set, reduces the covariance between dividends and participants' consumption and thus leads to lower risk premia. In multisector economies, financial innovation spreads across markets through the diversified portfolio of new entrants, and has rich effects on the cross-section of expected returns. The price changes can also lead some investors to leave the markets and give rise to non-degenerate forms of participation turnover. The model is consistent with several features of financial markets over the past few decades: substantial innovation, higher participation, significant turnover in investor composition, improved risk management practices, a slight increase in real interest rates, and a reduction in risk premia.

Abstract This paper presents a consumption-based model that explains the equity premium puzzle through two channels. First, because of borrowing constraints, the shareholder cannot completely diversify his income risk and requires a sizable risk premium on stocks. Second, because of limited stock market participation, the precautionary saving demand lowers the risk-free rate but not stock return and generates a substantial liquidity premium. This model also replicates many other salient features of the data, including the first two moments of the risk-free rate, excess stock volatility, stock return predictability, and the unstable relation between stock volatility and the dividend yield.

Abstract Data from the Taiwan Stock Exchange identify the originator of each submitted order, and there are no designated dealers or specialists. We study marketable order imbalances, i.e., the net order flow resulting from trades that demand immediacy. We distinguish imbalances by trader type (individuals, domestic institutions, foreign institutions) and by the usual size of each trader's order. Day-to-day persistence in order imbalance is strongest for small foreign institutions and weakest for large individual traders. Such persistence emanates both from splitting orders over time and from herding, and there is little evidence that aggregate price pressures from such persistence last beyond a trading day, indicating that de facto market making is quite effective. We attempt to discern which types of traders are de facto liquidity providers, which are likely to be informed, and which trade for liquidity reasons. The evidence indicates that all trader classes are successful market makers, large domestic institutions conduct the most informed trades, and large individuals are noise or liquidity traders.

Abstract We test the hypothesis that insider trading impairs market liquidity by analyzing intraday trades and quotes around 1,497 IPO lockup expirations in the period 1995–1999. We find that, while lockup expirations are associated with considerable insider trading for some IPO firms, they have little effect on effective spreads. By contrast, two other liquidity measures, quote depth and trading activity, improve substantially. In the 23% of lockup expirations where insiders disclose share sales, spreads actually decline. These findings indicate that a large body of well-informed, blockholding insider traders can enter a market from which they had previously been absent, and substantially change trading volume and share price without impairing market liquidity.

Abstract The informational opacity of small businesses makes them an interesting area for the study of banks' lending practices and procedures. We use data from a survey of small businesses to analyze the micro level differences in the loan approval processes of large and small banks. We provide evidence that large banks ($1 billion or more in assets) employ standard criteria obtained from financial statements in the loan decision process, whereas small banks rely to a greater extent on information about the character of the borrower. These cookie-cutter and character approaches are compatible with the incentives and environments facing large and small banks.

Abstract Pricing in the euroyen market is based on LIBOR, the London Interbank Offered Rate, set at 11:00AM London time or TIBOR, the Tokyo Interbank Offered Rate, set at 11:00AM Tokyo time. The changing TIBOR-LIBOR spread reflects the credit risk associated with Japanese banks or the “Japan premium”. The spread is modeled as a function of determinants of bank default and firm value. Systematic variation in the spread can be explained by interest rate and stock price effects along with public information flows of good and bad news regarding Japanese banking, with a separate role for bank credit downgrades and upgrades.

Abstract Capital markets perform two distinct functions: provision of capital and facilitation of good governance through information production and monitoring. I argue that the governance function has more impact on the efficiency with which resources are utilized within the firm. Based on industry-level data across 38 countries, I present evidence suggesting a positive relation between market-based governance and improvements in industry efficiency. The measures of governance are also positively correlated with productivity improvements and growth in real output. Furthermore, while governance affects efficiency, the capital provision services induce technological change. The evidence underscores the role of capital markets as a conduit of socially valuable governance services as distinct from capital provision.

Abstract Using a sample of emerging market closed-end funds, I find evidence that indirect investment barriers exert powerful effects on asset pricing differences across countries. I show that not only do indirect investment barriers contribute to international capital market segmentation, but also they can lead to segmentation even in the absence of strong capital inflow restrictions. This result is consistent with Bekaert and Harvey's (1995) conclusion that “other markets appear segmented even though foreigners have relatively free access to their capital markets” (p. 403). The empirical results of this paper provide a rational market segmentation explanation of both premiums and discounts in emerging market closed-end funds, and they are consistent with the deterrent effect of indirect barriers on equity flows to emerging markets found in the capital flow literature.

Abstract This paper examines the price dynamics in the S&P 500 and Nasdaq-100 index futures contracts. By utilizing transactions data with attached trader type identification codes, we are able to analyze price dynamics for trades initiated by exchange locals and off-exchange customers. The empirical results show that price discovery appears to be initiated in the E-mini index futures contracts and that trades initiated by exchange locals seem to be more informative than those initiated by off-exchange traders. Furthermore, results show that exchange locals appear to make informed trades on the E-mini contracts around large trades that occur on the open outcry floor. We maintain that the exchange locals' ability to observe pit dynamics may contribute toward explaining the price leadership of the Emini contracts. Overall, the results are consistent with the notion that exchange locals are informed traders who derive their informational advantage from the proximity to order flow.