Knowledge that Transforms

This paper studies a new theory for pricing options in a large trader economy. This theory necessitates studying the impact that derivative security markets have on market manipu? lation. In an economy with a stock, money market account, and a derivative security, it is shown, by example, that the introduction ofthe derivative security generates market manip? ulation trading strategies that would otherwise not exist. A sufficient condition is provided on the price process such that no additional market manipulation trading strategies are introduced by a derivative security. Options are priced under this condition, where it is shown that the standard binomial option model still applies but with random volatilities.

This paper provides further evidence of the holiday effect in stock returns and additional insight into the effect. This paper reports abnormally high returns on the trading day before holidays in all three of the major stock markets in the U.S.: the NYSE, AMEX, and NASDAQ. The holiday effect is also present in the U.K. and Japanese stock markets, even though each country has different holidays and institutional arrangements. This study finds that the holiday effects in the U.K. and Japanese stock markets are independent of the holiday effect in the U.S. stock market. Unlike the other seasonal patterns in stock returns, such as January and weekend effects, this investigation of size decile portfolios shows that the size effect is not present in mean returns on preholidays.

We examine 38 takeovers of distressed firms and find that these takeovers are more likely to involve firms in the same industry and less likely to be hostile takeovers than are acquisitions in general. We use five different measures to evaluate post-merger performance of the combined bidder and target firms. All performance measures suggest that bidders are unable to successfully restructure targets. The market demonstrates an ability to forecast the success of restructuring. Restructuring success is negatively related to the size of premium paid by the bidder for the target and positively related to the financial distress of the target.

This article investigates differences in yields on identical Treasury notes and bills and shows that they reflect differences in liquidity (immediacy) risk and taxes. It proposes an empirical measure for differences in the liquidity risk of notes and bills: the volatility of the underlying rate times the ratio of bills' turnover to notes' turnover. Because differential taxes affect sellers but not buyers of bills and notes, the results reject, free of informational problems, the hypothesis that the notes' demand curve is horizonta. Note-bill yield differences also decrease with inventories of notes—the less liquid asset.

This paper examines alternative methods for pricing options when the underlying security volatility is stochastic. We show that when there is no correlation between innovations in security price and volatility, the characteristic function of the average variance of the price process plays a pivotal role. It may be used to simplify Fourier option pricing techniques and to implement simple power series methods. We compare these methods for the alternative mean-reverting stochastic volatility models introduced by Stein and Stein (1991) and Heston (1993). We also examine the biases in the Black-Scholes model that are eliminated by allowing for stochastic volatility, and we correct some errors in the Stein and Stein (1991) analysis of this issue.

It is well known that stock returns, on average, are negative on Mondays. Yet, it is less well known that this finding is substantially the consequence of returns in prior trading sessions. When Friday's return is negative, Monday's return is negative nearly 80 percent of the time with a mean return of −0.61 percent. When Friday's return is positive, the subsequent Monday's mean return is positive, 0.11 percent. This relationship is stronger than for any other pair of trading days and is most acute in small- and medium-size companies. The trading behavior of individual investors appears to be at least one factor contributing to this pattern. Individual investors are more active sellers of stock on Mondays, particularly following bad news in the market.

David J. Denis, Diane K. Denis, Atulya Sarin, The Information Content of Dividend Changes: Cash Flow Signaling, Overinvestment, and Dividend Clienteles, The Journal of Financial and Quantitative Analysis, Vol. 29, No. 4 (Dec., 1994), pp. 567-587

This paper develops a capital asset pricing theory in a market where noise traders interact with information traders. Noise traders are traders who commit cognitive errors while information traders are free of cognitive errors. The theory includes the determination of the mean-variance efficient frontier, the return on the market portfolio, the term structure, and option prices. The paper derives a necessary and sufficient condition for the existence of price efficiency in the presence of noise traders and analyzes the effects of noise traders on price efficiency, volatility, return anomalies, volume, and noise trader survival.

Mark Grinblatt, Sheridan Titman, A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques, The Journal of Financial and Quantitative Analysis, Vol. 29, No. 3 (Sep., 1994), pp. 419-444