Knowledge that Transforms

For a sample of NYSE firms, we show that wide spreads are accompanied by low depths, and that spreads widen and depths fall in response to bigger volume. Spreads widen and depths fall in anticipation of earnings announcements; these effects are more pronounced for announcements with larger subsequent price changes. Spreads are also wider following earnings announcements, but this effect dissipates quickly after controlling for volume. Collectively, our results suggest liquidity providers are sensitive to changes in information asymmetry risk and use both spreads and depths to actively manage this risk.

A model of trading in speculative markets is developed based on differences of opinion among traders. Our purpose is to explain some of the empirical regularities that have been documented concerning the relationship between volume and price and the time-series properties of price and volume. We assume that traders share common prior beliefs and receive common information but differ in the way in which they interpret this information. Some results are that absolute price changes and volume are positively correlated, consecutive price changes exhibit negative serial correlation, and volume is positively autocorrelated.

I use a new technique to derive a closed-form solution for the price of a European call option on an asset with stochastic volatility. The model allows arbitrary correlation between volatility and spotasset returns. I introduce stochastic interest rates and show how to apply the model to bond options and foreign currency options. Simulations show that correlation between volatility and the spot asset’s price is important for explaining return skewness and strike-price biases in the Black-Scholes (1973) model. The solution technique is based on characteristic functions and can be applied to other problems. Many plaudits have been aptly used to describe Black and Scholes ’ (1973) contribution to option pricing theory. Despite subsequent development of option theory, the original Black-Scholes formula for a European call option remains the most successful and widely used application. This formula is particularly useful because it relates the distribution of spot returns I thank Hans Knoch for computational assistance. I am grateful for the suggestions of Hyeng Keun (the referee) and for comments by participants

I develop a multitarget takeover model with bid revisions, in which bidders desire a reputation for having low valuations. Such a reputation increases the likelihood that future targets will accept low premium bids. Bidders develop reputation by using low take-it-or-leave-it offers. Consequently, tender premiums bid revision rates, and success rates are lower for continuing bidders than for those considering only a single target. Success rates vary within a series, and reputation building is more likely with highly correlated target valuations. I provide an exploratory empirical analysis consistent with lower premiums from continuing bidders and discuss some resulting implications regarding "raiders, " conglomerates, and resistance strategies. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

It is shown that the arbitrage pricing theory holds in each infinitesimal period of a continuous trading model under the assumption that dividend payoffs are functionals of factor and idiosyncratic uncertainty. This generalizes the one-period model's result that the arbitrage pricing theory holds under the assumption that price changes in a given period satisfy a factor structure. Since instantaneous returns in a multiperiod model are endogenously determined, the theory is derived under assumptions that may be viewed as restricting more primitive characteristics of the economy than the assumptions made for the one-period model. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Evidence is provided on an implication of models by Myers and Majluf (1984) and Miller and Rock (1985), which predict that equity issues convey information about firms' future earnings. Consistent with the prediction, the results show that earnings forecast revisions by financial analysts subsequent to the announcement of equity issues are significantly related to announcement period abnormal returns. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

A testable single-beta model of asset prices is presented. If state variables have a long-run stationary joint density function, then the rate return on a very long-term default-free discount bond will be perfectly correlated with the representative investor’s marginal utility of consumption. Thus, the covariance of an asset’s return with the return on such a bond will be an appropriate measure of the asset’s riskiness. The model can be, therefore, applied or tested even though the market portfolio or aggregate consumption may not be observable. It also is shown that the expected rate of return on a very long-term bond is equal to its variance. This proposition can be tested to determine whether state variables follow stationary processes.

The author investigate the empirical importance of information revelation in the pricing of block trades. In particular, he examine whether block prices are correlated with the unexpected part of firms' quarterly earnings. For his sample of block trades, information revelation does indeed appear to be a significant factor shortly before earnings announcements. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

I provide a general equilibrium theory of the term structure of real interest rates in a discrete-time economy. I derive the prices for one-period and two-period real bonds and a simple recursive formula for general k-period bonds, and prove that the price formula with appropriately specified parameters converges to that of the Cox, Ingersoll, and Ross model (1985). In addition, I consider the behavior of nominal bond prices in a partial equilibrium setting in which an exogenous price level process is correlated with the real economy. Finally, I provide an illustrative empirical investigation of the model. The results indicate a significant correlation between the price level and the growth rate of consumption, which does not support the "money nuetrality" assumption underlying Cox, Ingersoll, and Ross's nominal bond prices and related empirical studies, such as Gibbons and Ramaswamyu (1992), Heston(1991), and Pearson and Sun (1991). Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

The author analyzes optimal capital and ownership structures as resulting from anticipated future control contests. He focuses on leverage as a device that enables the incumbent management to extract the maximum value from the rival. He shows that firm value depends on both capital and ownership structures. The analysis leads to the following predictions: (1) more efficient managers use less debt, (2) firms facing better rivals for control issue more debt, and (3) firms with supermajority rules issue less debt. Several predictions are consistent with known empirical regularities. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.