Knowledge that Transforms

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.

Weekly data for foreign currency futures prices are examined for evidence of risk premiums. Covariance risks are measured with respect to the excess returns from benchmark portfolios for consumption and wealth. When the parameters representing the prices of the covariance risks are held constant, no risk premiums are detected. However, when these prices are allowed to vary with the conditional expected returns and variances of the benchmark portfolios, possibly reflecting changing investment opportunities, strong evidence of risk premiums is obtained.

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.

We examine market crashes in the multiperiod framework of Glosten and Milgrom (1985). Our analysis shows that if the market’s prior beliefs underestimate the extent of dynamic bedging strategies such as portfolio insurance, then the price will be greater than that which would be implied by fundamentals if the extent of portfolio insurance were known with certainty. Over time, the market learns of the amount of portfolio insurance, and consequently reevaluates the previous inferences drawn from purchases that were erroneously regarded as based on favorable information. The result is that the price falls when the amount of portfolio insurance is revealed.

Solutions are presented for prices on interest rate options in a two-factor version of the Cox–Ingersoll–Ross model of the term structure. Specific solutions are developed for caps on floating interest rates and for European options on discount bonds, coupon bonds, coupon bond futures, and Euro-dollar futures. The solutions for the options are expressed as multivariate integrals, and we show how to reduce the calculations to univariate numerical integrations, which can be calculated very quickly. The two-factor model provides more flexibility in fitting observed term structures, and the fixed parameters of the model can be set to capture the variability of the term structure over time.