Knowledge that Transforms

This article investigates investor activism when there are a number of strategic investors that are capable of intervening in corporate governance. These strategic investors can monitor and/or trade in anonymous financial markets. In equilibrium, a core group of monitoring investors emerges endogenously to curtail managerial opportunism. These core activists both intervene and trade aggressively. Although the smallest investors are passive, there is no monotonic relationship between the size of preexisting shareholdings and activism. In fact, among those investors who choose activism, those with the smallest holdings are the most aggressive.

We examine the dynamic relation between return and volume of individual stocks. Using a simple model in which investors trade to share risk or speculate on private information, we show that returns generated by risk-sharing trades tend to reverse themselves, while returns generated by speculative trades tend to continue themselves. We test this theoretical prediction by analyzing the relation between daily volume and first-order return autocorrelation for individual stocks listed on the NYSE and AMEX. We find that the cross-sectional variation in the relation between volume and return autocorrelation is related to the extent of informed trading in a manner consistent with the theoretical prediction.

In this article, we study a well-known real option: the opening and closing of mines. Using a new database that tracks the annual opening and closing decisions of 285 developed North American gold mines in the period 1988-1997, we find that the real options model is a useful descriptor of mines' opening and shutting decisions. In addition, we find that the decision whether to shut a mine is related to firm-specific managerial factors not normally considered within a strict real options model.

This article theoretically explores the characteristics underpinning quadratic term structure models (QTSMs), which designate the yield on a bond as a quadratic function of underlying state variables. We develop a comprehensive QTSM, which is maximally flexible and thus encompasses the features of several diverse models including the double square-root model of Longstaff (1989), the univariate quadratic model of Beaglehole and Tenney (1992), and the squared-autoregressive-independent-variable nominal term structure (SAINTS) model of Constantinides (1992). We document a complete classification of admissibility and empirical identification for the QTSM, and demonstrate that the QTSM can overcome limitations inherent in affine term structure models (ATSMs). Using the efficient method of moments of Gallant and Tauchen (1996), we test the empirical performance of the model in determining bond prices and compare the performance to the ATSMs. The results of the goodness-of-fit tests suggest that the QTSMs outperform the ATSMs in explaining historical bond price behavior in the United States.

Most mutual funds adopt investment styles that cluster around a broad market benchmark. Few funds take extreme positions away from the index, but those who do are more likely to favor growth stocks and past winners. The bias toward glamour and the tendency of poorly performing value funds to shift styles may reflect agency and behavioral considerations. After adjusting for style, there is evidence that growth managers on average outperform value managers. Though a fund's factor loadings and its portfolio characteristics generally yield similar conclusions about its style, an approach using portfolio characteristics predicts fund returns better.

Proprietary information generated through the process of lending can impact the structure of the banking industry. With more competing banks, borrower-specific information becomes more disperse, as each bank becomes informed about a smaller pool of borrowers. This reduces banks' screening ability, creating an inefficiency as more low-quality borrowers obtain financing. Incumbent banks' information advantage may also create difficulties for potential entrants, so that entry should be easier in markets with high borrower turnover or where entrants have specific expertise in evaluating credit risks. We draw implications for whether financial deregulation is likely to increase borrowers' surplus, and what patterns of entry might be observed.

Substantial academic research explains why firms should hedge, but little work has addressed how firms should hedge. We assume that firms can experience costly states of nature and derive optimal hedging strategies using vanilla derivatives (e.g., forwards and options) and custom "exotic" derivative contracts for a value-maximizing firm facing both hedgable (price) and unhedgable (quantity) risks. Customized exotic derivatives are typically better than vanilla contracts when correlations between prices and quantities are large in magnitude and when quantity risks are substantially greater than price risks. Finally, we discuss how our model may be applied in practice.

This article uses a new dataset of credit card accounts to analyze credit card delinquency, personal bankruptcy, and the stability of credit risk models. We estimate duration models for default and assess the relative importance of different variables in predicting default. We investigate how the propensity to default has changed over time, disentangling the two leading explanations for the recent increase in default rates-a deterioration in the risk composition of borrowers versus an increase in borrowers' willingness to default due to declines in default costs. Even after controlling for risk composition and economic fundamentals, the propensity to default significantly increased between 1995 and 1997. Standard default models missed an important time-varying default factor, consistent with a decline in default costs.

This article provides a comprehensive study of survivorship issues using the mutual fund data of Carhart (1997). We demonstrate theoretically that when survival depends on multiperiod performance, the survivorship bias in average performance typically increases with the sample length. This is empirically relevant because evidence suggests a multiyear survival rule for U.S. mutual funds. In the data we find the annual bias increases from 0.07% for 1-year samples to 1% for samples longer than 15 years. We find that survivor conditioning weakens evidence of performance persistence. Finally, we explain how survivor conditioning affects the relation between performance and fund characteristics.

One reason why funds charge different prices to their investors is that they face different demand curves. One source of differentiation is asset retention: Performance-sensitive investors migrate from worse to better prospects, taking their performance sensitivity with them. In the cross-section we show that past attrition significantly influences the current pricing of retail but not institutional funds. In time-series we show that the repricing of retail funds after merging in new shareholders is predicted by the estimated effect on its demand curve. This result is robust to other influences on repricing, including asset and account-size changes.