Knowledge that Transforms

[Academic and practitioner research evaluates portfolio performance using size and value/growth attributes or factors. We assess the merits of popular evaluation procedures based on matched-characteristic benchmark portfolios or time-series return regressions by applying them to a sample of active money managers and passive indexes. Estimated abnormal returns display large variation across approaches. The benchmarks typically used in academic research—attribute-matched portfolios from independent sorts, the three-factor time-series model, and cross-sectional regressions of returns on stock characteristics—track returns poorly. Some simple alterations improve the performance of these methods.]

[Although it is of interest to test whether or not a particular asset pricing model is literally true, a more useful task for empirical researchers is to determine how wrong a model is and to compare the performance of competing asset pricing models. In this paper, we propose a new methodology to test whether or not two competing linear asset pricing models have the same Hansen-Jagannathan distance. We show that the asymptotic distribution of the test statistic depends on whether the competing models are correctly specified or misspecified, and on whether the competing models are nested or non-nested. In addition, given the increasing interest in misspecified models, we propose a simple methodology for computing the standard errors of the estimated stochastic discount factor parameters that are robust to model misspecification. Using monthly data on 25 size and book-to-market ranked portfolios and the one-month T-bill, we show that the commonly used returns and factors are, for the most part, too noisy for us to conclude that one model is superior to the other models in terms of Hansen-Jagannathan distance. Specifically, there is little evidence that conditional and intertemporal capital asset pricing model (CAPM)-type specifications outperform the simple unconditional CAPM. In addition, we show that many of the macroeconomic factors commonly used in the literature are no longer priced once potential model misspecification is taken into account.]

[We investigate the relative importance of the twenty-four provisions followed by the Investor Responsibility Research Center (IRRC) and included in the Gompers, Ishii, and Metrick governance index (Gompers, Ishii, and Metrick 2003). We put forward an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments. We find that increases in the index level are monotonically associated with economically significant reductions in firm valuation as well as large negative abnormal returns during the 1990-2003 period. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either reduced firm valuation or negative abnormal returns.]

[This paper tests whether foreign equity listings are associated with permanent valuation gains and examines how market and firm characteristics influence any valuation effects. Using a global sample of 1,676 listings placed in 25 countries, we find that much of the valuation gains to overseas listings are not permanent. The transitory nature of valuation gains holds for both average US listings and average first-time firm listings. We find little evidence of a permanent effect on returns for firms that list abroad, even for firms' listings in markets that are more liquid, provide better legal protection, or have a larger shareholder base.]

[We analyze the effects of differences of opinion on the dynamics of trading volume in stocks and options. We find that disagreements about the mean of the current- and next-period public information lead to trading in stocks in the current period but have no effect on options trading. Without options, we find that disagreements about the precision of all past and current public information affect trading in stocks in the current period. With options, only disagreements about the precisions of the next- and current-period information affect stocks and options trading in the current period. Our results suggest that options trading is concentrated around information events that are likely to cause disagreements among investors, whereas trading in stocks may be diffusive over many periods.]

[This article studies the causal effect of individuals' overconfidence and bounded rationality on information aggregation by using a new multiperiod game in which agents are rewarded for submitting accurate estimates of an unknown asset's value based on (i) their private information and (ii) others' past estimates. By carrying out laboratory sessions of this game in which subjects' overconfidence is a treatment variable, I find that overconfidence affects the information aggregation process by increasing the dispersion of estimates and decreasing the rate of estimates' convergence. However, even when subjects are not overconfident, qualitatively similar deviations from the fully rational model predictions are observed. I show that this can be explained by subjects' strategic response to errors.]

[Using a novel information asymmetry index based on measures of adverse selection developed by the market microstructure literature, we test whether information asymmetry is an important determinant of capital structure decisions, as suggested by the pecking order theory. Our index relies exclusively on measures of the market's assessment of adverse selection risk rather than on ex ante firm characteristics. We find that information asymmetry does affect the capital structure decisions of U. S. firms over the sample period 1973-2002. Our findings are robust to controlling for conventional leverage factors (size, tangibility, Q ratio, profitability), the sources of firms' financing needs, and such firm attributes as stock return volatility, stock turnover, and intensity of insider trading. For example, we estimate that on average, for every dollar of financing deficit to cover, firms in the highest adverse selection decile issue 30 cents of debt more than firms in the lowest decile. Overall, this evidence explains why the pecking order theory is only partially successful in explaining all of firms' capital structure decisions. It also suggests that the theory finds support when its basic assumptions hold in the data, as should reasonably be expected of any theory.]

[We develop a model of the optimal initial public offering (IPO) decision in the presence of learning about the average profitability of a private firm. The entrepreneur trades off diversification benefits of going public against benefits of private control. Going public is optimal when the firm's expected future profitability is sufficiently high. The model predicts that firm profitability should decline after the IPO, on average, and that this decline should be larger for firms with more volatile profitability and firms with less uncertain average profitability. These predictions are supported empirically in a sample of 7183 IPOs in the United States between 1975 and 2004.]

[By generalizing the Leland and Pyle (1977) model to the case of multiple correlated assets, this paper studies the signaling and hedging behavior of an intermediary who sells multiple assets in financial markets. Based on information asymmetry, this paper demonstrates the intrinsic interdependence of risk management and asset selling for intermediaries, and obtains several testable empirical implications. For instance, an intermediary with a more diversified underlying portfolio will face greater liquidity (a smaller price impact) when selling assets to the market. Several applications are discussed, including bank loan sales and selling mechanisms.]

[We develop a tractable and flexible stochastic volatility multifactor model of the term structure of interest rates. It features unspanned stochastic volatility factors, correlation between innovations to forward rates and their volatilities, quasi-analytical prices of zerocoupon bond options, and dynamics of the forward rate curve, under both the actual and risk-neutral measures, in terms of a finite-dimensional affine state vector. The model has a very good fit to an extensive panel dataset of interest rates, swaptions, and caps. In particular, the model matches the implied cap skews and the dynamics of implied volatilities.]