Knowledge that Transforms

[In this article we construct a model in which a consumer's utility depends on the consumption history. We describe a general equilibrium framework similar to Cox, Ingersoll, and Ross (1985a). A simple example is then solved in closed form in this general equilibrium setting to rationalize the observed stickiness of the consumption series relative to the fluctuations in stock market wealth. The sample paths of consumption generated from this model imply lower variability in consumption growth rates compared to those generated by models with separable utility functions. We then present a partial equilibrium model similar to Merton (1969, 1971) and extend Merton's results on optimal consumption and portfolio rules to accommodate nonseparability in preferences. Asset pricing implications of our framework are briefly explored.]

[We present a model of corporate acquisitions in which initially uninformed bidders must incur costs to learn their (independent) valuations of a potential takeover target. The first bidder makes either a preemptive bid that will deter the second bidder from investigating or a lower bid that will induce the second bidder to investigate and possibly compete. We show that the expected price of the target may be higher when the first bidder makes a deterring bid than when there is competitive bidding. Hence, by weakening the first bidder's incentive to choose a preemptive bid, regulatory and management policies to assist competing bidders may reduce both the expected takeover price and social welfare.]

[This article presents a simple model of the innovation of new futures contracts by transaction volume-maximizing futures exchanges in incomplete markets under uncertainty, with mean-variance preferences and proportional transactions costs. We characterize the set of Nash equilibria for a number of exchanges simultaneously or sequentially choosing contracts. The optimal monopolistic contract design is shown to be Pareto-optimal. An example shows the failure of Pareto optimality for a particular Nash equilibrium. Likewise, in a monopolistic multiperiod setting, an example shows the failure of Pareto optimality given an incentive for the exchange to induce turnover.]

[This article analyzes the volume of trade in a multiperiod noisy rational expectations model. When traders receive private signals at the first trading date and are allowed a second round of trade, two types of equilibria exist. In the first, traders do not learn about the average private signal from the second round of trade, and all trade takes place at the first date. In the second, traders do learn from the second round, and trade thus takes place at both the first and second dates. The article characterizes volume when a public signal is disclosed at the second date.]

[We derive and test a dynamic discrete-time model of asset returns. Both the risks of individual securities and equilibrium risk premia change predictably in the model, but these changes can be attributed to movements in the returns and prices of only two well-diversified portfolios. Any other components of returns should be unpredictable. Using the generalized method of moments, the model is estimated and tested on portfolios of equities. We find the data supportive of the model's restrictions, even when instruments designed to capture the January effect are employed.]

[This article studies an asymmetric information game with "type convergence," in which, under some realizations of a common uncertainty, inducing informed agents to reveal their types through self-selection by contract choice is either costly or impossible. Under other realizations, self-selection permits costless distinctions between informed agents. I obtain sufficient conditions under which contracting with options prior to the realization of the common uncertainty leads to the existence of a perfectly separating, costless Nash equilibrium. Applications to variable rate loan commitments and life insurance contracting are discussed.]

[This article reexamines the value of tax trading when the tax rate on long-term realizations is less than that on short-term realizations. In particular, the value of the option to realize long-term capital gains and repurchase stock in order to increase one's tax basis and restart the option to realize future losses short term is examined empirically. Our estimate of the incremental value of restarting, which is based on the results of simulations of several alternative tax trading policies over a large number of independent return sequences, is generally much smaller than that reported by Constantinides (1984). The incremental value of restarting is shown to depend critically on the particular pattern of realized returns and the assumed tax treatment of unrealized capital gains at the end of the simulation period. The effects of stock price volatility, transaction costs, portfolio offset rules, and realization cutoff levels on the value of tax trading are also investigated.]

[The Cox, Ross, and Rubinstein binomial model is generalized to the multinomial case. Limits are investigated and shown to yield the Black-Scholes formula in the case of continuous sample paths for a wide variety of complete market structures. In the discontinuous case a Merton-type formula is shown to result, provided jump probabilities are replaced by their corresponding Arrow-Debreu prices.]

[This article develops a model in which patterns in buy and sell volume, order imbalances, and expected price changes arise endogenously. The model covers cases in which the market maker is competitive and is a monopolist. Our results provide an explanation for the existence of patterns in mean returns within the trading day and across trading days.]

[When a firm is in financial distress, in most cases a set of mutually advantageous reorganization plans exist. This article shows that the bankruptcy code, by providing rules governing the negotiation process, yields a unique solution to the reorganization process. In addition, the structure imposed by the code mitigates the holdout problem created by the individual claimant's divergent incentives.]