Knowledge that Transforms

[While the literature usually justifies informational efficiency in the context of rationality, this article shows informational efficiency by applying the evolutionary idea of natural selection. In a dynamic futures market, speculators are assumed to merely act upon their predetermined trading types (buyer or seller), their predetermined fractions of wealth allocated for speculation, and their inherent abilities to predict the spot price, reflected in their distributions of prediction errors with respect to the spot price. This article shows that the proportion of time that the futures price equals the spot price converges to one with probability 1.]

[This article examines the relation between two factors affecting stock returns, the bid-ask spread and price discreteness, and the increase in return variance after ex-dates of stock splits and stock dividends. Controlling for these effects, the variance of daily returns still increases significantly. The variance of weekly returns also increases significantly, and the variance of returns for a control sample of nonsplitting firms shows no significant increase. Variance ratio tests show that bid-ask errors are small for these stocks and therefore cannot explain the large increase in variance. Spreads and price discreteness do not explain increased variance after stock distributions.]

[In this article we use a single unifying framework to analyze the sources of profits to a wide spectrum of return-based trading strategies implemented in the literature. We show that less than 50% of the 120 strategies implemented in the article yield statistically significant profits and, unconditionally, momentum and contrarian strategies are equally likely to be successful. However, when we condition on the return horizon (short, medium, or long) of the strategy, or the time period during which it is implemented, two patterns emerge. A momentum strategy is usually profitable at the medium (3- to 12-month) horizon, while a contrarian strategy nets statistically significant profits at long horizons, but only during the 1926-1947 subperiod. More importantly, our results show that the cross-sectional variation in the mean returns of individual securities included in these strategies plays an important role in their profitability. The cross-sectional variation can potentially account for the profitability of momentum strategies and it is also responsible for attenuating the profits from price reversals to long-horizon contrarian strategies.]

[I consider the costs and benefits of introducing a new security in a standard framework where uninformed traders with hedging needs interact with risk-averse informed traders. Opening a new market may make everybody worse off, even when the new security is traded in equilibrium. This article emphasizes cross-market links between hedging and speculative demands: risk-averse arbitrageurs can use the new market to hedge their positions in the preexisting security, which can affect liquidity in the old market. More generally, the availability of such hedging opportunities will influence the strategies to which traders will direct resources.]

[We analyze an overlapping generations model with fixed costs of stock market participation. Participation in the stock market is determined endogenously and covaries positively with preceding innovations in dividends. The equilibrium share price is positively related to market participation of the same period and to information about future dividends. There is "rational trend chasing" in the sense that, although all agents are rational, market participation rises after an increase of the share price and falls after a decrease. Finally, we show that the endogenous fluctuations of market participation lead to increased volatility of the share price.]

[Recent empirical evidence indicates that capital structure changes affect pricing strategies. In most cases, prices increase following the implementation of a leveraged buyout of a major firm in an industry, with the more leveraged firm in the industry charging higher prices on average. Notable exceptions exist, however, when the leverage increasing firm's rival is relatively unlevered. The first observation is consistent with a model where firms compete for market share on the basis of price. The second observation can be explained within the context of a Stackelberg model where the relatively unlevered rival acts as the Stackelberg price leader.]

[We determine the minimum cost of superreplicating a nonnegative contingent claim when there are convex constraints on portfolio weights. We show that the optimal cost with constraints is equal to the price of a related claim without constraints. The related claim is a dominating claim, that is, a claim whose payoffs are increased in an appropriate way relative to the original claim. The results hold for a variety of options, including some path-dependent options. Constraints on the gamma of the replicating portfolio, constraints on portfolio amounts, and constraints on the number of shares are also considered.]

[While American calls on non-dividend-paying stocks may be valued as European, there is no completely explicit exact solution for the values of American puts. We use a technique called randomization to value American puts and calls on dividend-paying stocks. This technique yields a new semiexplicit approximation for American option values in the Black-Scholes model. Numerical results indicate that the approximation is both accurate and computationally efficient.]

[Brokerage contracts for many categories of real assets are characterized by a common, constant commission rate payable upon sale, exclusive agency, and contractual asking prices. For a large market in steady state, these conventional contracts produce in equilibrium no agency problem between a broker and his clients. Each broker spends the same time or effort selling each client's asset as the broker would spend on his own assets. As in standard agency problems, extra effort by a broker generates first-order stochastically dominant distributions of bids by potential buyers. Unlike standard agency problems, each broker can allocate his time or effort between selling the assets of his multiple clients and searching for new clients in competition with other brokers. Because brokers' time spent searching for new sellers is dissipative, entry by brokers is excessive in equilibrium.]

[In this article we study the effects of transaction costs on asset prices. We assume an overlapping generations economy with a riskless, liquid bond, and many risky stocks carrying proportional transaction costs. We obtain stock prices and turnover in closed form. Surprisingly, a stock's price may increase in transaction costs, and a more frequently traded stock may be less adversely affected by an increase in transaction costs. Calculations based on the "marginal" investor overestimate the effects of transaction costs. For realistic parameter values, transaction costs have very small effects on stock prices but large effects on turnover.]