Knowledge that Transforms

This article examines how financial constraints and product market exposures determine the response of multinational and local firms to sharp depreciations. U.S. multinational affiliates increase sales, assets, and investment significantly more than local firms during, and subsequent to, depreciations. Differing product market exposures do not explain these differences in performance. Instead, a differential ability to circumvent financial constraints is a significant determinant of the observed differences in investment responses. Multinational affiliates also access parent equity when local firms are most constrained. These results indicate another role for foreign direct investment in emerging markets--multinational affiliates expand economic activity during currency crises when local firms are most constrained. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected]., Oxford University Press.

While recent studies document increasing idiosyncratic volatility over the past four decades, an explanation for this trend remains elusive. We establish a theoretical link between growth options available to managers and the idiosyncratic risk of equity. Empirically both the level and variance of corporate growth options are significantly related to idiosyncratic volatility. Accounting for growth options eliminates or reverses the trend in aggregate firm-specific risk. These results are robust for different measures of idiosyncratic volatility, different growth option proxies, across exchanges, and through time. Finally, our results suggest that growth options explain the trend in idiosyncratic volatility beyond alternative explanations.

This paper uses volume arising from small trades to analyze the relationship between retail investor trading behavior and the cross-section of future stock returns. The central finding is that stocks with intense sell-initiated small-trade volume, measured over the past several months, outperform stocks with intense buy-initiated small-trade volume. This return difference accrues from the first month after the portfolio formation up to two years later. Among small- and medium-sized firms, the return difference continues in the third year. The results suggest that stocks favored by retail investors subsequently experience prolonged underperformance relative to stocks out of favor with retail investors. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

This paper examines whether investor sentiment about the stock market affects prices of the S&P 500 options. The findings reveal that the index option volatility smile is steeper (flatter) and the risk-neutral skewness of monthly index return is more (less) negative when market sentiment becomes more bearish (bullish). These significant relations are robust and become stronger when there are more impediments to arbitrage in index options. They cannot be explained by rational perfect-market-based option pricing models. Changes in investor sentiment help explain time variation in the slope of index option smile and risk-neutral skewness beyond factors suggested by the current models. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: [email protected], Oxford University Press.

Recent winners have temporarily higher loadings than recent losers on the growth rate of industrial production. The loading spread derives mostly from the positive loadings of winners. The growth rate of industrial production is a priced risk factor in standard asset pricing tests. In many specifications, this macroeconomic risk factor explains more than half of momentum profits. We conclude that risk plays an important role in driving momentum profits. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected]., Oxford University Press.

This paper examines bank behavior in venture capital. It considers the relation between a bank's venture capital investments and its subsequent lending, which can be thought of as intertemporal cross-selling. Theory suggests that unlike independent venture capital firms, banks may be strategic investors who seek complementarities between venture capital and lending activities. We find evidence that banks use venture capital investments to build lending relationships. Having a prior relationship with a company in the venture capital market increases a bank's chance of subsequently granting a loan to that company. Companies can benefit from these relationships through more favorable loan pricing. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: [email protected]., Oxford University Press.

Aggregate stock prices, relative to virtually any indicator of fundamental value, soared to unprecedented levels in the 1990s. Even today, after the market declines since 2000, they remain well above historical norms. Why? We consider one particular explanation: a fall in macroeconomicrisk, or the volatility of the aggregate economy. Empirically, we find a strong correlation between low-frequency movements in macroeconomic volatility and low-frequency movements in the stock market. To model this phenomenon, we estimate a two-state regime switching model for the volatility and mean of consumption growth, and find evidence of a shift to substantially lower consumption volatility at the beginning of the 1990s. We then use these estimates from postwar data to calibrate a rational asset pricing model with regime switches in both the mean and standard deviation of consumption growth. Plausible parameterizations of the model are found to account for a significant portion of the run-up in asset valuation ratios observed in the late 1990s.

This article interprets the well-known value effect through the implications of standard Q-theory. An investment growth factor, defined as the difference in returns between low-investment stocks and high-investment stocks, contains information similar to the Fama and French (1993) value factor (HML), and can explain the value effect about as well as HML. In the cross-section, portfolios of firms with low investment growth rates (IGRs) or low investment-to-capital ratios have significantly higher average returns than those with high IGRs or high investment-to-capital ratios. The value effect largely disappears after controlling for investment, and the investment effect is robust against controls for the marginal product of capital. These results are consistent with the predictions of a standard Q-theory model with a stochastic discount factor. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected], Oxford University Press.

This paper investigates the international asset allocation effects of time-variations in higher-order moments of stock returns such as skewness and kurtosis. In the context of a four-moment International Capital Asset Pricing Model (ICAPM) specification that relates stock returns in five regions to returns on a global market portfolio and allows for time-varying prices of covariance, co-skewness, and co-kurtosis risk, we find evidence of distinct bull and bear regimes. Ignoring such regimes, an unhedged US investor's optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a substantial increase in the investor's optimal holdings of US stocks, as does the introduction of skewness and kurtosis preferences.

We test whether capital account liberalization led to higher economic growth using de jure measures of capital account and financial current account openness for 94 nations, from 1950 (or independence) onward. We argue that measurement error, differing time periods used, and collinearity among independent variables account for conflicting results in prior scholarship. We use pooled time-series, cross-sectional OLS and system GMM estimators to examine economic growth rates, 1955–2004. Capital account liberalization had a positive association with growth in both developed and emerging market nations. We confirm that equity market liberalization has an independent effect on economic growth.