[I characterize the optimal design of a new futures market (an innovation) by an exchange in the presence of market frictions. Futures markets are characterized by both the contract and the level of trader participation; both can be determined by an exchange. A game in which exchanges simultaneously design markets is considered, and a particular equilibrium (not necessarily unique) is constructed. A game in which exchanges sequentially design markets (and incur design costs) is also considered and the (generically unique) equilibrium is constructed. The nature of equilibrium with multiple exchanges is discussed in these simultaneous and sequential settings, illustrating the role played by liquidity considerations both in market design and in the nature of competition between exchanges.]
[I examine the anomalous behavior of the taxable and tax-exempt yield curves. Long municipal yields appear too high relative to the equivalent after-tax yield that can be earned in Treasury or corporate bonds. I discuss existing explanations of the problem and propose a simple model that relates the yields of taxable bonds to the yield curve for par tax exempts. The ratio of the tax-exempt yield to the taxable yield increases with maturity in the model, so it is consistent with observed phenomena such as inverted yield curves for taxables and contemporaneous rising yield curves for tax exempts. Statistical and descriptive comparisons between the yields predicted by the model and observed yields on par bonds show that the model has some promise in explaining the apparent anomalies in the behaviors of the two yield curves.]
[We compare a sealed-bid uniform-price auction (the Treasury's experimental format) with a sealed-bid discriminatory auction (the Treasury's format heretofore), assuming the good is perfectly divisible. We show that the auction theory that prompted the experiment, which assumes single-unit demands, does not adequately describe the bidding game for Treasury securities. Collusive strategies are self-enforcing in uniform-price divisible-good auctions. In these equilibria, the seller's expected revenue is lower than in equilibria of discriminatory auctions.]
[I use a new technique to derive a closed-form solution for the price of a European call option on an asset with stochastic volatility. The model allows arbitrary correlation between volatility and spot-asset returns. I introduce stochastic interest rates and show how to apply the model to bond options and foreign currency options. Simulations show that correlation between volatility and the spot asset's price is important for explaining return skewness and strike-price biases in the Black-Scholes (1973) model. The solution technique is based on characteristic functions and can be applied to other problems.]
[For a sample of NYSE firms, we show that wide spreads are accompanied by low depths, and that spreads widen and depths fall in response to higher volume. Spreads widen and depths fall in anticipation of earnings announcements; these effects are more pronounced for announcements with larger subsequent price changes. Spreads are also wider following earnings announcements, but this effect dissipates quickly after controlling for volume. Collectively, our results suggest liquidity providers are sensitive to changes in information asymmetry risk and use both spreads and depths to actively manage this risk.]
[We study firms signaling with cash disbursements and show that the choice of a deterministic or a stochastic disbursement depends on a property of the firm's production function that is analogous to absolute risk aversion for a utility function. With decreasing (increasing) absolute risk aversion, the high-quality firm prefers to distinguish itself from the low-quality firm with a stochastic (deterministic) outlay. We then study in detail two common forms of corporate cash distributions: dividends, a deterministic disbursement, and share repurchases, a stochastic disbursement.]
[The optimal contract between managers and investors is endogenously derived when managers have preferences for both monetary compensation and corporate resources under their control. When the optimal payout is privately known to managers, they can be induced to make payouts by linking their compensation to the payout. Public equity is a claim on this discretionary payout. If investors can obtain new information about the firm's optimal payout level, it can be utilized by transferring the control from management to investors. The new information allows the firm to achieve a more efficient allocation through recontracting. We show that the new information will be obtained if and only if the payout falls below a promised level.]
[We document a pattern in the serial dependence of security returns around nontrading days. The correlation of returns the second day after a weekend or holiday with returns the first day after is unusually low, and in many return series is negative, implying a reversal of price movements. We also document unusually large positive return autocorrelations the last day before and the first day after weekends and holidays. The pattern has existed in equity returns for over 100 years, and also exists in several futures markets, implying that the pattern is robust to alternative market microstructures.]
[Implied volatility is widely believed to be informationally superior to historical volatility, because it is the "market's" forecast of future volatility. But for S&P 100 index options, the most actively traded contract in the United States, we find implied volatility to be a poor forecast of subsequent realized volatility. In aggregate and across subsamples separated by maturity and strike price, implied volatility has virtually no correlation with future volatility, and it does not incorporate the information contained in recent observed volatility.]
[We study a dynamic model where uncertainty about interim output adjustments causes producers to face price, cost and output uncertainty. Stochastically separable production decisions are independent of the producer's risk preferences and expectations and are based on the prevailing futures price as a certain output price. Conditions under which futures contracts achieve stochastic separation are established. Optimal hedging and maturity structure of futures contracts, equilibrium futures prices, and the effects of futures trading on output are studied. The systematic risk premium depends on the product of the futures beta and the covariance of the market return with production revenues.]