Higher initial margin requirements are associated with lower subsequent stock market volatility during normal and bull periods, but show no relationship during bear periods. Higher margins are also negatively related to the conditional mean of stock returns, apparently because they reduce systemic risk. We conclude that a prudential rule for setting margins (or other regulatory restrictions) is to lower them in sharply declining markets in order to enhance liquidity and avoid a depyramiding effect in stock prices, but subsequently raise them and keep them at the higher level in order to prevent a future pyramiding effect

One of the puzzles regarding initial public offerings (IPOs) is that issuers rarely get upset about leaving substantial amounts of money on the table, defined as the number of shares sold times the difference between the first-day closing market price and the offer price. The average IPO leaves $9.1 million on the table. This number is approximately twice as large as the fees paid to investment bankers and represents a substantial indirect cost to the issuing firm. We present a prospect theory model that focuses on the covariance of the money left on the table and wealth changes. Our reasoning also provides an explanation for a second puzzling pattern: much more money is left on the table following recent market rises than after market falls. This results in an explanation of hot issue markets. We also offer a new explanation for why IPOs are underpriced.

We analyze 1,607 investors who switched from phone-based to online trading during the 1990s. Those who switch to online trading perform well prior to going online, beating the market by more than 2% annually. After going online, they trade more actively, more speculatively, and less profitably than before—lagging the market by more than 3% annually. Reductions in market frictions (lower trading costs, improved execution speed, and greater ease of access) do not explain these findings. Overconfidence—augmented by self-attribution bias and the illusions of knowledge and control—can explain the increase in trading and reduction in performance of online investors.

This article provides several new insights into the economic sources of skewness. First, we document the differential pricing of individual equity options versus the market index and relate it to variations in return skewness. Second, we show how risk aversion introduces skewness in the risk-neutral density. Third, we derive laws that decompose individual return skewness into a systematic component and an idiosyncratic component. Empirical analysis of OEX options and 30 stocks demonstrates that individual risk-neutral distributions differ from that of the market index by being far less negatively skewed. This article explains the presence and evolution of risk-neutral skewness over time and in the cross section of individual stocks.

This article studies momentum in stock returns, focusing on the role of industry, size, and book-to-market (B/M) factors. Size and B/M portfolios exhibit momentum as strong as that in individual stocks and industries. The size and B/M portfolios are well diversified, so momentum cannot be attributed to firm- or industry-specific returns. Further, industry, size, and B/M portfolios are negatively autocorrelated and cross-serially correlated over intermediate horizons. The evidence suggests that stocks covary “too strongly” with each other. I argue that excess covariance, not underreaction, explains momentum in the portfolios.

This article provides a comprehensive study of survivorship issues using the mutual fund data of Carhart (1997). We demonstrate theoretically that when survival depends on multiperiod performance, the survivorship bias in average performance typically increases with the sample length. This is empirically relevant because evidence suggests a multiyear survival rule for U.S. mutual funds. In the data we find the annual bias increases from 0.07% for 1-year samples to 1% for samples longer than 15 years. We find that survivor conditioning weakens evidence of performance persistence. Finally, we explain how survivor conditioning affects the relation between performance and fund characteristics.

We show an isomorphism between optimal portfolio selection or competitive equilibrium models with utilities incorporating linear habit formation, and corresponding models without habit formation. The isomorphism can be used to mechanically transform known solutions not involving habit formation to corresponding solutions with habit formation. For example, the Constantinides (1990) and Ingersoll (1992) solutions are mechanically obtained from the familiar Merton solutions for the additive utility case, without recourse to a Bellman equation or first-order conditions. More generally, recent solutions to portfolio selection problems with recursive utility and a stochastic investment opportunity set are readily transformed to novel solutions of corresponding problems with utility that combines recursivity with habit formation. The methodology also applies in the context of Hindy–Huang–Kreps (1992) preferences, where our isomorphism shows that the solution obtained by Hindy and Huang (1993) can be mechanically transformed to Dybvig’s (1995) solution to the optimal consumption-investment problem with consumption ratcheting.

Journal Article Testing Trade-Off and Pecking Order Predictions About Dividends and Debt Get access Eugene F. Fama, Eugene F. Fama University of Chicago Address correspondence to Eugene F. Fama, Graduate School of Business, University of Chicago, 1101 East 58th St., Chicago, IL 60637, or e-mail: [email protected]. Search for other works by this author on: Oxford Academic Google Scholar Kenneth R. French Kenneth R. French Dartmouth College Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 15, Issue 1, January 2002, Pages 1–33, https://doi.org/10.1093/rfs/15.1.1 Published: 16 June 2015

We examine the optimal trading strategy for a CRRA investor who maximizes the expected utility of wealth on a finite date and faces transaction costs. Closed-form solutions are obtained when this date is uncertain. We then show a sequence of analytical solutions converge to the solution to the problem with a deterministic finite horizon. Consistent with the common life-cycle investment advice, the optimal trading strategy is found to be horizon dependent and largely buy and hold. Moreover, it might be optimal for the investor in our model not to buy any stock, even when the risk premium is positive. Further analysis of the optimal policy is also provided.

Correlations between international equity market returns tend to increase in highly volatile bear markets, which has led some to doubt the benefits of international diversification. This article solves the dynamic portfolio choice problem of a U.S. investor faced with a time-varying investment opportunity set modeled using a regime-switching process which may be characterized by correlations and volatilities that increase in bad times. International diversification is still valuable with regime changes and currency hedging imparts further benefit. The costs of ignoring the regimes are small for all-equity portfolios but increase when a conditionally risk-free asset can be held.