Knowledge that Transforms

This paper develops a valuation formula for multi-period stochastic cash flows consistent with rational risk-averse investor behavior and equilibrium in securities markets. It shows that the CAPM does not have to be sequentially applied in discounting of the cash flows of multi-period projects, and a single beta can be used to measure the riskiness of an uncertain income stream. Hence, a multi-period project is priced as if it offers a single payment. The formula uses a set of assumptions that is slightly more restrictive than the minimum set Constantinides (1980) uses to produce the multi-period version of the CAPM. This paper also demonstrates that, under certain assumptions, covariances of stochastic cash flows with changes in the term structure may be sufficient measures of the cash flows' riskiness.

This paper assesses the ability of financial statement variables to forecast sensitivities to systematic risk factors generated by a multifactor, macroeconomic forces model. Forecasts of beta derived from financial variables are shown to outperform naive, random walk forecasts, although Bayesian-adjusted betas perform as well as the financial variables model.

On average, nonconvertible preferred stocks have significantly positive abnormal returns and trading volume on the ex-day. For the less liquid stocks, however, the abnormal returns are significantly positive, and abnormal trading volume is insignificantly different from zero. This evidence suggests that long-term individual investors set the ex-day prices of less liquid stocks. For the more liquid stocks, the ex-day abnormal returns are closer to zero, and there is significantly positive abnormal trading volume on the ex-day and the day before the ex-day. These results suggest that short-term investors set the ex-day prices of more liquid stocks through dividend capture strategies. Despite this evidence, some inconsistent empirical findings make the overall evidence on dividend capture somewhat mixed.

This paper presents a model in which managers of firms that are takeover targets use debt-financed share repurchase to bond themselves to reduce perquisite consumption and increase investment in the firm. The resulting value increase makes the firm a less attractive target. The optimal level of share repurchase is the result of a trade-off between the benefit of a reduced probability of takeover and the cost of an increased probability of bankruptcy. Unlike earlier explanations of defensive repurchases, which are based on information signalling or control of voting rights, this explanation is independent of the extent of shareholding by target management.

Jimmy E. Hilliard, Jeff Madura, Alan L. Tucker, Currency Option Pricing with Stochastic Domestic and Foreign Interest Rates, The Journal of Financial and Quantitative Analysis, Vol. 26, No. 2 (Jun., 1991), pp. 139-151

This study examines initial public offering contract choice decisions. In best-efforts offerings, minimum sales constraints allow issuers to precommit to withdraw the offering if a fixed minimum number of shares is not sold. In firm-commitment offerings, the over-allotment option allows the underwriter to increase sales when demand is strong. Two theories of contract choice–Benveniste and Spindt (1989) and Ritter's (1987) extension of Rock (1986)–offer predictions about the role of these contract features. We find that the 1977–1982 evidence is consistent with Benveniste and Spindt (1989). The evidence is less supportive of the Ritter (1987) hypothesis that minimum sales constraints serve to reduce the winner's curse of the riskier issuers.

A multiperiod model of optimal capital structure is developed under the assumption that earnings follow an autoregressive process. Firm value and leverage vary through time and, at each date, the firm achieves an optimal debt level that is a function of the full state contingent debt policy. The reversion parameter of the earnings series is shown to be positively related to various measures of variability and negatively related to leverage. If earnings processes are not homogeneous across firms, then standard earnings risk measures in capital structure studies do not adequately represent crosssectional differences in variability in firm value.

Previous studies in the valuation of American options apparently undervalue the right of early exercise. This study uses actual prices from the CBOE's S&P 100 option instead of model-generated values. Deviations from the theoretical put-call parity relationship are caused by the possibility of early exercise. These deviations are used to infer the value of early exercise. The actual value of early exercise is both statistically and economically significant. As expected from theoretical considerations, the value of early exercise for put options is greater than for call options.

This paper examines the pricing of S&P 100 calls using 14 months of transactions data. We find that market prices of S&P 100 calls differ systematically from Black-Scholes values. The biases in Black-Scholes model prices are both statistically and economically significant and correspond to biases that arise if market prices incorporate a stochastically changing volatility of the index.

This paper examines cash management bill announcements in an event study framework and finds that segmentation in the Treasury bill market is widespread and not limited to bills maturing across month-ends. Announcements of cash management bills, which represent unexpected additional supplies of outstanding Treasury bills, cause the yields on these bills to rise significantly relative to yields on adjacent maturity bills. This paper also finds, consistent with other studies, that segmentation is greater at the short end of the bill market.