When shares are traded infrequently, beta estimates are often severely biased. This paper reviews the problems introduced by infrequent trading, and presents a method for measuring beta when share price data suffer from this problem. The method is used with monthly returns for a one-in-three random sample of all U.K. Stock Exchange shares from 1955 to 1974. Most of the bias in conventional beta estimates is eliminated when the proposed estimators are used in their place.

Abstract We examine a set of equity index-linked bonds that provide the same payoff as an investment in an equity index, but are relatively illiquid. We demonstrate that these securities sell at a discount relative to their underlying value and hence have higher expected returns. We show that this apparent mispricing can be attributed to the illiquidity of the bonds. Trading costs for equity-linked bonds, as measured by bid-ask spreads, are free of any asymmetric information or inventory holding cost component; hence the only illiquidity component left is clearing costs. This study shows that, even in the absence of asymmetric information and inventory holding costs, illiquidity depresses asset prices and therefore increases expected security returns. Using an ex ante measure of the expected return premium due to illiquidity, we link the time-series variation in the illiquidity premium to security-specific attributes related to their marketability. We show that liquidity risk has a systematic component, and relate this market-wide factor to a number of macroeconomic variables that have previously been shown to be related to illiquidity.

This study of 862 press recommendations demonstrates that the size effect can distort longer-term performance measures, and hence event studies. Relative to similar sized companies, post-publication performance is neutral. However, market adjustments, the CAPM and Market Model, with equally or capitalization weighted indexes, all produce biased results. Event studies are most exposed to such bias when the measurement interval is long, event securities differ systematically in size or weighting from the index constituents, the size effect is large and/or volatile, and when CAPM-type methodologies are used. These distortions are avoided by explicitly controlling for size.

This paper examines the performance of the leading methods for setting capital requirements for securities firms' trading books. Tests are conducted on a large sample of UK equity market makers' books over a substantial number of periods of equity market stress from 1985 to 1995. The comprehensive and building-block approaches, favoured by US and European regulators, fail to provide effective cover. Only portfolio-based, value-at-risk (VaR) type models are efficient in providing appropriate levels of capital to cover the position risk of equity trading books.

Theory on the pricing of financial assets can be traced back to Bernoulli's famous St Petersburg paper of 1738. Since then, research into asset pricing and derivative valuation has been influenced by a couple of dozen major contributions published during the twentieth century. These seminal works have underpinned the key ideas of mean–variance optimisation, equilibrium analysis and no-arbitrage arguments. This paper presents a historical review of these important contributions to finance.

ABSTRACT Regulatory authorities set capital requirements to cover the position risk of securities firms and to protect against losses arising from fluctuations in the value of their holdings. The requirements may be set using the comprehensive approach required by the U.S. Securities and Exchange Commission, the building‐block approach required by the European Community, or the portfolio approach required by the United Kingdom. We compare these three alternatives using a large sample of U.K. equity trading books. The portfolio approach systematically specifies larger requirements for riskier books, and vice versa. It is more efficient than the building‐block approach, and far more efficient than the comprehensive approach.

ABSTRACT This paper describes an empirical study of over 4000 specific share return forecasts made by 35 UK stockbrokers and by the internal analysts of a large UK investment institution. A comparison of forecast and realised returns reveals a small but potentially useful degree of forecasting ability. A large part of the information content of the forecasts, however, appears to be discounted in the market place within the first month. Nevertheless, an analysis of some 3000 transactions motivated by, and executed at the time of, the forecasts shows that the apparent predictive ability of the recommendations could be translated into superior performance by the fund's investment managers. Differences in forecasting ability between brokers do not appear to persist over time, but predictive accuracy can be improved by pooling simultaneous forecasts from different sources.