ABSTRACT To test the major prediction of a signalling hypothesis‐that the market price is monotonic in the signal‐the price response to the signal must be measured. Since a signal is an outcome of a rational decision rule of the signaller, the market can infer the true type of the signaller from the signal. This necessitates estimation of the price response to the signal, conditional on the rational decision rule. Thus, the empirical models (e.g., event studies in corporate finance) that estimate the market price responses to signals without conditioning on the rational decision rules are misspecified if viewed as tests of the prediction of a signalling hypothesis. This paper builds a generalized econometric model with two possible discrete signals, derives the rational decision rules, presents a simple estimator of the price response to a signal, and illustrates its use in testing a recently expounded hypothesis that firms signal their true value by forcing or not forcing an outstanding convertible bond.

This paper presents an econometric model to value latent information underlying corporate events. This model computes the market's inference of the value of latent information from the probability of an event, conditional on firm-specific, preevent information. It provides a convenient framework for testing significance of preevent information variables, such as accounting attributes and lagged stock return. Simulations show that this model, when applied to both event and preevent period data, can decrease the incidence of bias in event studies. If restricted to only event period data, this model reduces to a truncated regression and does not perform as well as standard procedures.

ABSTRACT This paper presents an econometric model to value latent information underlying corporate events. This model computes the market's inference of the value of latent information from the probability of an event, conditional on firm‐specific, preevent information. It provides a convenient framework for testing significance of preevent information variables, such as accounting attributes and lagged stock return. Simulations show that this model, when applied to both event and preevent period data, can decrease the incidence of bias in event studies. If restricted to only event period data, this model reduces to a truncated regression and does not perform as well as standard procedures.

To test the major prediction of a signalling hypothesis-that the market price is m onotonic in the signal-the price response to the signal must be measu red. Since a signal is an outcome of a rational decision rule of the signaller, the market can infer the true type of the signaller from t he signal. This necessitates estimation of the price response to the signal, conditional on the rational decision rule. Thus, the empirica l models (e.g., event studies in corporate finance) that estimate the market price responses to signals without conditioning on the ration al decision rules are misspecified if viewed as tests of the predicti on of a signalling hypothesis. This paper builds a generalized econom etric model with two possible discrete signals, derives the rational decision rules, presents a simple estimator of the price response to a signal, and illustrates its use in testing a recently expounded hyp othesis that firms signal their true value by forcing or not forcing an outstanding convertible bond. Copyright 1988 by American Finance Association.

ABSTRACT Optimal dynamic regulatory policies for closing ailing banks and for deposit insurance premia are derived as functions of the rate of flow of bank deposits, and interest rate on deposits, the economy's risk‐free interest rate, and the regulators' bank audit/administration costs. Under competitive conditions, the threshold assets‐to‐deposits ratio below which a bank should be optimally closed is shown to be greater than or equal to one. Optimal deposit insurance premia and probabilities of bank closure are shown to be nondecreasing in the bank's risk on investment and nonincreasing in the bank's current assets‐to‐deposits ratio.