I show that the effect of option introductions on underlying stock prices is best described by a two‐regime switching means model whose optimal switch date occurs in 1981. In accordance with previous studies, I find positive abnormal returns for options listed during 1973 to 1980. By contrast, I find negative abnormal returns for options listed in 1981 and later. Possible causes for this switch include the introduction of index options in 1982, the implementation of regulatory changes in 1981, and the possibility that options expedite the dissemination of negative information.

Early studies find that option introductions tend to raise the price of underlying stocks. More recent research indicates that post-1980 option introductions are associated with negative abnormal returns in underlying stocks. Other studies document increased short sale activities following option listing. This paper provides evidence that the documented abnormal returns and changes in short interest around option listings are consistent with the mitigation of short sale constraints resulting from the option introduction, and that both the abnormal returns and short interest changes around listing dates can be predicted using ex ante characteristics of the underlying stock.

ABSTRACT We examine the long‐term stock performance following dividend initiations and resumptions from 1927 to 1998. We show that postannouncement abnormal returns are significantly positive for equally weighted calendar time portfolios, but become insignificant when the portfolios are value weighted. Moreover, the equally weighted results are not robust across subsamples. We also document postannouncement reductions in the risk factor loadings of underlying stocks. Cross‐sectionally, these reductions are negatively related to the contemporaneous price drifts, suggesting the price drifts may be a sample‐specific result of chance. Our results underscore the importance of testing for changes in risk loadings in future long‐term event studies.

Abstract Miller (1977) hypothesizes that dispersion of investor opinion in the presence of short-sale constraints leads to stock price overvaluation. However, previous empirical tests of Miller's hypothesis examine the valuation effects of only one of these two necessary conditions. We examine the valuation effects of the interaction between differences of opinion and shortsale constraints. We find robust evidence of significant overvaluation for stocks that are subject to both conditions simultaneously. Stocks are not systematically overvalued when either one of these two conditions is not met.

ABSTRACT We examine debenture yields over the period 1983–1991 to evaluate the market's sensitivity to bank‐specific risks, and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

Previous studies of bank subordinated debenture yields have detected scant evidence that market investors rationally price bank-specific default risks. However, investors' incentives to monitor their banks' true default risks have increased over the past decade, as federal regulators have removed the conjectural guarantees on subordinated debentures that were so prominent in the period following Continental Illinois' failure. By examining debenture yields over the period 1983-91, we demonstrate that subordinated debenture prices reflect accounting risk measures, and that the market's sensitivity to bank-specific risks has rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

We theoretically and empirically investigate the role of information on the cross section of stock returns and firms' cost of capital when investors face estimation risk and learn from noisy signals of uncertain quality. The resultant equilibrium is an information-dependent conditional CAPM. We find strong empirical support for the model. Innovations in market volatility, oil prices, exchange rates, and dispersion of analysts' forecasts not only help explain the cross section of stock returns, but their influence depends on the stock's systematic estimation risk. Moreover, dividend and share repurchase initiations have significant downward announcement effects on estimated betas and their standard errors.

We reexamine long-term abnormal returns for portfolios sorted on governance characteristics. Firms with strong shareholder rights and firms with weak shareholder rights differ from the population of firms and from each other in how they cluster across industries. Using well-specified tests under this industry clustering, we find statistically zero long-term abnormal returns for portfolios sorted on governance. Our results have important implications for interpreting studies that link governance to firm value and stock returns, demonstrate the importance of the coarseness of industry definitions in financial research, and shed light on addressing statistical problems created by industry clustering in samples.

Abstract Efficiency in the capital markets requires that capital flows are sufficient to arbitrage anomalies away. We examine the relation between flows to a quantitative (quant) strategy that is based on capital market anomalies and the subsequent performance of this strategy. When these flows are high, quant funds are able to implement arbitrage strategies more effectively, which in turn leads to lower profitability of market anomalies in the future, and vice versa. Thus, the degree of cross-sectional equity market efficiency varies across time with the availability of arbitrage capital.

We investigate the dual notions that “dumb money” exacerbates well-known stock return anomalies and “smart money” attenuates these anomalies. We find that aggregate flows to mutual funds (dumb money) appear to exacerbate cross-sectional mispricing, particularly for growth, accrual, and momentum anomalies. In contrast, hedge fund flows (smart money) appear to attenuate aggregate mispricing. Our results suggest that aggregate flows to mutual funds can have real adverse allocation effects in the stock market and that aggregate flows to hedge funds contribute to the correction of cross-sectional mispricing.