F. Douglas Foster, S. Viswanathan, Variations in Trading Volume, Return Volatility, and Trading Costs: Evidence on Recent Price Formation Models, The Journal of Finance, Vol. 48, No. 1 (Mar., 1993), pp. 187-211

We analyze event abnormal returns when returns predict events. In fixed samples, we show that the expected abnormal return is negative and becomes more negative as the holding period increases. Asymptotically, abnormal returns converge to zero provided that the process of the number of events is stationary. Nonstationarity in the process of the number of events is needed to generate a large negative bias. We present theory and simulations for the specific case of a lognormal model to characterize the magnitude of the small-sample bias. We illustrate the theory by analyzing long-term returns after initial public offerings (IPOs) and seasoned equity offerings (SEOs). The Author 2008. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: [email protected]., Oxford University Press.

F. Douglas Foster, S. Viswanathan, Strategic Trading with Asymmetrically Informed Traders and Long-Lived Information, The Journal of Financial and Quantitative Analysis, Vol. 29, No. 4 (Dec., 1994), pp. 499-518

We propose a dynamic theory of financial intermediaries that are better able to collateralize claims than households, that is, have a collateralization advantage. Intermediaries require capital as they have to finance the additional amount that they can lend out of their own net worth. The net worth of financial intermediaries and the corporate sector are both state variables affecting the spread between intermediated and direct finance and the dynamics of real economic activity, such as investment, and financing. The accumulation of net worth of intermediaries is slow relative to that of the corporate sector. The model is consistent with key stylized facts about macroeconomic downturns associated with a credit crunch, namely, their severity, their protractedness, and the fact that the severity of the credit crunch itself affects the severity and persistence of downturns. The model captures the tentative and halting nature of recoveries from crises.

We develop a dynamic model of investment, capital structure, leasing, and risk management based on firms' need to collateralize promises to pay with tangible assets. Both financing and risk management involve promises to pay subject to collateral constraints. Leasing is strongly collateralized costly financing and permits greater leverage. More constrained firms hedge less and lease more, both cross-sectionally and dynamically. Mature firms suffering adverse cash flow shocks may cut risk management and sell and lease back assets. Persistence of productivity reduces the benefits to hedging low cash flows and can lead firms not to hedge at all.

In a one-period model of market making with many exogenously informed traders, we first show that the variance of prices and expected trading volume depend on the public information released at the start of trading. This is accomplished by representing beliefs with elliptically contoured distributions, for which the form of optimal decision rules does not depend on the specific distribution used. Second, if the model is altered so that the decision to become informed is made endogenous, then the decision rules of the market-maker and informed traders depend on the public information. Third, in a multiperiod model with many informed traders and long-lived private information, recursion formulas similar to those of Kyle (1985) hold for all elliptically contoured distributions, trading volume is autocorrelated and, unless per period liquidity trading is bounded away from zero as new trading periods are added, informed traders’ profits vanish.

In an adverse selection model of a securities market with one informed trader and several liquidity traders, we study the implications of the assumption that the informed trader has more information on Monday than on other days. We examine the interday variations in volume, variance, and adverse selection costs, and find that on monday the trading costs and the variance of price changes are highest, and the volume is lower than on Tuesday. These effects are stronger for firms with better public reporting and for firms with more discretionary liquidity trading.

ABSTRACT Lookback options are path dependent contingent claims whose payoffs depend on the extrema of a given security's price over a certain period of time. Using probabilistic tools, we derive explicit formulas for various European lookback options, and provide some results about their American counterparts.

Lookback options are path dependent contingent claims whose payoffs depend on the extrema of a given security's price over a certain period of time. Using probabilistic tools, we derive explicit formulas for various European lookback options, and provide some results about their American counterparts.

Both financing and risk management involve promises to pay that need to be collateralized, resulting in a financing versus risk management trade-off. We study this trade-off in a dynamic model of commodity price risk management and show that risk management is limited and that more financially constrained firms hedge less or not at all. We show that these predictions are consistent with the evidence using panel data for fuel price risk management by airlines. More constrained airlines hedge less both in the cross section and within airlines over time. Risk management drops substantially as airlines approach distress and recovers only slowly after airlines enter distress.