Knowledge that Transforms

Building on Vijh (Rev. Financial Stud. 7 (1994)), we use additions to the S&P 500 to distinguish two views of return comovement: the traditional view, which attributes it to comovement in news about fundamental value, and an alternative view, in which frictions or sentiment delink it from fundamentals. After inclusion, a stock's beta with the S&P goes up. In bivariate regressions which control for the return of non-S&P stocks, the increase in S&P beta is even larger. These results are generally stronger in more recent data. Our findings cannot easily be explained by the fundamentals-based view and provide new evidence in support of the alternative friction- or sentiment-based view.

We catalog the complete contents of Institutional Investor All-American analyst reports and examine the market reaction to their release. Including the justifications supporting an analyst's opinion reduces, and in some models eliminates, the significance of earnings forecasts and recommendation revisions. Analysts both provide new information and interpret previously released information. The information in a report is most important for downgrades; target prices and the analyst's justifications are the only significant elements for reiterations. No correlation exists between valuation methodology and either analyst accuracy or the market's reaction to a report. Our adjusted R2s are much larger than those of studies using only summary measures.

This paper resolves the disagreement between Longstaff et al. [2001. Journal of Finance Economics 62, 39–66] and Andersen and Andreasen [2001. Journal of Financial Economics 62, 3–37] over the effectiveness of the common business practice of using best-fit single-factor term structure models to deduce exercise strategies of Bermudan swaptions. I examine the cost of using recalibrated single-factor models to determine the exercise strategy for Bermudan swaptions in a multifactor world. I show that single-factor exercise strategies applied in a multifactor world only give rise to economically insignificant losses. Furthermore, I find that the conditional model risk as defined in Longstaff et al. [2001. Journal of Finance Economics 62, 39–66] is statistically insignificant given the number of observations. Additional tests using the Primal–Dual algorithm of Andersen and Broadie [2004. Management Science 50(9)] indicate that losses found in Longstaff et al. [2001. Journal of Finance Economics 62, 39–66] cannot, as claimed, be ascribed to the number of factors.

We study dealer behavior in the foreign exchange spot market using detailed observations on all the transactions of four interbank dealers. There is strong support for an information effect in incoming trades. The direction of trade is most important, but we also find that the information effect increases with trade size in direct bilateral trades. All four dealers control their inventory intensively. Inventory control is not, however, manifested through a dealer's own prices in contrast to findings by Lyons (J. Financial Econ. 39(1995) 321). Furthermore, we document differences in trading styles, especially how they actually control their inventories.

This paper studies The Netherlands' private sector self-regulation initiative (“The Peters Committee”) to improve corporate governance practices. We examine the relation between firm value and corporate governance characteristics before and after the private sector initiative. We find the initiative had no effect on corporate governance characteristics or their relationship with firm value. Event study results suggest the market was skeptical about the success of self-regulation of corporate governance practices in The Netherlands. Our results on The Netherlands self-regulation initiative suggest little should be expected from initiatives that rely on monitoring without enforcement (e.g., similar or weaker initiatives in other European Union (EU) countries).

We reexamine the post-listing puzzle by studying the stock performance of 2103 firms that moved from NASDAQ to NYSE or AMEX, or from AMEX to NYSE during 1973–1999. The matched four-factor regressions demonstrate that the listing firms do not underperform. Size-and-book-to-market matched factor regression finds that the “post-listing drift” is confined to the small set of firms moving from NASDAQ to AMEX during 1981–1990, within size deciles 3–6 and book-to-market quintiles 1–3. A further control of the industry effect is able to resolve the remaining abnormal returns. Our results are consistent with the pseudo market timing hypothesis in Schultz, (2003) [Schultz, P., 2003. Pseudo market timing and the long-run underperformance of IPOs. J. Fin. 58, 483–517.].

We compare the investment activities and sources of finance of venture capital (VC) funds in Germany, Israel, Japan and the United Kingdom. VC investments differ across countries in terms of their stage, sector and geographical focus. Sources of VC funds also differ across countries; for example, banks are particularly important in Germany and Japan, corporations in Israel, and pension funds in the United Kingdom. Although the differences in investments are related to funding sources—for example, bank and pension fund-backed VCs invest in later stage activities than individual and corporate backed funds—a large proportion of variation within as well as between countries is unrelated to sources of finance. Moreover, differences in the relation between funding source and VC activity are unrelated to the country's financial systems. We conclude that neither financial systems nor sources of finance are the main explanations for the pronounced differences in VC activities.

The standard view of the monetary transmission mechanism rests on the central bank's ability to manipulate the overnight interest rate by controlling reserve supply. In the 1990s, there was a significant decline in the level of reserve balances in the US accompanied at first by an increase in federal funds rate volatility. However, following this initial rise, volatility declined. In this paper, we find evidence of structural breaks in volatility. We estimate a Tobit model of temporary open market operations and conclude that there have been changes in the Desk's reaction function that played a major role in controlling volatility.

We propose a parsimonious ‘unspanned stochastic volatility’ model of the term structure and study its implications for fixed-income option prices. The drift and quadratic variation of the short rate are affine in three state variables (the short rate, its long-term mean and variance) which follow a joint Markov (vector) process. Yet, bond prices are exponential affine functions of only two state variables, independent of the current interest rate volatility level. Because this result holds for an arbitrary volatility process, such a process can be calibrated to match fixed income derivative prices. Furthermore, this model can be ‘extended’ (by relaxing the time-homogeneity) to fit any arbitrary term structure. In its ‘HJM’ form, this model nests the analogous stochastic equity volatility model of Heston (1993) [Heston, S.L., 1993. A closed form solution for options with stochastic volatility. Review of Financial Studies 6, 327–343]. In particular, if the volatility process is specified to be affine, closed-form solutions for interest rate options obtain. We propose an efficient algorithm to compute these prices. An application using data on caps and floors shows that the model can capture very well the implied Black spot volatility surface, while simultaneously fitting the observed term structure.

Using data from 1996 to 2000, we investigate the effects of ownership, especially by a strategic foreign owner, on bank efficiency for eleven transition countries in an unbalanced panel consisting of 225 banks and 856 observations. Applying stochastic frontier estimation procedures, we compute profit and cost efficiency taking account of both time and country effects directly. In second-stage regressions, we use the efficiency measures along with return on assets to investigate the influence of ownership type. With respect to the impact of ownership, we conclude that privatization by itself is not sufficient to increase bank efficiency as government-owned banks are not appreciably less efficient than domestic private banks. We find that foreign-owned banks are more cost-efficient than other banks and that they also provide better service, in particular if they have a strategic foreign owner. The remaining government-owned banks are less efficient in providing services, which is consistent with the hypothesis that the better banks were privatized first in transition countries.