Relative purchasing power parity (PPP) holds for pure price inflations, which affect prices of all goods and services by the same proportion, while leaving relative prices unchanged. Pure price inflations also affect nominal returns of all traded financial assets by exactly the same amount. Recognizing that relative PPP may not hold for the official inflation data constructed from commodity price indices because of relative price changes and other frictions that cause prices to be “sticky,” we provide a novel method for extracting a proxy for realized pure price inflation from stock returns. We find strong support for relative PPP in the short run using the extracted inflation measures.

We argue that when the offer price of an initial public offering (IPO) is set many days before the issue closes for bidding by investors, relevant price information leaks and becomes public knowledge before investors have finished bidding for firm's shares. Consequently, there are instances when all investors realize ex ante that the offer price is ‘too low’ and we observe a large oversubscription for the firm's shares, as well as instances when the investors realize that the offer price is ‘too high’ and the issue fails. If failure is costly, then the offering is underpriced in order to reduce the likelihood that the issue will fail. This is in addition to the underpricing, as suggested in Rock (1986), to compensate the uninformed investors for the adverse selection problem they face in the allocation of shares. Our argument thus explains why underpricing may be larger in situations when there is information leakage. We further argue that if the issuer collects the interest float on checks deposited by investors for shares they bid, this interest revenue reduces the cost associated with underpricing and thus provides an incentive to underprice the issue further. Our analysis explains some stylized facts about differences in oversubscription and underpricing across countries and allows us to explore some empirical and policy implications. For instance, we show that the method used in the United Kingdom and in most Asian countries may lead to more underpricing and more extreme levels of oversubscription than the method used for firm commitment offerings in the United States.

Financing a multinational subsidiary by intra-firm parent debt has the advantage that while interest payments on the debt are tax deductible, there are no offsetting bankruptcy costs. Tax authorities put limits on the rate the parent is allowed to charge since the multinational firm has incentives to exaggerate the interest rate on the intra-firm debt when the foreign corporate tax rate is higher than the domestic rate. Since the interest rate on external debt — which entails potential bankruptcy costs — is determined competitively in the market, this can be used as a benchmark to justify the rate charged on intra-firm debt. We show that the firm would finance the subsidiary partly by intra-firm parent debt and partly by external debt, both of equal seniority, but it sometimes would choose to pay its external debtors in full even when it is not contractually obligated to do so. For any given level of total debt financing, higher corporate tax rates in the foreign country are associated with a larger proportion of debt financing by external debt, higher interest rates and a larger probability of bankruptcy; higher corporate tax rates in the home country are associated with a smaller proportion of debt financing by external debt, lower interest rates and a smaller probability of bankruptcy.

We argue that in the after-market trading of an IPO, the underwriting syndicate, by standing ready to buy back shares at the offer price ("price stabilization"), compensates uninformed investors ex post for the adverse selection cost they face in bidding for IPOs. This domi? nates ex ante compensation by underpricing. The reason is that stabilization exploits ex post information about investor demand whereas underpricing must be based on ex ante infor? mation. However, liquidity and syndication costs constrain the use of stabilization which, in equilibrium, generates some underpricing as well. We develop a model that formalizes this intuition and generates several empirical implicatio

We propose that it is precisely because firms’ repurchases of their own stock through tender offers are associated with large stock-price increases that repurchases are unattractive as a means of distributing cash. As a result, firms distribute some cash in the form of dividends—despite the tax disadvantage—and carry the rest to future periods. However, when their stock is sufficiently undervalued, firms distribute all accumulated cash through stock repurchases. We show that dividends are smoothed and are positively related both to earnings innovations and to previous period’s dividends. Also, the stock-price reaction to a repurchase announcement, of a given size, is increasing in the previous period’s dividends.

When a security trades at multiple locations simultaneously, an informed trader has several avenues in which to exploit his private information. The greater the proportion of liquidity trading by “large” traders who can split their trades across markets, the larger is the correlation between volume in different markets and the smaller is the informativeness of prices. We show that one of the markets emerges as the dominant location for trading in that security. When informed traders can use their information for more than one trading period, the timely release of price information by market makers at one location adversely affects the profits informed traders expect to make subsequently at other locations. Market makers, competing to offer the lowest cost of trading at their location, consequently deter informed trading by voluntarily making the price information public and by “cracking down” on insider trading.

Robert Z. Aliber, Bhagwan Chowdhry, Shu Yan; Some Evidence that a Tobin Tax on Foreign Exchange Transactions May Increase Volatility *, European Finance Re

In a takeover contest, the presence of bidders' existing debtholders, if they can be expropriated by issuing new debt with equal or senior priority, allows bidders to commit to bid more than their valuation of the target. Such commitment can be beneficial because it deters potential entry by subsequent bidders and may allow a first bidder to acquire the target at a bargain price. The cost is that if entry by subsequent bidders does nevertheless take place, because the first bidder has committed himself to bid high premia, a bidding war ensues resulting in offers that may involve excessive premia, i.e., bids that are larger than the bidders' valuation of the target.