Chau-nan Chen, Tien-wang Tsaur; Currency Substitution and Foreign Inflation*, The Quarterly Journal of Economics, Volume 98, Issue 1, 1 February 1983, Page

Utilizing the 2005 Lehman index rule change, we examine the role of multiple bond ratings in corporate hedging. We find an asymmetric pattern for firms near a rating downgrade and those near an upgrade. Specifically, firms near a downgrade right before the Lehman event display a strong demand for a third Fitch rating shortly after it, whereas those near an upgrade do not. More than 75% of the firms that would have been effectively downgraded ex post rightfully acquired a third Fitch rating ex ante. This decision prevents 67% of these firms from being downgraded from their original broad rating categories. Furthermore, having a third rating is attractive to investors only for bonds near a downgrade. Investors increase the holdings of these bonds and trade them more actively after the Lehman event. These results suggest that firms use multiple ratings to hedge against downgrade risk.

The compass rose phenomenon is studied based on the random walk model of stock prices. It is found that the structure is inherently present in any financial data having a finite precision, but becomes visible only under some conditions. A quantitative description of the pattern visibility condition is given, providing a method for the interpretation of pattern appearance and a more comprehensive understanding of the compass rose phenomenon. This is achieved by defining a measure of pattern quality. The arguments and the proposed method are supported by numerical examples. One such example is the presentation of patterns in portfolios with some specific weights.

We study the dynamic profit‐maximizing selling mechanism in a merger and acquisitions (M&A) environment with costly bidder entry and without entry fees. Depending on the parameters, the optimal mechanism is implemented by a standard auction or by a two‐stage procedure with exclusive offers to one bidder followed by an auction potentially favoring that bidder. The optimal mechanism may involve common deal protections like termination fees, asset lockups, or stock option lockups. Our proposed procedures resemble sales of targets filing Chapter 11 bankruptcy or M&A involving public targets, and they shed light on how to use deal protections in practice.

We study the dynamics of trading volume and bid-ask spread using a multiperiod trading model with oligopolistic market makers. Traders smooth out their trading even though they are not strategic, and thus trading persists after the arrival of information or liquidity shocks. Traders act quickly on their private information while postponing hedging trades until later periods. The market power of market makers enables them to widen bid-ask spreads when trading incentives are heightened. Consequently, both trading volume and bid-ask spread may exhibit U-shaped patterns. Our model calibration aligns with the empirical intraday patterns observed in bid-ask spreads and trading volumes.

This paper incorporates rational expectations, full price flexibility, and currency substitution into the usual small-economy model, taking explicit account of inflation abroad. Not only will the steady-state terms of trade be affected by an increase in the rate of monetary expansion when the inflation rate abroad is assumed to be nonzero, but its dynamic path may also be different from the usual case in which inflation abroad is ignored. It has been shown that if the import demands are relatively inelastic, the terms of trade will undershoot their equilibrium value; if the import demands are elastic, the terms of trade will overshoot. The key to these diametrically opposite results is the degree of ultimate deterioration in the terms of trade, which, in turn, turn on the size of the two import demand elasticities.

This paper incorporates rational expectations, full price flexibility, and currency substitution into the usual small-economy model, taking explicit account of inflation abroad. Not only will the steady-state terms of trade be affected by an increase in the rate of monetary expansion when the inflation rate abroad is assumed to be nonzero, but its dynamic path may also be different from the usual case in which inflation abroad is ignored. It has been shown that if the import demands are relatively inelastic, the terms of trade will undershoot their equilibrium value; if the import demands are elastic, the terms of trade will overshoot. The key to these diametrically opposite results is the degree of ultimate deterioration in the terms of trade, which, in turn, turn on the size of the two import demand elasticities.

We examine how the financial constraints of repurchasing firms affect their post-buyback performance. By every constraint measure we use, a set of constrained firms repurchase. They display significantly poorer post-buyback abnormal return and operating performance than unconstrained firms. Financial constraints are more important in explaining the performance of share buybacks for firms with high actual repurchase ratios. Constrained firms, especially those with high actual repurchase ratios, experience a significantly greater increase in post-buyback distress risk than unconstrained firms. Managerial hubris could explain why constrained firms buy back shares even if the buybacks do not improve shareholder wealth.

This paper draws parallels between the principal components analysis of factorless high‐dimensional nonstationary data and the classical spurious regression. We show that a few of the principal components of such data absorb nearly all the data variation. The corresponding scree plot suggests that the data contain a few factors, which is corroborated by the standard panel information criteria. Furthermore, the Dickey–Fuller tests of the unit root hypothesis applied to the estimated “idiosyncratic terms” often reject, creating an impression that a few factors are responsible for most of the nonstationarity in the data. We warn empirical researchers of these peculiar effects and suggest to always compare the analysis in levels with that in differences.

Johansen’s (1988, 1991) likelihood ratio test for cointegration rank of a Gaussian VAR depends only on the squared sample canonical correlations between current changes and past levels of a simple transformation of the data. We study the asymptotic behavior of the empirical distribution of those squared canonical correlations when the number of observations and the dimensionality of the VAR diverge to infinity simultaneously and proportionally. We find that the distribution almost surely weakly converges to the so-called Wachter distribution. This finding provides a theoretical explanation for the observed tendency of Johansen’s test to find “spurious cointegration”. It also sheds light on the workings and limitations of the Bartlett correction approach to the over-rejection problem. We propose a simple graphical device, similar to the scree plot, for a preliminary assessment of cointegration in high-dimensional VARs.