To short a stock, an arbitrageur must first borrow it. This paper describes the market for borrowing and lending U.S. equities, emphasizing the conditions generating and sustaining short-sale constraints. A large institutional lending intermediary provided eighteen months (4/2000–9/2001) of data on loan supply (“shortability”), loan fees (“specialness”), and loan recalls. The data suggest that while loan market specials and recalls are rare on average, the incidence of these short-sale constraints is increasing in the divergence of opinion among investors. Beyond some threshold, investor optimism itself can limit arbitrage via the loan market mechanism.

The term structure of interest rates has occupied economists for many years. This is testimony to the importance of the term structure (or, equivalently, valuation operator) and to the difficulty of obtaining reliable estimates of it. Until recently, it was not possible to reconcile the theoretical existence of a multiplicity of valuation operators in an incomplete bond market and the empirical nonexistence of even a single one. MacKay and Prisman [Estimating valuation operators in incomplete market with noises: Can noise complete the market. Working paper, 1996] tackle this problem. In this paper, an amendment to and a generalization of their methodology is presented. The amendment preserves the linearity of valuation operators and allows use of efficient linear programming techniques. Further, it facilitates an admissible consideration of the puzzle of negative option prices embedded in bonds. The empirical results presented in this paper were obtained using data on extendable Government of Canada bonds. The results indicate that although the gap between the lowest and the highest prices assigned to a cash flow by different valuation operators is significant, it is not sufficient to resolve the above-mentioned puzzle.

This paper examines the historical effects of the El Niño-Southern Oscillation (ENSO) cycle on world prices and economic activity. The primary focus is on world real non-oil primary commodity prices, although the effects on G-7 consumer price inflation and GDP growth are also considered. This paper has several distinct advantages over previous studies. First, several econometric models are estimated using fairly broad measures of prices and economic activity. Second, the models include continuous measures of ENSO intensity (sea surface temperature and sea-level air pressure anomalies in the Pacific Ocean) rather than dummy variable measures. Finally, confidence intervals are constructed for all estimated effects of ENSO on world prices and economic activity. The analysis indicates that ENSO has economically important and statistically significant effects on world real commodity prices. A one-standard-deviation positive surprise in ENSO, for example, raises real commodity price inflation about 3.5 to 4 percentage points. Moreover, ENSO appears to account for almost 20% of commodity price inflation movements over the past several years. ENSO also has some explanatory power for world consumer price inflation and world economic activity, accounting for approximately 10% to 20% of movements in those variables.

We study a model of financial reporting where investors infer the precision of reported earnings. Reporting a larger earnings surprise reduces the inferred earnings precision, dampening the impact on firm value of reporting higher earnings, and providing a natural demand for smoother earnings. We show that for sufficiently “bad” news, the manager under‐reports earnings by the maximum, preferring to take a “big bath” in the current period in order to report higher future earnings. If the news is “good,” the manager smoothes earnings, with the amount of smoothing depending on the level of cashflows observed. He either over‐reports or partially under‐reports for slightly good news, and gradually increases his under‐reporting as the news gets better, until he is under‐reporting the maximum amount for sufficiently good news. This result holds both when investors are “naïve” and ignore management’s ability to manipulate earnings, or “sophisticated” and correctly infer management’s disclosure strategy.

Recently there have been a number of recommendations to increase the role of subordinated debt (SND) in satisfying bank capital requirements as a preferred means to discipline the risk-taking behavior of systemically important banks. One such proposal recommended using SND yield spreads as the triggers for mandatory supervisory action under prompt corrective action guidelines introduced in US banking legislation in the early 1990s. Currently such action is prompted by bank capital ratios. Evidence from previous research suggests that yield information may be a better predictor of bank problems. This paper empirically analyzes potential costs and benefits of using SND signals to trigger prompt corrective action.

Corporate governance and managerial behavior, both in terms of entrenchment and financial leverage, have been individually shown to directly affect firm performance and to indirectly affect it through influence on other determinants of performance. Employing an empirical model that captures documented interactions among the explanatory variables, we examine the importance of these integrated factors in an investment decision by focusing on the determinants of bank bidding activity for failed thrift institutions. While the endogenous relationships based on previous research appear tractable, their overall addition to the explanatory power of the bidding model based on traditional auction variables is very limited. These results suggest questions that should be further examined regarding how much managerial variables as defined by previous studies actually affect firm investment decisions once their endogeneity and unique linkages are formally recognized.

This study uses a model of comparative advantage to model the choice of workers into three broad occupations. The pursuit of comparative advantage is shown to reduce the level of inequality from what would occur in a random assignment of workers into occupations. However, after pricing the skills of workers separately within occupations, the results indicate that the sectors are becoming more similar in the way that they value workers' skills, thus reducing the importance of comparative advantage over time. Inequality is rising as the economy is increasingly characterized by the pursuit of absolute advantage rather than comparative advantage.

I examine the sources of exchange rate dynamics by focusing on the information structure of FX trading. This structure permits the existence of an equilibrium distribution of transaction prices at a point in time. I develop and estimate a model of the price distribution using data from the Deutsche mark/dollar market that prroduces two striking results: (1) Much of the short‐term volatility in exchange rates comes from sampling the heterogeneous trading decisions of dealers in a distribution that, under normal market conditions, changes comparatively slowly; (2) public news is rarely the predominant source of exchange rate movements over any horizon.

This article studies the role of risk arbitrageurs in takeovers and the source of their advantage. We show how the presence of arbitrageurs affects the value of the target shares, since arbitrageurs are more likely to tender. Therefore an arbitrageur has the informational advantage of knowing he bought shares. In equilibrium, the number of arbitrageurs buying shares and the price they pay are determined endogenously. We also present several empirical implications, including the relationship among trading volume, takeover premium, liquidity of the shares, and the number of risk arbitrageurs investing in one particular deal.

Using Electoral Cycles in Police Hiring to Estimate the Effects of Police on Crime: Reply by Steven D. Levitt. Published in volume 92, issue 4, pages 1244-1250 of American Economic Review, September 2002