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Volume 42: Issue 5 (December 1987)


Front Matter

Pages: i-vi  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb00607.x  |  Cited by: 0


IRWIN FRIEND: EDWARD J. HOPKINSON EMERITUS PROFESSOR OF FINANCE AND ECONOMICS

Pages: vii-ix  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04355.x  |  Cited by: 0


ASSOCIATION MEETINGS

Pages: x-xi  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb00609.x  |  Cited by: 0


ANNOUNCEMENTS

Pages: xii-xiii  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb00610.x  |  Cited by: 0


Back Matter

Pages: xiv-lvii  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb00611.x  |  Cited by: 1


Time-Dependent Variance and the Pricing of Bond Options

Pages: 1113-1128  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04356.x  |  Cited by: 41

STEPHEN M. SCHAEFER, EDUARDO S. SCHWARTZ

In this paper, we develop a model for valuing debt options that takes into account the changing characteristics of the underlying bond by assuming that the standard deviation of return is proportional to the bond's duration. The resulting model uses the bond price as the single state variable and thus preserves much of the simplicity and robustness of the Black‐Scholes approach. The paper provides comparisons between option prices computed using this model and those using the Black‐Scholes and Brennan and Schwartz models.


Arbitrage, Continuous Trading, and Margin Requirements

Pages: 1129-1142  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04357.x  |  Cited by: 18

DAVID C. HEATH, ROBERT A. JARROW

This paper studies the impact that margin requirements have on both the existence of arbitrage opportunities and the valuation of call options. In the context of the Black‐Scholes economy, margin restrictions are shown to exclude continuous‐trading arbitrage opportunities and, with two additional hypotheses, still to allow the Black‐Scholes call model to apply. The Black‐Scholes economy consists of a continuously traded stock with a price process that follows a geometric Brownian motion and a continuously traded bond with a price process that is deterministic.


Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets

Pages: 1143-1166  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04358.x  |  Cited by: 38

ROBERT M. DAMMON, RICHARD C. GREEN

In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or “tax arbitrage.” This paper characterizes the joint restrictions on financial‐asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short‐sale constraints. The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then “no‐tax‐arbitrage” prices will exist. They also show that the existence of “no‐tax‐arbitrage” prices ensures the existence of equilibrium prices.


Forward Markets, Stock Markets, and the Theory of the Firm

Pages: 1167-1185  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04359.x  |  Cited by: 11

RICHARD D. MacMINN

This paper models a competitive financial market economy in which there are forward markets as well as stock and bond markets. Although there are separation theorems in the stock and forward markets literatures, this analysis shows that neither separation theorem survives in this integrated financial market economy. Next, the analysis shows that the separation results hold and are equivalent if the manager has an appropriate compensation package. Then the model is modified to allow for depreciation charges and tax credits. A positive theory of hedging is developed that shows that the corporation can preserve deductions and credits by hedging and so increase corporate value.


An Empirical Investigation of the Market for Comex Gold Futures Options

Pages: 1187-1194  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04360.x  |  Cited by: 3

WARREN BAILEY

Option‐pricing models that assume a constant interest rate may misprice futures options if the interest rate fluctuates significantly or if the price of the underlying asset is correlated with the interest rate. The futures option‐pricing model of Ramaswamy and Sundaresan allows for a stochastic interest rate and correlation of the underlying asset's price with the interest rate. Using a data set of daily closing prices for Comex gold futures options, this paper tests the Ramaswamy and Sundaresan model against a constant interest rate model. Results indicate that the stochastic interest rate model is a superior predictor of market prices.


The Seasonal Stability of the Factor Structure of Stock Returns

Pages: 1195-1211  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04361.x  |  Cited by: 14

D. CHINHYUNG CHO, WILLIAM M. TAYLOR

This paper investigates the month‐by‐month stability of (a) daily returns and correlation coefficients of stock returns, (b) correlation and covariance matrices, (c) number of return‐generating factors, and (d) the APT pricing relationship. The results show that there is a January effect and a small‐firm effect in stock returns. Correlation matrices are more stable than covariance matrices, but both types of matrices are not stable across months and across the sample groups. The number of return‐generating factors is rather stable most of the time and for most of the sample groups, but there is some significant instability that is related to the average correlation coefficients among stocks. The APT pricing relationship does not seem to be supported by the two‐stage process using the maximum‐likelihood factor analysis.


Stock Return Anomalies and the Tests of the APT

Pages: 1213-1224  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04362.x  |  Cited by: 29

MUSTAFA N. GULTEKIN, N. BULENT GULTEKIN

This paper shows that the empirical tests of the Arbitrage Pricing Theory (APT) model are very sensitive to the anomalies observed in January in the stock returns data. There is a strong seasonal pattern in the estimates of the risk premia from the APT model. The most important implication of the findings in this paper is that the APT model can explain the risk‐return relation mostly for January. Once the January returns are excluded from the data, there is no significant relation between the expected stock returns and the risk measures predicted by the APT model.


Efficient Financing under Asymmetric Information

Pages: 1225-1243  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04363.x  |  Cited by: 177

MICHAEL BRENNAN, ALAN KRAUS

This paper characterizes the conditions under which the adverse‐selection problem, which may prevent a firm from issuing securities to finance an otherwise profitable investment, may be costlessly overcome by an appropriate choice of financing strategy. The conditions are specialized when the information asymmetry may be characterized by either a first‐degree‐stochastic‐dominance or a mean‐preserving‐spread ordering across possible distributions of firm earnings. Possible financing strategies that resolve the information asymmetry are discussed, and the results are related to recent empirical findings concerning security issues.


The Issue Decision of Manager-Owners under Information Asymmetry

Pages: 1245-1260  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04364.x  |  Cited by: 8

WILLIAM D. BRADFORD

A firm must issue common stock in order to undertake a new investment, and the firm's manager‐owners can value the firm more accurately than the market. The ability of the manager‐owners to trade in the firm's shares during the issue (a) reduces the investments that are foregone because of the market's mispricing the firm's shares, (b) changes the size and direction of the stock price change when the firm announces a new stock issue, and (c) changes the market value of the firm before and after the issue announcement, whether or not it decides to issue.


Acquisition of Divested Assets and Shareholders' Wealth

Pages: 1261-1273  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04365.x  |  Cited by: 46

NEIL W. SICHERMAN, RICHARD H. PETTWAY

The divesting of corporate assets has become quite popular. Previous studies of divestitures have found conflicting impacts upon shareholders' wealth of the buying firm. This study measures the impacts of product‐line relatedness between the acquiring firm and the divested unit and financial weakness of the selling firm upon the abnormal returns to the acquiring firm. Although the study finds that the impact of financial strength of the seller is ambiguous, the purchase of related assets produces more wealth than does the purchase of unrelated divested units. Further, firms that purchase related divested units have larger proportions of insider ownership.


Debt Management under Corporate and Personal Taxation

Pages: 1275-1291  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04366.x  |  Cited by: 7

DAVID C. MAUER, WILBUR G. LEWELLEN

The presence of long‐term debt in a corporation's capital structure is shown to give rise to a valuable tax‐timing option that can be exercised by the firm on behalf of its shareholders. This option, which is not available if the firm is fully equity financed, implies that leverage will have a positive tax effect on total firm value even if there is no such effect associated with the tax deductibility of the coupon interest payments on debt. The more volatile interest rates and bond prices are, the more valuable the tax‐timing option and the larger the favorable impact of debt on shareholder wealth.


Components of the Bid-Ask Spread and the Statistical Properties of Transaction Prices

Pages: 1293-1307  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04367.x  |  Cited by: 160

LAWRENCE R. GLOSTEN

The bid‐ask spread can be decomposed into two parts: one part due to asymmetric information and the other part due to other factors such as monopoly power. The part due to asymmetric information attenuates statistical biases in mean return, variance, and serial covariance. Thus, using spread data to adjust for biases in return moments requires knowing not only the spread but the composition of the spread. Furthermore, any spread‐estimation procedure using transaction prices must estimate two spread components. On the other hand, the appropriateness of some previously suggested statistical corrections is independent of the spread composition.


The Temporal Price Relationship between S&P 500 Futures and the S&P 500 Index

Pages: 1309-1329  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04368.x  |  Cited by: 209

IRA G. KAWALLER, PAUL D. KOCH, TIMOTHY W. KOCH

This paper empirically examines the intraday price relationship between S&P 500 futures and the S&P 500 index using minute‐to‐minute data. Three‐stage least‐squares regression is used to estimate lead and lag relationships with estimates for expiration days of the S&P 500 futures compared with estimates for days prior to expiration. The results suggest that futures price movements consistently lead index movements by twenty to forty‐five minutes while movements in the index rarely affect futures beyond one minute.


Off-Board Trading of NYSE-Listed Stocks: The Effects of Deregulation and the National Market System

Pages: 1331-1345  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04369.x  |  Cited by: 4

JAMES L. HAMILTON

An econometric time‐series model of off‐board trading of NYSE‐listed stocks shows that high NYSE commission rates were an incentive for third‐market trading but that trading on the regional exchanges, which is most of the off‐board trading, has been affected very little by commissions or their deregulation. The effects of some changes in the trading organization and rules are estimated, including several that are part of the emerging National Market System. The estimates imply that the NMS has increased competition for the NYSE, as Congress intended, and has prompted the NYSE to improve its performance to retain market share.


The Market Reaction to Stock Splits

Pages: 1347-1370  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04370.x  |  Cited by: 135

CHRISTOPHER G. LAMOUREUX, PERCY POON

In this paper, a model of market reaction to stock splits is presented and tested. We argue that the announcement of a split sets off the following chain of events. The market recognizes that, subsequent to the (reverse) split ex‐day, the daily number of transactions along with the raw volume of shares traded will increase (decrease). This increase in volume results in an increase in the noisiness of the security's return process. The increase in noise raises the tax‐option value of the stock, and it is this value that generates the announcement effect of stock splits. Empirical evidence using security returns, daily trading volume, and shareholder data strongly supports this theory. The evidence, in conjunction with this theory, also agrees with extant literature that splits result in decreased liquidity, but there is no evidence that this reduction in liquidity is priced.


Portfolio Selection in the Mean-Variance Model: A Note

Pages: 1371-1376  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04371.x  |  Cited by: 20

LARS TYGE NIELSEN


A Note on Quantity versus Price Risk and the Theory of Financial Intermediation

Pages: 1377-1383  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04372.x  |  Cited by: 0

STEPHEN D. SMITH, DEBORAH WRIGHT GREGORY, KATHLEEN A. WEISS


Friday the Thirteenth: ‘Part VII’-A Note

Pages: 1385-1387  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04373.x  |  Cited by: 2

ROBERT W. KOLB, RICARDO J. RODRIGUEZ


Institutional Contributions to the Leading Finance Journals, 1975 through 1986: A Note

Pages: 1389-1397  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04374.x  |  Cited by: 34

ALBERT W. NIEMI


Book Reviews

Pages: 1399-1407  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04375.x  |  Cited by: 0

Book reviewed in this article:


MISCELLANEA

Pages: 1409-1410  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb04376.x  |  Cited by: 0


INDEX TO VOLUME XLII

Pages: 1411-1416  |  Published: 12/1987  |  DOI: 10.1111/j.1540-6261.1987.tb00608.x  |  Cited by: 0