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Volume 45: Issue 4 (September 1990)


Pages: i-ii  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02418.x  |  Cited by: 0

Front Matter

Pages: i-vi  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb00528.x  |  Cited by: 0


Pages: iii-iii  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02419.x  |  Cited by: 0

Symposium on Institutional Design and Finance Markets at The Western Finance Association Meetings

Pages: iv-iv  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02420.x  |  Cited by: 0


Pages: v-v  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02421.x  |  Cited by: 0


Pages: vi-vii  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02422.x  |  Cited by: 0

Back Matter

Pages: viii-xxxviii  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb00529.x  |  Cited by: 0


Pages: 1-16  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02423.x  |  Cited by: 0

Shareholder Preferences and Dividend Policy

Pages: 993-1018  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02424.x  |  Cited by: 183


This paper develops a theory of choice among alternative procedures for distributing cash from corporations to shareholders. Despite the preferential tax treatment of capital gains for individual investors, it is shown that a majority of a firm's shareholders may support a dividend payment for small distributions. For larger distributions an open market stock repurchase is likely to be preferred by a majority of shareholders, and for the largest distributions tender offer repurchases dominate.

Equity Issues and Stock Price Dynamics

Pages: 1019-1043  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02425.x  |  Cited by: 348


This paper presents an information‐theoretic, infinite horizon model of the equity issue decision. The model predicts that (a) equity issues on average are preceded by an abnormal positive return on the stock, although for some firms the issue is preceded by a loss; (b) equity issues on average are preceded by an abnormal rise in the market; and (c) the stock price drops at the announcement of an issue. The model provides a measure of the welfare cost of asymmetric information; the welfare loss may be small even if the price drop at issue announcement is large.

Initial Public Offerings and Underwriter Reputation

Pages: 1045-1067  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02426.x  |  Cited by: 1291


This paper examined the returns earned by subscribing to initial public offerings of equity (IPOs). Rock (1986) suggests that IPO returns are required by uninformed investors as compensation for the risk of trading against superior information. We show that IPOs with more informed investor capital require higher returns. The marketing underwriter's reputation reveals the expected level of “informed” activity. Prestigious underwriters are associated with lower risk offerings. With less risk there is less incentive to acquire information and fewer informed investors. Consequently, prestigious underwriters are associated with IPOs that have lower returns.

Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships

Pages: 1069-1087  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02427.x  |  Cited by: 434


Customer relationships arise between banks and firms because, in the process of lending, a bank learns more than others about its own customers. This information asymmetry allows lenders to capture some of the rents generated by their older customers; competition thus drives banks to lend to new firms at interest rates which initially generate expected losses. As a result, the allocation of capital is shifted toward lower quality and inexperienced firms. This inefficiency is eliminated if complete contingent contracts are written or, when this is costly, if banks can make nonbinding commitments that, in equilibrium, are backed by reputation.

Stock Returns, Expected Returns, and Real Activity

Pages: 1089-1108  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02428.x  |  Cited by: 631


Measuring the total return variation explained by shocks to expected cash flows, time‐varying expected returns, and shocks to expected returns is one way to judge the rationality of stock prices. Variables that proxy for expected returns and expected‐return shocks capture 30% of the variance of annual NYSE value‐weighted returns. Growth rates of production, used to proxy for shocks to expected cash flows, explain 43% of the return variance. Whether the combined explanatory power of the variables—about 58% of the variance of annual returns—is good or bad news about market efficiency is left for the reader to judge.

Predicting Stock Returns in an Efficient Market

Pages: 1109-1128  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02429.x  |  Cited by: 142


An intertemporal general equilibrium model relates financial asset returns to movements in aggregate output. The model is a standard neoclassical growth model with serial correlation in aggregate output. Changes in aggregate output lead to attempts by agents to smooth consumption, which affects the required rate of return on financial assets. Since aggregate output is serially correlated and hence predictable, the theory suggests that stock returns can be predicted based on rational forecasts of output. The empirical results confirm that stock returns are a predictable function of aggregate output and also support the accompanying implications of the model.

Heteroskedasticity in Stock Returns

Pages: 1129-1155  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02430.x  |  Cited by: 215


We use predictions of aggregate stock return variances from daily data to estimate time‐varying monthly variances for size‐ranked portfolios. We propose and estimate a single factor model of heteroskedasticity for portfolio returns. This model implies time‐varying betas. Implications of heteroskedasticity and time‐varying betas for tests of the capital asset pricing model (CAPM) are then documented. Accounting for heteroskedasticity increases the evidence that risk‐adjusted returns are related to firm size. We also estimate a constant correlation model. Portfolio volatilities predicted by this model are similar to those predicted by more complex multivariate generalized‐autoregressive‐conditional‐heteroskedasticity (GARCH) procedures.

Liquidity of the CBOE Equity Options

Pages: 1157-1179  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02431.x  |  Cited by: 112


We examine the CBOE option market depth and bid‐ask spreads. Absence of price effects surrounding large option trades suggests excellent market depth. However, bid‐ask spreads for the CBOE options and the NYSE stocks are nearly equal, even though an average option is equivalent to less than half a stock plus borrowing. We explain this tradeoff between market depth and bid‐ask spreads on the CBOE and the NYSE by differences in market mechanisms. We also show that the adverse‐selection component of the option spread, which measures the extent of information‐related trading on the CBOE, is very small.

Pricing Warrants: An Empirical Study of the Black-Scholes Model and Its Alternatives

Pages: 1181-1209  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02432.x  |  Cited by: 55


This paper uses a sample of over 25,000 daily warrant prices to empirically investigate potential problems with the commonly used warrant pricing model proposed by Black and Scholes as an extension of their call option model. One problem seems to be especially important: the constant variance assumption of the dilution adjusted Black‐Scholes model appears to cause biases in model prices for almost all warrants and over the entire sample period. We show that more accurate price forecasts are obtained with a specific form of the constant elasticity of variance model.

The Behavior of Eurocurrency Returns Across Different Holding Periods and Monetary Regimes

Pages: 1211-1236  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02433.x  |  Cited by: 11


Recent empirical studies of the risk premium across foreign exchange and other asset markets such as equity and longer term bonds have found conflicting evidence about the latent variable model restrictions of the consumption‐based intertemporal capital asset pricing model. While studies using data for holding periods of one month or less generally reject the model, evidence using three‐month holding periods indicates that the model cannot be rejected when including the returns on long relative to short deposit rates. This paper investigates the sources of differences in results using returns on foreign exchange and Eurocurrency deposits at three different maturities.

Stock Returns and Real Activity: A Century of Evidence

Pages: 1237-1257  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02434.x  |  Cited by: 356


This paper analyzes the relation between real stock returns and real activity from 1889–1988. It replicates Fama's (1990) results for the 1953–1987 period using an additional 65 years of data. It also compares two measures of industrial production in the tests: (1) the series produced by Babson for 1889–1918, spliced with the Federal Reserve Board index of industrial production for 1919–1988, and (2) the new Miron and Romer (1989) index spliced with the Federal Reserve Board index in 1941. Fama's findings are robust for a much longer period—future production growth rates explain a large fraction of the variation in stock returns. The new Miron‐Romer measure of industrial production is less closely related to stock price movements than the older Babson and Federal Reserve Board measures.

Turn-of-Month Evaluations of Liquid Profits and Stock Returns: A Common Explanation for the Monthly and January Effects

Pages: 1259-1272  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02435.x  |  Cited by: 133


This paper presents and tests a hypothesis that the standardization of payments in the United States at the turn of each calendar month generally induces a surge in stock returns at the turn of each calendar month. The hypothesis also asserts that returns generally will be greater following the month of December and will vary inversely with the stringency of monetary policy. Empirical results using stock index returns for 1969–1986 support the hypothesis. This analysis provides an explanation for the previously documented monthly effect in stock returns and a partial explanation for the January effect.

Insider Trading in the OTC Market

Pages: 1273-1284  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02436.x  |  Cited by: 213


In this paper, we examine the profitability of insider trading in firms whose securities trade in the OTC/NASDAQ market. Although the evidence suggests timing and forecasting ability on the part of insiders, high transaction costs (especially bid‐ask spreads) appear to eliminate the potential for positive abnormal returns from active trading. By implication, outside investors who mimic the trading of insiders are also precluded from earning abnormal profits. In addition, we provide evidence on the determinants of insiders' profits. The data suggest that insiders closer to the firm trade on more valuable information than insiders removed from the firm.

The Effects of Stock Splits on Bid-Ask Spreads

Pages: 1285-1295  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02437.x  |  Cited by: 88


This paper examines the effects of stock splits on bid‐ask spreads for NYSE‐listed companies. Percentage spreads increase after splits, representing a liquidity cost to investors. These spread increases are directly related to decreases in share prices following splits and can explain part, but not all, of the observed increase in return variability after splits. The evidence thus suggests a liquidity cost of stock splits that must be weighed against any other perceived benefits of splits. Such a liquidity cost may validate that stock splits are a signal of favorable information about the firm.

The Intertemporal Relation Between the U.S. and Japanese Stock Markets

Pages: 1297-1306  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02438.x  |  Cited by: 20


This paper finds a high correlation between the open to close returns for U.S. stocks in the previous trading day and the Japanese equity market performance in the current period. In contrast, the Japanese market has only a small impact on the U.S. return in the current period. High correlations among open to close returns are a violation of the efficient market hypothesis; however, in trading simulations, the excess profits in Japan vanish when transactions costs and transfer taxes are included.

Time Varying Term Premia and Traditional Hypotheses about the Term Structure

Pages: 1307-1314  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02439.x  |  Cited by: 11


Empirical evidence of time varying term premia in bond returns is frequently interpreted as evidence against the Expectations Hypothesis. This paper shows that the Expectations Hypothesis can actually imply time varying term premia if the time frame for which the Expectations Hypothesis holds differs from the return measurement period. Furthermore, many of the properties of these term premia are consistent with those of observed term premia. These results are important because they imply that the case against the Expectations Hypothesis is weaker than claimed in the empirical literature.

Optimal Hedging under Intertemporally Dependent Preferences

Pages: 1315-1324  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02440.x  |  Cited by: 17


This paper examines optimal hedging behavior in a market where preferences for current consumption are partly determined by the consumer's past consumption history. The model considers an individual exposed to price risk, who allocates wealth between consumption and futures contracts over a (continuous‐time) finite planning horizon. The speculative component of the hedge ratio is shown to be smaller and the consumption path smoother than in models where preferences are separable over time. Some comparative‐static properties of the hedge ratio are also examined.

Corporate Capital Structure, Agency Costs, and Ownership Control: The Case of All-Equity Firms

Pages: 1325-1331  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02441.x  |  Cited by: 106


This paper provides evidence that all‐equity firms exhibit greater levels of managerial stockholdings, more extensive family relationships among top management, and higher liquidity positions than a matched sample of levered firms. Further, top managers of all‐equity firms with family involvement in corporate operations have greater control of corporate voting rights than managers of all‐equity firms without family involvement. These findings are consistent with the interpretation that managerial control of voting rights and family relationships among senior managers are important factors in the decision to eliminate leverage.

Forward and Futures Prices: Evidence from the Foreign Exchange Markets

Pages: 1333-1336  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02442.x  |  Cited by: 12


Cornell and Reinganum (1981), hereafter CR, report that price differentials for future contracts and forward contracts are statistically insignificant in foreign exchange markets. Based on this finding, CR conclude that marking‐to‐market is insignificant in the formulation of currency futures prices. This note identifies two potential concerns with the CR tests. One problem relates to the timing of delivery dates for “matched” contracts. A second problem relates to the time period for the CR study. We show that correcting for these problems does not affect the overall conclusions of the CR study; marking‐to‐market does not appear to have a significant effect on currency futures prices.

Changes in the Cost of Intermediation: The Case of Savings and Loans

Pages: 1337-1346  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02443.x  |  Cited by: 19


The minimum cost output configuration for a firm may change as the result of a variety of factors, including changes in market structure. In this paper we test this structural change hypothesis with savings and loan data. We find support for the hypothesis that separable, constant returns to scale production functions characterize the average savings and loan in our sample in 1983. This is in contrast to the cost complementarities found in 1978. We argue that this result may be the result of regulatory changes that allowed savings and loans to alter their production mix to fully capture the benefits of joint production.

Book Reviews

Pages: 1347-1360  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02444.x  |  Cited by: 0

Book reviewed in this article:


Pages: 1361-1362  |  Published: 9/1990  |  DOI: 10.1111/j.1540-6261.1990.tb02445.x  |  Cited by: 0