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Volume 51: Issue 3 (July 1996)

Another Puzzle: The Growth in Actively Managed Mutual Funds

Pages: 783-810  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02707.x  |  Cited by: 1143


Mutual funds represent one of the fastest growing type of financial intermediary in the American economy. The question remains as to why mutual funds and in particular actively managed mutual funds have grown so fast, when their performance on average has been inferior to that of index funds. One possible explanation of why investors buy actively managed open end funds lies in the fact that they are bought and sold at net asset value, and thus management ability may not be priced. If management ability exists and it is not included in the price of open end funds, then performance should be predictable. If performance is predictable and at least some investors are aware of this, then cash flows into and out of funds should be predictable by the very same metrics that predict performance. Finally, if predictors exist and at least some investors act on these predictors in investing in mutual funds, the return on new cash flows should be better than the average return for all investors in these funds. This article presents empirical evidence on all of these issues and shows that investors in actively managed mutual funds may have been more rational than we have assumed.

Cream‐Skimming or Profit‐Sharing? The Curious Role of Purchased Order Flow

Pages: 811-833  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02708.x  |  Cited by: 267


Purchased order flow refers to the practice of dealers or trading locales paying brokers for retail order flow. It is alleged that such agreements are used to “cream skim” uninformed liquidity trades, leaving the information‐based trades to established markets. We develop a test of this hypothesis, using a model of the stochastic process of trades. We then estimate the model for a sample of stocks known to be used in order purchase agreements that trade on the New York Stock Exchange (NYSE) and the Cincinnati Stock Exchange. Our main empirical result is that there is a significant difference in the information content of orders executed in New York and Cincinnati, and that this difference is consistant with cream‐skimming.

Diversification, Integration and Emerging Market Closed‐End Funds

Pages: 835-869  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02709.x  |  Cited by: 119


We study a new class of unconditional and conditional mean‐variance spanning tests that exploits the duality between Hansen‐Jagannathan bounds (1991) and mean‐standard deviation frontiers. The tests are shown to be equivalent to standard spanning tests in population, but we document substantial differences in the small sample performance of alternative tests. Our empirical application examines the diversification benefits from emerging equity markets using an extensive new data set on U.S. and U.K.‐traded closed‐end funds. We find significant diversification benefits for the U.K. country funds, but not for the U.S. funds. The difference appears to relate to differences in portfolio holdings rather than to the behavior of premiums in the United States versus the United Kingdom.

Investment Policy and Exit‐Exchange Offers Within Financially Distressed Firms

Pages: 871-888  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02710.x  |  Cited by: 23


This article examines the conflict of interest between shareholders and bondholders in a setting in which firms can renegotiate the terms of existing debt with public debtholders. In particular, we consider one of the most common types of debt restructuring: the exit‐exchange offer. Our analysis explores the relation between exit‐exchange offers and investment choice by the manager, and it concludes that managers, acting strategically on behalf of shareholders, may select inefficient investment projects in order to enhance their bargaining position vis‐a‐vis creditors. Holding the upside potential of an investment project fixed, managers/shareholders prefer projects with lower payoffs in states of bankruptcy because it induces individual bondholders to accept poorer terms in a debt‐for‐debt exit‐exchange offer, thus generating a greater residual for shareholders in states of solvency. Additionally, we show how the investment inefficiencies in our analysis depend on (i) the inability of bondholders to coordinate their actions; (ii) the ability of managers to commit to suboptimal investment projects; and (iii) the coupling of an individual bondholder's decision to tender and her decision to consent to allow the firm to strip fiduciary covenants. We suggest conditions under which a ban on coupled exit‐exchange offers—or alternatively, constraints on “debt‐for‐debt” exchanges—would be efficiency‐enhancing.

Delayed Reaction to Good News and the Cross‐Autocorrelation of Portfolio Returns

Pages: 889-919  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02711.x  |  Cited by: 157


We document a directional asymmetry in the small stock concurrent and lagged response to large stock movements. When returns on large stocks are negative, the concurrent beta for small stocks is high, but the lagged beta is insignificant. When returns on large stocks are positive, small stocks have small concurrent betas and very significant lagged betas. That is, the cross‐autocorrelation puzzle documented by Lo and MacKinlay (1990a) is associated with a slow response by some small stocks to good, but not to bad, common news. Time series portfolio tests and cross‐sectional tests of the delay for individual securities suggest that existing explanations of the cross‐autocorrelation puzzle based on data mismeasurement, minor market imperfections, or time‐varying risk premiums fail to capture the directional asymmetry in the data.

Swap Rates and Credit Quality

Pages: 921-949  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02712.x  |  Cited by: 220


This article presents a model for valuing claims subject to default by both contracting parties, such as swaps and forwards. With counterparties of different default risk, the promised cash flows of a swap are discounted by a switching discount rate that, at any given state and time, is equal to the discount rate of the counterparty for whom the swap is currently out of the money (that is, a liability). The impact of credit‐risk asymmetry and of netting is presented through both theory and numerical examples, which include interest rate and currency swaps.

Why Do Markets Move Together? An Investigation of U.S.‐Japan Stock Return Comovements

Pages: 951-986  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02713.x  |  Cited by: 459


This article explores the fundamental factors that affect cross‐country stock return correlations. Using transactions data from 1988 to 1992, we construct overnight and intraday returns for a portfolio of Japanese stocks using their NYSE‐traded American Depository Receipts (ADRs) and a matched‐sample portfolio of U. S. stocks. We find that U. S. macroeconomic announcements, shocks to the Yen/Dollar foreign exchange rate and Treasury bill returns, and industry effects have no measurable influence on U.S. and Japanese return correlations. However, large shocks to broad‐based market indices (Nikkei Stock Average and Standard and Poor's 500 Stock Index) positively impact both the magnitude and persistence of the return correlations.

Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads

Pages: 987-1019  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02714.x  |  Cited by: 1126


This article examines the optimal capital structure of a firm that can choose both the amount and maturity of its debt. Bankruptcy is determined endogenously rather than by the imposition of a positive net worth condition or by a cash flow constraint. The results extend Leland's (1994a) closed‐form results to a much richer class of possible debt structures and permit study of the optimal maturity of debt as well as the optimal amount of debt. The model predicts leverage, credit spreads, default rates, and writedowns, which accord quite closely with historical averages. While short term debt does not exploit tax benefits as completely as long term debt, it is more likely to provide incentive compatibility between debt holders and equity holders. Short term debt reduces or eliminates “asset substitution” agency costs. The tax advantage of debt must be balanced against bankruptcy and agency costs in determining the optimal maturity of the capital structure. The model predicts differently shaped term structures of credit spreads for different levels of risk. These term structures are similar to those found empirically by Sarig and Warga (1989). Our results have important implications for bond portfolio management. In general, Macaulay duration dramatically overstates true duration of risky debt, which may be negative for “junk” bonds. Furthermore, the “convexity” of bond prices can become “concavity.”

Author Index of the Abstracts

Pages: 1021-1022  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb00216.x  |  Cited by: 0

Abstracts of Papers Presented at the 1996 AFA Meeting

Pages: 1023-1071  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02715.x  |  Cited by: 0

Minutes of the Annual Membership Meeting

Pages: 1073-1075  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02716.x  |  Cited by: 0

Michael Keenan

Report of the Executive Secretary and Treasurer

Pages: 1077-1078  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02717.x  |  Cited by: 0

Michael Keenan

Consolidated Revenues and Expenses

Pages: 1079-1080  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02718.x  |  Cited by: 0

Report of the Managing Editor of The Journal of Finance for the Year 1995

Pages: 1081-1093  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02719.x  |  Cited by: 0

René M. Stulz

Report of the AFA Representative to the National Bureau of Economic Research*

Pages: 1095-1096  |  Published: 7/1996  |  DOI: 10.1111/j.1540-6261.1996.tb02720.x  |  Cited by: 0

Robert S. Hamada