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Volume 63: Issue 1 (February 2008)

Agency Conflicts, Investment, and Asset Pricing

Pages: 1-40  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01309.x  |  Cited by: 157


The separation of ownership and control allows controlling shareholders to pursue private benefits. We develop an analytically tractable dynamic stochastic general equilibrium model to study asset pricing and welfare implications of imperfect investor protection. Consistent with empirical evidence, the model predicts that countries with weaker investor protection have more incentives to overinvest, lower Tobin's q, higher return volatility, larger risk premia, and higher interest rate. Calibrating the model to the Korean economy reveals that perfecting investor protection increases the stock market's value by 22%, a gain for which outside shareholders are willing to pay 11% of their capital stock.

Heterogeneous Beliefs, Speculation, and the Equity Premium

Pages: 41-83  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01310.x  |  Cited by: 182


Agents with heterogeneous beliefs about fundamental growth do not share risks perfectly but instead speculate with each other on the relative accuracy of their models' predictions. They face the risk that market prices move more in line with the trading models of competing agents than with their own. Less risk‐averse agents speculate more aggressively and demand higher risk premiums. My calibrated model generates countercyclical consumption volatility, earnings forecast dispersion, and cross‐sectional consumption dispersion. With a risk aversion coefficient less than one, agents' speculation causes half the observed equity premium and lowers the riskless rate by about 1%.

Which Money Is Smart? Mutual Fund Buys and Sells of Individual and Institutional Investors

Pages: 85-118  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01311.x  |  Cited by: 159


Gruber (1996) and Zheng (1999) report that investors channel money toward mutual funds that subsequently perform well. Sapp and Tiwari (2004) find that this “smart money” effect no longer holds after controlling for stock return momentum. While prior work uses quarterly U.S. data, we employ a British data set of monthly fund inflows and outflows differentiated between individual and institutional investors. We document a robust smart money effect in the United Kingdom. The effect is caused by buying (but not selling) decisions of both individuals and institutions. Using monthly data available post‐1991 we show that money is comparably smart in the United States.

Competition for Order Flow and Smart Order Routing Systems

Pages: 119-158  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01312.x  |  Cited by: 211


We study the rivalry between Euronext and the London Stock Exchange (LSE) in the Dutch stock market to test hypotheses about the effect of market fragmentation. As predicted by our theory, the consolidated limit order book is deeper after entry of the LSE. Moreover, cross‐sectionally, we find that a higher trade‐through rate in the entrant market coincides with less liquidity supply in this market. These findings imply that (i) fragmentation of order flow can enhance liquidity supply and (ii) protecting limit orders against trade‐throughs is important.

Information Asymmetry and Asset Prices: Evidence from the China Foreign Share Discount

Pages: 159-196  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01313.x  |  Cited by: 280


We examine the effect of information asymmetry on equity prices in the local A‐ and foreign B‐share market in China. We construct measures of information asymmetry based on market microstructure models, and find that they explain a significant portion of cross‐sectional variation in B‐share discounts, even after controlling for other factors. On a univariate basis, the price impact measure and the adverse selection component of the bid‐ask spread in the A‐ and B‐share markets explains 44% and 46% of the variation in B‐share discounts. On a multivariate basis, both measures are far more statistically significant than any of the control variables.

Ambiguity, Information Quality, and Asset Pricing

Pages: 197-228  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01314.x  |  Cited by: 530


When ambiguity‐averse investors process news of uncertain quality, they act as if they take a worst‐case assessment of quality. As a result, they react more strongly to bad news than to good news. They also dislike assets for which information quality is poor, especially when the underlying fundamentals are volatile. These effects induce ambiguity premia that depend on idiosyncratic risk in fundamentals as well as skewness in returns. Moreover, shocks to information quality can have persistent negative effects on prices even if fundamentals do not change.

Price Volatility and Investor Behavior in an Overlapping Generations Model with Information Asymmetry

Pages: 229-272  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01315.x  |  Cited by: 74


This paper studies an overlapping generations model with multiple securities and heterogeneously informed agents. The model produces multiple equilibria, including highly volatile equilibria that can exhibit strong or weak correlations between asset returns—even when asset supplies and future dividends are uncorrelated across assets. Less informed agents rationally behave like trend‐followers, while better informed agents follow contrarian strategies. Trading volume has a hump‐shaped relation with information precision and is positively correlated with absolute price changes. Finally, accurate information increases the volatility and correlation of stock returns in the highly volatile, strongly correlated equilibrium.

Individual Investor Trading and Stock Returns

Pages: 273-310  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01316.x  |  Cited by: 640


This paper investigates the dynamic relation between net individual investor trading and short‐horizon returns for a large cross‐section of NYSE stocks. The evidence indicates that individuals tend to buy stocks following declines in the previous month and sell following price increases. We document positive excess returns in the month following intense buying by individuals and negative excess returns after individuals sell, which we show is distinct from the previously shown past return or volume effects. The patterns we document are consistent with the notion that risk‐averse individuals provide liquidity to meet institutional demand for immediacy.

The Demise of Investment Banking Partnerships: Theory and Evidence

Pages: 311-350  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01317.x  |  Cited by: 60


In 1970 the New York Stock Exchange relaxed rules that prohibited the public incorporation of member firms. Investment banking concerns went public in waves, with Goldman Sachs the last of the bulge bracket banks to float. We explain the pattern of investment bank flotations. We argue that partnerships foster the formation of human capital and we use technological advances that undermine the role of human capital to explain the partnership's going‐public decision. We support our theory using a new data set of investment bank partnership statistics.

Downward‐Sloping Demand Curves, the Supply of Shares, and the Collapse of Internet Stock Prices

Pages: 351-378  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01318.x  |  Cited by: 26


Over March and April 2000, Internet stocks lost 56%, or $700 billion. This sudden collapse has been attributed to an increasing supply of shares from lockup expirations and equity offerings. I show that Internet stocks collapsed in this period regardless of whether their lockups expired. Furthermore, daily Internet stock portfolio returns were almost unaffected by the number or dollar amount of lockup expirations that day, or by the amount of stock offered in IPOs or SEOs. Most of the Internet stock decline is explained by poor marketwide returns, particularly for growth stocks.

Information, Trading, and Product Market Interactions: Cross‐sectional Implications of Informed Trading

Pages: 379-413  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01319.x  |  Cited by: 72


I present a simple model of informed trading in which asset values are derived from imperfectly competitive product markets and private information events occur at individual firms. The model predicts that informed traders may have incentives to make information‐based trades in the stocks of competitors, especially when events occur at firms with large market shares. In the context of 759 earnings announcements, I use intraday transactions data to test the hypothesis that net order flow and returns in the stocks of nonannouncing competitors have information content for announcing firms.

The Long‐Lasting Momentum in Weekly Returns

Pages: 415-447  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01320.x  |  Cited by: 139


Reversal is the current stylized fact of weekly returns. However, we find that an opposing and long‐lasting continuation in returns follows the well‐documented brief reversal. These subsequent momentum profits are strong enough to offset the initial reversal and to produce a significant momentum effect over the full year following portfolio formation. Thus, ex post, extreme weekly returns are not too extreme. Our findings extend to weekly price movements with and without public news. In addition, there is no relation between news uncertainty and the momentum in 1‐week returns.

IPO Pricing and Share Allocation: The Importance of Being Ignorant

Pages: 449-478  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01321.x  |  Cited by: 39


Since an underwriter sets an IPO's offer price without knowing its market value, investors can acquire information about its value and avoid overpriced deals (“lemon‐dodge”). To mitigate this well‐known risk, the bank enters into a repeat game with a coalition of investors who do not lemon‐dodge in exchange for on‐average underpriced shares. We (i) derive and test a quantitative IPO pricing rule (showing that tech IPOs were not excessively underpriced during the boom of the 1990s); and (ii) analyzing a unique multibank data set, find strong support for the conjecture that a bank preferentially allocates shares to its coalition.


Pages: 479-480  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01346.x  |  Cited by: 0


Pages: 485-490  |  Published: 1/2008  |  DOI: 10.1111/j.1540-6261.2008.01343.x  |  Cited by: 0