The Journal of Finance

On the Positive Role of Financial Intermediation in Allocation of Venture Capital in a Market with Imperfect Information

Published: 12/1983,  Volume: 38,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1983.tb03840.x  |  Cited by: 180

YUK‐SHEE CHAN

This paper develops a theory of financial intermediation that highlights the contribution of intermediaries as informed agents in a market with imperfect information. We consider a venture capital market where the entrepreneurs select the qualities of projects and their perquisite consumptions, about which the investors are imperfectly informed. It is shown that when all investors have positive search costs, the entrepreneurs are induced to offer the unacceptable inferior projects (“lemons” only), and the investors will not enter the venture capital market, but put their funds in other low return investments–an undesirable allocation of resources.Beginning with an initial undesirable situation, the financial intermediaries may evolve as informed agents that induce a Pareto‐preferred allocation, leading the investors to a higher welfare state. We focus our analysis on the existence of intermediation equilibra when the market for intermediation services is competitive. The distribution of returns on projects, the fees charged by intermediaries, and the fraction of institutional holdings are all endogenous in equilibrium. It is shown that (i) there cannot be a competitive intermediation equilibrium with very high institutional holdings, and (ii) in other cases multiple equilibra may exist, but the one with the highest institutional holdings dominates the others in a Pareto sense.

Information Production, Market Signalling, and the Theory of Financial Intermediation: A Comment

Published: 9/1982,  Volume: 37,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1982.tb03601.x  |  Cited by: 2

YUK‐SHEE CHAN

Collateral and Competitive Equilibria with Moral Hazard and Private Information

Published: 6/1987,  Volume: 42,  Issue: 2  |  DOI: 10.1111/j.1540-6261.1987.tb02571.x  |  Cited by: 200

YUK‐SHEE CHAN, ANJAN V. THAKOR

The authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications. Both moral hazard and adverse selection are considered. The principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts. Specifically, some well‐known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept. Two somewhat surprising results emerge. First, high‐quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits. Second, high‐quality borrowers may put up more collateral.

Depositors' Welfare, Deposit Insurance, and Deregulation

Published: 7/1985,  Volume: 40,  Issue: 3  |  DOI: 10.1111/j.1540-6261.1985.tb05024.x  |  Cited by: 8

YUK‐SHEE CHAN, KING‐TIM MAK

We develop an analytical model to address the question of optimal deposit insurance policy and to examine the impact of deregulation on depositors' welfare and the soundness of the insurance system. We find that the optimal level of regulation depends critically on the functional relationship between risk and return. We show that in general deregulation of bank activities and/or of deposit rate ceilings will in volve tradeoff between depositors' welfare and the soundness of the insurance system. Our analysis also indicates that risk‐sensitive premium and capital requirement schedules may not be efficient in managing the risk of banks.

Is Fairly Priced Deposit Insurance Possible?

Published: 3/1992,  Volume: 47,  Issue: 1  |  DOI: 10.1111/j.1540-6261.1992.tb03984.x  |  Cited by: 177

YUK‐SHEE CHAN, STUART I. GREENBAUM, ANJAN V. THAKOR

We analyze risk‐sensitive, incentive‐compatible deposit insurance in the presence of private information and moral hazard. Without deposit‐linked subsidies it is impossible to implement risk‐sensitive, incentive‐compatible deposit insurance pricing in a competitive, deregulated environment, except when the deposit insurer is the least risk averse agent in the economy. We establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital; the result holds for alternative sorting instruments as well. This suggests a contradiction between deregulation and fairly priced, risk‐sensitive deposit insurance.

Imperfect Information and Cross‐Autocorrelation among Stock Prices

Published: 9/1993,  Volume: 48,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1993.tb04752.x  |  Cited by: 76

KALOK CHAN

I develop a model to explain why stock returns are positively cross‐autocorrelated. When market makers observe noisy signals about the value of their stocks but cannot instantaneously condition prices on the signals of other stocks, which contain marketwide information, the pricing error of one stock is correlated with the other signals. As market makers adjust prices after observing true values or previous price changes of other stocks, stock returns become positively cross‐autocorrelated. If the signal quality differs among stocks, the cross‐autocorrelation pattern is asymmetric. I show that both own‐ and cross‐autocorrelations are higher when market movements are larger.

Can Tax‐Loss Selling Explain the January Seasonal in Stock Returns?

Published: 12/1986,  Volume: 41,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1986.tb02534.x  |  Cited by: 30

K. C. CHAN

This paper analyzes the tax‐loss selling hypothesis as an explanation of the January seasonal in stock returns and argues that rational tax‐loss selling implies little relation between the January seasonal and the long‐term loss. Empirical results show that the January seasonal is as strongly related to the long‐term loss as it is to the short‐term loss. The evidence is inconsistent with a model that explains the January seasonal by optimal tax trading.

Macroeconomic Influences and the Variability of the Commodity Futures Basis

Published: 6/1993,  Volume: 48,  Issue: 2  |  DOI: 10.1111/j.1540-6261.1993.tb04727.x  |  Cited by: 93

WARREN BAILEY, K. C. CHAN

We provide evidence that the spread between commodity spot and futures prices (the basis) reflects the macroeconomic risks common to all asset markets. The basis of many commodities is correlated with the stock index dividend yield and corporate bond quality spread. Explanatory power is related to exposure to macroeconomic fluctuations: about 40 percent of the variation in the basis of a portfolio of commodities with high business cycle sensitivity is explained by the stock and bond yields. Further diagnostics indicate that these associations are largely due to the presence of risk premiums, rather than spot price forecasts, in the basis.

An Unconditional Asset‐Pricing Test and the Role of Firm Size as an Instrumental Variable for Risk

Published: 6/1988,  Volume: 43,  Issue: 2  |  DOI: 10.1111/j.1540-6261.1988.tb03941.x  |  Cited by: 121

K. C. CHAN, NAI‐FU CHEN

In an intertemporal economy where both risk (stock beta) and expected return are time varying, the authors derive a linear relation between the unconditional beta and the unconditional return under certain stationarity assumptions about the stochastic process of size‐portfolio betas. The model suggests the use of long time periods to estimate the unconditional portfolio betas. The authors find that, after controlling for the betas thus estimated, a firm‐size proxy, such as the logarithm of the firm size, does not have explanatory power for the averaged returns across the size‐ranked portfolios.

What Determines the Domestic Bias and Foreign Bias? Evidence from Mutual Fund Equity Allocations Worldwide

Published: 5/3/2005,  Volume: 60,  Issue: 3  |  DOI: 10.1111/j.1540-6261.2005.768_1.x  |  Cited by: 690

KALOK CHAN, VICENTIU COVRIG, LILIAN NG

We examine how mutual funds from 26 developed and developing countries allocate their investment between domestic and foreign equity markets and what factors determine their asset allocations worldwide. We find robust evidence that these funds, in aggregate, allocate a disproportionately larger fraction of investment to domestic stocks. Results indicate that the stock market development and familiarity variables have significant, but asymmetric, effects on the domestic bias (domestic investors overweighting the local markets) and foreign bias (foreign investors under or overweighting the overseas markets), and that economic development, capital controls, and withholding tax variables have significant effects only on the foreign bias.

Structural and Return Characteristics of Small and Large Firms

Published: 9/1991,  Volume: 46,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1991.tb04626.x  |  Cited by: 522

K. C. CHAN, NAI‐FU CHEN

We examine differences in structural characteristics that lead firms of different sizes to react differently to the same economic news. We find that a small firm portfolio contains a large proportion of marginal firms‐firms with low production efficiency and high financial leverage. We construct two size‐matched return indices designed to mimic the return behavior of marginal firms and find that these return indices are important in explaining the time‐series return difference between small and large firms. Furthermore, risk exposures to these indices are as powerful as log(size) in explaining average returns of size‐ranked portfolios.

Institutional Equity Trading Costs: NYSE Versus Nasdaq

Published: 6/1997,  Volume: 52,  Issue: 2  |  DOI: 10.1111/j.1540-6261.1997.tb04819.x  |  Cited by: 151

LOUIS K. C. CHAN, JOSEF LAKONISHOK

We compare execution costs (market impact plus commission) on the New York Stock Exchange (NYSE) and Nasdaq for institutional investors. The differences in cost generally conform to each market's area of specialization. Controlling for firm size, trade size, and the money management firm's identity, costs are lower on Nasdaq for trades in comparatively smaller firms, while costs for trading the larger stocks are lower on NYSE. The cost differences estimated from a regression model are, however, sensitive to the choice of time period.

The Behavior of Stock Prices Around Institutional Trades

Published: 9/1995,  Volume: 50,  Issue: 4  |  DOI: 10.1111/j.1540-6261.1995.tb04053.x  |  Cited by: 582

LOUIS K. C. CHAN, JOSEF LAKONISHOK

All trades executed by 37 large investment management firms from July 1986 to December 1988 are used to study the price impact and execution cost of the entire sequence (“package”) of trades that we interpret as an order. We find that market impact and trading cost are related to firm capitalization, relative package size, and, most importantly, to the identity of the management firm behind the trade. Money managers with high demands for immediacy tend to be associated with larger market impact.

Depositary Receipts, Country Funds, and the Peso Crash: The Intraday Evidence

Published: 12/2000,  Volume: 55,  Issue: 6  |  DOI: 10.1111/0022-1082.00303  |  Cited by: 46

Warren Bailey, Kalok Chan, Y. Peter Chung

We study the intraday impact of exchange rate news on emerging market American Depositary Receipts (ADRs) and closed‐end country funds during the 1994 Mexican peso crisis. Peso exchange‐rate changes affect prices and trading volumes of Latin American equities, and some closed‐end fund behavior is consistent with “noise trader” theories of small investors. However, there is no evidence that peso depreciation triggers a significant sell‐off of non‐Mexican securities or that other non‐Mexican trading patterns change at times of high peso news flow. Thus, the “Tequila Effect” is largely confined to price changes.

Why Option Prices Lag Stock Prices: A Trading‐based Explanation

Published: 12/1993,  Volume: 48,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1993.tb05136.x  |  Cited by: 121

KALOK CHAN, Y. PETER CHUNG, HERB JOHNSON

While many studies find that option prices lead stock prices, Stephan and Whaley (1990) find that stocks lead options. We find no evidence that options, even deep out‐of‐the‐money options, lead stocks. After confirming Stephan and Whaley's results, we show their results can be explained as spurious leads induced by infrequent trading of options. We show that the stock lead disappears when the average of the bid and ask prices is used instead of transaction prices. Hence, we find no evidence of arbitrage opportunities associated with the stock lead.

What if Trading Location Is Different from Business Location? Evidence from the Jardine Group

Published: 5/6/2003,  Volume: 58,  Issue: 3  |  DOI: 10.1111/1540-6261.00564  |  Cited by: 101

Kalok Chan, Allaudeen Hameed, Sie Ting Lau

AbstractWe examine the price behavior and market activity of the Jardine Group companies after they were delisted from Hong Kong in 1994. Although the trading activity of the Jardine Group moved to Singapore, the core businesses remained in Hong Kong and Mainland China. Evidence indicates the Jardine stocks are correlated less (more) with the Hong Kong (Singapore) market after the delisting. This result cannot be explained by various hypotheses, such as relocation of core business, time‐varying betas, migration of trading activity, and currency and tax distortions. We conclude that price fluctuations are affected by country‐specific investor sentiment.

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

Published: 1/10/2008,  Volume: 63,  Issue: 1  |  DOI: 10.1111/j.1540-6261.2008.01313.x  |  Cited by: 318

KALOK CHAN, ALBERT J. MENKVELD, ZHISHU YANG

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.

The Level and Persistence of Growth Rates

Published: 3/21/2003,  Volume: 58,  Issue: 2  |  DOI: 10.1111/1540-6261.00540  |  Cited by: 248

Louis K. C. Chan, Jason Karceski, Josef Lakonishok

Expectations about long‐term earnings growth are crucial to valuation models and cost of capital estimates. We analyze historical long‐term growth rates across a broad cross section of stocks using several indicators of operating performance. We test for persistence and predictability in growth. While some firms have grown at high rates historically, they are relatively rare instances. There is no persistence in long‐term earnings growth beyond chance, and there is low predictability even with a wide variety of predictor variables. Specifically, IBES growth forecasts are overly optimistic and add little predictive power. Valuation ratios also have limited ability to predict future growth.

The Stock Market Valuation of Research and Development Expenditures

Published: 12/2001,  Volume: 56,  Issue: 6  |  DOI: 10.1111/0022-1082.00411  |  Cited by: 1415

Louis K. C. Chan, Josef Lakonishok, Theodore Sougiannis

We examine whether stock prices fully value firms' intangible assets, specifically research and development (R&D). Under current U.S. accounting standards, financial statements do not report intangible assets and R&D spending is expensed. Nonetheless, the average historical stock returns of firms doing R&D matches the returns of firms without R&D. However, the market is apparently too pessimistic about beaten‐down R&D‐intensive technology stocks' prospects. Companies with high R&D to equity market value (which tend to have poor past returns) earn large excess returns. A similar relation exists between advertising and stock returns. R&D intensity is positively associated with return volatility.

Momentum Strategies

Published: 12/1996,  Volume: 51,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1996.tb05222.x  |  Cited by: 1492

LOUIS K. C. CHAN, NARASIMHAN JEGADEESH, JOSEF LAKONISHOK

We examine whether the predictability of future returns from past returns is due to the market's underreaction to information, in particular to past earnings news. Past return and past earnings surprise each predict large drifts in future returns after controlling for the other. Market risk, size, and book–to–market effects do not explain the drifts. There is little evidence of subsequent reversals in the returns of stocks with high price and earnings momentum. Security analysts' earnings forecasts also respond sluggishly to past news, especially in the case of stocks with the worst past performance. The results suggest a market that responds only gradually to new information.

Fundamentals and Stock Returns in Japan

Published: 12/1991,  Volume: 46,  Issue: 5  |  DOI: 10.1111/j.1540-6261.1991.tb04642.x  |  Cited by: 851

LOUIS K. C. CHAN, YASUSHI HAMAO, JOSEF LAKONISHOK

This paper relates cross‐sectional differences in returns on Japanese stocks to the underlying behavior of four variables: earnings yield, size, book to market ratio, and cash flow yield. Alternative statistical specifications and various estimation methods are applied to a comprehensive, high‐quality data set that extends from 1971 to 1988. The sample includes both manufacturing and nonmanufacturing firms, companies from both sections of the Tokyo Stock Exchange, and also delisted securities. Our findings reveal a significant relationship between these variables and expected returns in the Japanese market. Of the four variables considered, the book to market ratio and cash flow yield have the most significant positive impact on expected returns.

Limit Orders, Depth, and Volatility: Evidence from the Stock Exchange of Hong Kong

Published: 4/2001,  Volume: 56,  Issue: 2  |  DOI: 10.1111/0022-1082.00345  |  Cited by: 228

Hee‐Joon Ahn, Kee‐Hong Bae, Kalok Chan

We investigate the role of limit orders in the liquidity provision in a pure order‐driven market. Results show that market depth rises subsequent to an increase in transitory volatility, and transitory volatility declines subsequent to an increase in market depth. We also examine how transitory volatility affects the mix between limit orders and market orders. When transitory volatility arises from the ask (bid) side, investors will submit more limit sell (buy) orders than market sell (buy) orders. This result is consistent with the existence of limit‐order traders who enter the market and place orders when liquidity is needed.

Does Money Explain Asset Returns? Theory and Empirical Analysis

Published: 3/1996,  Volume: 51,  Issue: 1  |  DOI: 10.1111/j.1540-6261.1996.tb05212.x  |  Cited by: 18

K. C. CHAN, SILVERIO FORESI, LARRY H. P. LANG

A cash‐in‐advance model of a monetary economy is used to derive a money‐based CAPM (M‐CAPM), which allows us to implement tests of asset pricing restrictions without consumption data. A test as in Fama and MacBeth of the model suggests that the money betas have some explanatory power for the cross‐sectional variation of expected returns; however, the model is rejected using conditional information. Consistent with our predictions, estimates of the curvature parameter are lower than those of the consumption CAPM (C‐CAPM) and pricing errors of the M‐CAPM tend to be smaller than those of the C‐CAPM.

An Empirical Comparison of Alternative Models of the Short‐Term Interest Rate

Published: 7/1992,  Volume: 47,  Issue: 3  |  DOI: 10.1111/j.1540-6261.1992.tb04011.x  |  Cited by: 741

K. C. CHAN, G. ANDREW KAROLYI, FRANCIS A. LONGSTAFF, ANTHONY B. SANDERS

We estimate and compare a variety of continuous‐time models of the short‐term riskless rate using the Generalized Method of Moments. We find that the most successful models in capturing the dynamics of the short‐term interest rate are those that allow the volatility of interest rate changes to be highly sensitive to the level of the riskless rate. A number of well‐known models perform poorly in the comparisons because of their implicit restrictions on term structure volatility. We show that these results have important implications for the use of different term structure models in valuing interest rate contingent claims and in hedging interest rate risk.