The Journal of Finance

Pricing New Corporate Bond Issues: An Analysis of Issue Cost and Seasoning Effects

Published: 07/01/1986   |   DOI: 10.1111/j.1540-6261.1986.tb04525.x

W. K. H. FUNG, ANDREW RUDD

The pricing of new corporate bond issues is examined, with particular emphasis on the seasoning effect and the cost of underwriting. Considerable attention is paid to some special features of the corporate bond market, including the use of actual trader quotes so as to accurately measure holding period returns. Our results suggest that the cost of issuing corporate bonds is less than previously reported.

Correlation Risk and Optimal Portfolio Choice

Published: 01/13/2010   |   DOI: 10.1111/j.1540-6261.2009.01533.x

ANDREA BURASCHI, PAOLO PORCHIA, FABIO TROJANI

We develop a new framework for multivariate intertemporal portfolio choice that allows us to derive optimal portfolio implications for economies in which the degree of correlation across industries, countries, or asset classes is stochastic. Optimal portfolios include distinct hedging components against both stochastic volatility and correlation risk. We find that the hedging demand is typically larger than in univariate models, and it includes an economically significant covariance hedging component, which tends to increase with the persistence of variance–covariance shocks, the strength of leverage effects, the dimension of the investment opportunity set, and the presence of portfolio constraints.

Taxes on Tax‐Exempt Bonds

Published: 03/19/2010   |   DOI: 10.1111/j.1540-6261.2009.01545.x

ANDREW ANG, VINEER BHANSALI, YUHANG XING

Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified because a portion of secondary market municipal bond trades involves income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.

What Works in Securities Laws?

Published: 01/20/2006   |   DOI: 10.1111/j.1540-6261.2006.00828.x

RAFAEL PORTA, FLORENCIO LOPEZ‐DE‐SILANES, ANDREI SHLEIFER

We examine the effect of securities laws on stock market development in 49 countries. We find little evidence that public enforcement benefits stock markets, but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets.

Information Flows in Foreign Exchange Markets: Dissecting Customer Currency Trades

Published: 03/18/2016   |   DOI: 10.1111/jofi.12378

LUKAS MENKHOFF, LUCIO SARNO, MAIK SCHMELING, ANDREAS SCHRIMPF

We study the information in order flows in the world's largest over‐the‐counter market, the foreign exchange (FX) market. The analysis draws on a data set covering a broad cross‐section of currencies and different customer segments of FX end‐users. The results suggest that order flows are highly informative about future exchange rates and provide significant economic value. We also find that different customer groups can share risk with each other effectively through the intermediation of a large dealer, and differ markedly in their predictive ability, trading styles, and risk exposure.

Linear‐Rational Term Structure Models

Published: 12/16/2016   |   DOI: 10.1111/jofi.12488

DAMIR FILIPOVIĆ, MARTIN LARSSON, ANDERS B. TROLLE

We introduce the class of linear‐rational term structure models in which the state price density is modeled such that bond prices become linear‐rational functions of the factors. This class is highly tractable with several distinct advantages: (i) ensures nonnegative interest rates, (ii) easily accommodates unspanned factors affecting volatility and risk premiums, and (iii) admits semi‐analytical solutions to swaptions. A parsimonious model specification within the linear‐rational class has a very good fit to both interest rate swaps and swaptions since 1997 and captures many features of term structure, volatility, and risk premium dynamics—including when interest rates are close to the zero lower bound.

Exchange Rates and Monetary Policy Uncertainty

Published: 02/02/2017   |   DOI: 10.1111/jofi.12499

PHILIPPE MUELLER, ALIREZA TAHBAZ‐SALEHI, ANDREA VEDOLIN

We document that a trading strategy that is short the U.S. dollar and long other currencies exhibits significantly larger excess returns on days with scheduled Federal Open Market Committee (FOMC) announcements. We show that these excess returns (i) are higher for currencies with higher interest rate differentials vis‐à‐vis the United States, (ii) increase with uncertainty about monetary policy, and (iii) increase further when the Federal Reserve adopts a policy of monetary easing. We interpret these excess returns as compensation for monetary policy uncertainty within a parsimonious model of constrained financiers who intermediate global demand for currencies.

The Joint Cross Section of Stocks and Options

Published: 05/28/2014   |   DOI: 10.1111/jofi.12181

BYEONG‐JE AN, ANDREW ANG, TURAN G. BALI, NUSRET CAKICI

Stocks with large increases in call (put) implied volatilities over the previous month tend to have high (low) future returns. Sorting stocks ranked into decile portfolios by past call implied volatilities produces spreads in average returns of approximately 1% per month, and the return differences persist up to six months. The cross section of stock returns also predicts option implied volatilities, with stocks with high past returns tending to have call and put option contracts that exhibit increases in implied volatility over the next month, but with decreasing realized volatility. These predictability patterns are consistent with rational models of informed trading.

Advance Refundings of Municipal Bonds

Published: 03/18/2017   |   DOI: 10.1111/jofi.12506

ANDREW ANG, RICHARD C. GREEN, FRANCIS A. LONGSTAFF, YUHANG XING

The advance refunding of debt is a widespread practice in municipal finance. In an advance refunding, municipalities retire callable bonds early and refund them with bonds with lower coupon rates. We find that 85% of all advance refundings occur at a net present value loss, and that the aggregate losses over the past 20 years exceed $15 billion. We explore why municipalities advance refund their debt at loss. Financially constrained municipalities may face pressure to advance refund since it allows them to reduce short‐term cash outflows. We find strong evidence that financial constraints are a major driver of advance refunding activity.

How Integrated are Credit and Equity Markets? Evidence from Index Options

Published: 12/12/2023   |   DOI: 10.1111/jofi.13300

PIERRE COLLIN‐DUFRESNE, BENJAMIN JUNGE, ANDERS B. TROLLE

We study the extent to which credit index (CDX) options are priced consistent with S&P 500 (SPX) equity index options. We derive analytical expressions for CDX and SPX options within a structural credit‐risk model with stochastic volatility and jumps using new results for pricing compound options via multivariate affine transform analysis. The model captures many aspects of the joint dynamics of CDX and SPX options. However, it cannot reconcile the relative levels of option prices, suggesting that credit and equity markets are not fully integrated. A strategy of selling CDX volatility yields significantly higher excess returns than selling SPX volatility.

Performance Incentives within Firms: The Effect of Managerial Responsibility

Published: 07/15/2003   |   DOI: 10.1111/1540-6261.00579

Rajesh K. Aggarwal, Andrew A. Samwick

We show that top management incentives vary by responsibility. For oversight executives, pay‐performance incentives are $1.22 per thousand dollar increase in shareholder wealth higher than for divisional executives. For CEOs, incentives are $5.65 higher than for divisional executives. Incentives for the median top management team are substantial at $32.32. CEOs account for 42 to 58 percent of aggregate team incentives. For divisional executives, the pay–divisional performance sensitivity is positive and increasing in the precision of divisional performance and the pay–firm performance sensitivity is decreasing in the precision of divisional performance. These results support principal–agent models with multiple signals of managerial effort.

The Integration of Insurance and Taxes in Corporate Pension Strategy

Published: 07/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb05022.x

JAMES L. BICKSLER, ANDREW H. CHEN

This paper examines the implications of the joint effects of insurance and taxes for the optimal corporate pension strategy. It is shown that neither the “mini‐max” nor the “maxi‐min” strategy advocated by previous authors is necessarily best in corporate pension management. In the presence of capital market imperfections, the analysis via a single‐period contingent‐claims model indicates that optimal corporate pension strategy in both asset‐allocation and funding decisions can be a noncorner interior solution.

The Term Structure of Real Rates and Expected Inflation

Published: 04/01/2008   |   DOI: 10.1111/j.1540-6261.2008.01332.x

ANDREW ANG, GEERT BEKAERT, MIN WEI

Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time‐varying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve in the United States is fairly flat around 1.3%. In one real rate regime, the real term structure is steeply downward sloping. An inflation risk premium that increases with maturity fully accounts for the generally upward sloping nominal term structure.

Bank Loans, Bonds, and Information Monopolies across the Business Cycle

Published: 05/09/2008   |   DOI: 10.1111/j.1540-6261.2008.01359.x

JOÃO A. C. SANTOS, ANDREW WINTON

Theory suggests that banks' private information about borrowers lets them hold up borrowers for higher interest rates. Since hold‐up power increases with borrower risk, banks with exploitable information should be able to raise their rates in recessions by more than is justified by borrower risk alone. We test this hypothesis by comparing the pricing of loans for bank‐dependent borrowers with the pricing of loans for borrowers with access to public debt markets, controlling for risk factors. Loan spreads rise in recessions, but firms with public debt market access pay lower spreads and their spreads rise significantly less in recessions.

Regulatory Arbitrage and Cross‐Border Bank Acquisitions

Published: 03/05/2015   |   DOI: 10.1111/jofi.12262

G. ANDREW KAROLYI, ALVARO G. TABOADA

We study how differences in bank regulation influence cross‐border bank acquisition flows and share price reactions to cross‐border deal announcements. Using a sample of 7,297 domestic and 916 majority cross‐border deals announced between 1995 and 2012, we find evidence of a form of “regulatory arbitrage” whereby acquisition flows involve acquirers from countries with stronger regulations than their targets. Target and aggregate abnormal returns around deal announcements are positive and larger when acquirers come from more restrictive bank regulatory environments. We interpret this evidence as more consistent with a benign form of regulatory arbitrage than a potentially destructive one.

Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00319

Klaas P. Baks, Andrew Metrick, Jessica Wachter

This paper analyzes mutual‐fund performance from an investor's perspective. We study the portfolio‐choice problem for a mean‐variance investor choosing among a risk‐free asset, index funds, and actively managed mutual funds. To solve this problem, we employ a Bayesian method of performance evaluation; a key innovation in our approach is the development of a flexible set of prior beliefs about managerial skill. We then apply our methodology to a sample of 1,437 mutual funds. We find that some extremely skeptical prior beliefs nevertheless lead to economically significant allocations to active managers.

Do Managerial Objectives Drive Bad Acquisitions?

Published: 03/01/1990   |   DOI: 10.1111/j.1540-6261.1990.tb05079.x

RANDALL MORCK, ANDREI SHLEIFER, ROBERT W. VISHNY

In a sample of 326 US acquisitions between 1975 and 1987, three types of acquisitions have systematically lower and predominantly negative announcement period returns to bidding firms. The returns to bidding shareholders are lower when their firm diversifies, when it buys a rapidly growing target, and when its managers performed poorly before the acquisition. These results suggest that managerial objectives may drive acquisitions that reduce bidding firms' values.

Contrarian Investment, Extrapolation, and Risk

Published: 12/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb04772.x

JOSEF LAKONISHOK, ANDREI SHLEIFER, ROBERT W. VISHNY

For many years, scholars and investment professionals have argued that value strategies outperform the market. These value strategies call for buying stocks that have low prices relative to earnings, dividends, book assets, or other measures of fundamental value. While there is some agreement that value strategies produce higher returns, the interpretation of why they do so is more controversial. This article provides evidence that value strategies yield higher returns because these strategies exploit the suboptimal behavior of the typical investor and not because these strategies are fundamentally riskier.

Information and Incentives Inside the Firm: Evidence from Loan Officer Rotation

Published: 05/07/2010   |   DOI: 10.1111/j.1540-6261.2010.01553.x

ANDREW HERTZBERG, JOSE MARIA LIBERTI, DANIEL PARAVISINI

We present evidence that reassigning tasks among agents can alleviate moral hazard in communication. A rotation policy that routinely reassigns loan officers to borrowers of a commercial bank affects the officers' reporting behavior. When an officer anticipates rotation, reports are more accurate and contain more bad news about the borrower's repayment prospects. As a result, the rotation policy makes bank lending decisions more sensitive to officer reports. The threat of rotation improves communication because self‐reporting bad news has a smaller negative effect on an officer's career prospects than bad news exposed by a successor.

The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Public Care Aversion from Bequest Motives

Published: 03/21/2011   |   DOI: 10.1111/j.1540-6261.2010.01641.x

JOHN AMERIKS, ANDREW CAPLIN, STEVEN LAUFER, STIJN VAN NIEUWERBURGH

The “annuity puzzle,” conveying the apparently low interest of retirees in longevity insurance, is central to household finance. Two possible explanations are “public care aversion” (PCA), retiree aversion to simultaneously running out of wealth and being in need of long‐term care, and an intentional bequest motive. To disentangle the relative importance of PCA and bequest motive, we estimate a structural model of the retirement phase using a novel survey instrument that includes hypothetical questions. We identify PCA as very significant and find bequest motives that spread deep into the middle class. Our results highlight potential interest in annuities that make allowance for long‐term care expenses.