The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.
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Brokers and Order Flow Leakage: Evidence from Fire Sales
Published: 08/09/2019 | DOI: 10.1111/jofi.12840
ANDREA BARBON, MARCO DI MAGGIO, FRANCESCO FRANZONI, AUGUSTIN LANDIER
Using trade‐level data, we study whether brokers play a role in spreading order flow information in the stock market. We focus on large portfolio liquidations that result in temporary price drops, and identify the brokers who intermediate these trades. These brokers’ clients are more likely to predate on the liquidating funds than to provide liquidity. Predation leads to profits of about 25 basis points over 10 days and increases the liquidation costs of the distressed fund by 40%. This evidence suggests a role of information leakage in exacerbating fire sales.
Optimal Hedging in Futures Markets with Multiple Delivery Specifications
Published: 09/01/1987 | DOI: 10.1111/j.1540-6261.1987.tb03924.x
AVRAHAM KAMARA, ANDREW F. SIEGEL
Nearly all futures contracts allow delivery of any of several qualities of the underlying asset. Consequently, the price of the futures contract is associated more with the price of the expected cheapest deliverable variety than with the price of the par‐delivery variety. The delivery specifications introduce a delivery risk for every hedger in the market. We derive the optimal hedging strategies in these markets. Their hedging effectiveness is evaluated for wheat futures contracts in Chicago. Hedging optimally would have significantly reduced the variance of the rates of return on hedges while yielding similar mean returns.
Reinvestment Risk and the Equity Term Structure
Published: 04/27/2021 | DOI: 10.1111/jofi.13035
ANDREI S. GONÇALVES
The equity term structure is downward sloping at long maturities. I estimate an Intertemporal Capital Asset Pricing Model (ICAPM) to show that the trade‐off between market and reinvestment risk explains this pattern. Intuitively, while long‐term dividend claims are highly exposed to market risk, they are good hedges for reinvestment risk because dividend prices rise as expected returns decline, and longer‐term claims are more sensitive to discount rates. In the estimated ICAPM, reinvestment risk dominates at long maturities, inducing relatively low risk premia on long‐term dividend claims. The model is also consistent with the equity term structure cyclicality and the upward‐sloping bond term structure.
Every Cloud Has a Silver Lining: Fast Trading, Microwave Connectivity, and Trading Costs
Published: 07/27/2020 | DOI: 10.1111/jofi.12969
ANDRIY SHKILKO, KONSTANTIN SOKOLOV
Modern markets are characterized by speed differentials, with some traders being fractions of a second faster than others. Theoretical models suggest that such differentials may have both positive and negative effects on liquidity and gains from trade. We examine these effects by studying a series of exogenous weather episodes that temporarily remove the speed advantages of the fastest traders by disrupting their microwave networks. The disruptions are associated with lower adverse selection and lower trading costs. In additional analysis, we show that the long‐term removal of speed differentials results in similar effects and also increases gains from trade.
Implementing Option Pricing Models When Asset Returns Are Predictable
Published: 03/01/1995 | DOI: 10.1111/j.1540-6261.1995.tb05168.x
ANDREW W. LO, JIANG WANG
The predictability of an asset's returns will affect the prices of options on that asset, even though predictability is typically induced by the drift, which does not enter the option pricing formula. For discretely‐sampled data, predictability is linked to the parameters that do enter the option pricing formula. We construct an adjustment for predictability to the Black‐Scholes formula and show that this adjustment can be important even for small levels of predictability, especially for longer maturity options. We propose several continuous‐time linear diffusion processes that can capture broader forms of predictability, and provide numerical examples that illustrate their importance for pricing options.
Portfolio Analysis with Factors and Scenarios
Published: 09/01/1981 | DOI: 10.1111/j.1540-6261.1981.tb04889.x
HARRY M. MARKOWITZ, ANDRÉF. PEROLD
Recently there has been a growing interest in the scenario model of covariance as an alternative to the one‐factor or many‐factor models. We show how the covariance matrix resulting from the scenario model can easily be made diagonal by adding new variables linearly related to the amounts invested; note the meanings of these new variables; note how portfolio variance divides itself into “within scenario” and “between scenario” variances; and extend the results to models in which scenarios and factors both appear where factor distributions and effects may or may not be scenario sensitive.
Nonparametric Estimation of State‐Price Densities Implicit in Financial Asset Prices
Published: 12/17/2002 | DOI: 10.1111/0022-1082.215228
Yacine Aït‐Sahalia, Andrew W. Lo
Implicit in the prices of traded financial assets are Arrow–Debreu prices or, with continuous states, the state‐price density (SPD). We construct a nonparametric estimator for the SPD implicit in option prices and we derive its asymptotic sampling theory. This estimator provides an arbitrage‐free method of pricing new, complex, or illiquid securities while capturing those features of the data that are most relevant from an asset‐pricing perspective, for example, negative skewness and excess kurtosis for asset returns, and volatility “smiles” for option prices. We perform Monte Carlo experiments and extract the SPD from actual S&P 500 option prices.
Joint Effects of Interest Rate Deregulation and Capital Requirements on Optimal Bank Portfolio Adjustments
Published: 06/01/1985 | DOI: 10.1111/j.1540-6261.1985.tb04973.x
CHUN H. LAM, ANDREW H. CHEN
The 1980 Depository Institution Deregulation and Monetary Control Act (DIDMCA) mandates that Regulation Q be phased out by 1986. With deregulation of interest rate ceilings, the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets. Thus, value‐maximizing bank managers would need to be concerned not only with the internal risk, but also with the external risk in bank portfolio management decisions. Based upon the cash flow version of the capital asset pricing model, this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm.
Firm Investment and Stakeholder Choices: A Top‐Down Theory of Capital Budgeting
Published: 06/01/2017 | DOI: 10.1111/jofi.12526
ANDRES ALMAZAN, ZHAOHUI CHEN, SHERIDAN TITMAN
This paper develops a top‐down model of capital budgeting in which privately informed executives make investment choices that convey information to the firm's stakeholders (e.g., employees). Favorable information in this setting encourages stakeholders to take actions that positively contribute to the firm's success (e.g., employees work harder). Within this framework we examine how firms may distort their investment choices to influence the information conveyed to stakeholders and show that investment rigidities and overinvestment can arise as optimal investment distortions. We also examine investment distortions in multi‐divisional firms and compare such distortions to those in single‐division firms.
Organization Capital and the Cross‐Section of Expected Returns
Published: 02/15/2013 | DOI: 10.1111/jofi.12034
ANDREA L. EISFELDT, DIMITRIS PAPANIKOLAOU
Organization capital is a production factor that is embodied in the firm's key talent and has an efficiency that is firm specific. Hence, both shareholders and key talent have a claim to its cash flows. We develop a model in which the outside option of the key talent determines the share of firm cash flows that accrue to shareholders. This outside option varies systematically and renders firms with high organization capital riskier from shareholders' perspective. We find that firms with more organization capital have average returns that are 4.6% higher than firms with less organization capital.
A Survey of Corporate Governance
Published: 04/18/2012 | DOI: 10.1111/j.1540-6261.1997.tb04820.x
Andrei Shleifer, Robert W. Vishny
This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.
Entrenchment and Severance Pay in Optimal Governance Structures
Published: 03/21/2003 | DOI: 10.1111/1540-6261.00536
Andres Almazan, Javier Suarez
This paper explores how motivating an incumbent CEO to undertake actions that improve the effectiveness of his management interacts with the firm's policy on CEO replacement. Such policy depends on the presence and the size of severance pay in the CEO's compensation package and on the CEO's influence on the board of directors regarding his own replacement (i.e., entrenchment). We explain when and why the combination of some degree of entrenchment and a sizeable severance package is desirable. The analysis offers predictions about the correlation between entrenchment, severance pay, and incentive compensation.