The Journal of Finance

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.

Explaining Forward Exchange Bias…Intraday

Published: 09/01/1995   |   DOI: 10.1111/j.1540-6261.1995.tb04061.x

RICHARD K. LYONS, ANDREW K. ROSE

Intraday interest rates are zero. Consequently, a foreign exchange dealer can short a vulnerable currency in the morning, close this position in the afternoon, and never face an interest cost. This tactic might seem especially attractive in times of fixed‐rate crisis, since it suggests an immunity to the central bank's interest rate defense. In equilibrium, however, buyers of the vulnerable currency must be compensated on average with an intraday capital gain as long as no devaluation occurs. That is, currencies under attack should typically appreciate intraday. Using data on intraday exchange rate changes within the European Monetary System, we find this prediction is borne out.

Reputation Effects in Trading on the New York Stock Exchange

Published: 05/08/2007   |   DOI: 10.1111/j.1540-6261.2007.01235.x

ROBERT BATTALIO, ANDREW ELLUL, ROBERT JENNINGS

Theory suggests that reputations allow nonanonymous markets to attenuate adverse selection in trading. We identify instances in which New York Stock Exchange (NYSE) stocks experience trading floor relocations. Although specialists follow the stocks to their new locations, most brokers do not. We find a discernable increase in liquidity costs around a stock's relocation that is larger for stocks with higher adverse selection and greater broker turnover. We also find that floor brokers relocating with the stock obtain lower trading costs than brokers not moving and brokers beginning trading post‐move. Our results suggest that reputation plays an important role in the NYSE's liquidity provision process.

Diagnostic Expectations and Credit Cycles

Published: 09/26/2017   |   DOI: 10.1111/jofi.12586

PEDRO BORDALO, NICOLA GENNAIOLI, ANDREI SHLEIFER

We present a model of credit cycles arising from diagnostic expectations—a belief formation mechanism based on Kahneman and Tversky's representativeness heuristic. Diagnostic expectations overweight future outcomes that become more likely in light of incoming data. The expectations formation rule is forward looking and depends on the underlying stochastic process, and thus is immune to the Lucas critique. Diagnostic expectations reconcile extrapolation and neglect of risk in a unified framework. In our model, credit spreads are excessively volatile, overreact to news, and are subject to predictable reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.

The Efficient Use of Conditioning Information in Portfolios

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00351

Wayne E. Ferson, Andrew F. Siegel

We study the properties of unconditional minimum‐variance portfolios in the presence of conditioning information. Such portfolios attain the smallest variance for a given mean among all possible portfolios formed using the conditioning information. We provide explicit solutions for n risky assets, either with or without a riskless asset. Our solutions provide insights into portfolio management problems and issues in conditional asset pricing.

The October 1979 Change in the U.S. Monetary Regime: Its Impact on the Forecastability of Canadian Interest Rates

Published: 03/01/1988   |   DOI: 10.1111/j.1540-6261.1988.tb02598.x

JAMES E. PESANDO, ANDRÉ PLOURDE

Subsequent to the October 1979 shift in monetary policy in the United States, interest rates in North America not only reached unprecedented levels but also exhibited unprecedented volatility. Using Canadian data, the authors show that anticipated quarterly changes in long‐term rates associated with the rational‐expectations model have remained small during this post‐shift period. The authors examine three sets of recorded forecasts of long‐term interest rates in Canada and note their failure to improve upon the no‐change prediction. The “perverse” relationship between the slope of the yield curve and the subsequent movement in long‐term rates exists in the Canadian data but is of only modest value in a forecasting context. The excess returns on long‐term bonds implicit in the recorded forecasts of the level of interest rates vary sharply, yet there is little evidence that forecasters have identified a predictable component of time‐varying term premia.

Estimating Private Equity Returns from Limited Partner Cash Flows

Published: 05/10/2018   |   DOI: 10.1111/jofi.12688

ANDREW ANG, BINGXU CHEN, WILLIAM N. GOETZMANN, LUDOVIC PHALIPPOU

We introduce a methodology to estimate the historical time series of returns to investment in private equity funds. The approach requires only an unbalanced panel of cash contributions and distributions accruing to limited partners and is robust to sparse data. We decompose private equity returns from 1994 to 2015 into a component due to traded factors and a time‐varying private equity premium not spanned by publicly traded factors. We find cyclicality in private equity returns that differs according to fund type and is consistent with the conjecture that capital market segmentation contributes to private equity returns.

Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00265

Andrew W. Lo, Harry Mamaysky, Jiang Wang

Technical analysis, also known as “charting,” has been a part of financial practice for many decades, but this discipline has not received the same level of academic scrutiny and acceptance as more traditional approaches such as fundamental analysis. One of the main obstacles is the highly subjective nature of technical analysis—the presence of geometric shapes in historical price charts is often in the eyes of the beholder. In this paper, we propose a systematic and automatic approach to technical pattern recognition using nonparametric kernel regression, and we apply this method to a large number of U.S. stocks from 1962 to 1996 to evaluate the effectiveness of technical analysis. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution—conditioned on specific technical indicators such as head‐and‐shoulders or double bottoms—we find that over the 31‐year sample period, several technical indicators do provide incremental information and may have some practical value.

The Cross‐Section of Volatility and Expected Returns

Published: 01/20/2006   |   DOI: 10.1111/j.1540-6261.2006.00836.x

ANDREW ANG, ROBERT J. HODRICK, YUHANG XING, XIAOYAN ZHANG

We examine the pricing of aggregate volatility risk in the cross‐section of stock returns. Consistent with theory, we find that stocks with high sensitivities to innovations in aggregate volatility have low average returns. Stocks with high idiosyncratic volatility relative to the Fama and French (1993, Journal of Financial Economics 25, 2349) model have abysmally low average returns. This phenomenon cannot be explained by exposure to aggregate volatility risk. Size, book‐to‐market, momentum, and liquidity effects cannot account for either the low average returns earned by stocks with high exposure to systematic volatility risk or for the low average returns of stocks with high idiosyncratic volatility.

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.

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.

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.

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.