The Journal of Finance

A New Approach to Testing Asset Pricing Models: The Bilinear Paradigm

Published: 06/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb02498.x

STEPHEN J. BROWN, MARK I. WEINSTEIN

We propose a new approach to estimating and testing asset pricing models in the context of a bilinear paradigm introduced by Kruskal [18]. This approach is both simple and at the same time quite general. As an illustration we apply it to the special case of the arbitrage pricing model where the number of factors is pre‐specified. The data appear to be generally in conflict with a five or seven factor representation of the model used by Roll and Ross [30]. When we consider the number of replications of our test and the large number of observations on which it is performed, the frequency with which we reject the three factor APM does not lead us to conclude that this model is unrepresentative of security returns. Further, the rejection of the five and seven factor versions is to be expected if the three factor version is correct. The paradigm gives insight into the appropriate specification of the model and suggests that there may be a small number of economy wide factors that affect security returns.

IQ and Stock Market Participation

Published: 11/14/2011   |   DOI: 10.1111/j.1540-6261.2011.01701.x

MARK GRINBLATT, MATTI KELOHARJU, JUHANI LINNAINMAA

Stock market participation is monotonically related to IQ, controlling for wealth, income, age, and other demographic and occupational information. The high correlation between IQ and participation exists even among the affluent. Supplemental data from siblings, studied with an instrumental variables approach and regressions that control for family effects, demonstrate that IQ's influence on participation extends to females and does not arise from omitted familial and nonfamilial variables. High‐IQ investors are more likely to hold mutual funds and larger numbers of stocks, experience lower risk, and earn higher Sharpe ratios. We discuss implications for policy and finance research.

Limited Arbitrage in Equity Markets

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00434

Mark Mitchell, Todd Pulvino, Erik Stafford

We examine 82 situations where the market value of a company is less than its subsidiary. These situations imply arbitrage opportunities, providing an ideal setting to study the risks and market frictions that prevent arbitrageurs from immediately forcing prices to fundamental values. For 30 percent of the sample, the link between the parent and its subsidiary is severed before the relative value discrepancy is corrected. Furthermore, returns to a specialized arbitrageur would be 50 percent larger if the path to convergence was smooth rather than as observed. Uncertainty about the distribution of returns and characteristics of the risks limits arbitrage.

Tax‐Induced Trading and the Turn‐of‐the‐Year Anomaly: An Intraday Study

Published: 06/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04728.x

MARK D. GRIFFITHS, ROBERT W. WHITE

This study tests the tax‐induced trading hypothesis as an explanation of the turn‐of‐the‐year anomaly using Canadian and U.S. intraday data. Since the Canadian tax year‐end precedes the calendar year‐end by five business days, tax effects may be isolated. We find the anomaly is related to the degree of seller‐and buyer‐initiated trading and depends upon the incidence of the taxation year‐end. Seller‐initiated transactions (at bid prices) dominate until the tax year‐end after which buyer‐initiated trades (at ask prices) dominate. The anomaly is a function of bid‐ask prices.

Evidence of Bank Market Discipline in Subordinated Debenture Yields: 1983–1991

Published: 09/01/1996   |   DOI: 10.1111/j.1540-6261.1996.tb04072.x

MARK J. FLANNERY, SORIN M. SORESCU

We examine debenture yields over the period 1983–1991 to evaluate the market's sensitivity to bank‐specific risks, and conclude that investors have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although this evidence does not establish that market discipline can effectively control banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the major U.S. banking firms.

Why Don't U.S. Issuers Demand European Fees for IPOs?

Published: 11/14/2011   |   DOI: 10.1111/j.1540-6261.2011.01699.x

MARK ABRAHAMSON, TIM JENKINSON, HOWARD JONES

We compare fees charged by investment banks for conducting IPOs in the United States and Europe. In recent years, the “7% solution,” as documented by Chen and Ritter (2000), has become even more prevalent in the United States, and is now the norm for IPOs raising up to $250 million. The same banks dominate both markets, but European IPO fees are roughly three percentage points lower, are much more variable, and have been falling. We review explanations for the gap in spreads and find the evidence consistent with strategic pricing. U.S. issuers could have saved over $1 billion a year by paying European fees.

Do Peer Firms Affect Corporate Financial Policy?

Published: 08/22/2013   |   DOI: 10.1111/jofi.12094

MARK T. LEARY, MICHAEL R. ROBERTS

We show that peer firms play an important role in determining corporate capital structures and financial policies. In large part, firms' financing decisions are responses to the financing decisions and, to a lesser extent, the characteristics of peer firms. These peer effects are more important for capital structure determination than most previously identified determinants. Furthermore, smaller, less successful firms are highly sensitive to their larger, more successful peers, but not vice versa. We also quantify the externalities generated by peer effects, which can amplify the impact of changes in exogenous determinants on leverage by over 70%.

The Behavior of the Common Stock of Bankrupt Firms

Published: 05/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb02257.x

TRUMAN A. CLARK, MARK I. WEINSTEIN

Catastrophic Risk and Credit Markets

Published: 03/13/2009   |   DOI: 10.1111/j.1540-6261.2009.01446.x

MARK J. GARMAISE, TOBIAS J. MOSKOWITZ

We provide a model of the effects of catastrophic risk on real estate financing and prices and demonstrate that insurance market imperfections can restrict the supply of credit for catastrophe‐susceptible properties. Using unique micro‐level data, we find that earthquake risk decreased commercial real estate bank loan provision by 22% in California properties in the 1990s, with more severe effects in African–American neighborhoods. We show that the 1994 Northridge earthquake had only a short‐term disruptive effect. Our basic findings are confirmed for hurricane risk, and our model and empirical work have implications for terrorism and political perils.

From T‐Bills to Common Stocks: Investigating the Generality of Intra‐Week Return Seasonality

Published: 06/01/1988   |   DOI: 10.1111/j.1540-6261.1988.tb03948.x

MARK J. FLANNERY, ARIS A. PROTOPAPADAKIS

The authors investigate the extent to which intra‐week seasonality still exists and whether its pattern is uniform across three stock indices and Treasury bonds with seven different maturities. They find that intra‐week seasonality continues to be significant and that its pattern is not uniform, either between the stock indices and the Treasury bonds or even among the bonds alone. A pattern shared by stocks and bonds is that Monday returns become increasingly negative with maturity. These findings suggest that neither institutional nor general‐equilibriumex planations by themselves can explain the pattern of intra‐week seasonality in securities markets.

The Effect of Money Shocks on Interest Rates in the Presence of Conditional Heteroskedasticity

Published: 09/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb04761.x

KEVIN B. GRIER, MARK J. PERRY

Most current empirical work finds no evidence that money shocks lower interest rates. We show that these nonresults are mainly due to a failure to model the conditional heteroskedasticity of interest rates. Autoregressive conditional heteroskedasticity (ARCH) models find a significant liquidity effect where ordinary least squares (OLS) models do not. The existence of a liquidity effect is found using different models and sample periods when ARCH models are used in estimation, but never when OLS is employed.

On The Robustness of Size and Book‐to‐Market in Cross‐Sectional Regressions

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb01113.x

PETER J. KNEZ, MARK J. READY

We use a robust regression estimator to analyze the risk premia on size and book‐to‐market. We find that the risk premium on size that was estimated by Fama and French (1992) completely disappears when the 1 percent most extreme observations are trimmed each month. We also show that the negative average of the monthly size coefficients reported by Fama and French can be entirely explained by the 16 months with the most extreme coefficients. We argue that further investigation of these results could lead to an understanding of the economic forces underlying the size effect, and may also yield important insights into how firms grow.

Optimal Debt and Equity Values in the Presence of Chapter 7 and Chapter 11

Published: 05/08/2007   |   DOI: 10.1111/j.1540-6261.2007.01238.x

MARK BROADIE, MIKHAIL CHERNOV, SURESH SUNDARESAN

Explicit presence of reorganization in addition to liquidation leads to conflicts of interest between borrowers and lenders. In the first–best outcome, reorganization adds value to both parties via higher debt capacity, lower credit spreads, and improved overall firm value. If control of the ex ante reorganization timing and the ex post decision to liquidate is given to borrowers, most of the benefits are appropriated by borrowers ex post. Lenders can restore the first–best outcome by seizing this control or by the ex post transfer of control rights. Reorganization is more likely and liquidation is less likely relative to the benchmark case with liquidation only.

The Impact of Public Information on the Stock Market

Published: 07/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb00083.x

MARK L. MITCHELL, J. HAROLD MULHERIN

We study the relation between the number of news announcements reported daily by Dow Jones & Company and aggregate measures of securities market activity including trading volume and market returns. We find that the number of Dow Jones announcements and market activity are directly related and that the results are robust to the addition of factors previously found to influence financial markets such as day‐of‐the‐week dummy variables, news importance as proxied by large New York Times headlines and major macroeconomic announcements, and noninformation sources of market activity as measured by dividend capture and triple witching trading. However, the observed relation between news and market activity is not particularly strong and the patterns in news announcements do not explain the day‐of‐the‐week seasonalities in market activity. Our analysis of the Dow Jones database confirms the difficulty of linking volume and volatility to observed measures of information.

Do Firms Rebalance Their Capital Structures?

Published: 11/10/2005   |   DOI: 10.1111/j.1540-6261.2005.00811.x

MARK T. LEARY, MICHAEL R. ROBERTS

We empirically examine whether firms engage in a dynamic rebalancing of their capital structures while allowing for costly adjustment. We begin by showing that the presence of adjustment costs has significant implications for corporate financial policy and the interpretation of previous empirical results. After confirming that financing behavior is consistent with the presence of adjustment costs, we find that firms actively rebalance their leverage to stay within an optimal range. Our evidence suggests that the persistent effect of shocks on leverage observed in previous studies is more likely due to adjustment costs than indifference toward capital structure.

Bank Mergers and Crime: The Real and Social Effects of Credit Market Competition

Published: 03/09/2006   |   DOI: 10.1111/j.1540-6261.2006.00847.x

MARK J. GARMAISE, TOBIAS J. MOSKOWITZ

Using a unique sample of commercial loans and mergers between large banks, we provide micro‐level (within‐county) evidence linking credit conditions to economic development and find a spillover effect on crime. Neighborhoods that experience more bank mergers are subject to higher interest rates, diminished local construction, lower prices, an influx of poorer households, and higher property crime in subsequent years. The elasticity of property crime with respect to merger‐induced banking concentration is 0.18. We show that these results are not likely due to reverse causation, and confirm the central findings using state branching deregulation to instrument for bank competition.

A Dynamic Equilibrium for the Ross Arbitrage Model

Published: 06/01/1980   |   DOI: 10.1111/j.1540-6261.1980.tb03491.x

JAMES A. OHLSON, MARK B. GARMAN

The Effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions

Published: 09/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb03898.x

MARK J. FLANNERY, CHRISTOPHER M. JAMES

This paper examines the relation between the interest rate sensitivity of common stock returns and the maturity composition of the firm's nominal contracts. Using a sample of actively traded commerical banks and stock savings and loan associations, common stock returns are found to be correlated with interest rate changes. The co‐movement of stock returns and interest rate changes is positively related to the size of the maturity difference between the firm's nominal assets and liabilities.

Price Pressure around Mergers

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00626.x

Mark Mitchell, Todd Pulvino, Erik Stafford

This paper examines the trading behavior of professional investors around 2,130 mergers announced between 1994 and 2000. We find considerable support for the existence of price pressure around mergers caused by uninformed shifts in excess demand, but that these effects are short‐lived, consistent with the notion that short‐run demand curves for stocks are not perfectly elastic. We estimate that nearly half of the negative announcement period stock price reaction for acquirers in stock‐financed mergers reflects downward price pressure caused by merger arbitrage short selling, suggesting that previous estimates of merger wealth effects are biased downward.

Model Specification and Risk Premia: Evidence from Futures Options

Published: 05/08/2007   |   DOI: 10.1111/j.1540-6261.2007.01241.x

MARK BROADIE, MIKHAIL CHERNOV, MICHAEL JOHANNES

This paper examines model specification issues and estimates diffusive and jump risk premia using S&P futures option prices from 1987 to 2003. We first develop a time series test to detect the presence of jumps in volatility, and find strong evidence in support of their presence. Next, using the cross section of option prices, we find strong evidence for jumps in prices and modest evidence for jumps in volatility based on model fit. The evidence points toward economically and statistically significant jump risk premia, which are important for understanding option returns.