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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Presidential Address: Issuers, Underwriter Syndicates, and Aftermarket Transparency
Published: 08/14/2007 | DOI: 10.1111/j.1540-6261.2007.01250.x
RICHARD C. GREEN
I model strategic interaction among issuers, underwriters, retail investors, and institutional investors when the secondary market has limited price transparency. Search costs for retail investors lead to price dispersion in the secondary market, while the price for institutional investors is infinitely elastic. Because retail distribution capacity is assumed to be limited for each underwriter‐dealer, Bertrand competition breaks down in the primary market and new issues are underpriced in equilibrium. Syndicates emerge in which underwriters bid symmetrically, with quantities allocated internally to efficiently utilize retail distribution capacity.
Positively Weighted Portfolios on the Minimum‐Variance Frontier
Published: 12/01/1986 | DOI: 10.1111/j.1540-6261.1986.tb02530.x
RICHARD C. GREEN
Duality theory is employed to provide necessary and sufficient conditions for portfolios on the minimum‐variance frontier to have positive investment proportions in all assets. These conditions involve the feasibility of portfolios that have non‐negative correlation with all assets and positive correlation with at least one. Using these results, several “qualitative” results concerning the signs of investment proportions in efficient portfolios are proved. It is argued that the conditions that ensure all‐positive weights in efficient portfolios are intuitively compelling and are not unique to the CAPM. With large numbers of assets, however, the signs of weights in minimum‐variance portfolios can be very sensitive to slight departures from these conditions due to, for example, sampling error.
Benchmark Portfolio Inefficiency and Deviations from the Security Market Line
Published: 06/01/1986 | DOI: 10.1111/j.1540-6261.1986.tb05037.x
RICHARD C. GREEN
This paper theoretically evaluates the robustness of the Security Market Line relationship when the market proxy employed is not mean‐variance efficient. The analysis focuses on the behavior of the “benchmark errors,” the deviations of assets and portfolios from the Security Market Line. First, we characterize how the location of an asset in mean‐variance space determines its benchmark error. Then the continuity properties of the benchmark errors are studied. The results indicate that the magnitudes of the errors exhibit continuous but not uniformly continuous behaviors. The relative rankings based on deviations from the Security Market Line, however, exhibit some severe discontinuities. In fact, these can be exactly reversed for two proxies arbitrarily close in mean‐variance space.
Risk Aversion and Arbitrage
Published: 03/01/1985 | DOI: 10.1111/j.1540-6261.1985.tb04948.x
RICHARD C. GREEN, SANJAY SRIVASTAVA
This paper characterizes conditions under which asset returns and consumption are consistent with risk‐averse preferences. It is shown that risk aversion is equivalent to “zero arbitrage” on a transformation of the payoff space. The implicit state prices which are dual to this no‐arbitrage condition can be interpreted as prices of “pure consumption hedges.” This zero‐arbitrage restriction implies the usual restrictions associated with nonsatiation. The analysis holds in both complete and incomplete market settings.
When Will Mean‐Variance Efficient Portfolios Be Well Diversified?
Published: 12/01/1992 | DOI: 10.1111/j.1540-6261.1992.tb04683.x
RICHARD C. GREEN, BURTON HOLLIFIELD
We characterize the conditions under which efficient portfolios put small weights on individual assets. These conditions bound mean returns with measures of average absolute covariability between assets. The bounds clarify the relationship between linear asset pricing models and well‐diversified efficient portfolios. We argue that the extreme weightings in sample efficient portfolios are due to the dominance of a single factor in equity returns. This makes it easy to diversify on subsets to reduce residual risk, while weighting the subsets to reduce factor risk simultaneously. The latter involves taking extreme positions. This behavior seems unlikely to be attributable to sampling error.
The Structure and Incentive Effects of Corporate Tax Liabilities
Published: 09/01/1985 | DOI: 10.1111/j.1540-6261.1985.tb02365.x
RICHARD C. GREEN, ELI TALMOR
This paper describes situations in which tax liabilities assume the form of a negative position in a call option. This structure motivates an examination of the investment decisions of taxed corporations in the presence of risk. It is shown that the structure of the tax liability creates an incentive to underinvest in more risky projects and an incentive for conglomerate merger. These effects are then evaluated in the presence of conflicts of interest between stockholders and bondholders, and under alternative assumptions about the tax code, and about the timing of investment and financing decisions.
Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets
Published: 12/01/1987 | DOI: 10.1111/j.1540-6261.1987.tb04358.x
ROBERT M. DAMMON, RICHARD C. GREEN
In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or “tax arbitrage.” This paper characterizes the joint restrictions on financial‐asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short‐sale constraints. The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then “no‐tax‐arbitrage” prices will exist. They also show that the existence of “no‐tax‐arbitrage” prices ensures the existence of equilibrium prices.
Are There Tax Effects in the Relative Pricing of U.S. Government Bonds?
Published: 04/18/2012 | DOI: 10.1111/j.1540-6261.1997.tb04815.x
RICHARD C. GREEN, BERNT A. ØDEGAARD
We investigate the impact of the Tax Reform Act of 1986 on the relative pricing of U.S. Treasury bonds. We obtain positive statistically and economically significant estimates for the implicit tax rates of a “representative” investor in the late 1970s and early 1980s. After the 1986 Tax Reform, the point estimates for the tax rate are close to zero. Tests for a regime shift associated with the 1986 Tax Reform support the hypothesis that this event largely eliminated tax effects from the term structure. We discuss both institutional and statutory explanations for this change.
Financial Expertise as an Arms Race
Published: 09/12/2012 | DOI: 10.1111/j.1540-6261.2012.01771.x
VINCENT GLODE, RICHARD C. GREEN, RICHARD LOWERY
We show that firms intermediating trade have incentives to overinvest in financial expertise. In our model, expertise improves firms’ ability to estimate value when trading a security. Expertise creates asymmetric information, which, under normal circumstances, works to the advantage of the expert as it deters opportunistic bargaining by counterparties. This advantage is neutralized in equilibrium, however, by offsetting investments by competitors. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.
Price Discovery in Illiquid Markets: Do Financial Asset Prices Rise Faster Than They Fall?
Published: 09/21/2010 | DOI: 10.1111/j.1540-6261.2010.01590.x
RICHARD C. GREEN, DAN LI, NORMAN SCHÜRHOFF
We study price discovery in municipal bonds, an important OTC market. As in markets for consumer goods, prices “rise faster than they fall.” Round‐trip profits to dealers on retail trades increase in rising markets but do not decrease in falling markets. Further, effective half‐spreads increase or decrease more when movements in fundamentals favor dealers. Yield spreads relative to Treasuries also adjust with asymmetric speed in rising and falling markets. Finally, intraday price dispersion is asymmetric in rising and falling markets, as consumer search theory would predict.
Optimal Investment, Growth Options, and Security Returns
Published: 12/17/2002 | DOI: 10.1111/0022-1082.00161
Jonathan B. Berk, Richard C. Green, Vasant Naik
As a consequence of optimal investment choices, a firm's assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firm's systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time‐series relation between the book‐to‐market ratio and asset returns; (ii) the cross‐sectional relation between book‐to‐market, market value, and return; (iii) contrarian effects at short horizons; (iv) momentum effects at longer horizons; and (v) the inverse relation between interest rates and the market risk premium.
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.