The Journal of Finance

Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle

Published: 05/01/2015   |   DOI: 10.1111/jofi.12286

ROBERT F. STAMBAUGH, JIANFENG YU, YU YUAN

Buying is easier than shorting for many equity investors. Combining this arbitrage asymmetry with the arbitrage risk represented by idiosyncratic volatility (IVOL) explains the negative relation between IVOL and average return. The IVOL‐return relation is negative among overpriced stocks but positive among underpriced stocks, with mispricing determined by combining 11 return anomalies. Consistent with arbitrage asymmetry, the negative relation among overpriced stocks is stronger, especially for stocks less easily shorted, so the overall IVOL‐return relation is negative. Further supporting our explanation, high investor sentiment weakens the positive relation among underpriced stocks and, especially, strengthens the negative relation among overpriced stocks.

Corporate Fraud and Business Conditions: Evidence from IPOs

Published: 11/09/2010   |   DOI: 10.1111/j.1540-6261.2010.01615.x

TRACY YUE WANG, ANDREW WINTON, XIAOYUN YU

We examine how a firm's incentive to commit fraud when going public varies with investor beliefs about industry business conditions. Fraud propensity increases with the level of investor beliefs about industry prospects but decreases when beliefs are extremely high. We find that two mechanisms are at work: monitoring by investors and short‐term executive compensation, both of which vary with investor beliefs about industry prospects. We also find that monitoring incentives of investors and underwriters differ. Our results are consistent with models of investor beliefs and corporate fraud, and suggest that regulators and auditors should be vigilant for fraud during booms.

Predictable Stock Returns in the United States and Japan: A Study of Long‐Term Capital Market Integration

Published: 03/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb03978.x

JOHN Y. CAMPBELL, YASUSHI HAMAO

This paper uses the predictability of monthly excess returns on U.S. and Japanese equity portfolios over the U.S. Treasury bill rate to study the integration of long‐term capital markets in these two countries. During the period 1971–1990 similar variables, including the dividend‐price ratio and interest rate variables, help to forecast excess returns in each country. In addition, in the 1980's U.S. variables help to forecast excess Japanese stock returns. There is some evidence of common movement in expected excess returns across the two countries, which is suggestive of integration of long‐term capital markets.

Risk Management with Derivatives by Dealers and Market Quality in Government Bond Markets

Published: 09/11/2003   |   DOI: 10.1111/1540-6261.00591

Narayan Y. Naik, Pradeep K. Yadav

This paper investigates how bond dealers manage core business risk with interest rate futures and the extent to which market quality is affected by their selective risk taking. We observe that dealers use futures to take directional bets and hedge changes in their spot exposure. We find that, cross‐sectionally, a dealer with longer (shorter) risk exposure sells (buys) a larger amount of exposure the next day. However, this risk control takes place via the futures market and not the spot market. Finally, we find strong support for the price effects of capital constraints emphasized by Froot and Stein (1998).

Political Uncertainty and Corporate Investment Cycles

Published: 01/17/2012   |   DOI: 10.1111/j.1540-6261.2011.01707.x

BRANDON JULIO, YOUNGSUK YOOK

We document cycles in corporate investment corresponding with the timing of national elections around the world. During election years, firms reduce investment expenditures by an average of 4.8% relative to nonelection years, controlling for growth opportunities and economic conditions. The magnitude of the investment cycles varies with different country and election characteristics. We investigate several potential explanations and find evidence supporting the hypothesis that political uncertainty leads firms to reduce investment expenditures until the electoral uncertainty is resolved. These findings suggest that political uncertainty is an important channel through which the political process affects real economic outcomes.

On the Costs of a Bank‐Centered Financial System: Evidence from the Changing Main Bank Relations in Japan

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.254893

David E. Weinstein, Yishay Yafeh

We examine the effects of bank–firm relationships on firm performance in Japan. When access to capital markets is limited, close bank–firm ties increase the availability of capital to borrowing firms, but do not lead to higher profitability or growth. The cost of capital of firms with close bank ties is higher than that of their peers. This indicates that most of the benefits from these relationships are appropriated by the banks. Finally, the slow growth rates of bank clients suggest that banks discourage firms from investing in risky, profitable projects. However, liberalization of financial markets reduces the banks' market power.

General Risk Aversion and Attitude Towards Risk

Published: 06/01/1980   |   DOI: 10.1111/j.1540-6261.1980.tb03492.x

YAKOV AMIHUD

Financial Networks: Contagion, Commitment, and Private Sector Bailouts

Published: 11/10/2005   |   DOI: 10.1111/j.1540-6261.2005.00821.x

YARON LEITNER

I develop a model of financial networks in which linkages not only spread contagion, but also induce private sector bailouts, where liquid banks bail out illiquid banks because of the threat of contagion. Introducing this bailout possibility, I show that linkages may be optimal ex ante because they allow banks to obtain some mutual insurance even though formal commitments are impossible. However, in some cases (e.g., when liquidity is concentrated among a small group of banks), the whole network may collapse. I also characterize the optimal network size and apply the results to joint liability arrangements and payment systems.

Informed Trading and Intertemporal Substitution

Published: 10/21/2019   |   DOI: 10.1111/jofi.12857

YIZHOU XIAO

I examine the possibility of information‐based trading in a multiperiod consumption setting. I develop a necessary and sufficient condition for trade to occur. Intertemporal substitution introduces a desire to correlate current consumption with future aggregate shocks. When agents have heterogeneous time‐inseparable preferences, information differentially affects relative preferences for current and future consumption, making information‐based trading mutually acceptable. The no‐trade result continues to hold if there is no aggregate shock, or if agents have either homogeneous or time‐separable preferences.

INTERTEMPORAL DETERMINATION OF THE MARKET PRICE OF RISK

Published: 12/01/1977   |   DOI: 10.1111/j.1540-6261.1977.tb03362.x

Yoram Landskroner

The Mismatch Between Mutual Fund Scale and Skill

Published: 05/20/2020   |   DOI: 10.1111/jofi.12950

YANG SONG

I demonstrate that skill and scale are mismatched among actively managed equity mutual funds. Many mutual fund investors confuse the effects of fund exposures to common systematic factors with managerial skill when allocating capital among funds. Active mutual funds with positive factor‐related past returns thus accumulate assets to the point that they significantly underperform. I also show that the negative aggregate benchmark‐adjusted performance of active equity mutual funds is driven mainly by these oversized funds.

Transition Densities for Interest Rate and Other Nonlinear Diffusions

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00149

Yacine Aït‐Sahalia

This paper applies to interest rate models the theoretical method developed in Aït‐Sahalia (1998) to generate accurate closed‐form approximations to the transition function of an arbitrary diffusion. While the main focus of this paper is on the maximum‐likelihood estimation of interest rate models with otherwise unknown transition functions, applications to the valuation of derivative securities are also briefly discussed.

DISCUSSION

Published: 03/01/1950   |   DOI: 10.1111/j.1540-6261.1950.tb00098.x

Richard C. Youngdahl

DISCUSSION

Published: 06/01/1978   |   DOI: 10.1111/j.1540-6261.1978.tb00769.x

Jess B. Yawitz

Derivation of the Capital Asset Pricing Model without Normality or Quadratic Preference: A Note

Published: 12/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb02398.x

YOUNG K. KWON

Derivation of the capital asset pricing model requires various assumptions including normality or quadratic preference. The objective of this note is to show that the normality or quadratic preference assumption can be replaced by the fair game condition that assets' residual returns have zero mean conditional upon the return of the market portfolio.

What's Not There: Odd Lots and Market Data

Published: 06/25/2014   |   DOI: 10.1111/jofi.12185

MAUREEN O'HARA, CHEN YAO, MAO YE

We investigate odd‐lot trades in equity markets. Odd lots are increasingly used in algorithmic and high‐frequency trading, but are not reported to the consolidated tape or in databases such as TAQ. In our sample, the median number of odd‐lot trades is 24% but in some stocks odd lots are 60% or more of trading. Odd‐lot trades contribute 35% of price discovery, consistent with informed traders using odd lots to avoid detection. Omitting odd‐lot trades leads to inaccuracies in order imbalance measures and makes sentiment measures unreliable. Excluding odd lots from the consolidated tape raises important regulatory issues.

Good Timing: CEO Stock Option Awards and Company News Announcements

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb04809.x

DAVID YERMACK

This article analyzes the timing of CEO stock option awards, as a method of investigating corporate managers' influence over the terms of their own compensation. In a sample of 620 stock option awards to CEOs of Fortune 500 companies between 1992 and 1994, I find that the timing of awards coincides with favorable movements in company stock prices. Patterns of companies' quarterly earnings announcements are consistent with an interpretation that CEOs receive stock option awards shortly before favorable corporate news. I evaluate and reject several alternative explanations of the results, including insider trading and the manipulation of news announcement dates.

A Consumption‐Based Explanation of Expected Stock Returns

Published: 03/09/2006   |   DOI: 10.1111/j.1540-6261.2006.00848.x

MOTOHIRO YOGO

When utility is nonseparable in nondurable and durable consumption and the elasticity of substitution between the two consumption goods is sufficiently high, marginal utility rises when durable consumption falls. The model explains both the cross‐sectional variation in expected stock returns and the time variation in the equity premium. Small stocks and value stocks deliver relatively low returns during recessions, when durable consumption falls, which explains their high average returns relative to big stocks and growth stocks. Stock returns are unexpectedly low at business cycle troughs, when durable consumption falls sharply, which explains the countercyclical variation in the equity premium.

Do Equity Markets Care about Income Inequality? Evidence from Pay Ratio Disclosure

Published: 02/06/2022   |   DOI: 10.1111/jofi.13113

YIHUI PAN, ELENA S. PIKULINA, STEPHAN SIEGEL, TRACY YUE WANG

We examine equity markets’ reaction to the first‐time disclosure of the CEO‐worker pay ratio by U.S. public companies in 2018. We find that firms disclosing higher pay ratios experience significantly lower abnormal announcement returns. Firms whose shareholders are more inequality‐averse experience a more negative market response to high pay ratios. Furthermore, during 2018 more inequality‐averse investors rebalance their portfolios away from stocks with a high pay ratio relative to other investors. Our results suggest that equity markets are concerned about high within‐firm pay dispersion, and investors’ inequality aversion is a channel through which high pay ratios negatively affect firm value.

Mandatory Portfolio Disclosure, Stock Liquidity, and Mutual Fund Performance

Published: 01/27/2015   |   DOI: 10.1111/jofi.12245

VIKAS AGARWAL, KEVIN A. MULLALLY, YUEHUA TANG, BAOZHONG YANG

We examine the impact of mandatory portfolio disclosure by mutual funds on stock liquidity and fund performance. We develop a model of informed trading with disclosure and test its predictions using the May 2004 SEC regulation requiring more frequent disclosure. Stocks with higher fund ownership, especially those held by more informed funds or subject to greater information asymmetry, experience larger increases in liquidity after the regulation change. More informed funds, especially those holding stocks with greater information asymmetry, experience greater performance deterioration after the regulation change. Overall, mandatory disclosure improves stock liquidity but imposes costs on informed investors.