The Journal of Finance

Luck versus Skill in the Cross Section of Mutual Fund Returns: Reexamining the Evidence

Published: 03/27/2022   |   DOI: 10.1111/jofi.13123

CAMPBELL R. HARVEY, YAN LIU

While Kosowski et al. (2006, Journal of Finance 61, 2551–2595) and Fama and French (2010, Journal of Finance 65, 1915–1947) both evaluate whether mutual funds outperform, their conclusions are very different. We reconcile their findings. We show that the Fama‐French method suffers from an undersampling problem that leads to a failure to reject the null hypothesis of zero alpha, even when some funds generate economically large risk‐adjusted returns. In contrast, Kosowski et al. substantially overreject the null hypothesis, even when all funds have a zero alpha. We present a novel bootstrapping approach that should be useful to future researchers choosing between the two approaches.

Dynamic Asset Allocation under Inflation

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00459

Michael J. Brennan, Yihong Xia

We develop a simple framework for analyzing a finite‐horizon investor's asset allocation problem under inflation when only nominal assets are available. The investor's optimal investment strategy and indirect utility are given in simple closed form. Hedge demands depend on the investor's horizon and risk aversion and on the maturities of the bonds included in the portfolio. When short positions are precluded, the optimal strategy consists of investments in cash, equity, and a single nominal bond with optimally chosen maturity. Both the optimal stock‐bond mix and the optimal bond maturity depend on the investor's horizon and risk aversion.

A Variance‐Ratio Test of Random Walks in Foreign Exchange Rates

Published: 06/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb02686.x

CHRISTINA Y. LIU, JIA HE

The separate variance‐ratio tests under homoscedasticity and heteroscedasticity both provide evidence rejecting the random walk hypothesis, using five pairs of weekly nominal exchange rate series over the period from August 7, 1974 to March 29, 1989. The rejections cast doubt on the random walk hypothesis in exchange rates, which has received support in the existing literature. Furthermore, since the rejections are robust to heteroscedasticity, they suggest autocorelations of weekly increments in the nominal exchange rate series, which may be consistent with the exchange rate overshooting or undershooting phenomenon.

Mutual Fund Flows and Cross‐Fund Learning within Families

Published: 03/05/2015   |   DOI: 10.1111/jofi.12263

DAVID P. BROWN, YOUCHANG WU

We develop a model of performance evaluation and fund flows for mutual funds in a family. Family performance has two effects on a member fund's estimated skill and inflows: a positive common‐skill effect, and a negative correlated‐noise effect. The overall spillover can be either positive or negative, depending on the weight of common skill and correlation of noise in returns. Its absolute value increases with family size, and declines over time. The sensitivity of flows to a fund's own performance is affected accordingly. Empirical estimates of fund flow sensitivities show patterns consistent with rational cross‐fund learning within families.

Dealer Bid‐Ask Quotes and Transaction Prices: An Empirical Study of Some AMEX Options

Published: 03/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb03858.x

THOMAS S. Y. HO, RICHARD G. MACRIS

This paper, utilizing dealer's “trading book” information, presents some empirical evidence supporting the validity of a dealer pricing model. It shows that much of the transaction prices variation may be explained by the specialist's optimal determination of his bid and ask quotes. Furthermore, it demonstrates that the dealer's bid‐ask spread is an important explanatory variable in the observed transaction return. Finally, it indicates that the dealer's inventory level may affect his quotes and thus the transaction prices and order arrivals. The paper provides insights into the relationship between transaction prices and equilibrium prices, which will permit more extensive use of transaction data in empirical investigations. It also provides a better understanding of optimal dealer pricing strategies, suggesting that the proposed empirical model may be used to evaluate a dealer's trading performance.

The Foundations of Freezeout Laws in Takeovers

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00664.x

Yakov Amihud, Marcel Kahan, Rangarajan K. Sundaram

We provide an economic basis for permitting freezeouts of nontendering shareholders following successful takeovers. We describe a specific freezeout mechanism based on easily verifiable information that induces desirable efficiency and welfare properties in models of both corporations with widely dispersed shareholdings and corporations with large pivotal shareholders. The mechanism dominates previous proposals along some important dimensions. We also examine takeover premia that arise in the presence of competition among raiders. Our mechanism is closely related to the practice of takeover law in the United States; thus, our analysis may be thought of as analyzing the economic foundations of current regulations.

Lucky CEOs and Lucky Directors

Published: 11/09/2010   |   DOI: 10.1111/j.1540-6261.2010.01618.x

LUCIAN A. BEBCHUK, YANIV GRINSTEIN, URS PEYER

We study the relation between opportunistic timing of option grants and corporate governance failures, focusing on “lucky” grants awarded at the lowest price of the grant month. Option grant practices were designed to provide lucky grants not only to executives but also to independent directors. Lucky grants to both CEOs and directors were the product of deliberate choices, not of firms’ routines, and were timed to make them more profitable. Lucky grants are associated with higher CEO compensation from other sources, no majority of independent directors, no outside blockholder on the compensation committee, and a long‐serving CEO.

The Intra‐Industry Effects of Going‐Private Transactions

Published: 09/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb04630.x

MYRON B. SLOVIN, MARIE E. SUSHKA, YVETTE M. BENDECK

We demonstrate that bids to take firms private generate significantly positive valuation effects for industry rivals of target firms. These valuation effects cannot reflect either synergy or monopoly since no consolidation of operating firms is involved in such transactions. Participation by buyout specialists in the bid does not significantly affect these gains. Bids by outsiders and bids by incumbent managers generate similar valuation effects for industry rivals. The effect on share prices of industry rivals is inversely related to the capitalized values of rival firms relative to the target firm. We also report valuation effects for target firms.

Is Fairly Priced Deposit Insurance Possible?

Published: 03/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb03984.x

YUK‐SHEE CHAN, STUART I. GREENBAUM, ANJAN V. THAKOR

We analyze risk‐sensitive, incentive‐compatible deposit insurance in the presence of private information and moral hazard. Without deposit‐linked subsidies it is impossible to implement risk‐sensitive, incentive‐compatible deposit insurance pricing in a competitive, deregulated environment, except when the deposit insurer is the least risk averse agent in the economy. We establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital; the result holds for alternative sorting instruments as well. This suggests a contradiction between deregulation and fairly priced, risk‐sensitive deposit insurance.

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.

GROWTH, CONSOLIDATION AND MERGERS IN BANKING

Published: 12/01/1974   |   DOI: 10.1111/j.1540-6261.1974.tb03122.x

S. A. Rhoades, A. J. Yeats

EVALUATING INVESTMENTS IN ACCOUNTS RECEIVABLE: A WEALTH MAXIMIZING FRAMEWORK

Published: 05/01/1978   |   DOI: 10.1111/j.1540-6261.1978.tb04857.x

Yong H. Kim, Joseph C. Atkins

Collateral and Competitive Equilibria with Moral Hazard and Private Information

Published: 06/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb02571.x

YUK‐SHEE CHAN, ANJAN V. THAKOR

The authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications. Both moral hazard and adverse selection are considered. The principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts. Specifically, some well‐known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept. Two somewhat surprising results emerge. First, high‐quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits. Second, high‐quality borrowers may put up more collateral.

The Brain Gain of Corporate Boards: Evidence from China

Published: 08/06/2014   |   DOI: 10.1111/jofi.12198

MARIASSUNTA GIANNETTI, GUANMIN LIAO, XIAOYUN YU

We study the impact of directors with foreign experience on firm performance in emerging markets. Using a unique data set from China, we exploit the introduction of policies to attract talented emigrants and increase the supply of individuals with foreign experience in different provinces at different times. We document that performance increases after firms hire directors with foreign experience and identify the channels through which the emigration of talent may lead to a brain gain. Our findings provide evidence on how directors transmit knowledge about management practices and corporate governance to firms in emerging markets.

Short‐Term Debt as Bridge Financing: Evidence from the Commercial Paper Market

Published: 09/17/2014   |   DOI: 10.1111/jofi.12216

MATTHIAS KAHL, ANIL SHIVDASANI, YIHUI WANG

We analyze why firms use nonintermediated short‐term debt by studying the commercial paper (CP) market. Using a comprehensive database of CP issuers and issuance activity, we show that firms use CP to provide start‐up financing for capital investment. Firms’ CP issuance is driven by a desire to minimize transaction costs associated with raising capital for new investment. We show that firms with high rollover risk are less likely to enter the CP market, borrow less CP, and borrow more from bank credit lines. Further, CP is often refinanced with long‐term bond issuance to reduce rollover risk.

Rare Disasters, Financial Development, and Sovereign Debt

Published: 08/13/2022   |   DOI: 10.1111/jofi.13175

SERGIO REBELO, NENG WANG, JINQIANG YANG

We propose a model of sovereign debt in which countries vary in their level of financial development, defined as the extent to which they can issue debt denominated in domestic currency in international capital markets. We show that low levels of financial development generate the “debt intolerance” phenomenon that plagues emerging markets: it reduces overall debt capacity, increases credit spreads, and limits the country's ability to smooth consumption.

Do Acquisitions Relieve Target Firms’ Financial Constraints?

Published: 03/27/2014   |   DOI: 10.1111/jofi.12155

ISIL EREL, YEEJIN JANG, MICHAEL S. WEISBACH

Managers often claim that target firms are financially constrained prior to being acquired and that these constraints are eased following the acquisition. Using a large sample of European acquisitions, we document that the level of cash that target firms hold, the sensitivity of cash to cash flow, and the sensitivity of investment to cash flow all decline, while investment increases following the acquisition. These effects are stronger in deals that are more likely to be associated with financing improvements. Our findings suggest that acquisitions relieve financial frictions in target firms, especially when the target firm is relatively small.

Learning about Consumption Dynamics

Published: 01/27/2015   |   DOI: 10.1111/jofi.12246

MICHAEL JOHANNES, LARS A. LOCHSTOER, YIQUN MOU

This paper characterizes U.S. consumption dynamics from the perspective of a Bayesian agent who does not know the underlying model structure but learns over time from macroeconomic data. Realistic, high‐dimensional macroeconomic learning problems, which entail parameter, model, and state learning, generate substantially different subjective beliefs about consumption dynamics compared to the standard, full‐information rational expectations benchmark. Beliefs about long‐run dynamics are volatile, with counter‐cyclical conditional volatility, and drift over time. Embedding these beliefs in a standard asset pricing model significantly improves the model's ability to match the stylized facts, as well as the sample path of the market price‐dividend ratio.

Preferencing, Internalization, Best Execution, and Dealer Profits

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00167

Oliver Hansch, Narayan Y. Naik, S. Viswanathan

The practices of preferencing and internalization have been alleged to support collusion, cause worse execution, and lead to wider spreads in dealership style markets relative to auction style markets. For a sample of London Stock Exchange stocks, we find that preferenced trades pay higher spreads, however they do not generate higher dealer profits. Internalized trades pay lower, not higher, spreads. We do not find a relation between the extent of preferencing or internalization and spreads across stocks. These results do not lend support to the “collusion” hypothesis but are consistent with a “costly search and trading relationships” hypothesis.

Mean‐Variance Versus Direct Utility Maximization

Published: 03/01/1984   |   DOI: 10.1111/j.1540-6261.1984.tb03859.x

YORAM KROLL, HAIM LEVY, HARRY M. MARKOWITZ

Levy and Markowitz showed, for various utility functions and empirical returns distributions, that the expected utility maximizer could typically do very well if he acted knowing only the mean and variance of each distribution. Levy and Markowitz considered only situations in which the expected utility maximizer chose among a finite number of alternate probability distributions. The present paper examines the same questions for a case with an infinite number of alternate distributions, namely those available from the standard portfolio constraint set.