The Journal of Finance

On Cointegration and Exchange Rate Dynamics

Published: 06/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb05160.x

FRANCIS X. DIEBOLD, JAVIER GARDEAZABAL, KAMIL YILMAZ

Baillie and Bollerslev (1989) have recently argued that nominal dollar spot exchange rates are cointegrated. Here we examine an immediate implication of their finding, namely, that cointegration implies an error‐correction representation yielding forecasts superior to those from a martingale benchmark, in light of a large earlier literature highlighting the predictive superiority of the martingale. In an out‐of‐sample forecasting exercise, we find the martingale model to be superior. We then perform a battery of improved cointegration tests and find that the evidence for cointegration is much less strong than previously thought, a result consistent with the outcome of the forecasting exercise.

Costly Information Acquisition, Social Networks, and Asset Prices: Experimental Evidence

Published: 02/27/2019   |   DOI: 10.1111/jofi.12768

EDWARD HALIM, YOHANES E. RIYANTO, NILANJAN ROY

We design an experiment to study the implications of information networks for incentives to acquire costly information, market liquidity, investors' earnings, and asset price characteristics in a financial market. Social communication crowds out information production as a result of an agent's temptation to free ride on the signals purchased by her neighbors. Although information exchange among traders increases trading volume, improves liquidity, and enhances the ability of asset prices to reflect the available information in the market, it fails to improve price informativeness. Net earnings and social welfare are higher with information sharing due to reduced acquisition of costly signals.

Retail Financial Innovation and Stock Market Dynamics: The Case of Target Date Funds

Published: 06/19/2023   |   DOI: 10.1111/jofi.13258

JONATHAN A. PARKER, ANTOINETTE SCHOAR, YANG SUN

Target date funds (TDFs) are designed to provide unsophisticated or inattentive investors with age‐appropriate exposures to different asset classes like stocks and bonds. The rise of TDFs has moved a significant share of retirement investors into macrocontrarian strategies that sell stocks after relatively good stock market performance. This rebalancing drives contrarian flows across equity mutual funds held by TDFs, stabilizing their funding, and reduces stock returns for stocks disproportionately held by these funds when stock market returns are relatively high. Continued growth in TDFs and similar investment products may dampen stock market volatility and increase the transmission of shocks across asset classes.

THE ROLE OF THE MULTINATIONAL FIRM IN THE INTEGRATION OF SEGMENTED CAPITAL MARKETS

Published: 05/01/1977   |   DOI: 10.1111/j.1540-6261.1977.tb03286.x

Michael Adler, Wayne Y. Lee, Kanwal S. Sachdeva

Optimal Regulation Under Uncertainty

Published: 09/01/1981   |   DOI: 10.1111/j.1540-6261.1981.tb04892.x

WILLIAM J. MARSHALL, JESS B. YAWITZ, EDWARD GREENBERG

This paper is concerned with the problem of price regulation when demand is uncertain. Uncertainty gives rise to substantial difficulties in determining both the return a firm's owners should be provided and a set of prices capable of producing that return. We argue that conventional approaches to price regulation are incapable of attaining the economically desirable objectives of efficiency and an equitable return to investors. The deficiencies in current practices are attributable to the separation of the risk measurement‐return determination and price setting activities in the conventional approach. We present a model of the regulated firm that synthesizes contemporary financial market theory and the theory of the firm under uncertainty.1 In our approach, the income stream produced by the firm is valued ex ante in the financial market according to investors' perceptions and preferences over riskreturn characteristics. We portray the firm as producing risk and return by choosing among available production technologies to maximize its market value, given the prices set by regulators. Within this framework, it is shown that regulators can choose the lowest prices consistent with an equitable return to investors. We also show that prices so chosen induce the choice of the optimal technology by the firm.

Autoregressive Modeling of Earnings‐Investment Causality

Published: 03/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb02547.x

SASSON BAR‐YOSEF, JEFFREY L. CALLEN, JOSHUA LIVNAT

The purpose of this paper is to empirically test the relationships between corporate earnings and investment. In particular, the study investigates whether knowledge of past investments improves the prediction of future earnings beyond predictions that are based on past earnings alone. Similarly, it investigates whether knowledge of past earnings improves the prediction of future investments beyond knowledge of past investments alone. This is the empirical definition of Granger causality. The empirical results show that the bivariate past series of earnings and investments is superior to the univariate series in predicting future investments but not in predicting future earnings.

Fundamentals and Stock Returns in Japan

Published: 12/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb04642.x

LOUIS K. C. CHAN, YASUSHI HAMAO, JOSEF LAKONISHOK

This paper relates cross‐sectional differences in returns on Japanese stocks to the underlying behavior of four variables: earnings yield, size, book to market ratio, and cash flow yield. Alternative statistical specifications and various estimation methods are applied to a comprehensive, high‐quality data set that extends from 1971 to 1988. The sample includes both manufacturing and nonmanufacturing firms, companies from both sections of the Tokyo Stock Exchange, and also delisted securities. Our findings reveal a significant relationship between these variables and expected returns in the Japanese market. Of the four variables considered, the book to market ratio and cash flow yield have the most significant positive impact on expected returns.

The Real and Financial Implications of Corporate Hedging

Published: 09/21/2011   |   DOI: 10.1111/j.1540-6261.2011.01683.x

MURILLO CAMPELLO, CHEN LIN, YUE MA, HONG ZOU

We study the implications of hedging for corporate financing and investment. We do so using an extensive, hand‐collected data set on corporate hedging activities. Hedging can lower the odds of negative realizations, thereby reducing the expected costs of financial distress. In theory, this should ease a firm's access to credit. Using a tax‐based instrumental variable approach, we show that hedgers pay lower interest spreads and are less likely to have capital expenditure restrictions in their loan agreements. These favorable financing terms, in turn, allow hedgers to invest more. Our tests characterize two exact channels—cost of borrowing and investment restrictions—through which hedging affects corporate outcomes. The analysis shows that hedging has a first‐order effect on firm financing and investment, and provides new insights into how hedging affects corporate value. More broadly, our study contributes novel evidence on the real consequences of financial contracting.

Dynamic CEO Compensation

Published: 09/12/2012   |   DOI: 10.1111/j.1540-6261.2012.01768.x

ALEX EDMANS, XAVIER GABAIX, TOMASZ SADZIK, YULIY SANNIKOV

We study optimal compensation in a dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed‐form contract that yields clear predictions for how the level and performance sensitivity of pay vary over time and across firms. The contract can be implemented by escrowing the CEO's pay into a “Dynamic Incentive Account” that comprises cash and the firm's equity. The account features state‐dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time‐dependent vesting to deter short‐termism.

Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds

Published: 06/19/2018   |   DOI: 10.1111/jofi.12706

ALEKSANDAR ANDONOV, YAEL V. HOCHBERG, JOSHUA D. RAUH

Representation on pension fund boards by state officials—often determined by statute decades past—is negatively related to the performance of private equity investments made by the pension fund, despite state officials’ relatively strong financial education and experience. Their underperformance appears to be partly driven by poor investment decisions consistent with political expediency, and is also positively related to political contributions from the finance industry. Boards dominated by elected rank‐and‐file plan participants also underperform, but to a smaller extent and due to these trustees’ lesser financial experience.

Why Option Prices Lag Stock Prices: A Trading‐based Explanation

Published: 12/01/1993   |   DOI: 10.1111/j.1540-6261.1993.tb05136.x

KALOK CHAN, Y. PETER CHUNG, HERB JOHNSON

While many studies find that option prices lead stock prices, Stephan and Whaley (1990) find that stocks lead options. We find no evidence that options, even deep out‐of‐the‐money options, lead stocks. After confirming Stephan and Whaley's results, we show their results can be explained as spurious leads induced by infrequent trading of options. We show that the stock lead disappears when the average of the bid and ask prices is used instead of transaction prices. Hence, we find no evidence of arbitrage opportunities associated with the stock lead.

Simple Forecasts and Paradigm Shifts

Published: 05/08/2007   |   DOI: 10.1111/j.1540-6261.2007.01234.x

HARRISON HONG, JEREMY C. STEIN, JIALIN YU

We study the asset pricing implications of learning in an environment in which the true model of the world is a multivariate one, but agents update only over the class of simple univariate models. Thus, if a particular simple model does a poor job of forecasting over a period of time, it is discarded in favor of an alternative simple model. The theory yields a number of distinctive predictions for stock returns, generating forecastable variation in the magnitude of the value‐glamour return differential, in volatility, and in the skewness of returns. We validate several of these predictions empirically.

Volatility, the Macroeconomy, and Asset Prices

Published: 09/30/2013   |   DOI: 10.1111/jofi.12110

RAVI BANSAL, DANA KIKU, IVAN SHALIASTOVICH, AMIR YARON

How important are volatility fluctuations for asset prices and the macroeconomy? We find that an increase in macroeconomic volatility is associated with an increase in discount rates and a decline in consumption. We develop a framework in which cash flow, discount rate, and volatility risks determine risk premia and show that volatility plays a significant role in explaining the joint dynamics of returns to human capital and equity. Volatility risk carries a sizable positive risk premium and helps account for the cross section of expected returns. Our evidence demonstrates that volatility is important for understanding expected returns and macroeconomic fluctuations.

Sparse Signals in the Cross‐Section of Returns

Published: 10/09/2018   |   DOI: 10.1111/jofi.12733

ALEX CHINCO, ADAM D. CLARK‐JOSEPH, MAO YE

This paper applies the Least Absolute Shrinkage and Selection Operator (LASSO) to make rolling one‐minute‐ahead return forecasts using the entire cross‐section of lagged returns as candidate predictors. The LASSO increases both out‐of‐sample fit and forecast‐implied Sharpe ratios. This out‐of‐sample success comes from identifying predictors that are unexpected, short‐lived, and sparse. Although the LASSO uses a statistical rule rather than economic intuition to identify predictors, the predictors it identifies are nevertheless associated with economically meaningful events: the LASSO tends to identify as predictors stocks with news about fundamentals.

Leverage Is a Double‐Edged Sword

Published: 02/15/2024   |   DOI: 10.1111/jofi.13316

AVANIDHAR SUBRAHMANYAM, KE TANG, JINGYUAN WANG, XUEWEI YANG

We use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out‐of‐sample, we find that relative performance differentials across unskilled and skilled investors persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by skilled investors, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.

THE JOINT DETERMINATION OF PORTFOLIO AND TRANSACTION DEMANDS FOR MONEY

Published: 03/01/1974   |   DOI: 10.1111/j.1540-6261.1974.tb00033.x

Andrew H. Y. Chen, Frank C. Jen, Stanley Zionts

The Cost of Debt

Published: 11/09/2010   |   DOI: 10.1111/j.1540-6261.2010.01611.x

JULES H. Van BINSBERGEN, JOHN R. GRAHAM, JIE YANG

We use exogenous variation in tax benefit functions to estimate firm‐specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book‐to‐market. By integrating the area between the benefit and cost functions, we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit (cost) of debt equal to 10.4% (6.9%) of asset value. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute only half of the total ex ante costs of debt.

Who Owns What? A Factor Model for Direct Stockholding

Published: 03/07/2023   |   DOI: 10.1111/jofi.13220

VIMAL BALASUBRAMANIAM, JOHN Y. CAMPBELL, TARUN RAMADORAI, BENJAMIN RANISH

We build a cross‐sectional factor model for investors' direct stockholdings and estimate it using data from almost 10 million retail accounts in the Indian stock market. Our model identifies strong investor clienteles for stock characteristics, most notably firm age and share price, and for particular clusters of stock characteristics. These clienteles are intuitively associated with investor attributes such as account age, size, and diversification. Coheld stocks tend to have higher return covariance, inconsistent with simple models of diversification but suggestive that clientele demands influence stock returns.

The Effect of Bank Relations on Investment Decisions: An Investigation of Japanese Takeover Bids

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00284

Jun‐Koo Kang, Anil Shivdasani, Takeshi Yamada

We study 154 domestic mergers in Japan during 1977 to 1993. In contrast to U.S. evidence, mergers are viewed favorably by investors of acquiring firms. We document a two‐day acquirer abnormal return of 1.2 percent and a mean cumulative abnormal return of 5.4 percent for the duration of the takeover. Announcement returns display a strong positive association with the strength of acquirer's relationships with banks. The benefits of bank relations appear to be greater for firms with poor investment opportunities and when the banking sector is healthy. We conclude that close ties with informed creditors, such as banks, facilitate investment policies that enhance shareholder wealth.

The Dynamics of Dealer Markets Under Competition

Published: 09/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb02282.x

THOMAS S. Y. HO, HANS R. STOLL

The behavior of competing dealers in securities markets is analyzed. Securities are characterized by stochastic returns and stochastic transactions. Reservation bid and ask prices of dealers are derived under alternative assumptions about the degree to which transactions are correlated across stocks at a given time and over time in a given stock. The conditions for interdealer trading are specified, and the equilibrium distribution of dealer inventories and the equilibrium market spread are derived. Implications for the structure of securities markets are examined.