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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Implementing Option Pricing Models When Asset Returns Are Predictable
Published: 03/01/1995 | DOI: 10.1111/j.1540-6261.1995.tb05168.x
ANDREW W. LO, JIANG WANG
The predictability of an asset's returns will affect the prices of options on that asset, even though predictability is typically induced by the drift, which does not enter the option pricing formula. For discretely‐sampled data, predictability is linked to the parameters that do enter the option pricing formula. We construct an adjustment for predictability to the Black‐Scholes formula and show that this adjustment can be important even for small levels of predictability, especially for longer maturity options. We propose several continuous‐time linear diffusion processes that can capture broader forms of predictability, and provide numerical examples that illustrate their importance for pricing options.
Portfolio Analysis with Factors and Scenarios
Published: 09/01/1981 | DOI: 10.1111/j.1540-6261.1981.tb04889.x
HARRY M. MARKOWITZ, ANDRÉF. PEROLD
Recently there has been a growing interest in the scenario model of covariance as an alternative to the one‐factor or many‐factor models. We show how the covariance matrix resulting from the scenario model can easily be made diagonal by adding new variables linearly related to the amounts invested; note the meanings of these new variables; note how portfolio variance divides itself into “within scenario” and “between scenario” variances; and extend the results to models in which scenarios and factors both appear where factor distributions and effects may or may not be scenario sensitive.
Personal Bankruptcy and Credit Market Competition
Published: 03/19/2010 | DOI: 10.1111/j.1540-6261.2009.01547.x
ASTRID A. DICK, ANDREAS LEHNERT
We document a link between U.S. credit supply and rising personal bankruptcy rates. We exploit the exogenous variation in market contestability brought on by banking deregulation—the relaxation of entry restrictions in the 1980s and 1990s—at the state level. We find deregulation explains at least 10% of the rise in bankruptcy rates. We also find that deregulation leads to increased lending, lower loss rates on loans, and higher lending productivity. Our findings indicate that increased competition prompted banks to adopt sophisticated credit rating technology, allowing for new credit extension to existing and previously excluded households.
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.
Joint Effects of Interest Rate Deregulation and Capital Requirements on Optimal Bank Portfolio Adjustments
Published: 06/01/1985 | DOI: 10.1111/j.1540-6261.1985.tb04973.x
CHUN H. LAM, ANDREW H. CHEN
The 1980 Depository Institution Deregulation and Monetary Control Act (DIDMCA) mandates that Regulation Q be phased out by 1986. With deregulation of interest rate ceilings, the cost of raising capital funds for commercial banks would become more volatile and more closely related with interest rates in the money and capital markets. Thus, value‐maximizing bank managers would need to be concerned not only with the internal risk, but also with the external risk in bank portfolio management decisions. Based upon the cash flow version of the capital asset pricing model, this paper analyzes the joint impact of interest rate deregulation and capital requirements on the portfolio behavior of a banking firm.
Firm Investment and Stakeholder Choices: A Top‐Down Theory of Capital Budgeting
Published: 06/01/2017 | DOI: 10.1111/jofi.12526
ANDRES ALMAZAN, ZHAOHUI CHEN, SHERIDAN TITMAN
This paper develops a top‐down model of capital budgeting in which privately informed executives make investment choices that convey information to the firm's stakeholders (e.g., employees). Favorable information in this setting encourages stakeholders to take actions that positively contribute to the firm's success (e.g., employees work harder). Within this framework we examine how firms may distort their investment choices to influence the information conveyed to stakeholders and show that investment rigidities and overinvestment can arise as optimal investment distortions. We also examine investment distortions in multi‐divisional firms and compare such distortions to those in single‐division firms.
Entrenchment and Severance Pay in Optimal Governance Structures
Published: 03/21/2003 | DOI: 10.1111/1540-6261.00536
Andres Almazan, Javier Suarez
This paper explores how motivating an incumbent CEO to undertake actions that improve the effectiveness of his management interacts with the firm's policy on CEO replacement. Such policy depends on the presence and the size of severance pay in the CEO's compensation package and on the CEO's influence on the board of directors regarding his own replacement (i.e., entrenchment). We explain when and why the combination of some degree of entrenchment and a sizeable severance package is desirable. The analysis offers predictions about the correlation between entrenchment, severance pay, and incentive compensation.
Mortgage Redlining: Race, Risk, and Demand
Published: 03/01/1994 | DOI: 10.1111/j.1540-6261.1994.tb04421.x
ANDREW HOLMES, PAUL HORVITZ
Charges that geographical redlining is widely practiced by mortgage lenders and is associated with racial discrimination have received much attention. However, empirical research in this area has yet to document a convincing answer to the question of whether redlining even exists. Much of the previous research in this area has suffered from failure to account for variations in risk, and/or failure to adequately control for geographical differences in demand. This study addresses these problems in an effort to determine whether the disparity in the flow of mortgage credit can be explained by differences in risk and demand.
Where Is the Risk in Value? Evidence from a Market‐to‐Book Decomposition
Published: 08/09/2019 | DOI: 10.1111/jofi.12836
ANDREY GOLUBOV, THEODOSIA KONSTANTINIDI
We study the value premium using the multiples‐based market‐to‐book decomposition of Rhodes‐Kropf, Robinson, and Viswanathan (2005). The market‐to‐value component drives all of the value strategy return, while the value‐to‐book component exhibits no return predictability in either portfolio sorts or firm‐level regressions. Existing results linking market‐to‐book to operating leverage, duration, exposure to investment‐specific technology shocks, and analysts’ risk ratings derive from the unpriced value‐to‐book component. In contrast, results on expectation errors, limits to arbitrage, and certain types of cash flow risk and consumption risk exposure are due to the market‐to‐value component. Overall, our evidence casts doubt on several value premium theories.
A Survey of Corporate Governance
Published: 04/18/2012 | DOI: 10.1111/j.1540-6261.1997.tb04820.x
Andrei Shleifer, Robert W. Vishny
This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.
Explaining Forward Exchange Bias…Intraday
Published: 09/01/1995 | DOI: 10.1111/j.1540-6261.1995.tb04061.x
RICHARD K. LYONS, ANDREW K. ROSE
Intraday interest rates are zero. Consequently, a foreign exchange dealer can short a vulnerable currency in the morning, close this position in the afternoon, and never face an interest cost. This tactic might seem especially attractive in times of fixed‐rate crisis, since it suggests an immunity to the central bank's interest rate defense. In equilibrium, however, buyers of the vulnerable currency must be compensated on average with an intraday capital gain as long as no devaluation occurs. That is, currencies under attack should typically appreciate intraday. Using data on intraday exchange rate changes within the European Monetary System, we find this prediction is borne out.
Reputation Effects in Trading on the New York Stock Exchange
Published: 05/08/2007 | DOI: 10.1111/j.1540-6261.2007.01235.x
ROBERT BATTALIO, ANDREW ELLUL, ROBERT JENNINGS
Theory suggests that reputations allow nonanonymous markets to attenuate adverse selection in trading. We identify instances in which New York Stock Exchange (NYSE) stocks experience trading floor relocations. Although specialists follow the stocks to their new locations, most brokers do not. We find a discernable increase in liquidity costs around a stock's relocation that is larger for stocks with higher adverse selection and greater broker turnover. We also find that floor brokers relocating with the stock obtain lower trading costs than brokers not moving and brokers beginning trading post‐move. Our results suggest that reputation plays an important role in the NYSE's liquidity provision process.
Diagnostic Expectations and Credit Cycles
Published: 09/26/2017 | DOI: 10.1111/jofi.12586
PEDRO BORDALO, NICOLA GENNAIOLI, ANDREI SHLEIFER
We present a model of credit cycles arising from diagnostic expectations—a belief formation mechanism based on Kahneman and Tversky's representativeness heuristic. Diagnostic expectations overweight future outcomes that become more likely in light of incoming data. The expectations formation rule is forward looking and depends on the underlying stochastic process, and thus is immune to the Lucas critique. Diagnostic expectations reconcile extrapolation and neglect of risk in a unified framework. In our model, credit spreads are excessively volatile, overreact to news, and are subject to predictable reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.
The Efficient Use of Conditioning Information in Portfolios
Published: 12/17/2002 | DOI: 10.1111/0022-1082.00351
Wayne E. Ferson, Andrew F. Siegel
We study the properties of unconditional minimum‐variance portfolios in the presence of conditioning information. Such portfolios attain the smallest variance for a given mean among all possible portfolios formed using the conditioning information. We provide explicit solutions for n risky assets, either with or without a riskless asset. Our solutions provide insights into portfolio management problems and issues in conditional asset pricing.