The Journal of Finance

Are Investors Rational? Choices among Index Funds

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00633.x

Edwin J. Elton, Martin J. Gruber, Jeffrey A. Busse

S&P 500 index funds represent one of the simplest vehicles for examining rational behavior. They hold virtually the same securities, yet their returns differ by more than 2 percent per year. Although the relative returns of alternative S&P 500 funds are easily predictable, the relationship between cash flows and performance is weaker than rational behavior would lead us to expect. We show that selecting funds based on low expenses or high past returns outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

“ARE BETAS BEST?”†

Published: 12/01/1978   |   DOI: 10.1111/j.1540-6261.1978.tb03426.x

Edwin J. Elton, Martin J. Gruber, Thomas J. Urich

SIMPLE CRITERIA FOR OPTIMAL PORTFOLIO SELECTION: TRACING OUT THE EFFICIENT FRONTIER

Published: 03/01/1978   |   DOI: 10.1111/j.1540-6261.1978.tb03407.x

Edwin J. Elton, Martin J. Gruber, Manfred W. Padberg

Explaining the Rate Spread on Corporate Bonds

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00324

Edwin J. Elton, Martin J. Gruber, Deepak Agrawal, Christopher Mann

The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes explain a substantial portion of the difference, the remaining portion of the spread is closely related to the factors that we commonly accept as explaining risk premiums for common stocks. Both our time series and cross‐sectional tests support the existence of a risk premium on corporate bonds.

DISCUSSION

Published: 05/01/1952   |   DOI: 10.1111/j.1540-6261.1952.tb00248.x

L. L. Ecker‐Racz, Martin R. Gainsbrugh, Lawrence H. Seltzer

Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00318

John Y. Campbell, Martin Lettau, Burton G. Malkiel, Yexiao Xu

This paper uses a disaggregated approach to study the volatility of common stocks at the market, industry, and firm levels. Over the period from 1962 to 1997 there has been a noticeable increase in firm‐level volatility relative to market volatility. Accordingly, correlations among individual stocks and the explanatory power of the market model for a typical stock have declined, whereas the number of stocks needed to achieve a given level of diversification has increased. All the volatility measures move together countercyclically and help to predict GDP growth. Market volatility tends to lead the other volatility series. Factors that may be responsible for these findings are suggested.

The Leverage Ratchet Effect

Published: 10/10/2017   |   DOI: 10.1111/jofi.12588

ANAT R. ADMATI, PETER M. DEMARZO, MARTIN F. HELLWIG, PAUL PFLEIDERER

Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if the new debt is junior and would reduce firm value. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history‐dependent. If forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.

VALUATION, OPTIMUM INVESTMENT AND FINANCING FOR THE FIRM SUBJECT TO REGULATION

Published: 05/01/1975   |   DOI: 10.1111/j.1540-6261.1975.tb01819.x

Franco Modigliani, Edwin J. Elton, Martin J. Gruber, Zvi Lieber

Symposium on Public Policy Issues in Finance

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02729.x

HAYNE E. LELAND, MARTIN FELDSTEIN, ROBERT R. GLAUBER, DAVID W. MULLINS, STEVEN M. H. WALLMAN

The thesis of this symposium, organized by James Bicksler, was that while finance theory will surely inform practitioners, it seems appropriate to pay some attention to the opposite flow: practitioners can inform theory. Contributors include a distinguished group of practitioners with extensive backgrounds in economics, and economists with extensive public policy experience: Martin Feldstein, Robert Glauber, David Mullins, and Steven Wallman. Their topics range from privatizing social security, to managing market crashes, to the regulatory agency cost problem, to regulatory constraints in a technologically advanced world.

DISCUSSION

Published: 05/01/1972   |   DOI: 10.1111/j.1540-6261.1972.tb00960.x

Merton H. Miller, William Poole, Alvin Marty

Legal Risk and Insider Trading

Published: 12/11/2023   |   DOI: 10.1111/jofi.13299

MARCIN KACPERCZYK, EMILIANO S. PAGNOTTA

Do illegal insiders internalize legal risk? We address this question with hand‐collected data from 530 SEC (the U.S. Securities and Exchange Commission) investigations. Using two plausibly exogenous shocks to expected penalties, we show that insiders trade less aggressively and earlier and concentrate on tips of greater value when facing a higher risk. The results match the predictions of a model where an insider internalizes the impact of trades on prices and the likelihood of prosecution and anticipates penalties in proportion to trade profits. Our findings lend support to the effectiveness of U.S. regulations' deterrence and the long‐standing hypothesis that insider trading enforcement can hamper price informativeness.

Global Pricing of Carbon‐Transition Risk

Published: 08/12/2023   |   DOI: 10.1111/jofi.13272

PATRICK BOLTON, MARCIN KACPERCZYK

The energy transition away from fossil fuels exposes companies to carbon‐transition risk. Estimating the market‐based premium associated with carbon‐transition risk in a cross section of 14,400 firms in 77 countries, we find higher stock returns associated with higher levels and growth rates of carbon emissions in all sectors and most countries. Carbon premia related to emissions growth are greater for firms located in countries with lower economic development, larger energy sectors, and less inclusive political systems. Premia related to emission levels are higher in countries with stricter domestic climate policies. The latter have increased with investor awareness about climate change risk.

Do Credit Markets Respond to Macroeconomic Shocks? The Case for Reverse Causality

Published: 07/14/2023   |   DOI: 10.1111/jofi.13261

MARTIJN BOONS, GIORGIO OTTONELLO, ROSSEN VALKANOV

The response of corporate bond credit spreads to three exogenous macro shocks—oil supply, investment‐specific technology, and government spending—is large, significant, and a mirror image of macroeconomic activity. This countercyclicality is driven largely by credit risk premia and translates into significant return predictability. Equity risk premia exhibit similar responses, providing external validity. Information rigidities and leverage play a key role in the transmission of the shocks. Since causal evidence linking macro shocks to credit markets is scarce and recent work highlights the real effects of credit fluctuations, our findings contribute to understanding the joint dynamics of credit markets and the macroeconomy.

Governance Mechanisms and Equity Prices

Published: 11/10/2005   |   DOI: 10.1111/j.1540-6261.2005.00819.x

K. J. MARTIJN CREMERS, VINAY B. NAIR

We investigate how the market for corporate control (external governance) and shareholder activism (internal governance) interact. A portfolio that buys firms with the highest level of takeover vulnerability and shorts firms with the lowest level of takeover vulnerability generates an annualized abnormal return of 10% to 15% only when public pension fund (blockholder) ownership is high as well. A similar portfolio created to capture the importance of internal governance generates annualized abnormal returns of 8%, though only in the presence of “high” vulnerability to takeovers. The complementarity effect exists for firms with lower industry‐adjusted leverage and is stronger for smaller firms.

Thirty Years of Shareholder Rights and Firm Value

Published: 01/08/2014   |   DOI: 10.1111/jofi.12138

MARTIJN CREMERS, ALLEN FERRELL

This paper introduces a new hand‐collected data set that tracks restrictions on shareholder rights at approximately 1,000 firms from 1978 to 1989. In conjunction with the 1990 to 2006 IRRC data, we track shareholder rights over 30 years. Most governance changes occurred during the 1980s. We find a robustly negative association between restrictions on shareholder rights (using G‐Index as a proxy) and Tobin's Q. The negative association only appears after judicial approval of antitakeover defenses in the 1985 landmark Delaware Supreme Court decision of Moran v. Household. This decision was an unanticipated exogenous shock that increased the importance of shareholder rights.

DISCUSSION

Published: 05/01/1959   |   DOI: 10.1111/j.1540-6261.1959.tb01582.x

J. Arnold Pines, Marvin Chandler

Basis‐Momentum

Published: 10/24/2018   |   DOI: 10.1111/jofi.12738

MARTIJN BOONS, MELISSA PORRAS PRADO

We introduce a return predictor related to the slope and curvature of the futures term structure: basis‐momentum. Basis‐momentum strongly outperforms benchmark characteristics in predicting commodity spot and term premiums in both the time series and the cross section. Exposure to basis‐momentum is priced among commodity‐sorted portfolios and individual commodities. We argue that basis‐momentum captures imbalances in the supply and demand of futures contracts that materialize when the market‐clearing ability of speculators and intermediaries is impaired, and that it represents compensation for priced risk. Our findings are inconsistent with alternative explanations based on storage, inventory, and hedging pressure.

Report on Helping C.I.S. Soviet Republics Finance Professionals Modernize

Published: 07/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04016.x

John Tepper Marlin

Aggregate Jump and Volatility Risk in the Cross‐Section of Stock Returns

Published: 10/27/2014   |   DOI: 10.1111/jofi.12220

MARTIJN CREMERS, MICHAEL HALLING, DAVID WEINBAUM

We examine the pricing of both aggregate jump and volatility risk in the cross‐section of stock returns by constructing investable option trading strategies that load on one factor but are orthogonal to the other. Both aggregate jump and volatility risk help explain variation in expected returns. Consistent with theory, stocks with high sensitivities to jump and volatility risk have low expected returns. Both can be measured separately and are important economically, with a two‐standard‐deviation increase in jump (volatility) factor loadings associated with a 3.5% to 5.1% (2.7% to 2.9%) drop in expected annual stock returns.

Fund Manager Use of Public Information: New Evidence on Managerial Skills

Published: 03/20/2007   |   DOI: 10.1111/j.1540-6261.2007.01215.x

MARCIN KACPERCZYK, AMIT SERU

We show theoretically that the responsiveness of a fund manager's portfolio allocations to changes in public information decreases in the manager's skill. We go on to estimate this sensitivity (RPI) as the R2 of the regression of changes in a manager's portfolio holdings on changes in public information using a panel of U.S. equity funds. Consistent with RPI containing information related to managerial skills, we find a strong inverse relationship between RPI and various existing measures of performance, and between RPI and fund flows. We also document that both fund‐ and manager‐specific attributes affect RPI.