DSpace Community: Salomon Center

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Why Wait? A Century of Life Before IPO

Title: Why Wait? A Century of Life Before IPO

Jovanovic, Boyan; Rousseau, Peter L.

Why Does Capital Structure Choice Vary With Macroeconomic Conditions?

Title: Why Does Capital Structure Choice Vary With Macroeconomic Conditions?

Levy, Amnon

Abstract: This paper develops a calibrated model that explains the pronouncedcounter-cyclical leverage patterns observed for firms that access publiccapital markets, and relates these patters to debt and equity issues.Moreover, it explains why leverage and debt issues do not exhibit thispronounced behavior for firms that face more severe constraints whenaccessing capital markets. In the model, managers issue a combination ofdebt and equity to finance investment by weighing the trade-off betweenagency problems and risk sharing. During contractions, leveragedmanagers receive a relatively small share of wealth, resulting in arelative increase in household demand for securities. Securities marketsclear as managers that are not up against their borrowing constraintsincrease leverage while satisfying the agency condition that theymaintain a large enough portion of their firm’s equity.

Why Does Capital Structure Choice Vary With Macroeconomic Conditions?

Title: Why Does Capital Structure Choice Vary With Macroeconomic Conditions?

Levy, Amnon

Abstract: This paper develops a calibrated model that explains the pronouncedcounter-cyclical leverage patterns observed for firms that access publiccapital markets, and relates these patterns to debt and equity issues.Moreover, it explains why leverage and debt issues do not exhibit thispronounced behavior for firms that face more severe constraints whenaccessing capital markets. In the model, managers issue a combination ofdebt and equity to finance investment by weighting the trade-off betweenagency problems and risk sharing. During contraction, leveraged managersreceive a relatively small share of wealth, resulting in a relativeincrease in household demand for securities. Securities markets clear asmanagers that are not up against their borrowing constraints increaseleverage while satisfying the agency condition that they maintain alarge enough portion of their firm's equity.

WHY ARE DIVIDENDS DISAPPEARING? AN EMPIRICAL ANALYSIS

Title: WHY ARE DIVIDENDS DISAPPEARING? AN EMPIRICAL ANALYSIS

Baker, Malcolm; Wurgler, Jeffrey

Abstract: We investigate the causes of time-series fluctuations in the propensityto pay dividends,including the post-1978 decline documented by Fama andFrench (2001). We consider explanations based on fluctuations individend clienteles, agency problems, information asymmetries, executivestock options, catering incentives, tax code awareness, and short-livedidiosyncratic factors. To evaluate these explanations, we conduct threestyles of analysis. First, we count and classify influences on thepropensity to pay that were noted in the financial press. Second, weexamine time-series relationships between the propensity to pay andproxies for the driving influences in the candidate explanations. Third,we assess whether the candidate explanations are theoreticallycompatible with related time-series patterns involving dividend policy.Overall, the results are most consistent with the catering explanation.Notably, catering incentives,as measured by the stock market"dividend premium," roughly line up with the four trends inthe propensity to pay between 1963 and 2000 and are able to account forthe observed magnitude of the post-1978 decline. There is also evidencethat idiosyncratic factors, including the Nixon-era dividend controlsand the recent growth in options, affected the propensity to pay inspecific periods.

Who You Know Matters: Venture Capital Networks and Investment Performance

Title: Who You Know Matters: Venture Capital Networks and Investment Performance

Hochberg, Yael; Ljungqvist, Alexander; Lu, Yang

Abstract: Many financial markets are characterized by strong relationships andnetworks, rather than arm’s-length, spot-market transactions. Weexamine the performance consequences of this organizational choice inthe context of relationships established when VCs syndicate portfoliocompany investments, using a comprehensive sample of U.S. based VCs overthe period 1980 to 2003. VC funds whose parent firms enjoy moreinfluential network positions have significantly better performance, asmeasured by the proportion of portfolio company investments that aresuccessfully exited through an initial public offering or a sale toanother company. Similarly, the portfolio companies of better networkedVC firms are significantly more likely to survive to subsequent roundsof financing and to eventual exit. The magnitude of these effects iseconomically large, and is robust to a wide range of specifications. Ourmodels suggest that the benefits of being associated with awell-connected VC are more pronounced in later funding rounds. Once wecontrol for network effects in our models of fund and portfolio companyperformance, the importance of how much investment experience a VC hasis reduced, and in some specifications, eliminated.

When Does Strategic Debt Service Matter?

Title: When Does Strategic Debt Service Matter?

Acharya, Viral V.; Huang, Jing-zhi; Subrahmanyam, Marti G.; Sundaram, Rangarajan K.

Abstract: Recent work has suggested that strategic underperformance ofdebt-service obligations by equity holders can resolve the gap betweenobserved yield spreads and those generated by Merton (1974)-stylemodels. We show that this is not quite correct. The value of the optionto underperform on debt-service obligations depends on two otheroptionalities available to equity holders, namely, the option to carrycash reserves within the firm and the option to raise new externalfinancing. We disentangle the effects of the three factors, andcharacterize the impact of each in isolation as well as theirinteraction. We find, among other things, that while strategic behaviorcan increase spreads significantly under some conditions, its impact isnegligible in others, and in some cases it even leads to a decline inequilibrium spreads. We show that this last apparently paradoxicalresult is a consequence of an interaction of optionalities that resultsin a trade-off between strategic and liquidity-driven defaults.

WHAT HAPPENED TO LIQUIDITY WHEN WORLD WAR I SHUT THE NYSE?

Title: WHAT HAPPENED TO LIQUIDITY WHEN WORLD WAR I SHUT THE NYSE?

Silber, William L.

Abstract: The suspension of trading on the New York Stock Exchange for more thanfour months following the outbreak of World War I fostered a substitutemarket on New Street as a source of liquidity. The New Street marketsuffered from a lack of price transparency because its transactions werenot disseminated on the NYSE ticker and its quotations were blacklistedat the leading newspapers. This paper shows that despite the impairedinformation flow and the somewhat wider bid-ask spreads compared withthe New York Stock Exchange, New Street offered economically meaningfulliquidity services. The absence of price transparency turned anindividual stock’s reputation for liquidity into an importantvariable in explaining the structure of bid-ask spreads on New Street.

WHAT HAPPENED TO LIQUIDITY WHEN WORLD WAR I SHUT THE NYSE?

WHAT GOOD IS A VOLATILITY MODEL?

Title: WHAT GOOD IS A VOLATILITY MODEL?

Engle, Robert F.; Patton, Andrew J.

Abstract: A volatility model must be able to forecast volatility; this is thecentral requirement in almost all financial applications. In this paperwe outline some stylised facts about volatility that should beincorporated in a model; pronounced persistence and meanreversion,asymmetry such that the sign of an innovation also affects volatilityand the possibility of exogenous or pre-determined variables influencingvolatility. We use data on the Dow Jones Industrial index to illustratethese stylised facts, and the ability of GARCH-type models to capturethese features. We conclude with some challenges for future research inthis area.

What Constitutes Appropriate Disclosure for a Financial Conglomerate?

Title: What Constitutes Appropriate Disclosure for a Financial Conglomerate?

White, Lawrence J.

Abstract: This paper addresses the disclosure issues for financial conglomeratesprincipally from the same perspective as that of the Basel Committee onBanking Supervision: that disclosure is important for the safety andsoundness of banks. However, we reach substantially differentconclusions with respect to three important disclosure issues: the roleof market value accounting; the frequency of disclosures; and the roleof subordinated debt. We start by asking why any special disclosuremight be required for financial conglomerates. This question immediatelyleads to a discussion of what is special about financial conglomerates.We also address the question of, "Disclosure to whom?" Thereare at least two potential audiences for information disclosures:financial regulators; and the public investors/creditors/customers of afinancial conglomerate. Issues of the appropriate structure for afinancial conglomerate, and the information revelation that shouldaccompany that structure, are also raised. Finally, we return to thetitle topic: What constitutes appropriate disclosure for a financialconglomerate. Unfortunately, by turning its back on the three mostimportant steps that could be taken to improve information disclosure --mandating market value accounting (MVA) for banks' reports toregulators, aiming toward daily submission of these reports, andrequiring the issuance of subordinated debt -- the Basel Committee hasfundamentally undermined its efforts to enhance banks' safety and soundness.

Wavelets in Economics and Finance: Past and Future

Title: Wavelets in Economics and Finance: Past and Future

Ramsey, James B.

Abstract: In this paper I review what insights we have gained about economic andfinancial relationships from the use of wavelets and speculate on whatfurther insights we may gain in the future. Wavelets are treated as a“lens” that enables the researcher to explore relationshipsthat previously were unobservable.

VENTURE CAPITAL CONTRACTS AND MARKET STRUCTURE

Title: VENTURE CAPITAL CONTRACTS AND MARKET STRUCTURE

Inderst, Roman; Mueller, Holger M.

Abstract: We examine the relation between optimal venture capital contracts andthe supply and demand for venture capital. Both the composition and typeof financial claims held by the venture capitalist and entrepreneurdepend on the market structure. Moreover, different market structuresinvolve different optimal forms of transferring utility: sometimes it isoptimal to transfer utility via equity stakes, sometimes it is optimalto use debt. Transferring utility via equity stakes affects incentives.Consequently, the net value created, the success probability, the market(or IPO) value, and the performance of venture-capital backedinvestments all depend on the supply and demand for capital. Similarly,venture capitalists face different incentives to screen projects ex anteif the capital supply is low or high. We then endogenize the capitalsupply and study the relation between venture capital contracts andentry costs, public policy, investment profitability, and markettransparency. Finally, we show that entry by inexperienced investorscreates a negative externality for the value creation in venturesfinanced by (regular) venture capitalists.

Venture Capital Contracts and Market Structure

Title: Venture Capital Contracts and Market Structure

Inderst, Roman; Mueller, Holger M.

Abstract: We examine the relation between optimal venture capital contracts andthe supply and demand for venture capital. Both the composition and typeof financial claims held by the venture capitalist and entrepreneurdepend on the market structure. Moreover, dierent market structuresinvolve dierent optimal forms of transferring utility: sometimes it isoptimal to transfer utility via equity stakes, sometimes it is optimalto use debt. Transferring utility via equity stakes affects incentives.Consequently, the net value created, the success probability, the market(or IPO) value, and the performance of venture-capital backedinvestments all depend on the supply and demand for capital. Similarly,venture capitalists face dierent incentives to screen projects ex anteif the capital supply is low or high. We then endogenize the capitalsupply and study the relation between venture capital contracts andentry costs, public policy, investment profitability, and markettransparency. Finally, we show that entry by inexperienced investorscreates a negative externality for the value creation in venturesfinanced by (regular) venture capitalists.

Vector Multiplicative Error Models: Representation and Inference

Title: Vector Multiplicative Error Models: Representation and Inference

Cipollini, Fabrizio; Engle, Robert F.; Gallo, Giampiero M.

Abstract: The Multiplicative Error Model introduced by Engle (2002) for positivevalued processes is specified as the product of a (conditionallyautoregressive) scale factor and an innovation process with positivesupport. In this paper we propose a multivariate extension of such amodel, by taking into consideration the possibility that the vectorinnovation process be contemporaneously correlated. The estimationprocedure is hindered by the lack of probability density functions formultivariate positive valued random variables. We suggest the use ofcopula functions and of estimating equations to jointly estimate theparameters of the scale factors and of the correlations of theinnovation processes. Empirical applications on volatility indicatorsare used to illustrate the gains over the equation by equation procedure.

Valuation in Over-the-Counter Markets

Title: Valuation in Over-the-Counter Markets

Duffie, Darrell; Gârleanu, Nicolae; Pedersen, Lasse Heje

Abstract: We provide the impact on asset prices of search-and-bargaining frictionsin over-the-counter markets. Under natural conditions, prices are lowerand illiquidity discounts higher when counterparties are harder to find,when sellers have less bargaining power, when the fraction of qualifiedowners is smaller, or when risk aversion, volatility, or hedging demandare larger. If agents face risk limits, then higher volatility leads togreater difficulty locating unconstrained buyers, resulting in lowerprices. Information can fail to be revealed through trading when searchis difficult. We discuss a variety of financial applications andtestable implications.

Valuation in Dynamic Bargaining Markets

Title: Valuation in Dynamic Bargaining Markets

Duffie, Darrell; Garleanu, Nicolae; Pedersen, Lasse Heje

Abstract: We study the impact on asset prices of illiquidity associated withsearch and bargaining in an economy in which agents can trade only whenthey find each other. Marketmakers' prices are higher and bid-askspreads are lower if investors can find each other more easily. Pricesbecome Walrasian as investors' or marketmakers' search intensities getlarge. Endogenizing search intensities yields natural welfareimplications. Information can fail to be revealed through trading whensearch is difficult.

UNDERSTANDING THE RELATIONSHIP BETWEEN FOUNDER-CEOS AND FIRM PERFORMANCE

Title: UNDERSTANDING THE RELATIONSHIP BETWEEN FOUNDER-CEOS AND FIRM PERFORMANCE

Adams, Renée B.; Almeida, Heitor; Ferreira, Daniel

Abstract: While previous empirical literature has examined the effect offounder-CEOs on firm performance, it has largely ignored the effect offirm performance on founder-CEO status. In this paper, we useinstrumental variables methods to better understand the relationshipbetween founder-CEOs and performance. Using the proportion of theÞrm s founders that are dead and the number of people who foundedthe company as instruments for founder-CEO status, we find strongevidence that founder-CEO status is endogenous in performanceregressions. This implies that the direct effect of founder-CEOs on firmperformance cannot be estimated correctly without accounting for theendogeneity of founder-CEO status. Perhaps surprisingly, we find thatperformance is negatively related to the likelihood that founders retainthe CEO title. This result appears to be driven primarily by founderdepartures after periods of good performance, rather than by anentrenchment effect that allows founders to remain as CEOs followingpoor performance. After factoring out the effect of performance onfounder-CEO status, we find a residual positive correlation betweenfounder-CEO status and firm performance. This finding suggests thatthere is a positive causal link from founder-CEOs to Þrm performance.

Uncovering the Risk–Return Relation in the Stock Market

Title: Uncovering the Risk–Return Relation in the Stock Market

Guo, Hui; Whitelaw, Robert F.

Abstract: There is an ongoing debate in the literature about the apparent weak ornegative relation between risk (conditional variance) and return(expected returns) in the aggregate stock market. We develop andestimate an empirical model based on the ICAPM to investigate thisrelation. Our primary innovation is to model and identify empiricallythe two components of expected returns–the risk component and thecomponent due to the desire to hedge changes in investmentopportunities. We also explicitly model the effect of shocks to expectedreturns on ex post returns and use implied volatility from tradedoptions to increase estimation efficiency. As a result, the coefficientof relative risk aversion is estimated more precisely, and we find it tobe positive and reasonable in magnitude. Although volatility risk ispriced, as theory dictates, it contributes only a small amount to thetime-variation in expected returns. Expected returns are drivenprimarily by the desire to hedge changes in investment opportunities. Itis the omission of this hedge component that is responsible for thecontradictory and counter-intuitive results in the existing literature.

Uncovering the Risk-Return Relation in the Stock Market

Title: Uncovering the Risk-Return Relation in the Stock Market

Guo, Hui; Whitelaw, Robert F.

Abstract: There is an ongoing debate in the literature about the apparent weak ornegative relation between risk (conditional variance) and return(expected returns) in the aggregate stock market. We develop andestimate an empirical model based on the ICAPM to investigate thisrelation. Our primary innovation is to model and identify empiricallythe two components of expected returns –the risk component and thecomponent due to the desire to hedge changes in investmentopportunities. We also explicitly model the effect of shocks to expectedreturns on ex post returns and use implied volatility from added optionsto increase estimation efficiency. As a result, the coefficient ofrelative risk aversion is estimated more precisely, and we find it to bepositive and reasonable in magnitude. Although volatility risk ispriced, as theory dictates, it contributes only a small amount to thetime-variation in expected returns. Expected returns are drivenprimarily by the desire to hedge changes in investment opportunities.It is the omission of this hedge component that is responsible for thecontradictory and counter-intuitive results in the existing literature.

Two Ways to Rule Out the Overconsumption Paths in the Ramsey Model with Irreversible Investment

Title: Two Ways to Rule Out the Overconsumption Paths in the Ramsey Model withIrreversible Investment

Comín, Diego

Abstract: In this note I develop two approaches to rule out the Overconsumptionpaths in the Ramsey model with irreversible capital. The first focuseson the multiplier of the irreversible constraint and is applied to thesituation where preferences are CES and the production function isCobb-Douglas. The second relies on a revealed preference argument andis used to rule out overconsumption paths when the preferences arestrictly concave and the initial level of perspective capital is belowits steady state level.

TURNING OVER TURNOVER

Title: TURNING OVER TURNOVER

Cremers, K.J. Martijn; Mei, Jianping

Abstract: The methodology of Bai and Ng (2002, 2003) for decomposing large paneldata into systematic and idiosyncratic components is applied to bothreturns and turnover. Combining this with a GLS-based principalcomponents approach, we demonstrate that their procedure works well forboth returns and turnover despite the presence of severeheteroscedasticity and non-stationarity in turnover of individualstocks. We then test Lo and Wang’s (2000) theoreticalmodel’s restriction that returns and turnover should have the samenumber of systematic factors. This is strongly rejected by the data,suggesting stock price and trading volume may not be compatible underthe existing multi-factor asset pricing-trading framework. We alsodemonstrate that several commonly used turnover measures may understatethe price impact of stock trading.

Time Series and Cross-sectional Variations of Expected Returns

Title: Time Series and Cross-sectional Variations of Expected Returns

Dai, Qiang

Abstract: The paper develops a general equilibrium stochastic growth model of amulti-sector economy subject to i.i.d. taste shocks. Each sectorproduces one good, and each firm has a linear production technology andfaces a quadratic capital adjustment cost. The model contains a standardintertemporal capital asset pricing theory of consumption and portfoliodemands with dynamically complete and frictionless markets and astandard q-theory of investment under uncertainty. We show that theequilibrium stochastic investment opportunity set is driven by therelative shares of firms' nominal capital stocks, and the equilibriumdynamics of the state vector is driven by firms' relative investmentintensities. Key implications of the model includes (i) the expectedequity returns are endogenously predictable both over time and in thecross-section; and (ii) the "value anomaly" arises in arational expectations equilibrium due to a negative (positive) hedgingdemand for value (growth) stocks against the risk of cross-sectionaldispersion of firms' nominal capital stocks.

Time Series and Cross-sectional Variations of Expected Returns

Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH

Title: Theoretical and Empirical Properties of Dynamic Conditional CorrelationMultivariate GARCH

Engle, Robert F.; Sheppard, Kevin

Abstract: In this paper, we develop the theoretical and empirical properties of anew class of multivariate GARCH models capable of estimating largetime-varying covariance matrices, Dynamic Conditional CorrelationMultivariate GARCH. We show that the problem of multivariate conditionalvariance estimation can be simplified by estimating univariate GARCHmodels for each asset, and then, using transformed residuals resultingfrom the first stage, estimating a conditional correlation estimator.The standard errors for the first stage parameters remain consistent,and only the standard errors for the correlation parameters need to bemodified. We use the model to estimate the conditional covariance of upto 100 assets using S&P 500 Sector Indices and Dow Jones IndustrialAverage stocks, and conduct specification tests of the estimator usingan industry standard benchmark for volatility models. This new estimatordemonstrates very strong performance especially considering ease ofimplementation of the estimator.

THE VALUATION OF MUTUAL FUND CONTRACTS

Title: THE VALUATION OF MUTUAL FUND CONTRACTS

Boudoukh, Jacob; Richardson, Matthew; Stanton, Richard; Whitelaw, Robert

Abstract: Combining insights from the contingent claims and the asset-backedsecurities literatures, we study the economics of value creation in theasset management business. In particular, we provide a theoretical modeland a closed form formula for the value of fund fees in the presence ofthe well known flow-performance relation, giving rise to interestingnonlinearities and volatility-related effects. The theoretical modelsheds light on the role of fees, asset growth, asset and benchmarkvolatility, and the intensity of the flow-performance relation. Tobetter understand the role of changing fund characteristics such as ageand size on the fund value and fund risk, we estimate the empiricalrelation between returns and flows conditional on these characteristicsfor various asset classes. We study these effects using Monte Carlosimulations for various economically meaningful parameter values forspecific asset classes. Measuring value as a fraction of assets undermanagement, we find that both value and risk, systematic andidiosyncratic, decline in size and age. In addition, value is a complex,non-monotonic function of the fee charged on the fund.

The Valuation of Caps, Floors and Swaptions in a Multi-Factor Spot-Rate Model

Title: The Valuation of Caps, Floors and Swaptions in a Multi-Factor Spot-Rate Model

Peterson, Sandra; Stapleton, Richard C.; Subrahmanyam, Marti G.

Abstract: We build a multi-factor, no-arbitrage model of the term structure ofspot interest rates. The stochastic factors are the short-term interestrate and the premia of the futures rates over the short-term interestrates. In the three-factor version of the model, for example, the firstfactor is the three-month LIBOR, the second factor is the premium of thefirst futures LIBOR over spot LIBOR, and the third factor is theincremental premium of the second futures over the first. The modelprovides an extension of the lognormal interest rate model of Black andKarasinski (1991) to multiple factors, each of which can exhibitmean-reversion. This method is computationally efficient for severalreasons. First, we suggest calibrating the model to LIBOR futuresprices, which enables us to satisfy the no-arbitrage condition withoutresorting to iterative methods. Second, we modify and implement thebinomial approximation methodology of Nelson and Ramaswamy (1990) andHo, Stapleton and Subrahmanyam (1995) to compute a multi-period tree ofrates with the no-arbitrage property. The method uses a recombining twoor three-dimensional binomial lattice of interest rates that minimizesthe number of states and term structures over time. In addition to thesecomputational advantages, a key feature of the model is that it isconsistent with the observed term structure of futures rates as well asthe term structure of volatilities implied by the prices of interestrate caps and floors. We use the model to price European-style andBermuda-style swaptions and yield-spread options. To implement themethodology, we first calibrate the model to the capletimplied-volatility curve on a given day, and then use the model to priceEuropean-style swaptions. We find that the two-factor model, where theLIBOR mean reverts rapidly to a slowly mean-reverting second factor,overprices the swaptions relative to market quotations. However,introducing a third factor significantly reduces the overpricing. Thecalibrated model is used to price Bermudan-style swaptions andyield-spread options. Then, we re-calibrated the two-factor modelsimultaneously to caplet and swaption prices and use the model output toprice Bermudan-style swaptions.

The Underlying Dynamics of Credit Correlations

Title: The Underlying Dynamics of Credit Correlations

Berd, Arthur; Engle, Robert; Voronov, Artem

Abstract: We propose a hybrid model of portfolio credit risk where the dynamics ofthe underlying latent variables is governed by a one factor GARCHprocess. The distinctive feature of such processes is that the long-termaggregate return distributions can substantially deviate from theasymptotic Gaussian limit for very long horizons. We introduce thenotion of correlation spectrum as a convenient tool for comparingportfolio credit loss generating models and pricing synthetic CDOtranches. Analyzing alternative specifications of the underlyingdynamics, we conclude that the asymmetric models with TARCH volatilityspecification are the preferred choice for generating significant andpersistent credit correlation skews.

The Underlying Dynamics of Credit Correlations

The Term Structure of Interest-Rate Futures Prices.

Title: The Term Structure of Interest-Rate Futures Prices.

Stapleton, Richard C.; Subrahmanyam, Marti G.

Abstract: We derive general properties of two-factor models of the term structureof interest rates and, in particular, the process for futures prices andrates. Then, as a special case, we derive a no-arbitrage model of theterm structure in which any two futures rates act as factors. The termstructure shifts and tilts as the factor rates vary. The cross-sectionalproperties of the model derive from the solution of a two dimensionalautoregressive process for the short-term rate, which exhibits both meanreversion and a lagged persistence parameter. We show that thecorrelation of the futures rates is restricted by the no-arbitrageconditions of the model. In addition, we investigate the determinants ofthe volatility of the futures rates of various maturities. These areshown to be related to the volatilities of the short rate, thevolatility of the second factor, the degree of mean reversion and thepersistence of the second factor shock. We obtain specific results forfutures rates in the case where the logarithm of the short-term rate[e.g., the London Inter-Bank Offer Rate (Libor)] follows atwo-dimensional process. Our results lead to empirical hypotheses thatare testable using data from the liquid market for Eurocurrency interestrate futures contracts.

The Spline GARCH Model for Unconditional Volatility and its Global Macroeconomic Causes

Title: The Spline GARCH Model for Unconditional Volatility and its GlobalMacroeconomic Causes

Engle, Robert F.; Rangel, J. Gonzalo

Abstract: We introduce a new model to measure unconditional volatility, theSpline-GARCH. The model is applied to equity markets for 50 countriesfor up to 50 years of daily data. Macroeconomic determinants ofunconditional volatility are investigated. It is found that volatilityin macroeconomic factors such as gdp growth, inflation and short terminterest rates are important explanatory variables that increasevolatility. There is evidence that high inflation and low growth ofoutput are positive determinants. Volatility is higher for emergingmarkets and for markets with small numbers of listings but also forlarge economies.

The Savings and Loan Debacle: A Perspective from the Early Twenty-First Century

Title: The Savings and Loan Debacle: A Perspective from the Early Twenty-First Century

White, Lawrence J.

The Role of Banks in Takeovers

Title: The Role of Banks in Takeovers

Ivashina, Victoria; Nair, Vinay B.; Saunders, Anthony; Massoud, Nadia Ziad

Abstract: To transfer loans from one debtor to another debtor, banks mighttransmit borrower information which is collected in the lending processto potential acquirers. In this paper, we investigate the importance ofbanks in the effectiveness of the takeover mechanism and hence incorporate governance. Using unsolicited takeovers between 1992 and 2003,we find that bank lending intensity and bank client network (the numberof firms that the bank deals with) have a significant and positiveeffect on the probability of a borrower firm becoming a target. We findthat this effect is enhanced in cases where the target and acquirer havea relationship with the same bank and is robust to the inclusion ofseveral firm characteristics including the presence of large externalshareholders. Moreover, takeover completion rates are positively relatedto bank lending intensity. Finally, we find that the equity market viewstakeovers where the target and the acquirer deal with the same bank morepositively relative to takeovers with no bank involvement. Overall, theevidence supports the view that banks increase the disciplining role ofthe market for corporate control.

The Role of Bank Advisors in Mergers and Acquisitions

Title: The Role of Bank Advisors in Mergers and Acquisitions

Allen, Linda; Jagtiani, Julapa; Peristiani, Stavros; Saunders, Anthony

Abstract: This paper looks at the role of commercial banks and investment banks asfinancial advisors. Unlike some areas of investment banking, commercialbanks have always been allowed to compete directly with traditionalinvestment banks in this area. In their role as lenders and advisors,banks can be viewed as serving a certification function. However, banksacting as both lenders and advisors face a potential conflict ofinterest that may mitigate or offset any certification effect. Overall,we find evidence of the certification effect for target firms, butconflicts of interest for acquirers. In particular, the target earnshigher abnormal returns when the target's own bank certifies the (moreinformationally opaque) target's value to the acquirer. In contrast, wefind no certification role for acquirers. This may be due to tworeasons. First, certification plays less of a role for acquirers becauseit is the target firm that must be priced in a merger. Second, acquirerspredominantly utilize commercial bank advisors in order to obtain accessto bank loans that may be used to finance the post-merger transitionperiod. Thus, we find that acquirers tend to choose their own banks(those with prior lending relationships to the acquirer) as advisors inmergers. However, this choice weakens any certification effect andcreates a potential conflict of interest because the acquirer's advisornegotiates the terms of both the merger transaction and future loancommitments. Moreover, the advisor's merger advice may be distorted byconsiderations related to the bank's credit exposure resulting from bothpast and future lending activity. The market prices these conflicts ofinterest; we find significantly negative abnormal returns for bankadvisors when they advise their own loan customers in acquiring other firms.

The Rise in Firm-Level Volatility: Causes and Consequences

Title: The Rise in Firm-Level Volatility: Causes and Consequences

Comin, Diego; Philippon, Thomas

Abstract: We document that the recent decline in aggregate volatility has beenaccompanied by a large increase in firm level risk. The negativerelationship between firm and aggregate risk seems to be present acrossindustries in the US, and across OECD countries. Firm volatilityincreases after deregulation. Firm volatility is linked to research anddevelopment spending as well as access to external financing. Further,R&D intensity is also associated with lower correlation of sectoralgrowth with the rest of the economy.

The Rise in Firm-Level Volatility: Causes and Consequences

Title: The Rise in Firm-Level Volatility: Causes and Consequences

Comin, Diego; Philippon, Thomas

Abstract: We study the increase in firm level risk and how it relates to thedecrease in aggregate risk [..]

The Q-Theory of Mergers

Title: The Q-Theory of Mergers

Jovanovic, Boyan; Rousseau, Peter L.

The Q-Theory of IPOs

Title: The Q-Theory of IPOs

Jovanovic, Boyan; Rousseau, Peter L.

Abstract: We find that new firms’ real investment responds much moreelastically to aggregate Tobin’s Q than does that of establishedfirms. On the financial side, IPOs respond more elastically toTobin’s Q than seasoned offerings of securities. The explanationseems to be that a high aggregate Q raises new firms’ desiredinvestment much more than it raises the desired investment ofincumbents. For the period from 1955 to 2001, the Q-elasticity of IPOsis about 1.2, and the elasticity of new-firms’ investment is about0.7. These are about 20 times more than is usual in Q regressions. Onthe other hand, the Q-elasticity of seasoned offerings is actuallynegative (-0.05), and the elasticity of incumbents’ investment is0.04. Though not statistically significant, the average of theseestimates is even smaller than is usual.

The Properties of Automatic Gets Modelling

Title: The Properties of Automatic Gets Modelling

Hendry, David F.; Krolzig, Martin

Abstract: After reviewing the simulation performance of general-to-specificautomatic regression model selection, as embodied in PcGets, we show howmodel selection can be non-distortionary: approximately unbiased‘selection estimates’ are derived, with reported standarderrors close to the sampling standard deviations of the estimated DGPparameters, and a near-unbiased goodness-of-fit measure. The handling oftheory-based restrictions, non-stationarity, and problems posed bycollinear data are considered. Finally, we consider how PcGets canhandle three ‘intractable’ problems: more variables thanobservations in regression analysis; perfectly collinear regressors; andmodelling simultaneous equations without a priori restrictions.

The Promise and Peril of Real Options

Title: The Promise and Peril of Real Options

Damodaran, Aswath

Abstract: In recent years, practitioners and academics have made the argument thattraditional discounted cash flow models do a poor job of capturing thevalue of the options embedded in many corporate actions. They have notedthat these options need to be not only considered explicitly and valued,but also that the value of these options can be substantial. In fact,many investments and acquisitions that would not be justifiableotherwise will be value enhancing, if the options embedded in them areconsidered. In this paper, we examine the merits of this argument. Whileit is certainly true that there are options embedded in many actions, weconsider the conditions that have to be met for these options to havevalue. We also develop a series of applied examples, where we attempt tovalue these options and consider the effect on investment, financing andvaluation decisions.

THE OPERATIONAL HEDGING PROPERTIES OF INTANGIBLE ASSETS: THE CASE OF NON-VOLUNTARY FOREIGN ASSET SELLOFFS

Title: THE OPERATIONAL HEDGING PROPERTIES OF INTANGIBLE ASSETS: THE CASE OFNON-VOLUNTARY FOREIGN ASSET SELLOFFS

Doukas, John A.; Padmanabhan, Prasad

Abstract: In this paper we examine the valuation effects and long-term performanceof U.S. multinational firms involved in forced transfers of theirforeign operating assets during the 1965-1988 period. The evidencesuggests that the operational hedging ability of the firm to addresscountry risk (nationalization threats) is related to the level of itsintangible assets. While it is well known that firms with high levels ofintangible assets prefer foreign direct investment, our results showthat intangible assets have hidden properties of protection againstcountry risk as well. We document significantly negative abnormalreturns only for divesting firms with low levels of intangible assets,but not for firms with high levels of intangible assets. In addition, weshow that low (high) growth firms are involved in partial (complete)withdrawals, and show that the long-term economic performance of firmschoosing the complete withdrawal strategy is better than those that optto remain. We argue that management's attempt to maintain economic linksin a hostile foreign environment can be attributed in part to the firm'slow growth opportunities, performance, and lack of contingent plans toaddress country risk.

The New Economy and Banks and Financial Institutions

Title: The New Economy and Banks and Financial Institutions

White, Lawrence J.

THE MYTH OF LONG-HORIZON PREDICTABILITY

Title: THE MYTH OF LONG-HORIZON PREDICTABILITY

Boudoukh, Jacob; Richardson, Matthew; Whitelaw, Robert F.

Abstract: The prevailing view in finance is that the evidence for long-horizonstock return predictability is significantly stronger than that forshort horizons. We show that for persistent regressors, a characteristicof most of the predictive variables used in the literature, theestimators are almost perfectly correlated across horizons under thenull hypothesis of no predictability. For example, for the persistencelevels of dividend yields, the analytical correlation is 99% between the1- and 2-year horizon estimators and 94% between the 1- and 5-yearhorizons, due to the combined effects of overlapping returns and thepersistence of the predictive variable. Common sampling error acrossequations leads to ordinary least squares coefficient estimates and R2sthat are roughly proportional to the horizon under the null hypothesis.This is the precise pattern found in the data. The asymptotic theory iscorroborated, and the analysis extended by extensive simulationevidence. We perform joint tests across horizons for a variety ofexplanatory variables, and provide an alternative view of the existing evidence.

The Long-Run Behavior of Debt and Equity Underwriting Spreads

Title: The Long-Run Behavior of Debt and Equity Underwriting Spreads

Kim, Dongcheol; Palia, Darius; Saunders, Anthony

Abstract: This paper is the first to look at the long-run (30-year) behavior ofunderwriting spreads in the markets for corporate equity and debt.Specifically, we analyze the determinants of underwriting spreads oncorporate bond issues, secondary equity offerings and initial publicofferings over the period 1970-2000. We explain the time-varyingcross-sectional behavior of these spreads by analyzing three sets ofvariables or factors: macro (systematic) factors, investment bankingmarket structure factors and issuer specific characteristics. We alsoanalyze the relationship between the direct costs (underwriting spreads)and indirect costs (underpricing) of new issues. Among our many resultswe find an apparent decline in spreads over time, an increasedclustering in spreads for both IPOs and SEOs, the dominance of issuer-specific characteristics in explaining spreads, and a relatively weaklinkage between the direct and indirect costs of issuance.

The Long-Run Behavior of Debt and Equity Underwriting Spreads

Title: The Long-Run Behavior of Debt and Equity Underwriting Spreads

Kim, Dongcheol; Palia, Darius; Saunders, Anthony

Abstract: This paper is the first to look at the long-run (30-year) behavior ofunderwriting spreads in the markets for corporate equity and debt.Specifically, we analyze the determinants of underwriting spreads oncorporate bond issues, secondary equity offerings and initial publicofferings over the period 1970-2000. We explain the time-varyingcross-sectional behavior of these spreads by analyzing three sets ofvariables or factors: macro (systematic) factors, investment bankingmarket structure factors and issuer specific characteristics. We alsoanalyze the relationship between the direct costs (underwriting spreads)and indirect costs (underpricing) of new issues. Among our many resultswe find an apparent decline in spreads over time, an increasedclustering in spreads for both IPOs and SEOs, the dominance of issuer-specific characteristics in explaining spreads, and a relatively weaklinkeage between the direct and indirect costs of issuance.

The Link between Default and Recovery Rates: Theory, Empirical Evidence and Implications

Title: The Link between Default and Recovery Rates: Theory, Empirical Evidenceand Implications

Altman, Edward I.; Brady, Brooks; Resti, Andrea; Sironi, Andrea

Abstract: This paper analyzes the association between aggregate default andrecovery rates on credit assets, and seeks to empirically explain thiscritical relationship. We examine recovery rates on corporate bonddefaults, over the period 1982-2002. Our econometric univariate andmultivariate models explain a significant portion of the variance inbond recovery rates aggregated across all seniority and collaterallevels. The central thesis is that aggregate recovery rates arebasically a function of supply and demand for the securities, withdefault rates playing a pivotal role. Such a link would bring about asignificant increase in both expected and unexpected losses as measuredby some widespread credit risk models, and would affect theprocyclicality effects of the New Basel Capital Accord. Our results havealso important implications for investors in corporate bonds and bankloans, and for all markets (e.g., securitizations, credit derivatives)that depend on recovery rates as a key variable.

The Link between Default and Recovery Rates: Theory, Empirical Evidence and Implications

The Link between Default and Recovery Rates: Implications for Credit Risk Models and Procyclicality

Title: The Link between Default and Recovery Rates: Implications for CreditRisk Models and Procyclicality

Altman, Edward I.; Brady, Brooks; Resti, Andrea; Sironi, Andrea

Abstract: This paper analyzes the impact of various assumptions about theassociation between aggregate default probabilities and the loss givendefault on bank loans and corporate bonds, and seeks to empiricallyexplain this critical relationship. Moreover, it simulates the effectson mandatory capital requirements like those proposed in 2001 by theBasel Committee on Banking Supervision. We present the analysis andresults in four distinct sections. The first section examines theliterature of the last three decades of the various structural-form,closed-form and other credit risk and portfolio credit value-at-risk(VaR) models and the way they explicitly or implicitly treat therecovery rate variable. Section 2 presents simulation results underthree different recovery rate scenarios and examines the impact of thesescenarios on the resulting risk measures: our results show a significantincrease in both expected and unexpected losses when recovery rates arestochastic and negatively correlated with default probabilities. InSection 3, we empirically examine the recovery rates on corporate bonddefaults, over the period 1982-2000. We attempt to explain recoveryrates by specifying a rather straightforward statistical least squaresregression model. The central thesis is that aggregate recovery ratesare basically a function of supply and demand for the securities. Oureconometric univariate and multivariate time series models explain asignificant portion of the variance in bond recovery rates aggregatedacross all seniority and collateral levels. Finally, in Section 4 weanalyze how the link between default probability and recovery risk wouldaffect the procyclicality effects of the New Basel Capital Accord, dueto be released in 2002. We see that, if banks use their own estimates ofLGD (as in the "advanced" IRB approach), an increase in thesensitivity of banks’ LGD due to the variation in PD over economiccycles is likely to follow. Our results have important implications forjust about all portfolio credit risk models, for markets which depend onrecovery rates as a key variable (e.g., securitizations, creditderivatives, etc.), for the current debate on the revised BIS guidelinesfor capital requirements on bank credit assets, and for investors incorporate bonds of all credit qualities.

The Link between Default and Recovery Rates

Title: The Link between Default and Recovery Rates

Altman, Edward I.; Brady, Brooks; Resti, Andrea; Sironi, Andrea

Abstract: This paper analyzes the association between aggregate default andrecovery rates on credit assets, and seeks to empirically explain thiscritical relationship. We examine recovery rates on corporate bonddefaults, over the period 1982-2002. Our econometric univariate andmultivariate models explain a significant portion of the variance inbond recovery rates aggregated across all seniority and collaterallevels. The central thesis is that aggregate recovery rates arebasically a function of supply and demand for the securities, withdefault rates playing a pivotal role. Such a link would bring about asignificant increase in both expected and unexpected losses as measuredby some widespread credit risk models, and would affect theprocyclicality effects of the New Basel Capital Accord. Our results havealso important implications for investors in corporate bonds and bankloans, and for all markets (e.g., securitizations, credit derivatives)that depend on recovery rates as a key variable.

The Last Great Arbitrage: Exploiting the Buy-and-Hold Mutual Fund Investor

Title: The Last Great Arbitrage: Exploiting the Buy-and-Hold Mutual Fund Investor

Boudoukh, Jacob; Richardson, Matthew P.; Subrahmanyam, Marti

Abstract: This paper demonstrates that an an institutional feature inherent in amultitude of mutual funds managing billions in assets generates fundNAVs that reflect stale prices. Since, in many cases, investors cantrade at these NAVs with little or no transactions costs, there is anobvious trading opportunity. Simple, feasible strategies generate Sharperatios that are sometimes one hundred times greater than the Sharperatio of the underlying fund. These opportunities are especiallyprevalent in international funds that buy Japanese or European equitiesand in funds that invest in thinly traded securities in the U.S. Whenimplemented, the gains from these strategies are matched by o settinglosses incurred by buy-and-hold investors in these funds. In oneparticular example, we explore the consequences of trading betweendifferent Vanguard mutual funds, motivated via the rules inherent inUniversity 403B plans. Compared to an equal-weighted buy-and-holdportfolio of international Vanguard funds with a 25% cumulative return,the strategy discussed in this paper produces a 139% return while beingin the stock market less than 25% of the time!

The IT Revolution and the Stock Market

Title: The IT Revolution and the Stock Market

Greenwood, Jeremy; Jovanovic, Boyan

Abstract: A new technology or product is often developed by the singleentrepreneur. Whether he reaches the initial public offering stage or isacquired by a listed firm, it takes time for the innovator to add valueto the stock market. Indeed, the innovation may, at first, reduce themarket's value because some firms --- usually large or old --- willcling to old technologies that have lost their momentum. This paperargues that (a) the market declined in the late 1960s because it feltthat the old technologies either had lost their momentum or would giveway to IT, and that (b) IT innovators boosted the stock market's valueonly in the 1980s. If the stock market provides a forecast of futureevents, then the recent dramatic upswing represents a rosy estimateabout growth in future profits for the economy. This translates into aforecast of higher output and productivity growth, holding other thingsequal (such as capital's share of income).

The Investor Recognition Hypothesis in a Dynamic General Equilibrium: Theory and Evidence

Title: The Investor Recognition Hypothesis in a Dynamic General Equilibrium:Theory and Evidence

Shapiro, Alexander

Abstract: This paper analyzes equilibrium in a dynamic pure-exchange economy undera generalization of Merton's (1987) investor recognition hypothesis(IRH). Because of information costs, a class of investors is assumed topossess incomplete information, which suffices to implement only aparticular trading strategy. The IRH is mapped into correspondingportfolio restrictions that bind a subset of agents. The model isformulated in continuous time, and detailed characterization ofequilibrium quantities is provided. The model implies that, all elseequal, a risk premium on a less visible stock need not be higher thanthat on a more visible stock with a lower volatility -- contrary toresults derived in a static mean-variance setting. An empirical analysissuggests that a consumption-based capital asset pricing model (CCAPM)augmented by the IRH is a more realistic model than the traditionalCCAPM for explaining the cross-sectional variation in unconditionalexpected equity returns.

THE INVESTMENT PERFORMANCE AND MARKET SIZE OF DEFAULTED BONDS AND BANK LOANS IN 2003: OUTLOOK FOR 2004/2005

Title: THE INVESTMENT PERFORMANCE AND MARKET SIZE OF DEFAULTED BONDS AND BANKLOANS IN 2003: OUTLOOK FOR 2004/2005

Altman, Edward I.; Kumar, Rohit

THE INVESTMENT PERFORMANCE AND MARKET SIZE OF DEFAULTED BONDS AND BANK LOANS IN 2003: OUTLOOK FOR 2004/2005

Title: THE INVESTMENT PERFORMANCE AND MARKET SIZE OF DEFAULTED BONDS AND BANKLOANS IN 2003: OUTLOOK FOR 2004/2005

Altman, Edward I.; Kumar, Rohit

The Investment Behavior of Private Equity Fund Managers

Title: The Investment Behavior of Private Equity Fund Managers

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the investment behavior of private equityfund managers. Based on recent theoretical advances, we link the timingof funds’ investment and exit decisions, and the subsequentreturns they earn on their portfolio companies, to changes in the demandfor private equity in a setting where the supply of capital is‘sticky’ in the short run. We show that existing fundsaccelerate their investment flows and earn higher returns wheninvestment opportunities improve and the demand for capital increases.Increases in supply lead to tougher competition for deal flow, andprivate equity fund managers respond by cutting their investmentspending. These findings provide complementary evidence to recent papersdocumenting the determinants of fund-level performance in private equity.

THE INVESTMENT BEHAVIOR OF PRIVATE EQUITY FUND MANAGERS

Title: THE INVESTMENT BEHAVIOR OF PRIVATE EQUITY FUND MANAGERS

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the investment behavior of private equityfund managers. Based on recent theoretical advances, we link the timingof funds’ investment and exit decisions, and the subsequentreturns they earn on their portfolio companies, to changes in the demandfor private equity in a setting where the supply of capital is‘sticky’ in the short run. We show that existing fundsaccelerate their investment flows and earn higher returns wheninvestment opportunities improve and the demand for capital increases.Increases in supply lead to tougher competition for deal flow, andprivate equity fund managers respond by cutting their investmentspending. These findings provide complementary evidence to recent papersdocumenting the determinants of fund-level performance in private equity.

The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly

Title: The Information in Long-Maturity Forward Rates: Implications forExchange Rates and the Forward Premium Anomaly

Boudoukh, Jacob; Richardson, Matthew; Whitelaw, Robert F.

Abstract: The forward premium anomaly is one of the most robust puzzles infinancial economics. We recast the underlying parity relation in termsof cross-country differences between forward interest rates rather thanspot interest rates with dramatic results. These forward interest ratedifferentials have statistically and economically significant forecastpower for annual exchange rate movements, both in- and out-of-sample,and the signs and magnitudes of the corresponding coefficients areconsistent with economic theory. Forward interest rates also forecastfuture spot interest rates and future inflation. Thus, we attribute muchof the forward premium anomaly to the anomalous behavior of shortterminterest rates, not to a breakdown of the link between fundamentals andexchange rates.

The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly

THE INFORMATION IN LONG-MATURITY FORWARD RATES: IMPLICATIONS FOR EXCHANGE RATES AND THE FORWARD PREMIUM ANOMALY

Title: THE INFORMATION IN LONG-MATURITY FORWARD RATES: IMPLICATIONS FOREXCHANGE RATES AND THE FORWARD PREMIUM ANOMALY

Boudoukh, Jacob; Richardson, Matthew; Whitelaw, Robert F.

Abstract: The forward premium anomaly is one of the most robust puzzles infinancial economics. We recast the underlying parity relation in termsof cross-country differences between forward interest rates rather thanspot interest rates with dramatic results. These forward interest ratedifferentials have statistically and economically significant forecastpower for annual exchange rate movements, both in- and out-of-sample,and the signs and magnitudes of the corresponding coefficients areconsistent with economic theory. Forward interest rates also forecastfuture spot interest rates and future inflation. Thus, we attribute muchof the forward premium anomaly to the anomalous behavior of shortterminterest rates, not to a breakdown of the link between fundamentals andexchange rates.

The Impact of Shareholder Control on Bondholders

Title: The Impact of Shareholder Control on Bondholders

Cremers, K.J. Martijn; Nair, Vinay B.; Wei, Chenyang (Jason)

Abstract: This paper investigates the effect of shareholder control on bondholderwealth. While stronger shareholder control can benefit bondholders bydisciplining managers, it also increases the likelihood of events thatcan hurt bondholders, e.g. hostile takeovers. We hypothesize thatshareholder control can have contrasting effects on bond yieldsdepending on the takeover vulnerability of a firm. Using the presence ofan institutional blockholder to proxy for shareholder control andfirm-level anti-takeover provisions to proxy for takeover vulnerability,we find that shareholder control is associated with lower yields if thefirm is protected from takeovers. We also find that shareholder controlis associated with higher yields if the firm is exposed to takeovers.The contrasting effects of shareholder control on yields are thestrongest for firms that are small and have low leverage. In thepresence of shareholder control, the difference in bond yields due todifferences in takeover vulnerability can be as high as 93 basis points.Further, the results are insignificant for a sub-sample of firms wherethe bondholders are protected from takeovers through the poison putcovenant. Bond ratings also appear to incorporate a similar effect ofshareholder control on bondholders Finally, we find that a bond pricingmodel that does not account for shareholder control generates anannualized abnormal return of 1% to 1.4% for portfolios that long firmswith both strong shareholder control and high takeover vulnerability andshort firms without either shareholder control or takeovervulnerability. Combined, these results suggest that the use of differentgovernance mechanisms, such as shareholder monitoring and takeovervulnerability, depends on a firm’s capital structure and thatbond-pricing models should account for shareholder control.

THE IMPACT OF MUTUAL FUND FAMILY MEMBERSHIP ON INVESTOR RISK

Title: THE IMPACT OF MUTUAL FUND FAMILY MEMBERSHIP ON INVESTOR RISK

Elton, Edwin J.; Gruber, Martin J.; Green, T. Clifton

Abstract: Many investors confine their mutual fund holdings to a single fundfamily, either for simplicity or through restrictions placed by theirretirement savings plan. We find evidence that mutual fund returns aremore closely correlated within than between fund families. As a result,restricting investment to one fund family leads to a greater totalportfolio risk than diversifying across fund families. The increasedcorrelation is due primarily to common stock holdings, but is also moregenerally related to families having similar exposures to economicsectors or industries. Fund families also show a propensity to focus onhigh risk or low risk strategies, which leads to a greater dispersion ofrisk across restricted investors. An investor considering adding anadditional fund either inside or outside the family would need tobelieve the inside fund offered an additional 50 to 70 basis points inreturn to achieve the same Sharpe ratio.

THE IMPACT OF INSTITUTIONAL OWNERSHIP ON CORPORATE OPERATING PERFORMANCE

Title: THE IMPACT OF INSTITUTIONAL OWNERSHIP ON CORPORATE OPERATING PERFORMANCE

Cornett, Marcia Millon; Marcus, Alan J.; Saunders, Anthony; Tehranian, Hassan

Abstract: This paper examines the relationship between institutional investorinvolvement in and the operating performance of large firms. We confirma significant relationship between a firm’s operating cash flowreturns and both the percent of institutional stock ownership and thenumber of institutional stockholders. However, the positive relationshipbetween the number of institutional investors holding stock andoperating cash flow returns is found only for pressure-insensitiveinstitutional investors (those with no business relationship with thefirm). The number of pressure-sensitive institutional investors (thosewith an existing or potential business relationship with the firm) hasno impact on performance. These results suggest that institutionalinvestors that need to protect actual or promote potential businessrelationships with firms in which they invest are compromised asmonitors of the firm, and lend credence to calls for greaterindependence of board members from firms.

THE FOUNDATIONS OF FREEZEOUT LAWS IN TAKEOVERS

Title: THE FOUNDATIONS OF FREEZEOUT LAWS IN TAKEOVERS

Amihud, Yakov; Kahan, Marcel; Sundaram, Rangarajan

Abstract: We provide an economic basis for permitting freezeouts of non-tenderingshareholders following successful takeovers. We describe a specificfreezeout mechanism based on easily verifiable information that inducesdesirable efficiency and welfare properties in models of bothcorporations with widely dispersed shareholdings and corporations withlarge pivotal shareholders. The mechanism dominates previous proposalsalong some important dimensions. We also examine takeover premia thatarise in the presence of competition among raiders. Our mechanism isclosely related to the practice of takeover law in the U.S.; thus, ouranalysis may be thought of as analyzing the economic foundations ofcurrent regulations.

The Financial Accelerator in Household Spending: Evidence from International Housing Markets

Title: The Financial Accelerator in Household Spending: Evidence fromInternational Housing Markets

Almeida, Heitor; Campello, Murillo; Liu, Crocker

Abstract: This paper explores contractual features of housing finance and usesdata from international housing markets to provide evidence supportingthe “financial accelerator” (Bernanke et al. 1996, 1999).Among households whose housing demand is constrained by the availabilityof collateral, those who can borrow against a larger fraction of thehousing value (achieve higher loan-to-value, or LTV ratio) have moreprocyclical debt capacity. This procyclicality in borrowing capacity isat the heart of the mechanism underlying the financial accelerator. Ourempirical strategy uses international variation in maximum LTV ratios toshow that housing prices as well as demand for new mortgages are moresensitive to income shocks in countries with higher LTV ratios,consistent with the dynamics of a collateral-based financial acceleratorin household spending. We also find that the empirical relationshipbetween maximum LTV ratios and income sensitivities is stronger incountries where housing prices are low relative to household income.Because collateral constraints are less likely to bind when housing ismore expensive (an income constraint may bind instead), these latterresults further suggest that a collateral-based accelerator is indeedbehind the observed cross-country differences in income sensitivities.

The Effects of Focus and Diversification on Bank Risk and Return: Evidence from Individual Bank Loan Portfolios

Title: The Effects of Focus and Diversification on Bank Risk and Return:Evidence from Individual Bank Loan Portfolios

Acharya, Viral V.; Hasan, Iftekhar; Saunders, Anthony

Abstract: We study empirically the effect of focus (specialization) vs.diversification on the return and the risk of banks using data from 105Italian banks over the period 1993–1999. Specifically, we analyzethe tradeoffs between (loan portfolio) focus and diversification using aunique data set that is able to identify individual bank loan exposuresto different industries, to different sectors, and to differentgeographical regions. Our results are consistent with a theory thatpredicts a deterioration in bank monitoring quality at high levels ofrisk and a deterioration in bank monitoring quality upon lendingexpansion into newer or competitive industries. We find that industrialloan diversification reduces bank return while endogenously producingriskier loans for all banks in our sample, this effect being mostpowerful for high-risk banks. Sectoral loan diversification onlyproduces an inefficient risk–return trade-off for banks with veryhigh levels of risk. Geographical diversification on the other hand doesresult in an improvement in the risk–return tradeoff for bankswith low levels of risk. Overall, our results suggest thatdiversification of bank assets is not guaranteed to produce moreperformance efficient and/or safer banks.

THE EFFECTS OF CROSS-BORDER BANK MERGERS ON BANK RISK AND VALUE

Title: THE EFFECTS OF CROSS-BORDER BANK MERGERS ON BANK RISK AND VALUE

Amihud, Yakov; Delong, Gayle L.; Saunders, Anthony

Abstract: This paper examines the effects of cross border bank mergers on the riskand (abnormal)returns of acquiring banks. We find that overall, theacquirers’ risk neither increases nor decreases. In particular, onaverage neither their total risk nor their systematic risk fallsrelative to banks in their home banking market. The abnormal returns toacquirers are negative and significant, but are somewhat higher whenrisk increases relative to banks in the acquirer’s home country.

The Effects of Cross-Border Bank Mergers on Bank Risk and Value

Title: The Effects of Cross-Border Bank Mergers on Bank Risk and Value

Amihud, Yakov; DeLong, Gayle L.; Saunders, Anthony

Abstract: This paper examines the effects of cross-border bank mergers on the riskand (abnormal) returns of acquiring banks. We find that overall, theacquirers’ risk neither increases nor decreases. In particular, onaverage neither their total risk nor their systematic risk fallsrelative to banks in their home banking market. The abnormal returns toacquirers are negative and significant, but are somewhat higher whenrisk increases relative to banks in the acquirer’s home country.

THE DETERMINANTS OF TAKEOVERS: RECENT EVIDENCE FROM U.S. THRIFTS

Title: THE DETERMINANTS OF TAKEOVERS: RECENT EVIDENCE FROM U.S. THRIFTS

Cebenoyan, Fatma; Cebenoyan, A. Sinan; Cooperman, Elizabeth S.

Abstract: This paper uses a two-step methodology to examine the relationshipbetween managerial cost inefficiency and the takeover of U.S. thriftsduring a period of market liberalization and widespread takeoveractivity, 1994 to 2000. In the first stage using stochastic costfrontiers, we estimate controllable managerial cost inefficiency scoresfor all stock firms operating each year in 1994 to 2000. In a secondstage, we use these scores to examine correlates of takeovers, focusingon cost inefficiency. For takeovers by banks, we find a significantnegative relationship between cost inefficiency and takeover, suggestingan exit of more cost efficient firms from the thrift industry duringthis period. However, takeovers by thrifts are associated with other characteristics.

The Determinants of Liquidity in the Corporate Bond Markets: An Application of Latent Liquidity

Title: The Determinants of Liquidity in the Corporate Bond Markets: AnApplication of Latent Liquidity

Chacko, George; Mahanti, Sriketan; Mallik, Gaurav; Subrahmanyam, Marti

Abstract: We present a new measure of liquidity known as “latentliquidity” and apply it to a unique corporate bond database todiscern the characteristics of bonds that lead to higher liquidity.Unlike conventional measures of liquidity, such as trading volume andbid-ask spreads, our measure of liquidity does not use transactionalinformation; instead, it uses information about the ownership ofsecurities to measure the accessibility of a security by a securitiesdealer. Therefore, our measure has the important advantage of being ableto assess liquidity for markets with extremely low trading activity,where transactions data are insufficient to compute traditional measuresof liquidity, but where liquidity is still an important issue. We relateour proposed latent liquidity measure to bond characteristics such asamount outstanding, credit quality, maturity, age, optionality andindustry segment. In the liquid segments of the market, wheretrade-based measures of liquidity are available, our proposed measureexhibits similar relationships to bond characteristics as thetrade-based measures. However, latent liquidity exhibits greaterconsistency in terms of its relationships with bond characteristics,over time. In addition, in the illiquid segment of the market, therelationships of our measure to bond characteristics are also similar towhat we observe in the liquid segment. This leads us to believe that ourmeasure is a viable measure of liquidity, when trade-based measures are unavailable

THE DECLINING INFORMATION CONTENT OF DIVIDEND ANNOUNCEMENTS AND THE EFFECT OF INSTITUTIONAL HOLDINGS

Title: THE DECLINING INFORMATION CONTENT OF DIVIDEND ANNOUNCEMENTS AND THEEFFECT OF INSTITUTIONAL HOLDINGS

Amihud, Yakov; Li, Kefei

Abstract: We propose an explanation for the “disappearing dividend”phenomenon: the decline in the information content of dividendannouncements. It reduces the propensity of firms to pay or increasedividends, since dividends are costly. A reason for the decline in theinformation content of dividends is the rise in holdings byinstitutional investors that are more sophisticated and informed. Weindeed find a decline in CAR at dividend change announcements since themid 1970s. Across firms, CAR declines in institutional holdings.Exploiting their superior information, institutional investors buybefore dividend increases and sell afterwards. And, dividends are lesslikely to rise in firms with high institutional holdings.

The Declining Information Content of Dividend Announcements and the Effect of Institutional Holdings

Title: The Declining Information Content of Dividend Announcements and theEffect of Institutional Holdings

Amihud, Yakov; Li, Kefei

Abstract: We propose an explanation for the "disappearing dividend"phenomenon: the decline in the information content of dividendannouncements. This reduces the propensity of firms to pay or increasedividends, since dividends are costly. The decline in the informationcontent of dividend, is partly because of the rise in stockholding byinstitutional investors that are more sophisticated and informed. Ourresults show a decline in the stock price reaction to announcements ofdividend changes since the mid 1970s. Across firms, the price reactionto dividend news is smaller in firms with high institutional holdings.Institutional investors exploit their superior information by buyingbefore dividend increases and selling afterwards. And, firms with highinstitutional holdings are less likely to raise dividends.

The Declining Equity Premium: What Role Does Macroeconomic Risk Play?

Title: The Declining Equity Premium: What Role Does Macroeconomic Risk Play?

Lettau, Martin; Ludvigson, Sydney C.; Wachter, Jessica A.

Abstract: Aggregate stock prices, relative to virtually any indicator offundamental value, soared to unprecedented levels in the 1990s. Eventoday, after the market declines since 2000, they remain well abovehistorical norms. Why? We consider one particular explanation: a fall inmacroeconomic risk, or the volatility of the aggregate economy. Weestimate a two-state regime switching model for the volatility and meanof consumption growth, and find evidence of a shift to substantiallylower consumption volatility at the beginning of the 1990s. We then showthat there is a strong and statistically robust correlation between lowmacroeconomic volatility and high asset prices: the estimated posteriorprobability of being in a low volatility state explains 30 to 60 percentof the post-war variation in the log price-dividend ratio, depending onthe measure of consumption analyzed. Next, we study a rational assetpricing model with regime switches in both the mean and standarddeviation of consumption growth, where the probabilities of a regimechange are calibrated to match estimates from post-war data. Plausibleparameterizations of the model are found to account for a significantfraction of the run-up in asset valuation ratios observed in the late 1990s.

The Cross-Sectional Implications of Rising Wage Inequality in the United States

Title: The Cross-Sectional Implications of Rising Wage Inequality in the United States

Heathcote, Jonathan; Storeslettenand, Kjetil; Violante, Giovanni L.

Abstract: This paper explores the implications of the recent sharp rise in US wageinequality for welfare and the cross-sectional distributions of hoursworked, consumption and earnings. From 1967 to 1996 cross-sectionaldispersion of earnings increased more than wage dispersion, due to arise in the correlation between wages and hours worked. Over the sameperiod, inequality in hours worked remained roughly constant, and thedispersion in consumption and wealth increased only modestly. Using datafrom the PSID, we decompose the observed rise in wage inequality intochanges in the variance of permanent, persistent and transitory shocks.With this changing wage process as the only primitive, we show that acalibrated overlapping-generations model with incomplete markets canaccount for these trends in cross-sectional US data. We also investigatethe welfare costs of the rise in wage inequality: the ex-ante loss isequivalent to a five percent decline in lifetime income for theworst-affected cohorts.

THE CHOICE OF OUTSIDE EQUITY: AN EXPLORATORY ANALYSIS OF PRIVATELY HELD FIRMS

Title: THE CHOICE OF OUTSIDE EQUITY: AN EXPLORATORY ANALYSIS OF PRIVATELY HELD FIRMS

Boehmer, Ekkehart; Ljungqvist, Alexander

Abstract: We analyze the choice between public and private equity financing of aunique, hand-collected sample of privately held firms that haveindicated their willingness to raise outside equity. We document thatthese firms are remarkably similar at the time of the announcement, yet71% complete an IPO, 18% sell equity privately, and the remaining firmsdo not raise capital at all. To understand what determines the ultimateoutcome, we follow these firms over time and record what they mightlearn up to their final decision. We identify the marginal conditionsthat favor raising outside equity, and those that determine the choicebetween public and private equity. Our results show that firms reactsystematically to changes in market conditions, such as equity returnsand the cost of capital, that occur after the announcement, controllingfor capital constraints, ownership structure, and the motivation forraising outside capital.

The cash flow, return and risk characteristics of private equity

Title: The cash flow, return and risk characteristics of private equity

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the cash flow, return, and riskcharacteristics of private equity. Unlike previous studies, we havedetailed cash flow data for each fund, rather than aggregate oraccounting returns. We also know the exact timing of investments andcapital returns to investors and the number and types of companies eachfund invested in. We document the draw down and capital return schedulesfor the typical private equity fund, and show that it takes severalyears for capital to be invested, and over ten years for capital to bereturned to generate excess returns. We provide several determiningfactors for these schedules, including existing investment opportunitiesand competition amongst private equity funds. In terms of performance,we document that private equity generates excess returns on the order offive to eight percent per annum relative to the aggregate public equitymarket. Moreover, while we estimate the betas of the private equityfunds’ portfolios to be greater than one, we show that on arisk-adjusted basis the excess value of the typical private equity fundis on the order of 24 percent relative to the present value of theinvested capital. One interpretation of this magnitude is that itrepresents compensation for holding a 10-year illiquid investment.

The Cash Flow, Return and Risk Characteristics of Private Equity

Title: The Cash Flow, Return and Risk Characteristics of Private Equity

Ljungqvist, Alexander; Richardson, Matthew

Abstract: Using a unique dataset of private equity funds over the last twodecades, this paper analyzes the cash flow, return, and riskcharacteristics of private equity. Unlike previous studies, we havedetailed cash flow data for each fund, rather than aggregate oraccounting returns. We also know the exact timing of investments andcapital returns to investors and the number and types of companies eachfund invested in. We document the draw down and capital return schedulesfor the typical private equity fund, and show that it takes severalyears for capital to be invested, and over ten years for capital to bereturned to generate excess returns. We provide several determiningfactors for these schedules, including existing investment opportunitiesand competition amongst private equity funds. In terms of performance,we document that private equity generates excess returns on the order offive to eight percent per annum relative to the aggregate public equitymarket. Moreover, while we estimate the betas of the private equityfunds’ portfolios to be greater than one, we show that on arisk-adjusted basis the excess value of the typical private equity fundis on the order of 24 percent relative to the present value of theinvested capital. One interpretation of this magnitude is that itrepresents compensation for holding a 10-year illiquid investment.

The Cash Flow, Return and Risk Characteristics of Private Equity

The cash flow, return and risk characteristics of private equity

THE ADEQUACY OF INVESTMENT CHOICES OFFERED BY 401K PLANS

Title: THE ADEQUACY OF INVESTMENT CHOICES OFFERED BY 401K PLANS

Elton, Edwin J.; Gruber, Martin J.; Blake, Christopher R.

Abstract: Defined-contribution plans represent a major organizational form forinvestors’ retirement savings. Today more than one third of allworkers are enrolled in 401K plans. In a 401K plan, participants selectassets from a set of choices designated by an employer. For over half of401K-plan participants, retirement savings represent their solefinancial asset. Yet to date there has been no study of the adequacy ofthe choices offered by 401K plans. This paper analyzes the adequacy andcharacteristics of the choices offered to 401K-plan participants forover 400 plans. We find that, for 62% of the plans, the types of choicesoffered are inadequate, and that over a 20-year period this makes adifference in terminal wealth of over 300%. We find that funds includedin the plans are riskier than the general population of funds in thesame categories. We study the characteristics of plans that areassociated with adequate investment choices, including an analysis ofthe use of company stock, plan size, and the use of outside consultants.When we examine one category of investment choices, S&P 500 indexfunds, we find that the index funds chosen by 401K-plan administratorsare on average inferior to the S&P 500 index funds selected by theaggregate of all investors.

Term Structure Dynamics in Theory and Reality

Title: Term Structure Dynamics in Theory and Reality

Dai, Qiang; Singleton, Kenneth

Abstract: This paper is a critical survey of models designed for pricing fixedincome securities and their associated term structures of market yields.Our primary focus is on the interplay between the theoreticalspecification of dynamic term structure models and their empirical fitto historical changes in the shapes of yield curves. We begin byoverviewing the dynamic term structure models that have been fit totreasury or swap yield curves and in which the risk factors followdiffusions, jump-diffusion, or have \switching regimes." Then thegoodness-of- ts of these models are assessed relative to their abilitiesto: (i) match linear projections of changes in yields onto the slope ofthe yield curve; (ii) match the persistence of conditional volatilities,and the shapes of term structures of unconditional volatilities, ofyields; and (iii) to reliably price caps, swaptions, and otherfixed-income derivatives. For the case of defaultable securities weexplore the relative fits to historical yield spreads.

Term Structure Dynamics in Theory and Reality

Title: Term Structure Dynamics in Theory and Reality

Dai, Qiang; Singleton, Kenneth

Abstract: This paper is a critical survey of models designed for pricing fixedincome securities and their associated term structures of market yields.Our primary focus is on the interplay between the theoreticalspecification of dynamic term structure models and their empirical fitto historical changes in the shapes of yield curves. We begin byoverviewing the dynamic term structure models that have been fit totreasury or swap yield curves and in which the risk factors followdiffusions, jump-diffusion, or have “switching regimes." Thenthe goodness-of-fits of these models are assessed relative to theirabilities to: (i) match linear projections of changes in yields onto theslope of the yield curve; (ii) match the persistence of conditionalvolatilities, and the shapes of term structures of unconditionalvolatilities, of yields; and (iii) to reliably price caps, swaptions,and other fixed-income derivatives. For the case of defaultablesecurities we explore the relative fits to historical yield spreads.

TENDER OFFERS AND LEVERAGE

Title: TENDER OFFERS AND LEVERAGE

Mueller, Holger M.; Panunzi, Fausto

Abstract: We examine the role of leverage in tender offers for widely held firms.Leverage allows raiders to appropriate part of the value gains arisingfrom takeovers, hence reducing the takeover premium and mitigating thefree-rider problem. Leveraged takeovers may thus be profitable even iftarget shareholders are dispersed. Bankruptcy costs, incentive problemson the part of the raider, and defensive leveraged recapitalizations andasset sales by the target management all limit the raider’sability to borrow, thus shifting takeover gains to target shareholdersand reducing the takeover likelihood. While bankruptcy costs are asocial cost, the takeover premium is merely a wealth transfer to targetshareholders. As the raider does not maximize social welfare, he usestoo much debt compared to the social optimum.

TENDER OFFERS AND LEVERAGE

Title: TENDER OFFERS AND LEVERAGE

Mueller, Holger M.; Panunzi, Fausto

Abstract: We examine the role of leverage in tender offers for widely held firms.Leverage allows raiders to appropriate part of the value gains arisingfrom takeovers, hence reducing the takeover premium and mitigating thefree-rider problem. Leveraged takeovers may thus be profitable even iftarget shareholders are dispersed. Bankruptcy costs, incentive problemson the part of the raider, and defensive leveraged recapitalizations andasset sales by the target management all limit the raider’sability to borrow, thus shifting takeover gains to target shareholdersand reducing the takeover likelihood. While bankruptcy costs are asocial cost,the takeover premium is merely a wealth transfer to targetshareholders. As the raider does not maximize social welfare, he usestoo much debt compared to the social optimum.

Tax and Education Policy in a Heterogeneous Agent Economy: What Levels of Redistribution Maximize Growth and Efficiency?

Title: Tax and Education Policy in a Heterogeneous Agent Economy: What Levelsof Redistribution Maximize Growth and Efficiency?

Benabou, Roland

Strategies in Financial Services, the Shareholders and the System Is Bigger and Broader Better?

Title: Strategies in Financial Services, the Shareholders and the System IsBigger and Broader Better?

Walter, Ingo

Abstract: The classic structure-conduct-performance approach to industrialorganization centers on three questions. First, why is does an industrylook the way it does, in terms of numbers of competitors, market sharedistribution and various other metrics? Second, how do firms actuallycompete, in terms the formation of prices, product and service quality,rivalry and collaboration within and across strategic groups, and otherattributes of economic behavior? And third, how does the industryperform for its shareholders, its employees, its clients and suppliers,and within the context the system as a whole in terms of its impact onincome and growth, stability, and possibly less clearly defined ideasabout such things as social equity? In the financial services industry,these same questions have attracted more than the normal degree ofattention. The industry is "special" in a variety of ways,including the fiduciary nature of the business, its role at the centerof the payments and capital allocation process with all its static anddynamic implications for economic performance, and the systemic natureof problems that can arise in the industry. So the structure, conductand performance of the industry have unusually important public interestdimensions. One facet of the discussion has focused on size of financialfirms, however measured, and the range of activities conducted by them.Exhibit 1 depicts a taxonomy of broad-gauge financial servicesbusinesses. What are the strategic opportunities and competitiveconsequences of deepening and broadening a firm’s business withinand between the four sectors and eight sub-sectors? Is size positivelyrelated to total returns to shareholders? If so, does this involve gainsin efficiency or transfers of wealth to shareholders from otherconstituencies, or maybe both? Does greater breadth generate sufficientinformation-cost and transaction-cost economies to be beneficial toshareholders and customers, or can it work against their interests inways that may ultimately impede shareholder value as well? And whatabout the “specialness,” notably the industry's fiduciarycharacter and systemic risk -- is bigger and broader also safer? Thispaper begins with a simple strategic framework for thinking about theseissues from the perspective of the management of financial firms. Whatshould they be trying to do, and how does this relate to the issues ofsize and breadth? It then reviews the available evidence and reaches aset of tentative conclusions from what we know so far, both from ashareholder perspective and that of the financial system as a whole.

Strategies in Banking and Financial Services Firms: A Survey

Title: Strategies in Banking and Financial Services Firms: A Survey

Walter, Ingo

Abstract: This survey paper reviews the basic parameters of strategic positioningand execution in multi-functional financial services firms. We beginwith a model of financial intermediation between end-users of thefinancial system as a way of locating specific financial intermediationfunctions. Shifts in intermediation shares are superimposed on thisflow-of-funds profile, focusing on their implications for alternativebusiness models available to financial institutions. The next section ofthe paper links the structural story to a normative strategicpositioning matrix, which combines standard structure-conductperformance precepts with the potential realization of scale, scope,x-efficiency, market-power, transaction- and information-costdimensions, as well as imbedded risk exposures and conflicts ofinterest. The final section of the paper considers the value of naturalhedges incorporated into multifunctional business platforms against theaccompanying potential for a conglomerate discount in the share price.

STOCK MARKET VALUATIONS AND FOREIGN DIRECT INVESTMENT

Title: STOCK MARKET VALUATIONS AND FOREIGN DIRECT INVESTMENT

Baker, Malcolm; Foley, C. Fritz; Wurgler, Jeffrey

Abstract: We outline and test two theories of foreign direct investment based oncapital market mispricing. The “cheap assets” or“fire-sale” theory considers FDI inflows as the purchase ofundervalued host country assets, while the “cheap financialcapital” theory views FDI outflows as a natural use of therelatively low-cost capital available to overvalued firms in the sourcecountry. The results are consistent with the cheap financial capitaltheory: FDI flows are unrelated to host country stock market valuations,as measured by the aggregate market-to-book-value ratio, but arestrongly positively related to source country valuations and negativelyrelated to future source country stock returns, especially when capitalaccount restrictions limit cross-country arbitrage.

Stochastic Skew in Currency Options

Title: Stochastic Skew in Currency Options

Carr, Peter; Wu, Liuren

Abstract: We document the behavior of over-the-counter currency option pricesacross moneyness, maturity, and calendar time on two of the mostactively traded currency pairs over the past eight years. We find thatthe risk-neutral distribution of currency returns is relativelysymmetric on average. However, on any given date, the conditionalcurrency return distribution can show strong asymmetry. This asymmetryvaries greatly over time and often switch directions. We design andestimate a class of models that capture these unique features of thecurrency options prices and perform much better than traditionaljump-diffusion stochastic volatility models.

Standard Risk Aversion and the Demand for Risky Assets in the Presence of Background Risk

Title: Standard Risk Aversion and the Demand for Risky Assets in the Presenceof Background Risk

Franke, Gunter; Stapleton, Richard C.; Subrahmanyam, Marti G.

Abstract: We consider the demand for state contingent claims in the presence of azero-mean, non-hedgeable background risk. An agent is defined to begeneralized risk averse if he/she reacts to an increase in backgroundrisk by choosing a demand function for contingent claims with a smallerslope. We show that the conditions for standard risk aversion: positive,declining absolute risk aversion and prudence are necessary andsufficient for generalized risk aversion. We also derive a necessary andsufficient condition for the agent's derived risk aversion to increasewith a simple increase in background risk.

Spiders: Where are the Bugs?

Title: Spiders: Where are the Bugs?

Elton, Edwin J.; Gruber, Martin J.; Comer, George; Li, Kai

Spiders: Where are the Bugs?

Title: Spiders: Where are the Bugs?

Elton, Edwin J.; Gruber, Martin J.; Comer, George; Li, Kai

Specification Analysis of Option Pricing Models Based on Time-Changed Levy Processes

Title: Specification Analysis of Option Pricing Models Based on Time-ChangedLevy Processes

Huang, Jing-zhi; Wu, Liuren

Abstract: We analyze the specifications of option pricing models based ontime-changed Levy processes. We classify option pricing models based onthe structure of the jump component in the underlying return process,the source of stochastic volatility, and the specification of thevolatility process itself. Our estimation of a variety of modelspecifications indicates that to better capture the behavior of theS&P 500 index options, we must incorporate a high frequency jumpcomponent in the return process and generate stochastic volatilitiesfrom two different sources, the jump component and the diffusion component.

So What Do I Get? The Bank’s View of Lending Relationships

Title: So What Do I Get? The Bank’s View of Lending Relationships

Bharath, Sreedhar; Dahiya, Sandeep; Saunders, Anthony; Srinivasan, Anand

Abstract: While a number of empirical studies have documented benefits of lendingrelationships to borrowers (lower loan rates, better creditavailability, etc.), not much is known about benefits of suchrelationships for lenders. For a relationship lender, its comparativeadvantage in information gathering/processing yields two potentialbenefits. First, a relationship lender would have a higher probabilityof selling future information-sensitive products (e.g. loans, securityunderwriting, etc.) to its borrowers compared to a non-relationshiplender. We refer to this as higher volume benefit of relationshiplending. Second, if borrower-specific information is only available torelationship lender, it can use this information monopoly to chargehigher rates on future loans. We refer to this as increased pricingbenefit of relationship lending. Our results show that, on average, alender with a past relationship with a borrower has a 42% probability ofproviding it with future loans, while a lender lacking a pastrelationship with a borrower has only a 3% probability of providing itwith a future loan. Consistent with theory, we find that borrowers withgreater information asymmetries (e.g. small borrowers, or non-ratedborrowers) are significantly more likely to use their relationship banksfor future loans. Although the association between past lendingrelationship and probability of being chosen to provide debt and equityunderwriting services in the future is statistically significant, theeconomic impact is much smaller compared to loan markets. However, ourfindings do not provide strong support for an increased pricing benefitfor relationship lenders. On average, the rate of interest for similarborrowers is 6-10 basis points lower if the loan is provided by arelationship lender. Underwriting fee for initial public offerings (IPO)with relationship lender(s) as lead underwriter(s) is 26 basis pointslower. This suggests that lenders are prepared to share some of thebenefits of relationship lending with borrowers.

Sharing Underwriters with Rivals: Implications for Competition in Investment Banking

Title: Sharing Underwriters with Rivals: Implications for Competition inInvestment Banking

Asker, John; Ljungqvist, Alexander

Abstract: We conjecture that issuing firms seek to avoid sharing underwriters withtheir product-market rivals in order to limit the risk thatstrategically sensitive information is leaked to a rival firm via theunderwriter relationship. We investigate this conjecture in a sample of5,272 equity deals and 12,453 debt deals by large U.S. firms between1975 and 2003. Using several distinct sources of identification, we findthat this phenomenon is at least as important in determining the choiceof lead underwriter as the bank's reputation or the issuing firm'sexisting relationship with the underwriter. We argue that this findinghas important implications for understanding the nature of competitionamong investment banks, the durability of underwriting relationships,the success of entrants, and the likely impact of investment bankmergers on market power.