An equity-linked life insurance policy with an asset value guarantee (ELPAVG) is an insurance policy whose benefit payable on death or at maturity consists of the greater of some guaranteed amount and the value of a reference portfolio which is defined by the deemed investment of a predetermined component of the policy premium in a portfolio of common stocks or mutual fund–the reference fund. In an earlier paper we demonstrated that the benefit payable under an ELPAVG could be decomposed into the known guaranteed amount and an immediately exercisable call option to purchase the reference portfolio for an exercise price equal to the guaranteed amount. The principles of the option pricing model were then employed to derive the equilibrium premium for both a single premium ELPAVG contract and a periodic premium contract. It was further noted that the hedging arguments, which are the core of most of the recent theory of option pricing, could be employed to derive an investment strategy for the insurance company which would eliminate the risks associated with the sale of ELPAVGs: this is an important result, for ELPAVGs may pose a significant threat to the solvency of insurance companies since the risks of loss under different contracts are not independent, but are commonly related to the overall performance of the reference fund. Actuaries have responded to this threat by attempting to determine a level of reserves sufficient to reduce the probability of ruin to an acceptable level. On the other hand, adoption of the riskless investment strategy in theory eliminates the need to hold any reserves except against mortality risk.

Recent research on blockholders focuses on activist hedge funds and documents positive stock but negative bond returns. This study investigates the role of blockholder heterogeneity on security market effects and target firm follow-on activities across three important dimensions: identity, motive, and purchasing method. We show that target firms’ security returns and post-acquisition activities strongly correlate with blockholder heterogeneity. Further, bond returns are significantly positive for firms with blockholders’ debt-assistance motive while both stock and bond returns are significantly negative in private placements. Overall, our findings highlight the importance of blockholder heterogeneity on the valuation and performance consequences in block acquisitions.

We document statistically significant relations between mutual fund betas and past market returns driven by fund feedback trading. Against this backdrop, evidence of “artificial” market timing emerges when standard market timing regressions are estimated across periods that span time variation in fund systematic risk levels, as is typical. Artificial timing significantly explains the inverse relation between timing model estimates of market timing and stock selectivity. A fund’s feedback trading relates to its past performance and remains significant after accounting for trading on momentum. Fund flows suggest that investors value feedback trading, which helps hedge downside risk during bear markets.

In a recent paper the net present value (NPV) accept-reject decision rule, invoking the conventional definition of expected net cash flows of a finite, uneven character along with a weighted average cost of capital, was derived from the condition of shareholder wealth maximization (Beranek [2]). Since the entire textbook-NPV expression was established–its logical form, the content of its variables, and the implied specification of its parameters–this has served as a partial rescue of textbook approaches to capital budgeting, approaches which had heretofore rested on an intuitive basis. But attempts to rescue textbook treatments of mutually exclusive (ME) choices and capital rationing must fail. Explaining why they must fail, and developing what we shall denote as the AB alternative solution, is the object of this paper.

The federal deposit insurance system of the United States was instituted as a result of severe financial crises in the United States and was intended to prevent the recurrence of some of the evils of such crises, specifically those resulting from bank deposit losses. Since the Federal Deposit Insurance Corporation (FDIC) was established in 1934, the United States has not experienced banking panics or harmful effects on the economy due to widespread destruction of bank deposits. As a result, there is a fairly widespread feeling that the present deposit insurance system has been a success. If prevention of panics and large-scale deposit destruction are the only criteria for success, this judgment may be justified, although, if the insurance system uses resources, it must be proved that panics and deposit losses would be unacceptably frequent or large in its absence.

One of the major problems in finance is that of combining the separate costs of debt and equity into an appropriate cutoff rate for new investment; this problem is particularly acute when the firm is changing its capital structure. Solutions to this problem which have been proposed include various types of both marginal costing and average costing.

Although federal judges are the ultimate arbiters of insider trading enforcement, the role of their political ideology in insider trading is unclear. Using the partisanship of judges’ nominating presidents to measure judge ideology, we first document that liberal judges are associated with heavier penalties in insider trading lawsuits than conservative judges. Next, we find that firms located in circuits with more liberal judges have fewer opportunistic insider sales. Cross-sectional analyses show that this deterrent effect is stronger when managers face a higher risk of insider trading lawsuits. Finally, we find that the Securities and Exchange Commission considers judges’ ideology when selecting litigation forums.

We derive the optimal underwriting method and the quantitative initial public offering (IPO) pricing rule that this method implies in a market with informational frictions consisting of fully rational banks, issuers, and investors. In an efficient IPO market, an issuer’s expected initial return will be determined entirely by the combination of this pricing rule and issuer fundamentals. Applying this rule, we find that we can explain the quantitative magnitude of the principal aspects of the time-series and cross-sectional variation in IPO average initial returns. We conclude that the IPO market is efficient.

I show that cash distributions through cash mergers, dividend payments, and stock buybacks are, in principle, similar to investor fund flows in generating demand for investable assets. Abnormal returns on certain assets can be forecasted because delegated investors predictably reinvest cash returns toward certain holdings. Novel measures of stock-level demand constructed using proportional reinvestments by mutual funds predict abnormal returns and issuances in noncash-paying stocks. These results highlight an alternative and substantial source of price fluctuations in the cross section of equities.

How synchronized are short sellers? We examine a unique data set on the distribution of profits across a stock’s short sellers and find evidence of substantial dispersion in the initiation of their positions. Consistent with this dispersion reflecting “synchronization risk,” that is, uncertainty among short sellers about when others will short sell, more dispersed short selling signals i) greater stock overpricing and ii) longer delays in overpricing correction. These effects are prevalent even among stocks facing low short-selling costs or other explicit constraints. Overall, our findings provide novel cross-sectional evidence of synchronization problems among short sellers and their pricing implications.

We identify Industry-Neutral Self-Financed Informed Trading (INSFIT) as stock trades financed by offsetting, equivalent dollar-denominated stock trades in the same industry. Approximately 37% of short-term mutual fund trading profits can be attributed to these trade pairs. Consistent with informed trading, INSFIT precedes unusually high media coverage for the underlying stocks. The trades underlying INSFIT are also larger as the release of stock-level news becomes more imminent. Both relative valuation and the hedging of industry exposure motivate INSFIT’s industry neutrality. While INSFIT positively impacts fund performance, active fund managers who execute INSFIT more aggressively obtain smaller trading profits per execution.

Controversy over the implications of debt and the rationale belying capital structure has seemingly come to rest upon a plateau defined by Miller's equilibrium analysis of aggregate corporate debt [10]. In “Debt and Taxes,” Miller reasserts his contention that whether capital is obtained through debt or equity has no bearing on the market value of the firm and is, therefore, irrelevant--a notion which has long been accepted with some reluctance by the finance academe. When the Modigliani-Miller model was first offered some 20 years ago [11], it was accompanied by a set of assumptions which portrayed the world of corporate finance in such malleable terms as to make the irrelevancy propositions palatable. Adaptation of this theoretical model (by its originators) to its secular counterpart through the imposition of corporate taxes [12] brought about a reassuring reversal of the irrelevancy doctrine, but left in its stead the disconcerting prescription to maximize firm value by financing exclusively via debt. Consideration of tax effects at the personal level by Farrar and Selwyn [7] marked the next concession to reality by capital structure theorists. Instead of alienating the original model still further from observed corporate behavior, this step provided a means of reconciling the overwhelming advantage of debt financing at the corporate level with the ultimate after-tax “consumption possibilities” afforded to individual investors. Miller's analysis explains that corporations are forced to “gross up” nominal interest rates to attract bondholders who must be compensated for their personal tax liability [10]. Potential increases in market value due to the taxdeductibility of interest payments are exhausted in the competitive drive toward equilibrium—at which point there are no gains from leverage. The sanctity of the irrelevance theorem thus appears to have been restored at the aggregate level.

In this issue of the Journal of Financial and Quantitative Analysis, Beranek [2] has presented a clever but cumbersome analysis showing that, for a simple multiperiod situation, computing a project's net present worth by discounting its cash flows at particular “costs of capital” and accepting the project if that net present worth is positive is completely consistent with raising the net present wealth of stockholders, initial investment from whom provides partial funding for the project.

The paper provides sufficient conditions under which a nonrandom economic variable specific to some asset (the dependent variable) can be represented as a linear combination of the betas of some random characteristics of the asset (the independent variables) with some economy-wide factors. This generalizes Ross' APT that proves the above in the case where the dependent variables are expected returns and the independent variables are returns. This generalization will provide a theoretical basis for many existing multibeta relationships beyond the setting of asset pricing models and, thus, motivate their wider use in empirical and theoretical research.

Traditional planning for working capital needs is typically conducted with a relatively short time horizon. In this process, management attempts to optimize the return on existing fixed assets. The period for capital investment planning is much longer, reflecting the irreversibility of these decisions. Current research in the two areas tends to dichotomize these decision processes. The implications seem to be that working capital policies only have impact in the short run. However, it is clear that cash flows for potential capital expenditures are based on assumptions relative to expected future demand and production to meet this demand—assumptions that are necessarily tied to working capital commitments in the long run. The overall planning for credit, inventory, and liquidity should, therefore, be carried out before, or simultaneously with, the capital investment decision. It is a planning requirement that becomes an integral part of the total asset planning system. The vast majority of existing working capital models or long-term capital planning models do not allow for the explicit existence of and the simultaneous interrelationships between these two important subsystems.

One of the most significant developments in macroeconomic analysis in the post-World War II era has been the dramatic resurgence of interest in the role of monetary factors in economic activity. The demand for money has been a focal point of this monetary renaissance, and in recent years a proliferation of studies has focused on questions such as the motives for holding money balances, the effects of changes in the rate of interest, and the existence of economies of scale for cash balances. The trend toward disaggregation of macro functions has been reflected in demand for money studies of the corporate sector as well as the household sector.

The theory of efficient capital markets indicates that the prices in an efficient market fully reflect all available information. In much of the literature on efficient markets the term fully reflect is made operational with the assumption that the conditions for market equilibrium can be expressed as expected returns. Fama suggests that most expected return theories can be expressed in the following manner:

(1)

where — adopting Fama's notation — E is the expected value operator; Pjt is the price of security j at time t; Pj,t+1 is its price at t+1; is the one-period percentage return (Pj,t+1|Pjt); φt is a general symbol to represent whatever set of information is assumed to be fully reflected in the price at time t; and the tildes indicate that Pj,t+1 and rj,t+1 are random variables at t.

There is little question that stock options have value, but there is considerable question as to how stock options should be valued. Persons studying the valuation question and writing in business periodicals have tied the value of the stock option to the expected or the actual appreciation in the value of the stock.

Professor Solow's article, “Technical Change and the Aggregate Production Function,” now virtually classic, has made a great impact on economists generally and in the last few years the subject has received unprecedented attention in economic literature. The reason for this extraordinary emphasis on “Technical Change” has been the conclusion—in Solow's above-mentioned article—based on statistical evidence, that gross output per man-hour in the United States nonfarm economy doubled over the period 1909–1949, “with 87.5 percent of the increase attributable to technical change and the remaining 12.5 percent to increased use of capital.”

Ever since Markowitz introduced the concept of portfolio theory in 1952, one of the questions predominant in the minds of financial theorists has been the constituency of the investor's optimal asset portfolio. Research into this area, which became known as capital market theory, attempted to analyze the equilibrium relationships between assets. One of the products of this research was the widely accepted Capital Asset Pricing Model (CAPM) of Sharpe and Lintner.