In the linear market-index model of the return-generating process, return on security j is given by

where αj and βj are constants characteristic of company j, is return on a market index, and is the company-specific component of return such that and . The coefficient βj is given by . It is known as market responsiveness, volatility, systematic risk, and, more commonly, simply as “beta.” It has been widely accepted as a measure of nondiversifiable risk and incorporated in popular performance measures. Many stock information services now provide estimates of beta.

This paper explores the determinants of monitoring activity provided by security analysts. Jensen and Meckling have argued that analysts play the role of monitors of managerial performance as a means of reducing agency costs of debt and equity. The other major role analysts play is that of making security markets more informationally efficient. The empirical results reported in this paper support the role of analyst monitoring as an efficient device for controlling agency-related costs of debt and equity and as a response to the information demands of investors.

I test whether corporate governance is ineffective in emerging markets by estimating the link between CEO turnover and firm performance for over 1,200 firms in eight emerging markets. I find two main results. First, CEOs of emerging market firms are more likely to lose their jobs when their firm's performance is poor, suggesting that corporate governance is not ineffective in emerging markets. Second, for the subset of firms with a large domestic shareholder, there is no link between CEO turnover and firm performance. For this subset of emerging market firms, corporate governance appears to be ineffective.

We analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the early 1990s for filter and moving average rules. Returns to less-studied rules also have declined but have probably not completely disappeared. High volatility prevents precise estimation of mean returns. These regularities are consistent with the Adaptive Markets Hypothesis (Lo (2004)), but not with the Efficient Markets Hypothesis.

This paper attempts to characterize liquidity-driven noise in the CRSP Government Bond price data set by comparing these price records to the independently collected Shearson Lehman Brothers (SLB) Bond Data Base. We argue that discrepancies between the data sets are due largely to liquidity-driven price errors, and we show that they are systematically related to certain bond characteristics. On the other hand, these discrepancies are small in magnitude and are approximately mean zero. We examine data filters based on observable bond characteristics and show that these filters can reduce the noise in price records while preserving their mean zero nature. The effects of these errors on performance evaluation are investigated by comparing results using filtered and unfiltered data.

One of the main principles of corporate finance is that managers should maximize the market value of the outstanding securities. While it is realized that managers and security holders may have divergent objectives, it is generally assumed that various market forces keep managerial and shareholders' goals in line. Out of the extensive literature on this issue, three such market forces emerge. First, non-value-maximizing firms are prime targets for take-over bids (e.g., see [14]): bidding firms could acquire control over the shares of the target firm, replace the management, follow a value-maximizing strategy, and realize a profit from the resulting appeciation of the target shares. Second, outside shareholders may charge managers-owners ex ante by discounting stock prices for expected managerial expropriation, which may induce managers to accept various restrictions on their behavior (e.g., see [11]). Third, shareholders may charge managers ex post, indirectly via the discipline imposed by a competitive managerial labor market (e.g., [8]). Note the difference from the previous mechanism: Jensen and Meckling [11] assume that managerial wages are fixed so that all the adjustment for expected expropriation is reflected in stock prices (and, ultimately, in costly monitoring and bonding devices). In Fama's [8] model, all the adjustment occurs in the managerial labor market, so that the value of the firm remains unaffected by expected managerial expropriation.

The estimation of dynamic no-arbitrage term structure models with a flexible specification of the market price of risk is beset by severe small-sample problems arising from the highly persistent nature of interest rates. We propose using survey forecasts of a short-term interest rate as an additional input to the estimation to overcome the problem. To illustrate the methodology, we estimate the 3-factor affine-Gaussian model with U.S. Treasury yields data and demonstrate that incorporating information from survey forecasts mitigates the small-sample problem. The model thus estimated for the 1990–2003 sample generates a stable and sensible estimate of the expected path of the short rate, reproduces the well-known stylized patterns in the expectations hypothesis tests, and captures some of the short-run variations in the survey forecast of the changes in longer-term interest rates.

This study analyzes detailed minutes of board meetings of business companies in which the Israeli government holds a substantial equity interest. Boards with at least 3 directors of each gender are found to be at least 79% more active at board meetings than those without such representation. This phenomenon is driven by women directors in particular; they are more active when a critical mass of at least 3 women is in attendance. Gender-balanced boards are also more likely to replace underperforming chief executive officers (CEOs) and are particularly active during periods when CEOs are being replaced.

Mechanical trading rules seem to have more potential than previous tests found. Fama and Blume (1966), looking at the Dow 30 of the late 1950s, found no profits for the best (½-percent) rule after adjusting for transactions costs. Fifteen of these stocks looked profitable in their sample, however; for the same rule, the surviving fourteen show statistically significant profits for 1970–1982 for transactions costs obtainable by floor traders. The test used here assumes constant risk premia, or more generally, that risk premia are on average approximately the same on days “in” as for the total period.

This paper investigates whether the size and book-to-market factors of Fama and French (1993) proxy for the risks associated with business cycle fluctuations. We find that changes in default spread (Δdef) and changes in term spread (Δterm) capture the systematic differences in average returns along the size and book-to-market dimensions in the way that the Fama-French factors do: small stock portfolios have higher loadings on Δdef than large stock portfolios, while high book-to-market portfolios have higher loadings on Δterm than low book-to-market portfolios. Furthermore, in the presence of Δdef and Δterm, the Fama-French factors are superfluous in explaining the size and book-to-market effects. The results suggest that the size and value premiums are compensation for higher exposure to the risks related to changing credit market conditions and interest rates proxied by Δdef and Δterm.

Stochastic Dominance rules are playing an increasingly prominent role in the literature on choice under uncertainty. Their foundation is the mainstream VonNeumann-Morgenstern expected utility paradigm. Their essence is to provide an admissible set of choices under restrictions on the utility functions that follow from prevalent and appealing modes of economic behavior: The admissible sets generated are useful for a large group of individual decision makers and the optimal choice for an individual can then be obtained from among the smaller set of admissible choices.

The average relative profitability of different firms in the economy jumps erratically. Although investors are unable to observe these productivity switches, they continuously update their beliefs regarding high and low productivity firms by observing the total return on each firm, which consists of the average productivity plus noise. The portfolio choices, interest rate, and stock return processes are derived in a Cox-Ingersoll-Ross (1985a) style general equilibrium model. Three stylized facts of stock market returns are addressed: negative skewness, excess kurtosis, and predictive asymmetry (excess returns and future changes in volatility are negatively correlated). To measure the last stylized fact, an EGARCH model is fitted to sample paths simulated from the model. Parameter values that permit faster learning fit the three facts better.

This paper establishes liquidity linkage between stock and Treasury bond markets. There is a lead-lag relationship between illiquidity of the two markets and bidirectional Granger causality. The effect of stock illiquidity on bond illiquidity is consistent with flight-to-quality or flight-to-liquidity episodes. Monetary policy impacts illiquidity. The evidence indicates that bond illiquidity acts as a channel through which monetary policy shocks are transferred into the stock market. These effects are observed across illiquidity of bonds of different maturities and are especially pronounced for illiquidity of short-term maturities. The paper provides evidence of illiquidity integration between stock and bond markets.

This research develops and tests a model for the prediction of tender offer outcomes. Variables that increase the supply of “obtainable shares” (such as increased bid premiums or the payment of solicitation fees) are shown to increase the probability of success. Increased ownership of target firm shares by the bidder also increases the probability of success. Variables that impede the tendering of shares (such as target management opposition or a competing bid) decrease the probability of success. Tests of the model utilizing both linear and logistic analysis support the theoretical constructs and help resolve the paradoxical findings of previous research.

A number of recent studies finds two asymmetries in dependence structures in international equity markets; specifically, dependence tends to be high in both highly volatile markets and in bear markets. In this paper, a further investigation of asymmetric dependence structures in international equity markets is performed by using the Markov switching model and copula theory. Combining these two theories enables me to model dependence structures with sufficient flexibility. Using this flexible framework, I indeed find that there are two distinct regimes in the U. S.-U. K. market. I also show that for the U. S.-U. K. market the bear regime is better described by an asymmetric copula with lower tail dependence with clear rejection of the Markov switching multivariate normal model. In addition, I show that ignorance of this further asymmetry in bear markets is very costly for risk management. Lastly, I conduct a similar analysis for other G7 countries, where I find other cases in which the use of a Markov switching multivariate normal model would be inappropriate.

We integrate appealing features of Markowitz’s mean-variance portfolio theory (MVT) and Shefrin and Statman’s behavioral portfolio theory (BPT) into a new mental accounting (MA) framework. Features of the MA framework include an MA structure of portfolios, a definition of risk as the probability of failing to reach the threshold level in each mental account, and attitudes toward risk that vary by account. We demonstrate a mathematical equivalence between MVT, MA, and risk management using value at risk (VaR). The aggregate allocation across MA subportfolios is mean-variance efficient with short selling. Short-selling constraints on mental accounts impose very minor reductions in certainty equivalents, only if binding for the aggregate portfolio, offsetting utility losses from errors in specifying risk-aversion coefficients in MVT applications. These generalizations of MVT and BPT via a unified MA framework result in a fruitful connection between investor consumption goals and portfolio production.

We develop a model to value options on commodity futures in the presence of stochastic interest rates as well as stochastic convenience yields. In the development of the model, we distinguish between forward and future convenience yields, a distinction that has not been recognized in the literature. Assuming normality of continuously compounded forward interest rates and convenience yields and log-normality of the spot price of the underlying commodity, we obtain closed-form solutions generalizing the Black-Scholes/Merton's formulas. We provide numerical examples with realistic parameter values showing that both the effect of introducing stochastic convenience yields into the model and the effect of having a short time lag between the maturity of a European call option and the underlying futures contract have significant impact on the option prices.

The paper analyzes lead-lag relationships for six major stock market indexes: New York S&P 500, Tokyo Nikkei, London FT–30, Hong Kong Hang Seng, Singapore Straits Times, and Australia All Ordinaries, for time periods before, during, and after the October 1987 market crash. Unidirectional and bidirectional causality tests are conducted by means of the Granger methodology. Practically no lead-lag relationships are found for the pre-crash and post-crash periods. However, important feedback relationships and unidirectional causality are detected for the month of the crash. There is also an increase in contemporaneous causality during and after the month of the crash. In general, our findings suggest that the October 1987 market crash probably was an international crisis of the equity markets and that it might have begun simultaneously in all the national stock markets.

Our objective in this paper is to examine whether one can use option-implied information to improve the selection of mean-variance portfolios with a large number of stocks, and to document which aspects of option-implied information are most useful to improve their out-of-sample performance. Portfolio performance is measured in terms of volatility, Sharpe ratio, and turnover. Our empirical evidence shows that using option-implied volatility helps to reduce portfolio volatility. Using option-implied correlation does not improve any of the metrics. Using option-implied volatility, risk premium, and skewness to adjust expected returns leads to a substantial improvement in the Sharpe ratio, even after prohibiting short sales and accounting for transaction costs.

This paper addresses the bias associated with parametric measurement of timing skill based on monthly timer returns when timers can make daily timing decisions. Simulations suggest that the classic Henriksson-Merton parametric measure of timing skill is weak and biased downward when applied to the monthly returns of a daily timer. The paper proposes an adjustment that mitigates this problem without the need to collect daily timer returns. Four tests of timing skill, carried out on a sample of 558 mutual funds, show that very few funds exhibit statistically significant timing skill. More encompassing, the adjusted-FF3 test (based on the specification that incorporates both the proposed adjustment and the Fama-French three-factor model) is the least biased measure of timing skill among the four—it provides for a sharper inference regarding timing skill and helps mitigate biases associated with the choice of investment style.