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.

This paper derives a new and intuitive estimation procedure for the term structure under potential tax arbitrage. No a priori assumptions regarding the equality of the prices and present values of bonds are made. The data are employed to determine whether this equality holds, and an appropriate estimator is thereby endogenously derived. The suggested estimator is based on the optimizing behavior of an investor in a market with frictions, and emerges directly from the solution of the dual of the no-arbitrage optimization problem. In addition, the proposed estimator benefits from being both theoretically sound and straightforward to apply.

This study develops a currency option pricing model under stochastic interest rates when interest rate parity holds, and it is assumed that domestic and foreign bond prices have local variances that depend only on time. We demonstrate how existing currency option models are simply derived from one framework. Empirical tests employing transactions option data reveal that a particularly simple form of the stochastic rate model is uniformly more accurate than a constant rate model for all boundaries and maturities tested.

We develop a closed-form general equilibrium model of stock index futures prices in a continuous-time economy with stochastic interest rates and market volatility. We show that futures prices implied by the model have very different properties from those of the cost of carry model. Using NYSE stock index futures data, we examine the restrictions imposed on futures prices by both the equilibrium and cost of carry models. Consistent with the equilibrium model, we find that stock index futures prices are related to market volatility and that their interest-rate sensitivity is a nonlinear function of contract maturity.

This paper describes the application of a convergence acceleration technique to the binomial option pricing model. The resulting model, termed the accelerated binomial option pricing model, also can be viewed as an approximation to the Geske-Johnson model for the value of the American put. The new model is accurate and faster than the conventional binomial model. It is applicable to a wide range of option pricing problems.

This study examines the hypothesis that in the presence of market frictions, relative put and call prices contain information concerning future returns of the underlying asset. A measure of relative prices is derived from the put-call parity relationship for index options and applied to a three-year sample of OEX option transactions. The results show that the measure of relative index option prices leads the stock market by at least 15 minutes.

This paper presents a numerical method for valuing complex investments with multiple interacting options. The method is a log-transformed variation of binomial option pricing designed to overcome problems of consistency, stability, and efficiency encountered in the Cox, Ross, and Rubinstein (1979) and other numerical methods. This method handles well options with a series of exercise prices (compound options), nonproportional dividends, and interactions among a variety of real options. Comparisons with several existing numerical methods regarding accuracy, consistency, stability, and efficiency are given.

This paper develops an equilibrium factor pricing theory when investors have heterogeneous beliefs about asset payoffs generated by the Ross linear factor model. Investors receive private information about the unknown parameters of the payoff process. They use this private information and equilibrium prices to predict asset payoffs. The paper develops a closed form price function for a noisy rational expectations equilibrium and relates it to the general solution. Even though we allow for a large number of investors, diversity of beliefs and parameter uncertainty both persist in equilibrium. We show that investors' beliefs about expected payoffs are approximately linear in the asset's betas, thus establishing the APT. As investors prefer to hold high information assets in equilibrium, the relative weight of these assets in the APT pricing bound is higher. The reverse is true for low information assets.

This paper examines the pricing of S&P 100 calls using 14 months of transactions data. We find that market prices of S&P 100 calls differ systematically from Black-Scholes values. The biases in Black-Scholes model prices are both statistically and economically significant and correspond to biases that arise if market prices incorporate a stochastically changing volatility of the index.

We analyze a model in which firms signal their quality by using financial policies to commit to cash outflows. Two financial policies may be used: dividend and debt-service obligations. We find sufficient conditions for the informational equilibrium to entail concommitant use of both dividends and leverage in the cost-minimizing combination of the commitment signal. In this equilibrium, better firms pay higher dividends and are more highly levered than lower quality firms.

A multiperiod model of optimal capital structure is developed under the assumption that earnings follow an autoregressive process. Firm value and leverage vary through time and, at each date, the firm achieves an optimal debt level that is a function of the full state contingent debt policy. The reversion parameter of the earnings series is shown to be positively related to various measures of variability and negatively related to leverage. If earnings processes are not homogeneous across firms, then standard earnings risk measures in capital structure studies do not adequately represent crosssectional differences in variability in firm value.

This paper provides a comprehensive study of weekly seasonal effects in GNMA, T-bond, T-note, and T-bill futures returns. Two distinct patterns are found in returns on GNMA, T-bond, and T-note contracts, while no seasonals are noted for T-bill futures. A negative Monday seasonal—similar to the well-known Monday effect in stock returns—is found for GNMA and T-bond contracts. A positive Tuesday seasonal is found on GNMA, T-bond, and T-note contracts. Our evidence indicates that the significance of weekly seasonals depends in an important way on the time period studied. The negative Monday phenomenon occurs only in the data before 1982, while the positive Tuesday effect is present only after 1984. In addition, we find that both seasonal phenomena occur only during months prior to a delivery month. This effect appears to be related to the calendar month. More specifically, the Monday effect is apparently concentrated during February, while the Tuesday effect is concentrated during May.

The appropriate set of parameters determining the volatility of the value of a portfolio of fixed cash flows of arbitrary maturities is the covariance matrix of unexpected interest rate changes over the term. Equilibrium models of the term structure limit the rank of the covariance matrix and implicitly impose restrictions on covariance estimation. The “full information” approach to risk measurement imposes only time stationarity assumptions on covariance matrix estimators and can result in sample matrices of full rank. Hilliard and Jordan (1989) develop a structured full rank covariance matrix that depends on only two parameters. This paper tests the Hilliard-Jordan model using likelihood ratios and criteria of forecast accuracy.

The paper examines the relevance of information asymmetry between the managers of the firm and the market for the equity issue process. It uses four proxies for information asymmetry and presents three groups of tests: cross-sectional regressions of the reaction at equity issue announcements, comparisons of information asymmetry before and after the announcements, and analyses of the timing behavior observed during the equity issue process. The results show that information asymmetry is a significant variable for equity issues.

We develop a class of discrete, path-independent models to compute prices of American options within the Black-Scholes (1973) framework, including models in which state variables have time-varying volatility functions and models with multiple state variables. Time-varying volatility functions are illustrated with applications to term structure models developed by Vasicek (1977) and Heath, Jarrow, and Morton (1988), (1990). Distinct from previous work in the literature, the multivariate models suggested in this paper are consistent with arbitrarily large, though constant, covariance functions. Finally, we compare and contrast the numerical accuracy of a large number of models with simulation results.

On average, nonconvertible preferred stocks have significantly positive abnormal returns and trading volume on the ex-day. For the less liquid stocks, however, the abnormal returns are significantly positive, and abnormal trading volume is insignificantly different from zero. This evidence suggests that long-term individual investors set the ex-day prices of less liquid stocks. For the more liquid stocks, the ex-day abnormal returns are closer to zero, and there is significantly positive abnormal trading volume on the ex-day and the day before the ex-day. These results suggest that short-term investors set the ex-day prices of more liquid stocks through dividend capture strategies. Despite this evidence, some inconsistent empirical findings make the overall evidence on dividend capture somewhat mixed.

Do bond-issuing firms attempt to choose the call, sinking fund, and term-to-maturity features of bonds to improve shareholder wealth? This paper develops and tests two hypotheses about the determinants of bond features using a conditional logistic model. The model is estimated on a sample of bonds issued between 1982 and 1986. Model estimates show that a bond's call, sinking fund, and term-to-maturity features are statistically related to the issuing firm's retention ratio, ratio of convertible to long-term debt, two-year change in net operating income, and whether the firm is listed on the NYSE and included in the S&P400. These findings support the view that firms financing highquality projects, but facing information asymmetries, choose shorter-term (medium-term) callable bonds with and without the sinking fund feature.

This paper examines the pricing of exchange rate risk in the U.S. stock market, using two factor and multi-factor arbitrage pricing models. Evidence is presented that the relation between stock returns and the value of the dollar differs systematically across industries. The empirical results, however, do not suggest that exchange risk is priced in the stock market. The unconditional risk premium attached to foreign currency exposure appears to be small and never significant. As a result, active hedging policies by financial managers cannot affect the cost of capital, and other reasons must explain why firms decide to hedge.

This study examines initial public offering contract choice decisions. In best-efforts offerings, minimum sales constraints allow issuers to precommit to withdraw the offering if a fixed minimum number of shares is not sold. In firm-commitment offerings, the over-allotment option allows the underwriter to increase sales when demand is strong. Two theories of contract choice–Benveniste and Spindt (1989) and Ritter's (1987) extension of Rock (1986)–offer predictions about the role of these contract features. We find that the 1977–1982 evidence is consistent with Benveniste and Spindt (1989). The evidence is less supportive of the Ritter (1987) hypothesis that minimum sales constraints serve to reduce the winner's curse of the riskier issuers.

As demonstrated by Boyce and Kalotay (1979) and Brick and Ravid (1985), the use of long-term debt may be preferred because of tax-related advantages. Brick and Ravid show that if there exists a tax advantage to debt and nonstochastic interest rates, long-term debt will increase the present value of the tax benefits of debt if the term structure of interest rates, adjusted for risk of default, is increasing. A decreasing term structure, on the other hand, calls for short-term debt. The present paper extends the tax-induced argument of Brick and Ravid to allow for the presence of stochastic interest rates. Once interest rates are uncertain, pricing even under risk neutrality becomes a complex issue. We analyze the debt maturity decision under two competing pricing equations: the return to maturity expectations hypothesis and the local expectations hypothesis. (This terminology is used in Cox, Ingersoll, and Ross (1981) and Campbell (1986).) Under uncertainty, a debt capacity factor will create an additional incentive to issue long-term debt. Our other results may be interpreted to indicate that if the term premium, the difference between the implied forward interest rate and the future expected spot rate, is positive (sufficiently negative) then long-term (short-term) debt maturity strategy is optimal.