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.

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.

We conduct a comprehensive study of commonality in liquidity using intraday spread and depth data from 47 stock exchanges. We find that firm-level changes in liquidity are significantly influenced by exchange-level changes across most of the world’s stock exchanges. Emerging Asian exchanges have exceptionally strong commonality, while those of Latin America exhibit little if any commonality. After documenting the pervasive role of commonality within individual exchanges, we examine commonality across exchanges. We find evidence of a distinct, global component in bid-ask spreads and depths. Local (exchange-level) sources of commonality represent roughly 39% of the firm’s total commonality in liquidity, while global sources contribute an additional 19%. We also investigate potential sources of exchange-level and global commonality. We show that commonality is driven by both domestic and U.S. macroeconomic announcements.

We study the impact of exchange rate fluctuations and political risk on the risk premiums reflected in cross-sections of individual equity returns from Mexico, a country that has experienced significant monetary and political turbulence. Indicators from Mexico's currency and sovereign debt markets are employed as proxies for exchange rate and political risks. We find some evidence of equity market premiums for exposure to these risks. The results suggest common factors in emerging market equity, currency, and sovereign debt markets, and have several implications for corporate and portfolio management and for the use of emerging market data by researchers.

Are firms more resilient to systemic banking crises in economies with higher levels of social trust? Using firm-level data in 34 countries from 1990 through 2011, we find that liquidity-dependent firms in high-trust countries obtain more trade credit and suffer smaller drops in profits and employment during banking crises than similar firms in low-trust economies. The results are consistent with the view that when banking crises block the normal bank-lending channel, greater social trust facilitates access to informal finance, cushioning the effects of these crises on corporate profits and employment.

We find that the market’s recent cross-sectional dispersion in stock returns is positively related to the subsequent value book-to-market premium and negatively related to the subsequent momentum premium. The partial relation between return dispersion (RD) and the subsequent value and momentum premiums remains strong when controlling for macroeconomic state variables suggested by the literature. Our findings are consistent with recent theoretical insights and empirical evidence that suggest that the market’s RD may serve as a leading countercyclical state variable, that the value premium is countercyclical, and that the momentum premium is procyclical.

We explain the currency carry trade (CT) performance using an asset pricing model in which factor loadings are regime dependent rather than constant. Empirical results show that a typical CT strategy has much higher exposure to the stock market and is mean reverting in regimes of high foreign exchange volatility. The findings are robust to various extensions. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the CT performance is better explained by a time-varying systematic risk that increases in volatile markets, suggesting a partial resolution of the uncovered interest parity puzzle.

We examine the value consequences of corporate social responsibility through the lens of institutional shareholders. We find a sharp asymmetry between corporate policies that mitigate the firm’s exposure to environmental risk and those that enhance its perceived environmental friendliness (“greenness”). Institutional investors shun stocks with high environmental risk exposure, which we show have lower valuations, as predicted by risk management theory. These findings suggest that corporate environmental policies that mitigate environmental risk exposure create shareholder value. In contrast, firms that increase greenness do not create shareholder value and are also shunned by institutional investors.

This paper shows that prospect theory is unlikely to explain the disposition effect. Prospect theory predicts that the propensity to sell a stock declines as its price moves away from the purchase price in either direction. Trading data, on the other hand, show that the propensity to sell jumps at zero return, but it is approximately constant over a wide range of losses and increasing or constant over a wide range of gains. Further, the pattern of realized returns does not seem to stem from optimal after-tax portfolio rebalancing, a belief in mean-reverting returns, or investors acting on target prices.

This article investigates differences in yields on identical Treasury notes and bills and shows that they reflect differences in liquidity (immediacy) risk and taxes. It proposes an empirical measure for differences in the liquidity risk of notes and bills: the volatility of the underlying rate times the ratio of bills' turnover to notes' turnover. Because differential taxes affect sellers but not buyers of bills and notes, the results reject, free of informational problems, the hypothesis that the notes' demand curve is horizonta. Note-bill yield differences also decrease with inventories of notes—the less liquid asset.

Theory indicates that frictions (e. g., information and transaction costs) could account for the lower than expected stock market participation rates. This paper examines the hypothesis that there has been a fundamental change in participation and links this change to the reduction of these frictions by the advent of the Internet. Using panel data on household participation rates over the past decade, the results show computer/Internet using households raised participation substantially more than non-computer using households. The increased probability of participation was equivalent to having over $27,000 in additional household income or over two more mean years of education.

This study provides evidence that differential interpretations are an important stimulus for speculative trading. We measure differential interpretations using data on analysts' revisions of forecasts of annual earnings after the announcement of quarterly earnings that are components of those annual earnings numbers. We find two conditions under which differential interpretations play a significant role in explaining trading. First, we present empirical evidence supporting Kandel and Pearson's (1995) argument that trading coincident with small price changes reflects investors' differential interpretations of information. This evidence is important because it is inconsistent with conventional models of trade that assume homogeneous interpretations. Second, we also find that differential interpretations explain a significant amount of the trading occurring in a sample where trading volume is higher than the (firm-specific) non-announcement period average. This result is consistent with informed traders acting on their differential interpretations when there is enough liquidity trading to help camouflage their own information-based trades. In sum, the study's results confirm Bachelier's (1900) intuition that differential interpretations are an important stimulus for trading.

Contrary to Baker and Wurgler (2002), I find that the importance of historical average market-to-book ratios in leverage regressions is not due to past equity market timing. Although equity transactions may be timed to equity market conditions, they do not have significant long lasting effects on capital structure. Debt transactions exhibit timing patterns that are unlikely to induce a negative relation between market-to-book ratios and leverage. I also find that historical average market-to-book ratios have significant effects on current financing and investment decisions, implying that they contain information about growth opportunities not captured by current market-to-book ratios.

Ex ante predictions of the riskiness of returns on common stocks — or, in more general terms, predictions of the probability distribution of returns — can be based on fundamental (accounting) data for the firm and also on the previous history of stock prices. In this article, we attempt to combine both sources of information to provide efficient predictions of the probability distribution of returns. We predict two parameters of the distribution of returns for each security in each year: the response to the overall market return (β), and the variance of the part of risk, specific to the security, that is uncorrelated with the market return. A cross section of time series data on returns and accounting variables, taken primarily from the Compustat tape, is used. Several recent developments in statistical methodology are applied.

We compare innovation strategies of public and private firms based on a large sample over the period 1997–2008. We find that public firms’ patents rely more on existing knowledge, are more exploitative, and are less likely in new technology classes, while private firms’ patents are broader in scope and more exploratory. We investigate whether these strategies are due to differences in firm information environments, CEO risk preferences, firm life cycles, corporate acquisition policies, or investment horizons between these two groups of firms. Our evidence suggests that the shorter investment horizon associated with public equity markets is a key explanatory factor.

We characterize the relation between asset structure and capital structure by exploiting variation in the salability of corporate assets. To establish this link, we distinguish across different assets in firms’ balance sheets (machinery, land, and buildings) and use an instrumental approach that incorporates market conditions for those assets. We also use a natural experiment driving differential increases in the supply of real estate assets across the United States: The Defense Base Closure and Realignment Act of 1990. Consistent with a supply-side view of capital structure, we find that asset redeployability is a main driver of leverage when credit frictions are high.

We investigate performance effects for China's listed firms when there is a change in the controlling shareholder. These changes include ownership transfers from one state entity to another state entity and from a state entity to a private entity. We find positive performance effects when control is passed to a private entity. In contrast, when the transfer is made to another branch of the state, there is little change in performance. The stock market responds positively to a change in control, with the largest effect observed for private transfers. Our results suggest the Chinese government should continue to sell down its share ownership in listed firms as the transfer of control to private owners enhances corporate profitability and efficiency. Moreover, to help ownership reform, China should encourage an active market for corporate control.

Legal rights of investors are recognized as an essential component of corporate governance. We assess the efficacy of these rights by examining board changes surrounding the filings of shareholder derivative lawsuits. We find that the incidence of derivative lawsuits is higher for firms with a greater likelihood of agency conflicts. We also find that derivative lawsuits are associated with significant improvements in the boards of directors. In particular, the proportion of outside representation on the board of directors increases. There is also some evidence that other board characteristics change favorably. These findings suggest that shareholder derivative lawsuits are not frivolous as is often claimed, but rather that they can serve as an effective corporate governance mechanism.

We analyze the impact of institutional and cultural differences on success in global venture capital (VC) investing. In both developed and emerging economies, superior legal rights (and enforcement) and better developed stock markets significantly enhance VC performance. Remarkably, cultural distance between countries of the portfolio company and its lead investor positively affects VC success. Further analysis reveals that cultural differences create incentives for rigorous ex ante screening, improving VC performance. Finally, local VC participation enhances success and mitigates foreign VCs’ “liability of foreignness,” albeit only in developed economies. Our findings follow from analyzing VC investments in nearly 10,000 companies across 30 countries.