We propose a simple model of equilibrium asset pricing in which there are differences in the amounts of information available for developing inferences about the returns parameters of alternative securities. In contrast with earlier work, we show that parameter uncertainty, or estimation risk, can have an effect upon market equilibrium. Under reasonable conditions, securities for which there is relatively little information are shown to have relatively higher systematic risk when that risk is properly measured, ceteris paribus. The initially very limited model is shown to be robust with respect to relaxation of a number of its principal assumptions. We provide theoretical support for the empirical examination of at least three proxies for relative information: period of listing, number of security returns observations available, and divergence of analyst opinion.

It is well known that the pro forma performance of a sample of investment funds contains biases. These biases are documented in Brown, Goetzmann, Ibbotson, and Ross (1992) using mutual funds as subjects. The organization structure of hedge funds, as private and often offshore vehicles, makes data collection a much more onerous task, amplifying the impact of performance measurement biases. Theis paper reviews these biases in hedge funds. We also propose using funds-of-hedge funds to measure aggregate hedge fund performance, based on the idea that the investment experience of hedge fund investors can be used to estimate the performance of hedge funds.

In rational, efficiently functioning markets, the returns on stock index and stock index futures contracts should be perfectly, contemporaneously correlated. This study investigates the time series properties of 5-minute, intraday returns of stock index and stock index futures contracts, and finds that S&P 500 and MM index futures returns tend to lead stock market returns by about five minutes, on average, but occasionally as long as 10 minutes or more, even after stock index returns have been purged of infrequent trading effects; however, the effect is not completely unidirectional, with lagged stock index returns having a mild positive predictive impact on futures returns.

This paper makes contributions in two directions. First, the paper presents a model in which value-maximizing firms pursue active hedging policies. Second, the paper derives optimal hedging policies for risk-averse agents. Whereas the methodology used and the results provided are quite general, this paper deliberately focuses the analysis on hedging foreign exchange exposure through forward contracts on foreign currencies. This emphasis is explained by the fact that hedging foreign currency exposure through forward contracts has been a topic of considerable interest in recent years.

The shape of the volatility smirk has significant cross-sectional predictive power for future equity returns. Stocks exhibiting the steepest smirks in their traded options underperform stocks with the least pronounced volatility smirks in their options by 10.9% per year on a risk-adjusted basis. This predictability persists for at least 6 months, and firms with the steepest volatility smirks are those experiencing the worst earnings shocks in the following quarter. The results are consistent with the notion that informed traders with negative news prefer to trade out-of-the-money put options, and that the equity market is slow in incorporating the information embedded in volatility smirks.

We investigate the firm characteristics associated with innovation in over 19,000 firms across 47 developing economies. While existing finance literature on innovation is limited to large public firms in developed markets such as the United States, our database includes public and private firms, and small and medium-sized enterprises. We define innovation broadly to include introduction of new products and technologies, knowledge transfers, and new production processes. We find that access to external financing is associated with greater firm innovation. Further, having highly educated managers, ownership by families, individuals, or managers, and exposure to foreign competition is associated with greater firm innovation.

This paper examines time-series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms’ capital structures through their influence on firms’ historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment toward target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.

This study examines whether religiosity at the county level is associated with future stock price crash risk. We find robust evidence that firms headquartered in counties with higher levels of religiosity exhibit lower levels of future stock price crash risk. This finding is consistent with the view that religion, as a set of social norms, helps to curb bad-news-hoarding activities by managers. Our evidence further shows that the negative relation between religiosity and future crash risk is stronger for riskier firms and for firms with weaker governance mechanisms measured by shareholder takeover rights and dedicated institutional ownership.

We investigate the value of active mutual fund management by examining the stockholdings and trades of mutual funds. We fine that stocks widely held by funds do not outperform other stocks. However, stocks purchased by funds have significantly higher returns than stocks they sell—this is true for large stocks as well as small stocks, and for value stocks as well as growth stocks. We find that growth-oriented funds exhibit better stock selection skills than income-oriented funds. Finally, we find only weak evidence that funds with the best past performance have better stock-picking skills than funds with the worst past performance.

We examine the determinants of cross-sectional differences in insider ownership, debt, and dividend policies. These policies are related not only directly, but also indirectly, through their relationship with operating characteristics of firms. To distinguish these effects, we examine the determinants of the three policy choices within a system of equations. Our empirical results support the hypothesis that levels of insider ownership differ systematically across firms. Further, high insider ownership firms choose lower levels of both debt and dividends. Finally, the effects of profitability, growth, and investment spending on debt and dividend policy support a modified “pecking order” hypothesis.

This paper applies the technique for valuing compound options to the risky coupon, bond problem. A formula is derived which contains n-dimensional multivariate normal intecjrals. It is shown that, for some compound option problems, the special correlation structure allows an application of an integral reduction which may simplify the numerical evaluation. The effects of various indenture restrictions on the formula are discussed, and a new formula for evaluating subordinated debt is presented.

I study the dynamics of investor cash flows in socially responsible mutual funds. Consistent with anecdotal evidence of loyalty, the monthly volatility of investor cash flows is lower in socially responsible funds than in conventional funds. I find strong evidence that cash flows into socially responsible funds are more sensitive to lagged positive returns than cash flows into conventional funds, and weaker evidence that cash outflows from socially responsible funds are less sensitive to lagged negative returns. These results indicate that investors derive utility from the socially responsible attribute, especially when returns are positive.

This study compares the relations between asset flow and performance in the retail mutual fund and fiduciary pension fund segments of the money management industry, and relate empirical differences to fundamental differences in the clientele they serve. A striking difference is the shape of the flow-performance relation. In contrast to mutual fund investors, pension clients punish poorly performing managers by withdrawing assets under management and do not flock disproportionately to recent winners. We interpret these and other empirical differences in the context of the manager evaluation procedures typical in each segment. We conclude that pension managers have little incentive to engage in the risk-shifting behavior previously identified among mutual fund managers.

We examine whether time variation in the comovements of daily stock and Treasury bond returns can be linked to measures of stock market uncertainty, specifically the implied volatility from equity index options and detrended stock turnover. From a forward-looking perspective, we find a negative relation between the uncertainty measures and the future correlation of stock and bond returns. Contemporaneously, we find that bond returns tend to be high (low) relative to stock returns during days when implied volatility increases (decreases) substantially and during days when stock turnover is unexpectedly high (low). Our findings suggest that stock market uncertainty has important cross-market pricing in-fluences and that stock-bond diversification benefits increase with stock market uncertainty.

The paper investigates how firms operating in capital market-oriented economies (the U.K. and the U.S.) and bank-oriented economies (France, Germany, and Japan) determine their capital structure. Using panel data and a two-step system-GMM procedure, the paper finds that the leverage ratio is positively affected by the tangibility of assets and the size of the firm, but declines with an increase in firm profitability, growth opportunities, and share price performance in both types of economies. The leverage ratio is also affected by the market conditions in which the firm operates. The degree and effectiveness of these determinants are dependent on the country's legal and financial traditions. The results also confirm that firms have target leverage ratioswith French firms being the fastest in adjusting their capital structure toward their target level and Japanese firms the slowest. Overall, the capital structure of a firm is heavily influenced by the economic environment and its institutions, corporate governance practices, tax systems, the borrower-lender relation, exposure to capital markets, and the level of investor protection in the country in which the firm operates.

In this paper, we analytically derive the expected loss function associated with using sample means and the covariance matrix of returns to estimate the optimal portfolio. Our analytical results show that the standard plug-in approach that replaces the population parameters by their sample estimates can lead to very poor out-of-sample performance. We further show that with parameter uncertainty, holding the sample tangency portfolio and the riskless asset is never optimal. An investor can benefit by holding some other risky portfolios that help reduce the estimation risk. In particular, we show that a portfolio that optimally combines the riskless asset, the sample tangency portfolio, and the sample global minimum-variance portfolio dominates a portfolio with just the riskless asset and the sample tangency portfolio, suggesting that the presence of estimation risk completely alters the theoretical recommendation of a two-fund portfolio.

We present a new methodology for estimating time-varying conditional skewness. Our model allows for changing means and variances, uses a maximum likelihood framework with instruments, and assumes a non-central t distribution. We apply this method to daily, weekly, and monthly stock returns, and find that conditional skewness is important. In particular, we show that the evidence of asymmetric variance is consistent with conditional skewness. Inclusion of conditional skewness also impacts the persistence in conditional variance.

This paper examines the cross-sectional relation between idiosyncratic volatility and expected stock returns. The results indicate that i) the data frequency used to estimate idiosyncratic volatility, ii) the weighting scheme used to compute average portfolio returns, iii) the breakpoints utilized to sort stocks into quintile portfolios, and iv) using a screen for size, price, and liquidity play critical roles in determining the existence and significance of a relation between idiosyncratic risk and the cross section of expected returns. Portfoliolevel analyses based on two different measures of idiosyncratic volatility (estimated using daily and monthly data), three weighting schemes (value-weighted, equal-weighted, inverse volatility-weighted), three breakpoints (CRSP, NYSE, equal market share), and two different samples (NYSE/AMEX/NASDAQ and NYSE) indicate that no robustly significant relation exists between idiosyncratic volatility and expected returns.

Variables that in theory determine credit spreads have limited explanatory power in existing empirical work on corporate bond data. We investigate the linear relationship between theoretical determinants of default risk and default swap spreads. We find that estimated coefficients for a minimal set of theoretical determinants of default risk are consistent with theory and are significant statistically and economically. Volatility and leverage have substantial explanatory power in univariate and multivariate regressions. A principal component analysis of residuals and spreads indicates limited evidence for a residual common factor, confirming that the theoretical variables explain a significant amount of the variation in the data.

Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.