We solve for the optimal dynamic trading strategy of an investor who faces a leverage constraint, i.e., a limitation on his ability to borrow for the purpose of investing in a risky asset. We assume that the investor has constant relative risk aversion, and that the value of the risky asset follows a geometric Brownian motion. In the absence of the leverage constraint, the optimal strategy involves investing a fixed proportion of wealth in the risky asset. We prove that, in the presence of the leverage constraint, the optimal investment also involves investing a fixed proportion of wealth in the risky asset when the leverage constraint is not binding. However, the two proportions are different, reflecting the extent to which the investor alters his strategy even when the leverage constraint is not binding because of the possibility that the leverage constraint will become binding in the future.

This paper examines problems in the use of divergence of analyst opinion as a proxy for estimation risk in empirical studies of security returns and asset pricing models. We demonstrate that diversity of opinion can increase even though the amount of private information increases, and we show that diversity of opinion may overstate estimation risk if the capital market aggregates the information held by investors. We produce empirical results consistent with our conclusions. Specifically, we find that divergence of opinion can produce measures of estimation risk that are inconsistent with a received proxy for estimation risk and with observed common stock returns.

This paper examines the adverse selection problem that arises from the repeated trades of informed traders. We develop a model of trading that incorporates the interaction of expectations, prices, and volume. We then examine how trading volume affects the speed of price adjustment to information, and demonstrate how this price effect differs across markets. Our results suggest that the efficiency of price adjustment to new information may differ dramatically depending on security market structure, even when there is endogenous entry of informed traders. We illustrate these price adjustment properties by developing a simulation of our theoretical model.

This paper tests the null hypothesis of no difference in the probability of a trade occurring at the ask using a new database containing intraday bid-ask quotes and transaction prices on both U.S. and Canadian Exchanges. We use LOGIT analysis to test the hypothesis across days of the week, price-stratified portfolios, and times of the day. We find systematic patterns in the probability of a trade at the ask resembling previously documented returns anomalies and conclude that the findings of previous weekend and intraday returns studies may be overstated. The significance of this conclusion substantially increases as one moves from the use of interday to intraday data.

This paper provides a closed form solution for the value of a multiple claim insurance contract that is subject to a deductible amount and/or an upper limit on claims. The solution is a time integral of European option prices. The model provides three important insights. First, systematic risk in insurance policies is altered in the presence of deductibles and maximum indemnity levels. Second, idiosyncratic risk affects policy valuation and the required rates of return on underwriting portfolios. Finally, contrary to traditional actuarial intuition, changes in the risk-free interest rate may either increase or reduce policy values.

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.

Many empirical studies find that the distribution of stock returns departs from normality. In such cases, it is desirable to employ a statistical estimation procedure that may be more efficient than ordinary least squares. This paper describes various robust methods, which have attracted increasing attention in the statistical literature, in the context of estimating beta risk. The empirical analysis documents the potential efficiency gains from using robust methods as an alternative to ordinary least squares, based on both simulated and actual returns data.

The much publicized Tylenol incident in 1982 led to stringent packaging regulations for over-the-counter pharmaceutical drugs. The sudden incident and the swift progression of associated events offer a unique opportunity to assess the wealth effects of the resultant regulations. The market value of common stock of Johnson & Johnson, makers of Tylenol, declined by approximately 29 percent, amounting to $2.31 billion. Although other firms in the industry also suffered significantly, their share price decline did not occur around the Tylenol incident but occurred around the subsequent packaging regulation proceedings. On average, 28 other pharmaceutical firms analyzed in this study experienced a decline of $310 million per firm, or a total of about $8.68 billion. The results suggest that the regulation had a significant negative effect on the common stock prices of firms in the pharmaceutical industry.

Current literature stresses that efficient funds do not exist when asset returns are continuously distributed. This paper shows that the existence of efficient funds can be restored if security returns are generated by a linear factor model.