Random stock returns result from irregular vibrations of a share's price through time. Divide any arbitrary time interval into two mutually exclusive and exhaustive sets. One set contains time periods when trading is formally open on an organized market such as the New York Stock Exchange (NYSE). Its complement contains closed trading time periods, i.e., when the NYSE is not open. Conventional theory assumes that the same return process operates over all periods in both sets. No allowance is made for possible differences in the return sequence between sets or among time periods within each set. There are reasons to assume that such differences may exist. For example, during a trading day, stock prices fluctuate as orders are executed. During nights, weekends, holidays, and holiday-weekends there are no transactions, but a share's value from close to open on the next trading day may still change to reflect revised expectations about a firm's productivity. In fact, capital changes and important news items are usually announced after the stock exchanges close.

This paper investigates the relationship between interest-rate risk and liquidity premiums on U.S. Treasury bills. Interest-rate risk stems from uncertainty about the future general level of market interest rates.

This paper generalizes the past signaling literature from one variable to many. Multivariate models have been studied in the general rational expectations literature (e.g., Allen [1], Kraus and Sick [3]), but this appears to be the first multivariate signaling application. (Here, I distinguish signaling from rational expectations literature by the fact that agents may attempt to promulgate, suppress, or add noise to signals.) Talmor studies signaling models which are fully revealing (i.e., for which, in equilibrium, the values of the signaled parameters are correct).

This paper demonstrates that refunding discounted debt represents a form of tax arbitrage that is profitable to taxpaying corporations when the present value of the additional tax shields, created through the refunding, exceeds the sum of the present value of the overall increase in pre-tax debt service requirements, after-tax transaction costs, and any tax incurred on the gain. The paper contrasts the factors that give rise to profitable opportunities to refund high-coupon debt and discounted debt. It also shows that, of the analytical approaches previously suggested for calculating the net advantage of refunding discounted debt, discounting the change in after-tax debt service payments at the after-tax cost of money for the refunding issue is the only one consistent with preserving debt service parity.

An equity-linked life insurance policy with an asset value guarantee (ELPAVG) is an insurance policy whose benefit payable on death or at maturity consists of the greater of some guaranteed amount and the value of a reference portfolio which is defined by the deemed investment of a predetermined component of the policy premium in a portfolio of common stocks or mutual fund–the reference fund. In an earlier paper we demonstrated that the benefit payable under an ELPAVG could be decomposed into the known guaranteed amount and an immediately exercisable call option to purchase the reference portfolio for an exercise price equal to the guaranteed amount. The principles of the option pricing model were then employed to derive the equilibrium premium for both a single premium ELPAVG contract and a periodic premium contract. It was further noted that the hedging arguments, which are the core of most of the recent theory of option pricing, could be employed to derive an investment strategy for the insurance company which would eliminate the risks associated with the sale of ELPAVGs: this is an important result, for ELPAVGs may pose a significant threat to the solvency of insurance companies since the risks of loss under different contracts are not independent, but are commonly related to the overall performance of the reference fund. Actuaries have responded to this threat by attempting to determine a level of reserves sufficient to reduce the probability of ruin to an acceptable level. On the other hand, adoption of the riskless investment strategy in theory eliminates the need to hold any reserves except against mortality risk.

The classical Capital Asset Pricing Model of Sharpe [5] and Lintner [4] has been generalized by Brennan [2, 3] to include the effect of investors' taxes. In Brennan's formulation, investors' portfolio incomes are divided into capital gains and ordinary income components whose marginal tax rates differ both from one another and across investors. In this paper, Brennan's model is further generalized to admit tax–exempt portfolio income as well. The results, which may accord with empirical data better than have those of the less general models, include a three–fund separation theorem, a three–term Capital Asset Pricing Formula which relates the excess rate of return of any risky portfolio to those of three fundamental risky portfolios whose rates of return are pairwise uncorrelated, and a representation suitable for empirical testing.

The major objective of Ken Eades' paper is to provide new insights into the role of dividend changes as information signaling devices. Eades argues that the traditional notion of the “information content of dividends” is based more on conjecture than on a well-specified economic model. Eades suggests that without a well-specified model, we are limited significantly in producing testable hypotheses about dividend signaling. Therefore, Eades extends the dividend signaling model of Bhattacharya [2] and provides statistical tests of the resulting hypotheses.

This paper shows how to decompose the dollar profit earned from an option into two basic components: i) mispricing of the option relative to the asset at the time of purchase; and ii) profit from subsequent fortuitous changes or mispricing of the underlying asset. This separation hinges on measuring the “true relative value” of the option from its realized payoff. The payoff from any one option has a huge standard error about this value that can be reduced by averaging the payoff from several independent option positions. Simulations indicate that 95% reductions in standard errors can be further achieved by using the payoff of a dynamic replicating porfolio as a Monte Carlo control variate. In addition, the paper shows that these low standard errors are robust to discrete rather than continuous dynamic replication and to the likely degree of misspecification of the benchmark formula used to implement the replication.

Option mispricing profit can be futher decomposed into profit due to superior estimation of the volatility (volatility profit) and profit from using a superior option valuation formula (formula profit). To make this decomposition reiably, the benchmark formula used for the attribution needs to be similar to the formula implicitly used by the market to price options. If so, then simulation indicates that this further decomposition can be achieved with low standard errors. Basic component ii) can be further decomposed into profit from a forward contract of the underlying asset (asset profit) and what I term pure option profit. The asset profit indicates whether the investor was skillful by buying or selling options on mispriced underlying assets. However, asset profit could also simply be just compensation for bearing risk—a distinction beyond the scope of this paper. Although simulation indicates that the attrivution procedure gives an unbiased allocation of the option profit to this source, its standard error is large—a feature common with others' attempts to measure performance of asssets.

This study presents theory and some exploratory empirical work on several separate strands of monetarism in an international context and reports the results of tests of the two interrelated hypotheses: (a) the United States' monetary expansion was responsible forthe exportation of inflation to the rest of the world during the period of generally fixed exchange rates that lasted from the end of World War II until August 1971 (followed by the Smithsonian revaluations and generalized floating in March 1973), and (b) foreign nations could not control their money supplies, even in the short run, to prevent importing inflation. Succinctly stated, the monetarist approach to macroeconomic phenomena holds that money is preeminent in determining the short-run shocks to real output and the long-run price level of an economy. However, received theory is simply not clear as to whose money is most important in an international context. Is it the domestic money stock which is kept relativelyindependent of foreign forces under fixed exchange rates through astute central bank policy, at least in the short run? Is it the rest of the world money stock which, under fixed exchange rates, is a close substitute for domestic money? Or is it the money stock of the so-called world's banker, the United States, which drives foreign economies? We address these issues and others in our empirical analysis.

In this paper the results of some new structural estimates of liquidity preference may be found. The justification for presenting them is that they differ from earlier estimates in certain ways. In some cases, the implications of these estimates differ sharply from the implications drawn by other observers on the basis of their estimates.

Using U.S. census survey data on CEOs’ residence in their formative years, I document a negative relation between CEOs’ endowed family wealth and managerial performance. Consistent with the view that CEOs born into low-income families face higher entry barriers but may possess greater levels of ability that enable them to become CEOs, I find that CEOs born into less privileged families outperform those from higher-wealth families. The outperformance of CEOs from less wealthy families is not driven by risk taking or omitted variables. Overall, my results suggest that CEOs’ social endowment provides a useful signal for their managerial ability.

Consistent with the empirical properties of the consumption data, I develop a model in which consumption and dividend growth follow regime-switching dynamics. I show that regime-shift risk is priced in the model. Regime-shift risk exhibits dominant influence on asset prices: It generates a high equity premium and also induces time-varying risk premiums. The model explains major business cycle-dependent asset market phenomena and, in particular, the stronger predictability of stock returns during recessions.

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.

Controversy over the implications of debt and the rationale belying capital structure has seemingly come to rest upon a plateau defined by Miller's equilibrium analysis of aggregate corporate debt [10]. In “Debt and Taxes,” Miller reasserts his contention that whether capital is obtained through debt or equity has no bearing on the market value of the firm and is, therefore, irrelevant--a notion which has long been accepted with some reluctance by the finance academe. When the Modigliani-Miller model was first offered some 20 years ago [11], it was accompanied by a set of assumptions which portrayed the world of corporate finance in such malleable terms as to make the irrelevancy propositions palatable. Adaptation of this theoretical model (by its originators) to its secular counterpart through the imposition of corporate taxes [12] brought about a reassuring reversal of the irrelevancy doctrine, but left in its stead the disconcerting prescription to maximize firm value by financing exclusively via debt. Consideration of tax effects at the personal level by Farrar and Selwyn [7] marked the next concession to reality by capital structure theorists. Instead of alienating the original model still further from observed corporate behavior, this step provided a means of reconciling the overwhelming advantage of debt financing at the corporate level with the ultimate after-tax “consumption possibilities” afforded to individual investors. Miller's analysis explains that corporations are forced to “gross up” nominal interest rates to attract bondholders who must be compensated for their personal tax liability [10]. Potential increases in market value due to the taxdeductibility of interest payments are exhausted in the competitive drive toward equilibrium—at which point there are no gains from leverage. The sanctity of the irrelevance theorem thus appears to have been restored at the aggregate level.

We derive the optimal underwriting method and the quantitative initial public offering (IPO) pricing rule that this method implies in a market with informational frictions consisting of fully rational banks, issuers, and investors. In an efficient IPO market, an issuer’s expected initial return will be determined entirely by the combination of this pricing rule and issuer fundamentals. Applying this rule, we find that we can explain the quantitative magnitude of the principal aspects of the time-series and cross-sectional variation in IPO average initial returns. We conclude that the IPO market is efficient.

We show that merger announcement returns account for virtually all of the measured size premium. An empirical proxy for ex ante takeover exposure positively and robustly relates to cross-sectional expected returns. The relation between size and expected returns becomes positive or insignificant, rather than negative, conditional on this takeover characteristic. Asset pricing models that include a factor based on the takeover characteristic outperform otherwise similar models that include the conventional size factor. We conclude that the takeover factor should replace the conventional size factor in benchmark asset pricing models.

Machine learning-based stock market beta estimators outperform established benchmark models both statistically and economically. Analyzing the predictability of time-varying market betas of U.S. stocks, we document that machine learning-based estimators produce the lowest forecast and hedging errors. They also help to create better market-neutral anomaly strategies and minimum variance portfolios. Among the various techniques, random forests perform the best overall. Model complexity is highly time-varying. Historical stock market betas, turnover, and size are the most important predictors. Compared to linear regressions, allowing for nonlinearity and interactions significantly improves predictive performance.

Using random H-1B visa lotteries as a natural experiment, we find that firms respond to shortages of high-skilled workers by acquiring firms that employ such workers. The effect is stronger among firms with high human capital and more senior workforces, firms facing tight labor markets and legal barriers to poaching workers, and firms lacking foreign affiliates. The acquired workers are highly educated, sharing skills and occupations similar to those of the acquirer’s existing workers. Our findings suggest skilled labor is an important driver of acquisitions and acquiring is an effective means of obtaining skilled labor.

In a rich, calibrated life-cycle model, we show that well-designed mandatory pension plans significantly improve the welfare of individuals procrastinating on savings, and even improve most rational individuals’ welfare through a return tax advantage and fair annuitization. For a group of heterogeneous savers, in terms of preferences and sophistication, the best plan has contributions of 10% of income from age 30, a glidepath investment strategy, payouts following a variable lifelong annuity, and options to choose a different investment strategy and to modify the annuitization feature. This plan generates an average welfare gain of $175,000 per individual.

U.S. multinational enterprises repatriated over $300 billion under the 2004 tax holiday. The repatriated funds can improve debt financing environment of nonrepatriating firms, especially those that are financially constrained. We document that such an externality of the tax holiday increases debt financing and consequently investments for financially constrained nonrepatriating firms relative to less constrained nonrepatriating firms. Using private loan market data, we further confirm a link from repatriated funds to increased debt financing for financially constrained nonrepatriating firms. Overall, the 2004 tax holiday appears to have benefited the U.S. economy through its positive externality on the debt market.