The objective of this paper is to provide a deeper insight into the links between financial markets and the real economy. To that end, we study the short-term anticipation and response of U.S. stock, Treasury, and corporate bond markets to the first release of surprise U.S. macroeconomic information. Specifically, we focus on the impact of these announcements not only on the level, but also on the volatility and comovement of those assets’ returns. We do so by estimating several extensions of the parsimonious multivariate GARCH-DCC model of Engle (2002) for the excess holding-period returns on seven portfolios of these asset classes. We find that both the process of price formation in each of those financial markets and their interaction appear to be driven by fundamentals. Yet our analysis reveals a statistically and economically significant dichotomy between the reaction of the stock and bond markets to the arrival of unexpected fundamental information. We also show that the conditional mean, volatility, and comovement among stock, Treasury, and corporate bond returns react asymmetrically to the information content of these surprise announcements. Overall, the above results shed new light on the mechanisms by which new information is incorporated into prices within and across U.S. financial markets.

Using panel data on top management characteristics and a management quality factor constructed using common factor analysis on individual management quality measures, we analyze the relation between top firm management quality and corporate innovation input and output. We show that top management quality is an important determinant of corporate innovation, with individual aspects of management quality affecting innovation in younger and older firms differently. Further, firms with higher top management quality engage in more risky (“explorative”) innovation strategies. Finally, hiring more and higher-quality inventors is an important channel through which firms with higher management quality achieve greater innovation output.

Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework that allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument (the density of wealthy individuals near a firm’s headquarters) for the presence of large, nonmanagerial individual shareholders in firms. These shareholders have a large impact on firms, controlling for selection effects.

One of the virtues of parameter preference models (presented in general form in Rubinstein [23]) is their empirical content. Applied models of financial theory rely heavily on the mean variance (MV) version of parameter preference. As spelled out in Samuelson [25], MV models are adequate with compact distributions of returns and when portfolio decisions are made frequently so that the risk parameter becomes sufficiently small.

We investigate how price discovery occurs in the options markets through traders' trade size choice. By employing transactions data on all options traded on a sample of 100 firms, we show that informed traders fragment their orders into small (medium) trades for low (high) volume contracts. We also find that almost 60% of the price discovery occurs in the exchange with the largest market share for a given option, where informed traders favor medium size trades. Upon examining distinct option series for a given stock, we find that at-the-money calls display the highest information share.

This paper examines how industry structure affects corporate investment patterns. Real options theory shows that deferring irreversible investment in the face of uncertainty is valuable. Theory also shows that the value of waiting to invest falls if investment opportunities are contestable. Consistent with these theories, we find that firms in monopolistic industries exhibit lower investment-q; sensitivity and are slower to invest than firms in competitive industries. However, we find that investment-q; sensitivity and investment speed are highest in oligopolistic industries, suggesting that the value of investing strategically can outweigh the value of waiting. Indeed, oligopolistic industries experience less entry and more exit than other industries.

Operating leverage increases profitability and reduces optimal financial leverage. Thus, operating leverage generates a negative relation between profitability and financial leverage that is thought to be inconsistent with the trade-off theory but is commonly observed in the data. We demonstrate the effect of operating leverage on firms’ profitability and financial leverage, as well as on the empirical relation between profitability and financial leverage, by using China’s entry into the World Trade Organization in 2001 and its effect on the capital–labor ratio of U.S. firms.

We provide evidence of a link between firm dividend policy and stock market liquidity. In the cross section, owners of less (more) liquid common stock are more (less) likely to receive cash dividends. Predictions of the proportion of dividend payers based on 1963–1977 cross-sectional estimates account for most of the declining propensity of firms to pay dividends as documented by Fama and French (2001). Furthermore, historic liquidity is an important determinant of dividend initiations and omissions. Finally, we show that sensitivity of firm value to aggregate liquidity declines after dividend initiations, suggesting that investors view stock market liquidity and dividends as substitutes.

A new testable implication is derived from the rational speculative bubbles model stating that the presence of bubbles implies positive duration dependence in runs of high returns. Specifically, the probability of observing an end to a run of high returns declines with the length of the run. Traditional duration dependence tests are adapted for use with discrete stock runs data and, consistent with the existence of bubbles, evidence of duration dependence in monthly real stock returns is found.

We investigate incentive effects of a typical hedge fund contract for a manager with power utility. With a one-year horizon, the manager displays risk taking that varies dramatically with fund value. We extend the model to multiple yearly evaluation periods and find that the manager's risk taking is rapidly moderated if the fund performs reasonably well. The most realistic approach to modeling fund closure uses an endogenous shutdown barrier where the manager optimally chooses to shut down. The manager increases risk taking as fund value approaches that barrier, and this boundary behavior persists strongly with multiyear horizons.

We study the relation between asset liquidity and stock liquidity. Our model shows that the relation may be either positive or negative depending on parameter values. Asset liquidity improves stock liquidity more for firms that are less likely to reinvest their liquid assets (i.e., firms with less growth opportunities and financially constrained firms). Empirically, we find a positive and economically large relation between asset liquidity and stock liquidity. Consistent with our model, the relation is more positive for firms that are less likely to reinvest their liquid assets. Our results also shed light on the value of holding liquid assets.

Three main approaches to the problem of portfolio selection may be discerned in the literature. The first of these is the mean-variance approach, pioneered by Markowitz [21], [22], and Tobin [30]. The second approach is that of chance-constrained programming, apparently initiated by Naslund and Whinston [26]. The third approach, Latané [19] and Breiman [6], [7], has its origin in capital growth considerations. The purpose of this paper is to contrast the mean-variance model, by far the most well-known and most developed model of portfolio selection, with the capital growth model, undoubtedly the least known. In so doing, we shall find the mean-variance model to be severely compromised by the capital growth model in several significant respects.

The measurement and determination of risk have received considerable attention in recent years. One measure of risk is systematic risk, defined in terms of the covariance of a security's return with the return from the market portfolio. The relationship is often standardized by dividing the covariance by the variance of return from the market portfolio. Hereafter, this measure of standardized systematic risk shall be referred to as beta.

The risk inherent in the price fluctuations of bonds has many dimensions. These include default risk, inflation risk, and call risk. The most important single source of risk, particularly for government and high-grade corporate bonds, is basis-risk price fluctuations caused by shifts in interest rates. For a given shift in the yield curve, and holding other factors unchanged, longer term-to-maturity bonds generally suffer greater price changes than shorter maturity bonds. This characterization is not exact because high coupon bonds are less volatile than low coupon bonds. Intuition says that this is to be expected because, other things being equal, high coupon bonds have a greater percentage of their value due to the interim coupons and, hence, have a shorter “effective” maturity. Duration may be interpreted as an attempt to quantify this qualitative statement through the use of a single, numerical measure intended to be used in place of maturity.

We study the impact of the enforcement of financial regulation by the United Kingdom’s regulatory authorities on the market price of penalized firms. Existing studies rely on analyses of multiple events that may distort the measurement of reputational losses. In the United Kingdom, the entire enforcement process involves only one public announcement and is accompanied by complete information on legal penalties. We find that reputational losses are nearly nine times the size of fines and are associated with misconduct harming customers or investors but not third parties.

We use Tobin’s q models of investments to estimate the relationship between corporate governance and the level of innovative activity. Simple ordinary least squares (OLS) models suggest that poor governance reduces innovative activity. However, OLS results are sensitive to controlling for serial correlation, unobserved effects, or using instrumental variables to control simultaneity. Controlling for these effects substantially reduces or eliminates the relationship between governance and innovative activity.

Recent theoretical models derive return continuation in a setting where investors have heterogeneous beliefs or receive heterogeneous information. This paper tests the link between heterogeneity of beliefs and return continuation in the cross-section of U.S. stock returns. Heterogeneity of beliefs about a firm’s fundamentals is measured by the dispersion in analyst forecasts of earnings. The results show that momentum profits are significantly larger for portfolios characterized by higher heterogeneity of beliefs. Predictive cross-sectional regressions show that heterogeneity of beliefs has a positive effect on return continuation after controlling for a stock’s visibility, the speed of information diffusion, uncertainty about fundamentals, information precision, and volatility. The results in this paper are robust to the potential presence of short-sale constraints and are not explained by arbitrage risk.

This article studies the impact of retail investors on stock liquidity during the COVID-19 pandemic lockdown in spring 2020. Retail trading exhibits a sharp increase, especially among stocks with high COVID-19–related media coverage. Retail trading attenuated the rise in illiquidity by roughly 40% but less so for high-media-attention stocks. Causality is addressed using the staggered implementation of the stay-at-home advisory across U.S. states. The results highlight that ample free time and access to financial markets facilitated by fintech innovations to trading platforms are significant determinants of retail-investor stock market participation.

We investigate whether the Troubled Assets Relief Program (TARP) gave recipients competitive advantages. Using a difference-in-difference (DID) approach, we find that: i) TARP recipients received competitive advantages and increased both their market shares and market power; ii) results may be driven primarily by the safety channel (TARP banks may be perceived as safer), which is partially offset by the cost-disadvantage channel (TARP funds may be relatively expensive); and iii) these competitive advantages are primarily or entirely due to TARP banks that repaid early. These results may help explain other findings in the literature, and yield important policy implications.

With the formation of a formal market for the trading of financial futures in October 1975, a renewed interest in the futures contract as an investment vehicle has emerged. The traditional approach was to view investing in futures as a way of off setting potential price risk associated with a given spot position. While these descriptive scenarios (see [3], [6], [10], [12], [13], [14], and [19]) adequately illustrate the traditional hedging strategy, their simplifying assumptions introduce a lack of realism into the investment process. The implication drawn from many of these articles is that, if one is interested in risk reduction, one should simply take the opposite position in the appropriate number of futures contracts to totally offset one's existing spot position.