We test how market overvaluation affects corporate innovation. Estimated stock overvaluation is strongly associated with measures of innovative inventiveness (novelty, originality, and scope), as well as research and development (R&D) and innovative output (patent and citation counts). Misvaluation affects R&D more via a nonequity channel than via equity issuance. The sensitivity of innovative inventiveness to misvaluation increases with share turnover and overvaluation. The frequency of exceptionally high innovative inputs/outputs increases with overvaluation. This evidence suggests that market overvaluation may generate social value by increasing innovative output and encouraging firms to engage in “moon shots.”

In recent years, academicians and practitioners have been using the concept of duration more frequently in the analysis of debt securities. Although the use of duration has greatly expanded our insights into the behavior of bond prices and bond risk, it has given rise to a considerable degree of confusion and misunderstanding. The purpose of this review paper is twofold: (1) to clarify the record on what duration is and is not and what it can do and cannot do, and (2) to discuss the appropriate uses of duration in the analysis of security portfolios.

We provide new evidence on the economic role of growth options behind the profitability, distress, lotteryness, and volatility anomalies. We use idiosyncratic skewness to measure growth options and estimate expected idiosyncratic skewness capturing investors’ expectations about the firm’s mix of growth options versus assets-in-place. We find that investors require a positive premium to hold stocks of inflexible firms with low growth options and negative expected skewness and that a newly proposed skewness factor based on growth options explains the aforementioned anomalies. Thus, the new measure of expected idiosyncratic skewness may serve to reduce the number of anomalies in the literature.

We investigate the effects of manager characteristics on capital structure in a structural model. We implement the manager’s optimal contracts through financial securities that lead to a dynamic capital structure, which reflects the effects of taxes, bankruptcy costs, and manager-shareholder agency conflicts. Long-term debt declines with the manager’s ability, inside equity stake, and the firm’s long-term risk, but increases with its short-term risk. Short-term debt declines with the manager’s ability, increases with her equity ownership, and declines with short-term risk. We show support for these implications in our empirical analysis.

We investigate the role of country characteristics on the competition-governance relation. We find that competition is associated with higher ratings in corporate governance, but only in developing countries. Further, corporate governance is associated with greater firm value, but only in less competitive industries from developed countries. For developing countries, the evidence suggests that corporate governance is valuable mostly in competitive industries. Additional tests show that corporate governance increases labor productivity and cost efficiency, mostly in less competitive industries in both developed and developing countries. Furthermore, in developing countries, corporate governance increases investment in capital, but primarily in competitive industries.

We examine the role of relationship-based resource allocations during the approval process of seasoned equity offerings (SEOs) in the Chinese capital market. Our results show that guanxi-based relationships significantly increase the likelihood of SEO approvals, particularly for suspect SEO applicants with abnormal levels of earnings management (EM), related-party transactions (RPTs), and intercompany loans. More importantly, we find that guanxi-influenced SEO firms have significantly poorer performance in the post-SEO period, which indicates that it results in inefficient resource allocations. Overall, our evidence suggests that relationship-based resource allocations lead to negative spillover effects that impose social welfare losses.

This paper investigates whether comovements between euro area equity returns at national and industry level changed after the introduction of the euro. By adopting a regression quantile-based methodology, we find that after 1999 the degree of comovements among euro area national equity markets was augmented. By explicitly controlling for the impact of global factors, we show that this result cannot be explained by recent worldwide trends. A more refined analysis based on an industry breakdown suggests that the increase in national index comovements is mainly driven by financial, industrial, and consumer services sectors.

General equilibrium in the classical two-period mean-variance capital asset pricing model is not unique. Corresponding to one single set of expectations, utility functions, and an initial wealth distribution, there may be several equilibria, and an asset may have different prices, expected rates of return, and betas in different equilibria. However, any equilibrium portfolio is sustained by a unique price system, and if investors have decreasing risk aversion, then any equilibrium allocation of the risky assets is sustained by a unique price system.

The inception of modern portfolio theory dates from Markowitz's pioneering article [7] and subsequent book [8]. Yet despite the early development of a full theory of portfolio management, this theory has rarely been implemented. One problem arises from the difficulty in generating inputs to the general portfolio model. Index models and simple structures for correlation relationships, which go a long way towards solving this problem, have been developed. Yet the time and cost of solving actual portfolio problems (involving the solution of a quadratic programming problem) and more importantly the difficulty of educating portfolio managers to relate to risk return trade-offs in terms of covariances has virtually brought the application of portfolio theory to a halt.

The purpose of this paper is to suggest simple procedures designed to cope with the effects of thin trading on event study tests. The procedures are directed at two central problems: (i) missing individual stock returns (i.e., days on which no trading is observed in a security), and (ii) the effect of a bid-ask spread on the time series behavior of daily stock return data. We attack these problems by explicitly incorporating them in the construction of a generating process for observed security returns. First, we develop a procedure for “filling in” missing returns. Then, we model a return-generating process of observed security returns that allows estimation of the variance of unobserved true security returns for use in hypothesis testing.

This article analyzes the effect of liquidity risk on the performance of equity hedge fund portfolios. Similarly to Avramov, Kosowski, Naik, and Teo (2007), (2011), we observe that, before accounting for the effect of liquidity risk, hedge fund portfolios that incorporate predictability in managerial skills generate superior performance. This outperformance disappears or weakens substantially for most emerging markets, event-driven, and long/short hedge fund portfolios once we account for liquidity risk. Moreover, we show that the equity market-neutral and long/short hedge fund portfolios’ “alphas” also entail rents for their service as liquidity providers. These results hold under various robustness tests.

In recent years much research has centered upon whether yield differentials between bonds which differ in default risk vary systematically over the business cycle. Theory suggests that during a cyclical upswing the yield differential (or risk premium) narrows, while during a downswing the differential widens. The cyclical behavior of yield spreads is well documented in the corporate bond market [4, 8, 12, 16]. This effect has only recently been given attention in the tax-exempt bond market [1, 11]. In addition, the municipal bond market may be segmented. If tax-exempt borrowers and investors are unable to substitute between tax-exempt securities of varying default risk, changes in the relative supply of and demand for these classes of securities could produce systematic fluctuations in tax-exempt yield differentials. These effects could be produced by regulatory statutes which require that banks purchase high-grade securities and the fixed nature of bond ratings.

This article proposes a structural model for sovereign credit risk with endogenous sovereign debt and default policies. A maximum-likelihood estimation of the model with local stock market prices generates daily model-implied sovereign spreads. This approach explains two-thirds of the daily variation in observed sovereign spreads for emerging and European economies over the 2000–2011 period. Global factors help to further explain the time variation in sovereign credit risk. In particular, sovereign spreads in emerging markets vary with U.S. market uncertainty, whereas European spreads depend on Euro-zone bond factors.

This paper examines the relationship between a firm’s exposure to industry downturns that we call industry risk and bank loan pricing. We measure industry risk based on the relationship between a firm’s stock returns and industry returns conditional on an industry downturn. We find industry risk is significantly related to the recovery rates in bankruptcy and the likelihood of the firm experiencing financial distress when its peers are also in distress. More importantly, we find that the spreads on unsecured bank loans are positively related to industry risk measures. These relationships are stronger for firms with more industry-specific assets.

We consider asset pricing in a monetary economy where liquid assets are held to lower transaction costs. The ensuing model extends the capital asset pricing model (CAPM) and the consumption CAPM by deriving real money growth as an additional factor determining returns. Empirically, the two model versions compare favorably to other theoretical asset pricing models along several dimensions, supporting the traditional intertemporal asset pricing perspective. A value premium arises because value firms are sensitive to liquidity shocks but growth firms are not. Although no alternative factor drives out the money growth factor, the conditioning CAY factors of Lettau and Ludvigson (2001b) add explanatory power.

We test the hypothesis that investment constraints in delegated portfolio management may distort demand for stocks, leading to price underreaction to news and stock return predictability. We find that institutions tend not to buy more of a stock with good news that they already overweight; they are reluctant to sell a stock with bad news that they already underweight. Stocks with good news overweighted by institutions subsequently significantly outperform stocks with bad news underweighted by institutions. The impact of institutional investment constraints sheds new light on asset pricing anomalies such as stock price momentum and post–earnings announcement drift.

This article provides a survey of China’s initial public offering (IPO) market, focusing on IPO pricing, bids and allocation, and aftermarket trading. We show that strict regulations result in suppressed IPO offer prices and high initial returns, causing a high cost of going public. Investors treat IPOs as lotteries with extremely high short-term returns, with little attention to the long term. The auction selling method, however, works in the way it is supposed to. Mutual funds bid in a more informative way than other investors, and their advantages are unlikely to be due to underwriters’ preferential treatment. We also discuss the latest registration-system reform.

This paper investigates how a firm’s capital structure choice affects the informational efficiency of its security prices in the secondary markets. We identify two new determinants of a firm’s capital structure policy: the liquidity (adverse selection) premium due to investors’ anticipated losses to informed trading, and operating efficiency improvement due to information revelation from the firm’s security prices. We show that the capital structure decision affects traders’ incentives to acquire information and subsequently, the distribution of informed traders across debt and equity claims. When information is less imperative for improving its operating decisions, a firm issues zero or negative debt (i.e., holding excess cash reserves) in order to reduce socially wasteful information acquisition and the liquidity premium associated with it. When information is crucial for a firm’s operating decisions, the optimal debt level is one that achieves maximum information revelation at the lowest possible liquidity cost. Our model can explain why many firms consistently hold no debt. It also provides new implications for financial system design and for the relationship among leverage, liquidity premium, profitability, and the cost of information acquisition.

Risk continues to be a widely discussed topic within the field of finance. Academicians add risk variables to their quantitative models, while financial practitioners include risk considerations in their qualitative deliberations. In both contexts, risk — together with some measure of profit or return — generally comprise a dual or composite criteria for investment decision-making purposes. Whereas the decisionmaking situation can be described as ex ante, this article deals with risk in an ex post context. In particular, it reports an investigation of alternative risk-return measures which are designed to rank and evaluate the ex post performance of investment portfolios. Section I reviews three composite measures of performance and examines their interrelationships. A fourth alternative measure is also suggested. In Section II, the measures are used to rank the portfolio performance of a sample of mutual funds. Some difficulties in making performance comparisons of these funds against the market are discussed in Section III. The final section briefly explores the implications of the study and suggests areas for subsequent research.

We study the empirical determinants of corporate ownership dynamics using a unique, hand-collected 20-year data set on the ownership structure of Chilean companies. Controllers’ blockholdings are on average high and stable over time. Controllers still make changes to their holdings through issuance and block trades. In a typical year controllers’ blockholdings decrease (increase) by 5 percentage points or more in approximately 6% (7%) of firms. We find that the separation between controllers’ voting and cash-flow rights reduces the likelihood of ownership dilution. Dilution is preceded by high stock returns and predicts low stock returns in the future when done through issuance.