This brief paper will show that (a) a theoretical equilibrium state of the world exists in the absence of capital controls and trade barriers when prices for the same goods in different markets are equal, after translation at the spot exchange rate; (b) differences in rates of aggregate price change in different markets eventually cause offsetting exchange rate changes which restore condition (a); (c) returns on equivalent securities denominated in different currencies but covered in the forward market are almost instantaneously equalized; (d) the market's expected rate of change of the exchange rate equals, to a close approximation, the control-free interest rate differential between the two currencies; (e) in the absence of predictable exchange market intervention by central banks, the interest rate differential is the best possible forecaster of the future spot rate; and (f) the forward rate also provides the best forecast of the future spot rate. A final corollary identifies a relationship between inflation rates and international interest rate differentials.

I'd like to begin by thanking the Western Finance Association for the lunch I just consumed …

It is only fair that I inform you at the outset that the views you are about to hear can only be described as biased. They are biased because I'll be limiting my remarks to those parts of finance that I think I know something about; secondly, my comments will contain a disproportionate reflection of my own work. The more generous among you might argue that this puts me in good company. A better explanation would recognize that I am really in a monopoly position for the next half hour or so: there are no contemporaneous sessions within commuting distance, your lunch was paid in advance and is not refundable, and for some of you at least there is a certain cost associated with getting up and leaving in full view of the organizers.

Since its inception the single-index market model has been the subject of a large body of theoretical and empirical research. This study deals with the very difficult issue surrounding the practical implementation of the model in portfolio analysis where significant, nonmarket sources of covariation in security returns are believed to be present.

We study the value of stock liquidity in the market for corporate control and show that the target firm’s liquidity has an impact on the transaction itself and on the resulting merged entity. We use a sample of U.S. merger and acquisition (M&A) transactions (1987–2007) to show that acquiring a more liquid firm makes the stock of the acquirer more liquid. This has consequences for M&A activity and pricing. Public acquirers are more likely than private acquirers to acquire more liquid targets. Liquidity also translates into a greater likelihood of completing the deal and higher compensation for the target.

Roll and Ross [6] have written what has quickly become the classic article on testing the Arbitrage Pricing Theory (APT) originally proposed by Ross [8]. They presented methods both for estimating the return generating process and for testing whether particular elements (factors) in the return generating process were priced in equilibrium. They found that more factors are priced than one would expect to be priced if the Capital Asset Pricing Model (CAPM) were held.

Investment managers are subject to personal and institutional norms that can constrain their investment choices. We conjecture that norm-constrained investors deviate from such norms only when they have compelling information, and we predict that deviating investments earn relatively high abnormal returns ex post. Consistent with our conjecture, we find that institutions averse to holding lottery-like stocks or sin stocks earn relatively high abnormal returns when they choose to hold such stocks. We find similar but weaker results for deviations from broader style categories. Overall, our evidence indicates that deviations from established institutional or social norms signal informed investing.

We examine how the Sarbanes-Oxley Act (SOX) affects pre-repurchase earnings management and its association with post-repurchase firm performance. Unlike prior pre-SOX studies, our post-SOX results indicate that open-market repurchasers do not engage in pre-buyback downward accrual-based earnings management. Audit committee independence, reforms in corporate governance structures, and changes in executives’ equity holdings prompted by SOX may explain the findings. Post-SOX, the significant negative association between pre-repurchase abnormal accruals and post-repurchase performance disappears, the market reaction to repurchase announcements becomes significantly less favorable, and there is no evidence of any shift away from accrual-based to real earnings management.

We provide evidence concerning the effect of managerial risk-taking incentives on merger and acquisition (M&A) decisions and outcomes for different types of mergers: vertical, horizontal, and diversifying. Using chief executive officer (CEO) relative inside leverage to proxy for the incentives of risk-averse managers, we find that CEOs with higher inside leverage are more likely to engage in vertical mergers, and those mergers generate lower announcement returns for shareholders. This effect of CEO relative inside leverage on returns for shareholders in vertical acquisitions is more pronounced when the acquirer has a higher degree of informational opacity, weak governance, and excess cash.

We investigate the relationship between traders’ expectations and market outcomes with experimental asset market data. The data show that those who have high price expectations buy more frequently and submit higher bids, and those who hold low price expectations sell more frequently and submit lower bids. Traders who have more accurate expectations achieve greater earnings. Simulations using only belief data reproduce the pricing patterns observed in the market well, indicating that the heterogeneity of expectations is a key to explaining market activity.

Many academic studies use fixed preannouncement event days (e.g., -20,-42, or -63) to measure takeover premiums. In this paper, we show that the use of traditional fixed windows generates premiums that are underestimated by as much as 8 percentage points. This downward bias is especially severe for transactions with long processes (e.g., target-initiated deals). We take account of this bias by hand collecting deal initiation dates and show that using these dates results in measured premiums that give contradictory conclusions to those found in existing literature. We also offer guidance for measuring premiums if hand collecting data is impractical.

How does informed trading affect liquidity in limit order markets, where traders can choose between market orders (demanding liquidity) and limit orders (providing liquidity)? In a dynamic model, informed trading overall helps liquidity: A higher share of informed traders i) improves liquidity as proxied by the bid–ask spread and market resiliency, and ii) has no effect on the price impact of orders. The model generates other testable implications, and suggests new measures of informed trading.

Despite nonstationarities in the factor betas and factor prices of the Chen, Roll, Ross (1986) multifactor model, investors are rewarded for bearing risks associated with the change in expected inflation and industrial production in non-January months; however, variations in these factors have opposite influences on stock prices. These findings may partially explain why several recent studies fail to detect a significant non-January risk premium in the stock market, but this evidence is only suggestive since theoretical and statistical difficulties prevent precise interpretations of specific pricing relations in the Chen, Roll, Ross model.

This paper studies how the precision of noisy public information that investors receive about the expected aggregate dividend growth rate affects stock market returns. I show that less precise information can increase the risk premium and stock return volatility. The numerical results from my calibrated model also show that noisy information can significantly increase the risk premium and stock return volatility. My finding implies that the presence of noisy information may help explain the large average risk premium and return volatility in the U.S. financial market. In addition, my finding suggests it is optimal for firms to disclose to investors more precise information to reduce the cost of equity capital.

We survey over 1,000 venture capitalists (VCs) on how the COVID-19 pandemic has affected their decisions and investments. Despite the historical importance of in-person meetings, VCs do not report difficulty finding quality entrepreneurs or major changes in time allocation. They do report difficulty in evaluating deals, more investor-friendly terms, and a decreased investment rate, with about one-sixth of VCs reporting pressure from limited partners to conserve capital. Although aggregate returns are largely unchanged, there is high dispersion both within and across funds. A follow-up survey shows faster-than-expected recovery in deal volume, terms, and returns.

During the late 1960s and throughout the 1970s, a myriad of tests of the two-parameter capital asset pricing model (hereafter CAPM) have been executed and reported in the literature. Relatively recently, much attention has been focused on the asymmetry—skewness—of realized asset, portfolio, and market return distributions. The intent of the present effort is to report the results of an investigation of the asymmetry of one of these variables—the returns of the market portfolio.

Recent studies indicate that the widespread assumption of parameter stationarity in empirical applications of asset pricing models may be inappropriate. This paper investigates the feasibility of modeling parameter instability as a sequence of persistent stable regimes. Recursive residual and log likelihood techniques are combined to detect and locate shift points. The results indicate that regime shifts are widespread, frequent, and often large enough to significantly effect empirical findings. The nature of the shifts appears to be a rotation of the regression line, indicating that correction of both alpha and beta parameters is required.

We study the evolution and renegotiation of the cash-flow rights that venture capitalists (VCs) obtain in their portfolio companies. When company performance between financing rounds is poor, subsequent contracts contain stronger VC cash-flow rights, and existing VCs tend to either give new VCs senior claims or forfeit their existing rights altogether. These results are consistent with the importance of financing problems between different VCs and with theory predicting that financing frictions worsen with poor performance. A consequence is that VC cash-flow rights are frequently significantly diluted before exit, implying that VC investments are riskier than previously estimated.

We examine whether internal funds matter for investment when the measurement error in q is addressed. By carefully employing methodologies that tackle the measurement error in q, we show that cash flow is a significant determinant of investment. We also find that an analyst-forecast-based q measure is not superior to a stock-market-based q measure. We further propose an approach that uses two alternative proxies of q as instruments for addressing measurement error. Our evidence indicates that instrumental-variables-type generalized method of moments estimators yield empirically well-specified models.

This study provides, as a result of comprehensive search, a better description of the intertemporal behaviors of corporate debt policy, comparable to those that exist for dividend policy. Although leverage policy may vary a great deal from firm to firm, we found that: (1) The rather simple partial adjustment model with constant payout ratio to have the best predictive performance and other superior models include the first-order markov process and the historical average leverage ratio; (2) in general, firms seem to operate with a concept of “target leverage ratio,” e.g., target ratio computed from the partial adjustment models, or from historical or industry averages; (3) there is some weak evidence of the presence of unused debt capacity for the total sample; (4) the average speed of adjustment to close the gap between the desired and actual leverage ratio is a respectable 67 percent in the first year (due to the lumpiness of debt issue, individual firms tend to be either under or overadjusted); (5) there are some indications that firms also adjust debt behavior to anticipated future increases or decreases in assets.

There are several areas for future research, for instance, the best debt model could serve as the first stage of a possible two-stage equation in the empirical verification of the MSM's assumption of the independence of the investment decision to the financing decision (e.g., [7]), on a further exploration of how firms' expectations affect debt behavior. Finally, the existence of a rational target leverage ratio should encourage research interest concerning the existence of an empirically testable optimal leverage ratio.

The U. S. National Bank was declared bankrupt in October of 1973. Just a few days short of a year later the Franklin National Bank failed. These were the largest bank failures ever experienced in the United States and they occurred against a backdrop of extensive bank regulatory operations first to prevent them and then to reduce the effect of these failures upon bank depositors and the banking public. The objective of this study was to determine the effects of these two large bank failures upon the structural relationship of risk and return of equity investments in other large commercial banks. Using historical hindsight, it can be seen that these large bank failures were isolated and noncumulative, but it should be remembered that the investors in bank equities at that time did not know that these failures would not precipitate other bank failures. This worry or apprehension.should have.been reflected in the equity prices of other large bank stocks. Did these failures substantially affect the perceived risk of failure in other large commercial banks? Did these failures result in a substantial increase in the required rate of return on bank equity? Under the efficient markets hypothesis it is assumed that all current prices reflect all knowledge and thus equity prices should adjust quickly to the presence of new information contained in a bank failure. Therefore, in order to determine the influence of these banking failures upon the structural relationships of risk and return of bank equities, the market model was used to relate the weekly holding period returns on 19 large commercial bank common shares to the weekly holding period returns on the S & P 500 index over the past four and one half years.

This study found that there was a lengthy period of structural stability when the realized returns on large bank stocks were compared with the realized returns on the market portfolio. Further, the study found that the U. S. National failure had no structural effect upon the relationships of risk cognizance and required return in that there were no resulting significiant changes in the parameters of the market model before and after the failure. On the other hand, the failure of the Franklin National had a significant structural effect upon risk cognizance. The perceived level of unsystematic risk significantly increased above that of a base period established before the Franklin failure. There was no structural change found in either the intercept term or the measure of systematic risk after the Franklin demise, only a change in unsystematic risk. The most significant change occurred just after the closing of the Franklin and subsided completely during the first and second quarter of 1975.