We provide novel evidence that hedge fund performance is persistent following weak hedge fund markets but is not persistent following strong markets. Specifically, we construct two performance measures, RET_DOWN and RET_UP, conditioned on the level of overall hedge fund sector returns. After adjusting for risks, funds in the highest RET_DOWN quintile outperform funds in the lowest quintile by approximately 7% in the subsequent year, whereas funds with better RET_UP do not outperform subsequently. The RET_DOWN measure can predict future fund performance over a horizon as long as 3 years, for both winners and losers and for funds with few share restrictions.

In a recent paper, Johnson [7] has given an analytic approximation to the American put price that delivers values that are very close to numerical solutions. The limitation to the Johnson approximation is that it is only applicable to put options on stocks without cash dividends. This study modifies the Johnson approximation to value options on stocks that have one exdividend date prior to the option expiration date, and these approximation values are compared to the analytic solutions provided by the Geske and Johnson [6] American put option pricing model. The approximation values are generally very close to the analytic solutions.

Debt overhang and moral hazard predict that poorly capitalized banks have a lower likelihood to issue equity, while the presence of regulatory and market pressures posits an opposite theoretical prediction. By using an international sample of bank seasoned equity offerings (SEOs), we show that the likelihood of issuing SEOs is higher in poorly capitalized banks and that such banks prefer SEOs to alternative capitalization strategies. A series of tests exploring the variation of capital regulation and market discipline show that market mechanisms rather than capital regulation are the primary driver of the decision to issue by poorly capitalized banks.

We analyze myopic trader models of noisy prices in financial markets. Unlike extant analysis, such as De Long et al. (1990a), a classical equilibrium exists in our analysis, e.g., a riskless perpetuity is priced by arbitrage and its price does not vary with noise. A unique noisy equilibrium exists only when i) noise traders' beliefs are rational regarding volatility and irrational regarding expected returns, and ii) noise traders can hold infinite positions. In the absence of these strong assumptions, multiple noisy equilibria can coexist with the classical equilibrium, but these equilibria exhibit conflicting comparative statics. Furthermore, the price of a long-lived asset with risky cash flows can vary with noise even when investors are not myopic. One conclusion is that myopia is neither a necessary nor a sufficient condition for noisy prices. A second is that it is difficult, if not impossible, to use myopic trader models to derive implications for investment or regulatory policy.

It is well known that present institutional arrangements do not permit investors to use the proceeds of short sales to finance the purchase of other stocks. On the contrary, investors must place the proceeds of short sales in escrow, and they must also affirmatively invest (deposit) an additional amount equal to margin requirements (which may be as much as 100 percent) of the “proceeds” of the short sales. These escrowing and depositing requirements together will be referred to as “short-sales escrowing requirements.” These escrowing requirements not only involve forced or “by-product” holdings of the (nominally) riskless asset, they also change the structure of the investor's wealth constraint by requiring the substitution of absolute values for the natural number of shares when short sales are made.

Disagreement, a key factor inducing trading, has been receiving ever increasing attention in recent years. Most research has focused on disagreement about the expected returns. Several authors have shown that if the average belief coincides with the true expected return, in the portfolio context prices are unaffected by disagreement. In this paper we study the pricing effects of disagreement about return variances. We show that i) disagreement about variances has systematic and significant pricing effects—more disagreement leads to higher prices, and ii) prices are very sensitive to the degree of disagreement: Even if the average belief about the variance is constant, tiny fluctuations in the disagreement about the variance lead to substantial price fluctuations. This second result may offer an explanation for the excess volatility puzzle: When small changes in the degree of disagreement occur, they induce relatively large price changes. Yet, the changes in disagreement may be hard to directly detect empirically, leading to apparent “excess volatility.”

We examine the effect of poison pill adoptions on firm value, controlling for the adopting firm's preexisting corporate governance structure. We find that only companies with the most democratic governance structures, defined as those with the fewest preexisting protective governance provisions, experience significantly positive abnormal stock returns and significantly positive abnormal revisions in five-year earnings growth rate forecasts. Moreover, regression results indicate that abnormal returns and forecast revisions are significantly related to governance structure and not to board composition or subsequent merger activity.

Using country- and institution-level data, we find that the “coming wave” of emerging- market (EM) investors systematically over- or underweight their equity portfolio holdings in a way that reflects the influences of past capital and trade flows from a foreign country. We interpret this finding as support for van Nieuwerburgh and Veldkamp (2009) information endowment hypothesis. Strong past capital and trade flows create an information advantage that leads EM investors to disproportionately overweight a given foreign market, even relative to developed market investor counterparts. We also pursue predictions of the information endowment hypothesis by constructing novel information-advantage proxies based on relationships among investment firms and the headquarters of their parent companies. These proxies also offer reliable explanatory power for international portfolio allocations.

In the theoretical literature of finance, it has been assumed for some time that capital markets are efficient, with security prices reflecting all available information [10]. One purpose of this paper is to consider market efficiency in the context of rights offerings. It has recently been suggested, for example, that rights offerings afford positive abnormal returns [17,18]. This view was immediately countered by the comment that the number of rights issued, and inversely the issue price, cannot affect the market value of the total exrights equity market [21, p. 44]. No empirical evidence was offered on either side, however.

In this paper, we examine the effects of errors in measurement of the two independent variables, return on market (Rm) and return on risk-free assets (Rf), in the traditional one-factor capital asset pricing model (CAPM). After discussing Sharpe-Lintner's CAPM and both Jensen and Fama's specifications thereof, we review briefly the recent results of Friend and Blume [6], hereafter FB; Black, Jensen and Scholes [1], hereafter BJS; and Miller and Scholes (11], hereafter MS. In Section II, we first explore possible sources of measurement errors for both Rm and Rf; then we specify these errors mathematically and derive analytically their effects on estimates of systematic risk of a security or portfolio, , and the Jensen's measure of performance, . In Section III, we derive an analytical expression for the regression coefficient of estimated b's where we estimate the equation . The result is then examined to find the conditions under which errors in measurement of Rm and Rf can cause b to have a positive or negative value even if the true b is zero. The conditions are then used to examine FB's results and their interpretation. In Section IV, an alternative hypothesis testing procedure for the CAPM is examined. We show that the empirical results so derived are also affected by the measurement errors and the sample variation of the systematic risk. The relative advantage between the two different testing hypothesis procedures is then explored. Finally, we comment on the relevance of the result to the popular zero-beta model and indicate areas for further research.

We explore the properties of equity mutual funds that experience a loss of assets after poor performance. We document that both inflows and outflows are less sensitive to performance, because performance-sensitive investors leave or decide not to invest after bad performance. Consistent with the idea that attrition measures the sorting of performance-sensitive investors, we find that attrition has less of an impact on the fund’s flow–performance sensitivity for institutional funds where there is less dispersion in investor performance sensitivity. Also, attrition has no effect on the flow–performance sensitivity when attrition arises after good performance or investors invest for nonperformance reasons.

Using survey data, we analyze institutional investors’ expectations about the future performance of fund managers and the impact of those expectations on asset allocation decisions. We find that institutional investors allocate funds mainly on the basis of fund managers’ past performance and of investment consultants’ recommendations, but not because they extrapolate their expectations from these. This suggests that institutional investors base their investment decisions on the most defensible variables at their disposal and supports the existence of agency considerations in their decision making.

The investment advice encapsulated in the Value Line Investment Survey's timeliness rankings is evaluated from 1965 to 1996 through time-series factor regressions, as well as by comparing recommendations to benchmark portfolios corresponding to their size, book-to-market, and momentum characteristics. In addition, recommendations that have experienced recent earnings surprises are purged to eliminate the effects of post-earnings announcement drift. There is evidence that Value Line recommendations exhibit performance beyond what is predicted by existing models of expected return. However, once transactions costs have been accounted for, it is doubtful profitable abnormal returns could have been realized.

This paper reexamines, at a range of investment horizons, the asymmetric dependence between hedge fund returns and market returns. Given the current availability of hedge fund data, the joint distribution of longer-horizon returns is extracted from the dynamics of monthly returns using the filtered historical simulation; we then apply the method based on copula theory to uncover the dependence structure therein. While the direction of asymmetry remains unchanged, the magnitude of asymmetry is attenuated considerably as the investment horizon increases. Similar horizon effects also occur on the tail dependence. Our findings suggest that nonlinearity in hedge fund exposure to market risk is more short term in nature, and that hedge funds provide higher benefits of diversification, the longer the horizon.

In this paper we present empirical tests of an extended version of the capital asset pricing model (CAPM) that replaces the single-period horizon with a probability distribution over different horizons. Adopting a simple parameterization of the probability distribution of the length of the horizon, we estimate the parameters of the distribution as well as the parameters of the CAPM. We find that the extended model is not rejected for several different samples of common stocks, and for these samples it outperforms not only the standard CAPM but also the Fama–French (1993) 3-factor model. The probability distribution over horizon dates varies over time with the New York Stock Exchange (NYSE) turnover rate. We also find that returns satisfy the Euler equation of a representative financial institution that holds the market portfolio and has horizon probabilities estimated from 13F filings.

This paper estimates an internally consistent structural model that imposes cross-sectional restrictions on the dynamics of the term structure of interest rates, inflation, and output growth. Distinct from previous term structure settings, this model introduces both time-varying central tendencies and a stochastic conditional mean of output growth. The estimation of the model, which is based on U.S. data over a 1960 to 2005 sample period, provides reliable estimates for the implicit term structures of real interest rates, expected inflation rates, and inflation risk premia, as well as for expectations of macroeconomic variables. The model has better out-of-sample forecasting properties than a number of alternative models, and it contradicts the puzzling evidence that during the “Great Moderation” in inflation subsequent to the mid-1980s, the forecasting ability of structural models deteriorated with respect to atheoretic statistical models.

In recent years, there have been a number of studies investigating the yield spread phenomena between new and seasoned bonds ([1], [2], [3], [4], [8], [10], [13]). This literature focuses upon two aspects of the equilibrium pricing of new versus seasoned bonds: (l) analysis of the microeconomic determinants of new issue/seasoned issue yield spreads such as specific differences in coupon rates, call features, maturity features, and the like; and (2) analysis of macroeconomic determinants of yield spreads such as economic growth, interest rate cycles, changing marginal tax rates, and the like.

On average, nonconvertible preferred stocks have significantly positive abnormal returns and trading volume on the ex-day. For the less liquid stocks, however, the abnormal returns are significantly positive, and abnormal trading volume is insignificantly different from zero. This evidence suggests that long-term individual investors set the ex-day prices of less liquid stocks. For the more liquid stocks, the ex-day abnormal returns are closer to zero, and there is significantly positive abnormal trading volume on the ex-day and the day before the ex-day. These results suggest that short-term investors set the ex-day prices of more liquid stocks through dividend capture strategies. Despite this evidence, some inconsistent empirical findings make the overall evidence on dividend capture somewhat mixed.

The stationarity of beta factors has received considerable attention in the financial economics literature. One particular area of study has been to investigate how the measured stationarity of beta factors changes over data sets of varying lengths. By increasing the length of the estimation period, sampling fluctuations may be reduced; however, the probability of beta factors having changed will increase. The optimal data set length, then, involves a trade-off between these two opposing phenomena. Baesel [2] reported the empirical finding that the stationarity of beta was, indeed, dependent upon the estimation period length over which beta factors were estimated. He found, using transition matrices that beta stationarity was an increasing function of the calendar period used for beta estimation. In this paper, analytic expressions will be derived to explain how and when this empirical phenomenon arises. Conditions will be presented for beta stationarity to increase with calendar period length, and it will be demonstrated that beta stationarity will not increase indefinitely with estimation period length. An identical condition is required for beta stationarity to be an increasing function of the subsequent calendar period length. This phenomenon was empirically investigated by Roenfeldt, Griepentrog, and Pflaum [6], and the analysis presented here explains, in part, their findings.

The interaction between product market competition, R&D investment, and the financing choices of R&D-intensive firms on the development of innovative products is only partially understood. We hypothesize that as competition increases, R&D-intensive firms will: i) increase R&D investment relative to existing assets in place; ii) carry more cash; and iii) maintain less net debt. Using the Hatch–Waxman Act as an exogenous shock to competition, we provide causal evidence supporting these hypotheses through a differences-in-differences analysis that exploits differences between the biopharma industry and other industries, and heterogeneity within the biopharma industry. We also explore how these changes affect innovative output.