This paper focuses on the defaultable lease rate term structure with endogenous default. We combine the competitive lease market argument proposed by Grenadier (1996) and the endogenous default structural model proposed by Leland and Toft (1996) to examine the interaction between the lessee’s capital structure and the equilibrium lease rate. Under this framework, determining the lease rate is a simultaneous equation problem that captures the trade-off between debt and lease financing. Using data on 2,482 real estate lease transactions, we empirically confirm the predictions derived from the numerical analysis of the model.

This paper identifies five universal currency hedge ratio (UHR) definitions. These are hedge positions in foreign bonds, stated as a fraction of national or global equity portfolios, that are the same for all investors, regardless of nationality. The first three involve the total demand for foreign bonds and depend on equities not being held for hedging purposes. The last two are associated with variance-minimizing regression hedges. These hold, in general, but are designed exclusively for hedging other traded asset positions. Jensen's inequality makes the choice of measurement currency irrelevant and makes the HRs universal without affecting their values.

This paper uses a time-state-preference valuation model to examine how the firm's choice of technology and production method affects its equilibrium level of risk and, as a result, the firm's cost of capital. A fixed and flexible method of production is analyzed for a firm using a Cobb-Douglas production function. In both cases, it is found that risk and the cost of capital decrease with the level of capital intensity. Implications are drawn for the specification of empirical tests of the determinants of risk.

The rapid advancement of technology leading to quicker obsolescence, shorter life cycles, and more intensive competition has resulted in renewed emphasis on the abandonment and replacement decision in the analysis of investment projects. Once an investment was undertaken, many corporations in the past often abandoned a project only when it either suddenly ceased to function, or else when it became so unprofitable that abandonment was literally forced. Several authors have demonstrated that a project could be abandoned well before any of these terminal conditions existed. Robicheck and Van Home, for instance [14], showed that an asset could be abandoned even though it may be expected to generate positive cash flows in subsequent years. Dyl and Long (DL) [6], in a modification to the Robichek and Van Home (RVH) model regarding the year of abandonment, suggested that rather than abandoning a project at the earliest time–whenever the abandonment value exceeded the present value of all subsequent future flows– all possible cases of abandonment over the life of the asset should be considered. In this manner, the procedure is to select the highest net present value of an asset over all cash flow and abandonment possibilities. This result particularly holds when all projects have the same degree of risk and when there are frictionless markets and no capital rationing.

The decomposition of a security risk into diversifiable (or unsystematic) and nondiversifiable (or systematic) risks has emerged from the portfolio approach of capital investment and has culminated in the well-known Capital Asset Pricing Model (CAPM), developed by Sharpe [4], Lintner [3] and others. In this framework, the diversifiable risk is the risk that can be “washed out” by diversification and the nondiversifiable risk is the risk which cannot be diversified away. It appears to us that the decomposition of risk into its components is in some cases vague and in most cases imprecise. We define the diversifiable and nondiversifiable risk measures as two complementary components of the standard deviation of a security's rate of return. Furthermore, we require thatthe nondiversifiable risk measure will completely determine its equilibrium market price. We shall see that the definition presented is appealing for all securities and particularly for those with negative Beta. To be more specific, recall that a security's β is given by the slope of the following time series regression:

This paper extends the affine class of term structure models to describe the joint dynamics of exchange rates and interest rates. In particular, the issue of how to reconcile the low volatility of interest rates with the high volatility of exchange rates is addressed. The incomplete market approach of introducing exchange rate volatility that is orthogonal to both interest rates and the pricing kernels is shown to be infeasible in the affine setting. Models in which excess exchange rate volatility is orthogonal to interest rates but not orthogonal to the pricing kernels are proposed and validated via Kalman filter estimation of maximal 5-factor models for 6 country pairs.

This paper presents the first theoretical analysis of the choice of firms between “preparing” and not preparing the equity market in advance of a possible dividend cut. In our model, insiders have private information about their firm’s intermediate cash flow as well as about the net present value of its growth opportunity. We show that, in equilibrium, firms in temporary financial difficulties but with good long-term growth prospects are more likely to prepare the market in advance of dividend cuts, while those with permanently declining earnings are less likely to prepare the market. Our model generates several new testable predictions.

We document that global board reforms are associated with a significant reduction in the underpricing of initial public offerings (IPOs). The effect is amplified for IPOs with greater agency problems and mitigated for IPOs certified by reputable intermediaries, IPOs with greater disclosure specificity, and IPOs in countries with better shareholder protection and stringent financial reporting regulations. Furthermore, global board reforms have led to an improvement in the long-term market performance, proceeds, and subscription level of IPOs and have enhanced board independence in the issuing firms. Our findings suggest that global board reforms have strengthened board oversight in the issuing firms, leading to less underpriced IPOs.

In a recent issue of JFQA, Aucamp and Eckardt [1] (henceforth referred to as AE), developed a new sufficient condition for the existence of a unique (and simple) nonnegative internal rate of return (IRR), which includes the one previously formulated by Norstrøm [8] as a particular case. As pointed out by the former authors, their new procedure is appealing since it is easier to apply than the rather involved Sturm-Kaplan [6] method, while being a refinement of Norstrøm's result.

In response to the many issues raised by Altman and Eisenbeis (A&E) [2], we will use their three-part outline. Before turning to their comments, however, we would like to take this opportunity to correct a typo in footnote 10 from our original paper [4]. The denominator of the formula is incorrect as shown, and should be .

New stock financing is assuming increasing significance as a source of funds for private firms. The problem of management of external financing has grown as well. As a practical matter, financial managers must depend on the assistance of underwriters with respect to pricing and distribution of new corporate stock. But recent changes, some set in the context of the capital asset pricing model, imply systematic underpricing of new securities. If these charges are true, the financial manager is faced with the dilemma of paying monopsony profits, or accepting the cost and risk involved in taking the issue to market without the investment banker, or seeking an alternative source of funds. In any event, the process of marketing new equity depends on the relationship among the many characteristics unique to the firm and that firm's cost of equity capital. This paper discussed these interrelated issues.

A multiperiod model of optimal capital structure is developed under the assumption that earnings follow an autoregressive process. Firm value and leverage vary through time and, at each date, the firm achieves an optimal debt level that is a function of the full state contingent debt policy. The reversion parameter of the earnings series is shown to be positively related to various measures of variability and negatively related to leverage. If earnings processes are not homogeneous across firms, then standard earnings risk measures in capital structure studies do not adequately represent crosssectional differences in variability in firm value.

We provide novel evidence showing that shareholder litigation risk influences firms’ choices of external growth strategies. Using staggered adoption of universal demand (UD) laws, we find that firms under the threat of litigation tend to choose corporate alliances over mergers and acquisitions (M&As). This finding supports the view that alliances offer a low-risk and low-cost alternative to M&As for firms facing litigation risk. Moreover, alliance performance improves after the passage of UD laws, suggesting that firms can make better deal selections under reduced litigation threats. Overall, we establish an unexplored link between litigation risk and firms’ choices of boundary-expanding transactions.

This paper advances the proposition that share restrictions engender potential conflicts of interest between fund managers and investors. Fund flows predict future fund returns for share-restricted funds, especially among funds with low levels of governance and funds managing insiders’ wealth, providing managers incentive to trade in advance of their clients. Some direct evidence for such managerial action is presented, using proprietary data on managerial investment in their own funds. The evidence suggests that private information about a fund, not necessarily its holdings, may constitute material information, with implications for proper fund governance and disclosure policy concerning managerial actions.

Contrary to the prediction of the standard portfolio diversification theory, many investors place a large fraction of their stock investment in a small number of stocks. I show that underdiversification may be caused by solvency requirements. My model predicts that for quite general preferences and return distributions: (1) underdiversification decreases in discretionary wealth; and (2) expected return and covariance determine which stocks to invest in, but variance, higher moments, and Sharpe ratio do not matter for this choice. In addition, a less-diversified stock portfolio has a higher expected return, a higher volatility, and a higher skewness, and idiosyncratic risks are priced.

Mutual fund managers with degrees from elite universities tend to outperform their counterparts from less elite universities. We show that the better performance of elite graduates is generated from their better connections with underwriters that facilitate allocations to underpriced initial public offerings (IPOs). Indeed, we find that the funds outperform only in months when they are connected to underwriters issuing IPOs. A strategy of buying mutual funds in months when they are connected to underwriters scheduled to issue IPOs generates significant abnormal returns, as high as 4.08% per annum in hot markets.

This note explores the properties of some stock markets indices that are claimed to approximate a continuously rebalanced equally weighted portfolio.

A comparison of single and multifactor portfolio performance methodologies using Value Line and size-ranked portfolios indicates that although both methodologies provide unbiased estimates of portfolio performance, there are systematic differences in the power of the two methodologies. The predictive power of the multifactor methodology is superior for well-diversified portfolios but inferior for less diversified portfolios.

The current assets and current liabilities of a firm are the stock reflections of closely interrelated operational and financial cash flows. The net effect of these combined flows must be recognized in searching for the optimal credit, inventory, or short-term borrowing policies. Yet, the vast majority of models for short-term investment and borrowing decisions do not allow for the interrelationships of this system.

What drives the compensation demanded by investors in risky bonds? Longstaff and Schwartz (1995) predict that one key factor is the time-varying negative correlation between interest rates and the yield spreads on corporate bonds. However, the effects of callability and taxes also need to be considered in empirical analyses. Canadian bonds have no tax effects, yet, after controlling for callability, the correlation between riskless interest rates and corporate bond spreads remains negligible. Our results provide support for reduced-form models that explicitly define a default hazard process and untie the relation between the firm’s asset value and default probability.