This paper examines a conceptual framework for normative models of financial management in commercial banks. Since the bank is viewed as a financial intermediary, it is argued that the appropriate conceptual framework for bank financial management models is one that focuses on imperfections in the markets in which the bank operates.

This paper studies the dynamic investment policies of firms under asymmetric information.Managers make decisions to maximize the wealth of existing shareholders. In equilibrium, the superior firms invest “myopically”, choosing intrinsically lower-valued projects that produce “early” cash flows. The inferior firms follow the socially preferred rule of investing in intrinsically higher-valued projects that produce “late” cash flows. In addition to explaining investment myopia, the model generates numerous predictions regarding announcement effects of equity issues and attempts by firms to stockpile cash, firms' preferences for limits on mandatory disclosure rules, and the effects of managerial entrenchment motives.

We study hedge fund performance evaluation under the stochastic discount factor framework of Farnsworth, Ferson, Jackson, and Todd (FFJT). To accommodate dynamic trading strategies and derivatives used by hedge funds, we extend FFJT’s approach by considering models with option and time-averaged risk factors and incorporating option returns in model estimation. A wide range of models yield similar conclusions on the performance of simulated long/short equity hedge funds. We apply these models to 2,315 actual long/short equity funds from the Lipper TASS database and find that a small portion of these funds can outperform the market.

Recently, there has been an increased interest in the role that bankruptcy or ruin plays in the valuation process. Several authors have discussed this subject (Gordon [17], Quirk [27], and Smith [35]) and some have constructed theoretical models attempting to show how the probability or risk of ruin introduces an element of risk into valuation (for example, Bierman [5], Borch [8], Tinsely [37]). The question of corporate survival is, therefore, central to the financial considerations of the firm. None, however, has attempted empirical tests of the role of such a probability in valuation.

Some recent empirical studies have concluded that the common stock investor can virtually eliminate diversifiable risk with a portfolio that contains a “small” number of separate common stock issues [5, 6, 10, 11, 13]. The conclusion has several important implications. One of the inherent limitations of a portfolio manager is his inability to evaluate an infinite number of securities. The seriousness of this problem is directly related to the risks associated with a “small” portfolio. The economic function of a mutual fund industry is to provide diversification and professional management. If it is assured that a “small” portfolio can virtually eliminate diversifiable risk, the necessity of these functions may be questioned. In addition, the strategy of concentration may be less “risky” than is commonly supposed. Finally, the modern portfolio models generally assume that portfolio additions are costless.

We estimate Moody’s preference for accurate versus biased ratings using hand-collected data on the internal labor market outcomes of its analysts. We find that accurate analysts are more likely to be promoted and less likely to depart. The opposite is true for analysts who downgrade more frequently, who assign ratings below those predicted by a ratings model, and whose downgrades are associated with large negative market reactions. Downgraded firms are also more likely to be assigned a new analyst. These patterns are consistent with Moody’s balancing its desire for accuracy against its corporate clients’ desire for higher ratings.

We examine how organizational form affects corporate payouts. Conglomerates pay out more than pure plays in both cash dividends and total payouts (cash dividends plus share repurchases). Furthermore, their payouts are more sensitive to cash flows compared to pure-play firms. The sensitivity of payouts to cash flow increases as the cross-segment correlation in a conglomerate decreases. Corporate payouts increase after mergers and acquisitions (M&As), especially among M&As in which acquirers and targets are less correlated. These results suggest that the coinsurance among different divisions of a conglomerate allows them to pay out more cash flow to their shareholders than pure-play firms.

This article provides new evidence on the housing-wealth effect on consumption using household panel data. A key advantage in studying the Chinese housing market is the absence of the collateral channel because households are prohibited from withdrawing housing equity. The results show that for every 1% increase in housing wealth, household consumption increases by 0.14%, suggesting an implied marginal propensity to consume out of housing wealth of 0.023. Further, we find that this marginal propensity to consume is the largest among employees who face greater income uncertainty, suggesting that precautionary-saving motives are driving the results.

An experimental approach is used to compare bidding behavior and auction performance in uniform-price and discriminatory auctions when there is incomplete information concerning the common value of the auctioned good. In a symmetric information environment, the different auction formats provide the same average revenue. However, when information is asymmetric the discriminatory auction results in higher average revenue than the uniform-price auction. The volatility of revenue is higher in the uniform-price auctions in all treatments. The results, therefore, provide support for the use of the discriminatory format. Subject characteristics and measures of experience in recent auctions are found to be useful in explaining bidding behavior.

We exploit exogenous legislative changes that alter the priority structure of different classes of debt to study how debtholder monitoring incentives affect bank earnings opacity. We present novel evidence that exposing nondepositors to greater losses in bankruptcy reduces earnings opacity, especially for banks with larger shares of nondeposit funding, listed banks, and independent banks. The reduction in earnings opacity is driven by a lower propensity to overstate earnings and is more pronounced among larger banks and in banks with more real estate loan exposure. Our findings highlight the importance of creditors’ monitoring incentives in improving the quality of information disclosure.

We apply an empirical approximation of the intertemporal capital asset pricingmodel (ICAPM) to show that cross-sectional dispersion in currency returns can berationalized by differences in currency excess returns’ sensitivitiesto the market return’s cash-flow news component. This finding echoesrecent explanations of the value and growth stock market anomaly. Thedistinction between cash-flow news and discount-rate news is key to jointlyexplain average stock and currency returns. Our analysis reveals the presence ofa common source of systematic risk in stock and foreign currency returns that isreflected in the market return’s cash-flow news component.

In derivations of the mean-variance model of portfolio selection, authors from Markowitz [6 and 7] and Tobin [11] to Merton [8] and Black [1] rely on the inverse of the matrix of variances and covariances for the returns on risky securities. Unfortunately, as is shown in this paper, such an inverse does not exist when risk-free combinations can be formed from the risky securities. Accordingly, the general validity of the mean-variance model is challenged by the existence of opportunities for hedging, including those fostered by short sales and the rapidly expanding markets for warrants, options, and futures. Fortunately, the mean-variance model is tractable even when the conventional methods for deriving it fail. Alternative solution procedures presented in this paper are valid with or without riskless securities and with either singular or nonsingular variance-covariance matrices. The important properties of the mean-variance model are shown to extend for the previously omitted cases. In particular, the frontier of mean-variance combinations is always well-defined, is always strictly convex, and (the efficient portion of the frontier) is always positively sloped. In addition, the frontier of mean-variance combinations always can be expressed in terms of a pair of mutual funds which are determined on purely technical grounds.

The first hypothesis underlying this study is that successive transactions exhibit systematic patterns. These patterns will be studied to better understand (1) the processes by which transactions are arranged, (2) the costs of transacting, and (3) the statistical characteristics of the reported transactions prices and their relationship to the market equilibrium. This study will not directly consider market efficiency, though its results may eventually lead to more searching and meaningful studies of market efficiency.

The weighted average cost of capital is a widely used concept in the theoretical literature of finance as well as in the analysis of capital expenditures of business firms. The importance of the concept derives from its use as the cutoff point for investment in capital projects and as an indicator of optimal capital structure. Differences between the weighted average cost of capital and the true overall cost of capital are typically attributed to deviations of market values from book values, changes in the proportional use of specific capital sources, or alterations in the risk characteristics of the stream of payments to owners and creditors. This paper abstracts from the aforementioned problems to focus on the mathematical error of using weighted average cost of capital to represent the true overall capital cost. It is determined that, in general, the calculation of weighted average cost leads to an erroneous value of the minimum acceptable level of return. The fault lies in the general inability to express the root(s) of a polynomial as an algebraic combination of the roots of other related polynomials.

This paper provides an explanation for why firms may choose to simultaneously issue multiple debt claims with varying maturities. The optimal mix of short- and long-term debt allows the firm to precommit to a more efficient liquidation policy. Even in risk-neutral settings, the optimal mix hinges critically on the mean and the variability of the firm's liquidation value. Determining the optimal mix of debt is more complex than just weighing the costs of issuing short- or long-term debt exclusively. The implications of alternate priority structures, informational settings, interest rate uncertainty, and maturity matching strategies are also considered.

Portfolio selection involves the formation of prior beliefs about expected rates of return and risk on available securities and the utilization of these beliefs in the choice of a portfolio. Markowitz has developed a pioneering theory of portfolio choice based on the assumption that the investor has formed prior cardinal beliefs about the expected rates of return, variances of rates of return, and covariances of rates of return among individual securities. Unfortunately, a feasible method of accurately generating the massive information requirements of the Markowitz model has not been developed. Historical measures of mean rates of, return and covariances of rates of return among individual securities have been shown to be unstable over time and to be ineffectual in generating ex ante efficient portfolios.

We use a text-based measure of popular sentiment toward finance to study how finance sentiment responds to rare historical disasters and to the ongoing COVID-19 pandemic. Finance sentiment declines after epidemics and earthquakes but rises following severe droughts, floods, and landslides. These heterogeneous effects suggest finance sentiment responds differently to the realization of insured versus uninsured risks. Finance sentiment declines at the start of the COVID-19 pandemic, but recovers in countries that experienced high stock markets returns and that responded with large fiscal spending. Finance sentiment seems to depend on the insurance provided by private markets and by public finance.

Much of the empirical research on mutual funds has rather significant implications for mutual fund investors. Unfortunately, many mutual fund investors have probably never heard about these research results or their implications. They probably, however, have heard some rules-of-thumb or guidelines from their brokers or peers about how to select a particular fund. The purpose of this note is to identify the selection criteria investors seem to use in their buying and selling of mutual fund shares once they have selected an investment objective. That is, do investors select mutual funds based on what I will call “efficient market” criteria (whether or not they are familiar with this literature), or do they use other factors? The criterion I use to measure selection by mutual fund investors is the annual net sales ratio, which is gross sales less redemptions divided by total assets at the start of the year.

The purpose of this paper is to determine the correct procedure for discounting cash outflows in a capital market context. Beedles has stated flatly that “the risk adjusted discount (RADR) approach should not be applied to investment projects with negative benefits” ([1], p. 176). Lewellen also has recently examined the problem because he felt that there “is something at least vaguely disturbing about the associated write-down of the present value of cash outflows for risk” ([7], p. 1332). Lewellen, however, concluded that “the standard procedure used for inflows can therefore be transferred intact. The logic is symmetric because the sign of the flows is reversed.” In a comment on Lewellen, Celec and Pettway stated that they are “in substantial disagreement with Lewellen's development as well as with any implied generality of employing the standard RADR procedure in valuing cash outflow streams” ([3], P. 1061). This inappropriateness of the standard RADR approach to valuing cash outflows seems to have been accepted in the 1iterature. Kudla [6] recently claimed that it has been proved by the above authors and others that the normative rules in capital budgeting do not hold in evaluating cash outflows.

We investigate whether access to information prior to an initial public offering (IPO) generates a trading advantage after the IPO. We find that limited partners (LPs) of lead venture capital funds obtain high returns when they invest in newly listed stocks backed by their funds. These returns are not explained by LPs’ differing stock-picking abilities, and they are higher when LPs’ information advantage over the public is higher. LPs are more likely to invest if they have an information advantage, and access to information eliminates the familiarity bias that they display otherwise.