JPMorgan 2010 Academic Reference

Asia Pacific Equity Research
18 January 2011
2010 Academic Reference

J.P. Morgan Quant: Collated abstracts of finance papers published in 2010
To help with the job of keeping track of the latest financial research output from academia we typically compile quarterly collations of the abstracts of academic papers In this reference document we include papers published in Q4 and for completeness also include all papers published in Q1, Q2 and Q3 to create a full 2010 summary report. Specifically we have collated the abstracts from nine popular financial journals. The journals from which articles have been collated are listed below: o o o o o o o o o Journal of Financial and Quantitative Analysis Journal of Financial Research Journal of Portfolio Management Journal of Alternative Investments Journal of Financial Economics The Financial Review Journal of Econometrics Journal of Finance Journal of Behavioral Finance
Globalo Quantitative Strategy Steve Malin
AC
(852) 2800 8568 steven.j.malin@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
Marco Dion
AC
(44-20) 7325-8647 marco.x.dion@jpmorgan.com J.P. Morgan Securities Ltd.
Robert Smith
(852) 2800 8569 robert.z.smith@jpmorgan.com J.P. Morgan Securities (Asia Pacific) Limited
Satoshi Okamoto
(81-3) 6736-8647 satoshi.okamoto@jpmorgan.com JPMorgan Securities Japan Co., Ltd.
Berowne Hlavaty
(61-2) 9220-1591 berowne.d.hlavaty@jpmorgan.com J.P. Morgan Securities Australia Limited
Dubravko Lakos-Bujas
(1-212) 622-3601 dubravko.lakos-bujas@jpmorgan.com J.P. Morgan Securities LLC
Viquar Shaikh
(91-22) 6157 3325 viquar.x.shaikh@jpmorgan.com J.P. Morgan India Private Limited
Please contact the journal directly if you are interested in specific articles.
Latha Nair
(91-22) 6157-3285 latha.x.nair@jpmorgan.com J.P. Morgan India Private Limited
Arfi Khan
(91-22) 6157-3266 arfi.m.khan@jpmorgan.com J.P. Morgan India Private Limited
See page 199 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com
Asia Pacific Equity Research 18 January 2011
Table of Contents
Summary ...............................................................................................................................13 Journal of Financial and Quantitative Analysis .................................................................14 Feb (2010) ..............................................................................................................................15
Is There Shareholder Expropriation in the United States? An Analysis of Publicly Traded Subsidiaries ...............................15 Clientele Change, Liquidity Shock, and the Return on Financially Distressed Stocks............................................................15 Predicting Global Stock Returns ...................................................................................................................................15 The Signaling Hypothesis Revisited: Evidence from Foreign IPOs ........................................................................................16 How Does Liquidity Affect Government Bond Yields?..........................................................................................................16 Investor Protection, Equity Returns, and Financial Globalization...........................................................................................16 An Epidemic Model of Investor Behavior...............................................................................................................................17 Predicting Hedge Fund Failure: A Comparison of Risk Measures ..........................................................................................17 Fund Flow Volatility and Performance ...................................................................................................................................17 Pharmaceutical R&D Spending and Threats of Price Regulation............................................................................................18
Apr (2010) ..............................................................................................................................19

Corporate Governance and Liquidity ...................................................................................................................................19 Factoring Information into Returns ...................................................................................................................................19 Portfolio Optimization with Mental Accounts.........................................................................................................................19 Deviations from Put-Call Parity and Stock Return Predictability............................................................................................20 Dynamic General Equilibrium and T-Period Fund Separation ................................................................................................20 Informational Efficiency and Liquidity Premium as the Determinants of Capital Structure ...................................................21 How Syndicate Short Sales Affect the Informational Efficiency of IPO Prices and Underpricing .........................................21 The Impact of the Euro on Equity Markets..............................................................................................................................22 Forecasting Volatility Using Long Memory and Comovements .............................................................................................22 Exploitable Predictable Irrationality: The FIFA World Cup Effect on the U.S. Stock Market ...............................................22
June (2010) ............................................................................................................................24

The Response of Corporate Financing and Investment to Changes in the Supply of Credit ...................................................24 Financing Frictions and the Substitution between Internal and External Funds ......................................................................24 Disagreement, Portfolio Optimization, and Excess Volatility .................................................................................................25 What Does the Individual Option Volatility Smirk Tell Us About Future Equity Returns?....................................................25 A Reexamination of the Causes of Time-Varying Stock Return Volatilities ..........................................................................25 The Role of State and Mutual Fund Ownership in the Split Share Structure in China ............................................................26 Dynamic Factors and Asset Pricing ...................................................................................................................................26 Market Feedback and Equity Issuance: Evidence from Repeat Equity Issues.........................................................................27 A Longer Look at the Asymmetric Dependence between Hedge Funds and the Equity Market.............................................27 Prospect Theory and the Disposition Effect ............................................................................................................................28
August (2010) ........................................................................................................................29

Estimating the Equity Premium ...................................................................................................................................29 Rational Cross-Sectional Differences in Market Efficiency: Evidence from Mutual Fund Returns........................................29 Idiosyncratic Risk, Long-Term Reversal, and Momentum......................................................................................................30 Arbitrage Risk and Stock Mispricing ...................................................................................................................................30 Behavioral Explanations of Stock Price Performance - Decomposition of Market-to-Book Ratios........................................30 Incorporating Economic Objectives into Bayesian Priors: Portfolio Choice under Parameter Uncertainty ............................31
Cross-Sectional Return Dispersion and Time Variation in Value and Momentum Premiums ................................................31 Multiple Risky Assets-Allocation Rules and Implications for U.S. Investors .........................................................................32 Longer-Term Time-Series Volatility Forecasts .......................................................................................................................32 Stock Returns and the Volatility of Liquidity ..........................................................................................................................32 Can Mutual Fund Managers Pick Stocks? Evidence from Their Trades Prior to Earnings Announcements ..........................34 Seasonality in the Cross Section of Stock Returns: The International Evidence .....................................................................34 Debt Capacity and Tests of Capital Structure Theories ...........................................................................................................34 Transparency, Price Informativeness, and Stock Return Synchronicity: Theory and Evidence ..............................................35 Information, Expected Utility, and Portfolio Choice ...............................................................................................................35 What Drove the Increase in Idiosyncratic Volatility during the Internet Boom?.....................................................................36 The Term Structure of Variance Swap Rates and Optimal Variance Swap Investments.........................................................36 Level-Dependent Annuities: Defaults of Multiple Degrees.....................................................................................................36 Affine Models of the Joint Dynamics of Exchange Rates and Interest Rates..........................................................................37
Journal of Financial Research .............................................................................................39 Spring (2010) .........................................................................................................................40

The Economic Gains Of Trading Stocks Around Holidays.....................................................................................................40 Dynamic Order Submission And Herding Behavior In Electronic Trading ............................................................................40 Switching To A Temporary Call Auction In Times Of High Uncertainty...............................................................................40 Risk Premium Effects on Implied Volatility Regressions .......................................................................................................41
Summer (2010) ......................................................................................................................42

Expected Volatility, Unexpected Volatility, And The Cross-Section Of Stock Returns .........................................................42 Risk Premium Effects On Implied Volatility Regressions.......................................................................................................42 Trading-Volume Shocks And Stock Returns: An Empirical Analysis ....................................................................................42 On The Robustness Of Range-Based Volatility Estimators.....................................................................................................43
Fall (2010) ..............................................................................................................................44

Dynamic Hedge Fund Style Analysis With Errors-In-Variables .............................................................................................44 Regular(Ized) Hedge Fund Clones ...................................................................................................................................44 Mutual Funds Selection Based On Funds Characteristics .......................................................................................................44 Debt Forgiveness And Stock Price Reaction Of Lending Banks.............................................................................................45 State Dependency Of Bank Stock Reaction To Federal Funds Rate Target Changes .............................................................45
Winter (2010) .........................................................................................................................46

Corporate Hedging And Shareholder Value ............................................................................................................................46 Risk And Hedging Behavior: The Role And Determinants Of Latent Heterogeneity .............................................................46 The Daylight Saving Time Anomaly In Stock Returns: Fact Or Fiction? ...............................................................................46 Daylight And Investor Sentiment ...................................................................................................................................47 Short Selling And Mispricings When Fundamentals Are Known ...........................................................................................47 Determinants Of Capital Structure In Business Start-Ups .......................................................................................................47 Sustainable Growth And Stock Returns...................................................................................................................................48
Journal of Portfolio Management ........................................................................................50 Winter (2010) .........................................................................................................................51

Portfolio of Risk Premia: A New Approach to Diversification ...............................................................................................51 Horizon Diversification: Reducing Risk in a Portfolio of Active Strategies ...........................................................................51 Efficient Replication of Factor Returns: Theory and Applications..........................................................................................52 Know Your VMS Exposure ...................................................................................................................................52
3
Maybe It Really Is Different This Time...................................................................................................................................53 Optimizing Carry Pickup in Real Money Portfolios................................................................................................................53 Finding Fair Value in Global Equities: Part I..........................................................................................................................53 Regimes: Nonparametric Identification and Forecasting.........................................................................................................54 The Ps of Pricing and Risk Management, Revisited................................................................................................................54 Correlation and Volatility Dynamics in REIT Returns: Performance and Portfolio Considerations.......................................54 Illiquidity and Portfolio Risk of Thinly Traded Assets............................................................................................................55
Spring (2010) .........................................................................................................................55

Crisis and Innovation ...................................................................................................................................55 Risk Management Lessons Worth Remembering from the Credit Crisis of 20072009.........................................................55 Accentuated Intraday Stock Price Volatility: What is the Cause? ...........................................................................................56 Finding Fair Value in Global Equities: Part IIForecasting Returns .....................................................................................56 Stocks of Admired and Spurned Companies ...........................................................................................................................57 A Valuation Study of Stock Market Seasonality and the Size Effect ......................................................................................57 Do Seasonal Anomalies Still Work? ...................................................................................................................................57 Volatility Exposure for Strategic Asset Allocation..................................................................................................................58 Valuation-Indifferent Weighting for Bonds.............................................................................................................................58 A Bond-Picking Model for Corporate Bond Allocation ..........................................................................................................59
Summer (2010) ......................................................................................................................60

Active Portfolio Management and Positive Alphas: Fact or Fantasy?....................................................................................60 Signal Weighting ...................................................................................................................................60 Thinking about Indices and Passive versus Active Management.........................................................................................61 Constraint Attribution ...................................................................................................................................61 The Properties of Equally Weighted Risk Contribution Portfolios..........................................................................................62 Rewarding Fundamentals ...................................................................................................................................62 Portfolios Weighted by Repurchase and Total Payout ............................................................................................................62 Reflections on Buy-Side Risk Management after (or Between) the Storms ............................................................................63 The Problems and Challenges of High-Yield Bond Benchmarking ........................................................................................63 Market-Based Default Rate Forecasting ..................................................................................................................................64 Warren Buffett, BlackScholes, and the Valuation of Long-Dated Options ...........................................................................64 Educational Endowments in Crises ...................................................................................................................................65 A Style-Based Market Risk Model for Hedge Fund Portfolios ...............................................................................................65
Fall (2010) ..............................................................................................................................66

On the Persistence of Style Returns ...................................................................................................................................66 Finding Better Securities while Holding Portfolios: Is Stochastic Dominance the Answer?...................................................66 Designing the New Policy Portfolio: A Smart, but Humble Approach ...................................................................................67 A Scenarios Approach to Asset Allocation..............................................................................................................................67 Measuring Global Systemic Risk: What Are Markets Saying about Risk? .............................................................................68 Offensive Risk Management II: The Case for Active Tail Hedging........................................................................................68 On the Consistent Use of VaR in Portfolio Performance Evaluation: A Cautionary Note ......................................................68 Is Patience a Virtue? The Unsentimental Case for the Long View in Evaluating Returns ......................................................69 The Empirical Law of Active Management: Perspectives on the Declining Skill of U.S. Fund Managers.............................69 The Sustainability of Endowment Spending Levels:A Wake-up Call for University Endowments ........................................70
Journal of Alternative Investments .....................................................................................72 Spring (2010) .........................................................................................................................73

Madoff: A Returns-Based Analysis ...................................................................................................................................73 Hedge Fund Transparency: Where Do We Stand?...................................................................................................................73 Stock Market and Agricultural Futures Diversification: An International Perspective ...........................................................74 Exit Strategies of Buyout Investments: An Empirical Analysis ..............................................................................................74 Can CDO Equity Be Short on Correlation? .............................................................................................................................75 Dual Offerings of ETFs on the Same Stock Index: U.S. vs. ....................................................................................................75
Summer (2010) ......................................................................................................................76

The Long-Horizon Benefits of Traditional and New Real Assets in the Institutional Portfolio ..............................................76 The Role of the Constant Recovery Assumption in the Sub prime Bubble .............................................................................76 Modeling the Cash Flow Dynamics of Private Equity Funds: Theory and Empirical Evidence .............................................76 Alternative Asset Pricing: Momentum and the Hedge Fund Puzzle........................................................................................77 An Early Look at the Deutsche Bank Alternative Investment Survey, 20022009 .................................................................77 Sources of Return within an Emerging Markets Fixed-Income and Foreign Exchange Portfolio...........................................77 Ethics: A Guiding Tenet of the CAIA Association Garners Broad Support within Academic Community............................78
Fall (2010) ..............................................................................................................................79

Insurance-Linked Securities: What Drives Their Returns?......................................................................................................79 On Understanding Bear Market Funds ...................................................................................................................................79 Portfolios of ETFs: Applications to Absolute Return Funds and Tactical Asset Allocation ...................................................79 Optimal Portfolios with Traditional and Alternative Investments: An Empirical Investigation..............................................80 Does a Contagion Effect Exist Between Equity Markets and Hedge Funds in Periods of Extreme Stress?............................80 Emerging Markets During the Crisis ...................................................................................................................................80
Winter (2011) .........................................................................................................................81

The StressVaR: A New Risk Concept for Extreme Risk and Fund Allocation .......................................................................81 Portfolio Choice for Oil-Based Sovereign Wealth Funds........................................................................................................81 Limited Liability Leverage : A New Measure of Leverage .....................................................................................................81 Protection Potential of Commodity Hedge Funds ...................................................................................................................82 Spillover Effects of Counter-Cyclical Market Regulation: Evidence from the 2008 Ban on Short Sales ...............................82 The Iconic Boom in Modern Russian Art................................................................................................................................82 Asset Class and Strategy Investment Tracking Based Approaches .........................................................................................83
Journal of Financial Economics ..........................................................................................85 Spring (2010) .........................................................................................................................86

O/S: The relative trading activity in options and stock............................................................................................................86 Performance persistence in entrepreneurship...........................................................................................................................86 Quantifying private benefits of control from a structural model of block trades .....................................................................86 A resolution of the distress risk and leverage puzzles in the cross section of stock returns ....................................................87 The good news in short interest ...................................................................................................................................87 Institutional investors, intangible information, and the book-to-market effect........................................................................87 The effect of state anti takeover laws on the firm's bondholders .............................................................................................88 How does law affect finance? An examination of equity tunneling in Bulgaria......................................................................88 Seasoned equity offerings, market timing, and the corporate lifecycle ...................................................................................88 Bailouts, the incentive to manage risk, and financial crises.....................................................................................................89 Does corporate governance matter in competitive industries?.................................................................................................89
5
The pecking order, debt capacity, and information asymmetry ...............................................................................................90 Institutional monitoring through shareholder litigation ...........................................................................................................90 Renegotiation of cash flow rights in the sale of VC-backed firms ..........................................................................................90 When should firms share credit with employees?....................................................................................................................91 Ownership concentration, foreign shareholding, audit quality, and stock price synchronicity: Evidence from China............91 Escape from New York: The market impact of loosening disclosure requirements ................................................................91 Resolving the exposure puzzle: The many facets of exchange rate exposure..........................................................................92 Sentiment and stock prices: The case of aviation disasters......................................................................................................92 Political rights and the cost of debt ...................................................................................................................................92 Reduced-form valuation of callable corporate bonds: Theory and evidence ...........................................................................93 Capital structure decisions: Evidence from deregulated industries..........................................................................................93 Activist arbitrage: A study of open-ending attempts of closed-end funds ...............................................................................93 First-passage probability, jump models, and intra-horizon risk...............................................................................................94 Are family firms more tax aggressive than non-family firms? ................................................................................................94 Asset liquidity and financial contracts: Evidence from aircraft leases ....................................................................................94 Informed trading before analyst downgrades: Evidence from short sellers .............................................................................95 Market liquidity, asset prices, and welfare ..............................................................................................................................95
Summer (2010) ......................................................................................................................96

A skeptical appraisal of asset pricing tests...............................................................................................................................96 When are outside directors effective? ...................................................................................................................................96 Liquidity biases in asset pricing tests ...................................................................................................................................96 The performance of emerging hedge funds and managers ......................................................................................................97 Inside the black box: The role and composition of compensation peer groups .......................................................................97 Detecting jumps from Lvy jump diffusion processes ............................................................................................................97 The Sarbanes-Oxley act and corporate investment: A structural assessment ..........................................................................98 The role of private equity group reputation in LBO financing ................................................................................................98 Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance ..............................98 Going public to acquire? The acquisition motive in IPOs .......................................................................................................99 Average correlation and stock market returns .........................................................................................................................99 Risk and CEO turnover ...................................................................................................................................99 Profiting from government stakes in a command economy: Evidence from Chinese asset sales ..........................................100 Trade credit, collateral liquidation, and borrowing constraints .............................................................................................100 Dynamic asset allocation with stochastic income and interest rates ......................................................................................100 Uncertainty about average profitability and the diversification discount ..............................................................................101 Creditor rights, information sharing, and bank risk taking ....................................................................................................101 CFOs and CEOs: Who have the most influence on earnings management?..........................................................................101 Liquidity and valuation in an uncertain world .......................................................................................................................102 Why do firms appoint CEOs as outside directors? ................................................................................................................102 The marketing of seasoned equity offerings ..........................................................................................................................102 Multi-market trading and arbitrage .................................................................................................................................103 Local institutional investors, information asymmetries, and equity returns ..........................................................................103 Co-movement, information production, and the business cycle ............................................................................................103 Returns of claims on the upside and the viability of U-shaped pricing kernels .....................................................................104 Preferred risk habitat of individual investors .........................................................................................................................104 Board interlocks and the propensity to be targeted in private equity transactions .................................................................104 The world price of home bias .................................................................................................................................105
Optimal compensation contracts when managers can hedge .................................................................................................105 Payoff complementarities and financial fragility: Evidence from mutual fund outflows ......................................................105 CEOs versus CFOs: Incentives and corporate policies..........................................................................................................106 Evaluating asset pricing models using the second Hansen-Jagannathan distance .................................................................106 Unstable banking .................................................................................................................................106 Bank lending during the financial crisis of 2008 ...................................................................................................................107 Paulson's gift .................................................................................................................................107 Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis ...........................................107 Will the U.S. bank recapitalization succeed? Eight lessons from Japan ................................................................................108 Costly external finance, corporate investment, and the subprime mortgage credit crisis ......................................................108 The subprime credit crisis and contagion in financial markets ..............................................................................................108 Auction failures and the market for auction rate securities....................................................................................................109 The real effects of financial constraints: Evidence from a financial crisis.............................................................................109
The Financial Review..........................................................................................................111 Spring (2010) .......................................................................................................................112

CEO Pay-For-Performance Heterogeneity Using Quantile Regression.................................................................................112 Signaling, Free Cash Flow and "Nonmonotonic" Dividends.................................................................................................112 Dividends versus Share Repurchases Evidence from Canada: 19852003 ...........................................................................112 The Ex-dividend Day: Action On and Off the Danish Exchange ..........................................................................................113 Debt Issuance in the Face of Tax Loss Carryforwards ..........................................................................................................113 Investors' Use of Historical Forecast Bias to Adjust Current Expectations ...........................................................................113 Changes in the Information Efficiency of Stock Prices: Additional Evidence ......................................................................114 Predictability in Consumption Growth and Equity Returns: A Bayesian Investigation ........................................................114 A Note on Affordability and the Optimal Share Price ...........................................................................................................114
Summer (2010) ....................................................................................................................115

Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold.........................................................................115 50+ Years of Diversification Announcements.......................................................................................................................115 Terrorism and Stock Market Sentiment .................................................................................................................................115 On Model Testing in Financial Economics............................................................................................................................116 Investment Irreversibility, Cash Flow Risk, and Value-Growth Stock Return Effects..........................................................116 Does Inclusion in a Smaller S&P Index Create Value? .........................................................................................................116 The Efficacy of Regulation Fair Disclosure ..........................................................................................................................116 Yes, The Value Line Enigma Is Still Alive: Evidence from Online Timeliness Rank Changes............................................117 Stock Splits and Bond Yields: Isolating the Signaling Hypothesis........................................................................................117 Does the Quality of Financial Advice Affect Prices? ............................................................................................................117 The Moving Average Ratio and Momentum .........................................................................................................................118 Arbitrage and the Evaluation of Linear Factor Models in UK Stock Returns .......................................................................118 Short-Horizon Return Predictability in International Equity Markets ...................................................................................118 Asset Pricing and Welfare Analysis with Bounded Rational Investors .................................................................................119
Fall (2010) ............................................................................................................................120

Anonymity, Stealth Trading and the Information Content of Broker Identity.......................................................................120 Evidence from Decimalization on the NYSE ........................................................................................................................120 Risk Changes around Calls of Convertible Bonds.................................................................................................................120 Syndication in Venture Capital Financing .............................................................................................................................121 Bond Market Access, Credit Quality, and Capital Structure: Canadian Evidence ................................................................121
7
Debt Maturity, Credit Risk, and Information Asymmetry: The case of Municipal Bonds ....................................................121 Industry Structure and Corporate Debt Maturity ...................................................................................................................122 Earnings Management Surrounding New Debt Issues...........................................................................................................122 Information Transfer Effects of Bond Rating Downgrades ...................................................................................................122 Treasury bond Volatility and Uncertainty about Monetary Policy ........................................................................................122 SEO Cycles .................................................................................................................................123 Partial Price Adjustments and Equity Carve-Outs .................................................................................................................123 Price Movers on the Stock Exchange of Thailand: Evidence from a Fully Automated Order-Driven Market......................123 Prior Payment Status and the Likelihood to Pay Dividends: International Evidence ............................................................124 Corporate Hedging Policy and Equity Mispricing.................................................................................................................124 Restructuring Using Operating Asset Exchanges: Issues and Evidence ................................................................................124 What are the capital structure determinants for tax-exempt organizations? ..........................................................................125 Political Risk and Purchases of Privatized State Owned Enterprises ....................................................................................125
Journal of Econometrics....................................................................................................127 Spring (2010) .......................................................................................................................128

A new instrumental method for dealing with endogenous selection......................................................................................128 A comparison of meanvariance efficiency tests...................................................................................................................128 A constrained maximum likelihood approach to estimating switching regressions ..............................................................128 Short and long run causality measures: Theory and inference...............................................................................................129 Adaptive estimation of the dynamics of a discrete time stochastic volatility model .............................................................129 Testing semiparametric conditional moment restrictions using conditional martingale transforms ......................................130 Stochastic model specification search for Gaussian and partial non-Gaussian state space models .......................................130 The Hausman test and weak instruments...............................................................................................................................130 On the distribution of the sample autocorrelation coefficients ..............................................................................................131 Testing for heteroskedasticity and serial correlation in a random effects panel data model..................................................131 Activity signature functions for high-frequency data analysis...............................................................................................131 A comparison of two model averaging techniques with an application to growth empirics..................................................132 Estimating a class of triangular simultaneous equations models without exclusion restrictions ...........................................132 Estimation of spatial autoregressive panel data models with fixed effects ............................................................................132 An improved bootstrap test of stochastic dominance ............................................................................................................133
Summer (2010) ....................................................................................................................134

Testing for unobserved heterogeneity in exponential and Weibull duration models .............................................................134 Structural measurement errors in non separable models........................................................................................................134 Non-negativity conditions for the hyperbolic GARCH model ..............................................................................................134 Semi parametric estimation of a simultaneous game with incomplete information...............................................................135 Nonparametric least squares estimation in derivative families ..............................................................................................135 Robust penalized quantile regression estimation for panel data?...........................................................................................136 Bayesian non-parametric signal extraction for Gaussian time series.....................................................................................136 A spatio-temporal model of house prices in the US ..............................................................................................................136
Fall (2010) ............................................................................................................................138

Some thoughts on the development of co integration ............................................................................................................138 Testing for co-integration in vector auto regressions with non-stationary volatility .............................................................138 Forecasting with equilibrium-correction models during structural breaks.............................................................................138 Model-based asymptotic inference on the effect of infrequent large shocks on co-integrated variables...............................139 Likelihood inference for a nonstationary fractional autoregressive model ............................................................................139
8
Likelihood based testing for no fractional cointegration .......................................................................................................139 Likelihood-based inference for cointegration with nonlinear error-correction ......................................................................140 Modelling and measuring price discovery in commodity markets ........................................................................................140 Co integration, long-run structural modelling and weak exogeneity: Two models of the UK economy...............................141 An analysis of the persistent long swings in the Dmk/$ rate .................................................................................................141 Speed of adjustment in cointegrated systems ........................................................................................................................141 Averaging estimators for auto regressions with a near unit root............................................................................................142 Co integration in a historical perspective...............................................................................................................................142 A spatio-temporal model of house prices in the USA............................................................................................................142 On the asymptotic optimality of the LIML estimator with possibly many instruments.........................................................143 Econometric modeling of technical change ...........................................................................................................................143 Jumps and betas: A new framework for disentangling and estimating systematic risks........................................................143 Robust confidence sets in the presence of weak instruments.................................................................................................144 On Bahadur efficiency of empirical likelihood......................................................................................................................144 Nonparametric estimation for a class of Lvy processes .......................................................................................................144 Efficient estimation in dynamic conditional quantile models ................................................................................................145 Estimating fixed-effect panel stochastic frontier models by model transformation...............................................................145 A generalized asymmetric Student-t distribution with application to financial econometrics...............................................145 Bayesian semi parametric stochastic volatility modeling ......................................................................................................146 Inference on parameter ratios with application to discrete choice models.............................................................................146 Estimating first-price auctions with an unknown number of bidders ....................................................................................147 Robust methods for detecting multiple level breaks in autocorrelated time series ................................................................147 The LIML estimator has finite moments! ..............................................................................................................................147 Nonparametric least squares estimation in derivative families ..............................................................................................148 Estimating panel data models in the presence of endogeneity and selection .........................................................................148 Bayesian non-parametric signal extraction for Gaussian time series.....................................................................................148 Robust penalized quantile regression estimation for panel data ............................................................................................149 Semi parametric estimation of a simultaneous game with incomplete information...............................................................149 Structural measurement errors in non separable models........................................................................................................150 Non-negativity conditions for the hyperbolic GARCH model ..............................................................................................150 Testing for unobserved heterogeneity in exponential and Weibull duration models .............................................................150 Intelligible factors for the yield curve .................................................................................................................................151 Semi parametric inference in multivariate fractionally co integrated systems.......................................................................151
Winter (2010) .......................................................................................................................152

Testing the correlated random coefficient model...................................................................................................................152 Model selection versus statistical model specification ..........................................................................................................152 The Bierens test for certain nonstationary models.................................................................................................................152 A low-dimension portmanteau test for non-linearity .............................................................................................................153 Regression models with mixed sampling frequencies ...........................................................................................................153 Some identification problems in the cointegrated vector autoregressive model....................................................................153 Smoothing local-to-moderate unit root theory.......................................................................................................................154 Bootstrapping I (1) data .................................................................................................................................154 Applications of sub sampling, hybrid, and size-correction methods .....................................................................................154 Understanding aggregate crime regressions ..........................................................................................................................155 The (mis)specification of discrete duration models with unobserved heterogeneity .............................................................155 A dynamic patent intensity model with secret common innovation factors ..........................................................................155
A direct Monte Carlo approach for Bayesian analysis of the seemingly unrelated regression model ...................................156 A consistent nonparametric test of affiliation in auction models...........................................................................................156 Efficient estimation of a multivariate multiplicative volatility model ...................................................................................156 Realised quantile-based estimation of the integrated variance ..............................................................................................157 GMM estimation of social interaction models with centrality...............................................................................................157 Pre-averaging estimators of the ex-post covariance matrix in noisy diffusion models with non-synchronous data..............157 A flexible approach to parametric inference in nonlinear and time varying time series models ...........................................158 Inconsistency of the MLE and inference based on weighted LS for LARCH models...........................................................158 No-arbitrage macroeconomic determinants of the yield curve ..............................................................................................159 Wavelet analysis of change-points in a non-parametric regression with heteroscedastic variance........................................159 The effects of dynamic feedbacks on LS and MM estimator accuracy in panel data models: Some additional results ........159 Specification tests of parametric dynamic conditional quantiles ...........................................................................................160 Root-N-consistent estimation of fixed-effect panel data transformation models with censoring ..........................................160 Quasi-maximum likelihood estimation of volatility with high frequency data......................................................................161 Characterization of the asymptotic distribution of semiparametric M-estimators .................................................................161 Semiparametric bounds on treatment effects .........................................................................................................................161 Threshold bipower variation and the impact of jumps on volatility forecasting....................................................................162 Dominating estimators for minimum-variance portfolios......................................................................................................162 An efficient GMM estimator of spatial autoregressive models .............................................................................................162 A primal Divisia technical change index based on the output distance function ...................................................................163
Journal of Finance ..............................................................................................................165 Spring (2010) .......................................................................................................................166

Product Market Competition, Insider Trading, and Stock Market Efficiency .......................................................................166 Real and Financial Industry Booms and Busts ......................................................................................................................166 Global Currency Hedging .................................................................................................................................166 A Habit-Based Explanation of the Exchange Rate Risk Premium ........................................................................................167 Collateral Spread and Financial Development.......................................................................................................................167 False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas.......................................................167 Do Hot Hands Exist among Hedge Fund Managers? An Empirical Evaluation....................................................................168 Stock Market Declines and Liquidity .................................................................................................................................168 Time Variation in Liquidity: The Role of Market-Maker Inventories and Revenues............................................................168 The Impact of Deregulation and Financial Innovation on Consumers: The Case of the Mortgage Market ..........................169 Individualism and Momentum around the World..................................................................................................................169 Correlation Risk and Optimal Portfolio Choice.....................................................................................................................169 The Variability of IPO Initial Returns .................................................................................................................................170 Levered Returns .................................................................................................................................170 The New Game in Town: Competitive Effects of IPOs.........................................................................................................170 Financial Structure, Acquisition Opportunities, and Firm Locations ....................................................................................171 Taxes on Tax-Exempt Bonds .................................................................................................................................171 Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models......171 Personal Bankruptcy and Credit Market Competition ...........................................................................................................172 Corporate Political Contributions and Stock Returns ............................................................................................................172 The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities .............172 Performance and Persistence in Institutional Investment Management.................................................................................173
10
Summer (2010) ....................................................................................................................174

The Variability of IPO Initial Returns .................................................................................................................................174 Levered Returns .................................................................................................................................174 The New Game in Town: Competitive Effects of IPOs.........................................................................................................174 Financial Structure, Acquisition Opportunities, and Firm Locations ....................................................................................175 Taxes on Tax-Exempt Bonds .................................................................................................................................175 Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models......175 Personal Bankruptcy and Credit Market Competition ...........................................................................................................175 Corporate Political Contributions and Stock Returns ............................................................................................................176 The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities .............176 Performance and Persistence in Institutional Investment Management.................................................................................176 Information and Incentives Inside the Firm: Evidence from Loan Officer Rotation .............................................................177 Networking as a Barrier to Entry and the Competitive Supply of Venture Capital ...............................................................177 Does Credit Competition Affect Small-Firm Finance ...........................................................................................................177 Human Capital, Bankruptcy, and Capital Structure...............................................................................................................178 Stapled Finance .................................................................................................................................178 Cash Holdings and Corporate Diversification .......................................................................................................................178 A Gap-Filling Theory of Corporate Debt Maturity Choice ...................................................................................................178 The Political Economy of Financial Regulation: Evidence from U.S. State Usury Laws in the 19th Century......................179 Risk and the Corporate Structure of Banks............................................................................................................................179 Financial Strength and Product Market Behavior: The Real Effects of Corporate Cash Holdings........................................179 Executive Compensation and the Maturity Structure of Corporate Debt...............................................................................180 The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices.........................................................................180 Capital Structure as a Strategic Variable: Evidence from Collective Bargaining..................................................................180 Presidential Address: Asset Price Dynamics with Slow-Moving Capital..............................................................................181 Disagreement and Learning: Dynamic Patterns of Trade ......................................................................................................181 Generalized Disappointment Aversion and Asset Prices.......................................................................................................181 Information Quality and Long-Run Risk: Asset Pricing Implications...................................................................................182 Intraday Patterns in the Cross-section of Stock Returns ........................................................................................................182 Sell-Side School Ties .................................................................................................................................182 Predictive Regressions: A Present-Value Approach..............................................................................................................182 Do Limit Orders Alter Inferences about Investor Performance and Behavior? .....................................................................183 Why Do Foreign Firms Leave U.S. Equity Markets? ............................................................................................................183 Market Segmentation and Cross-predictability of Returns ....................................................................................................183 Mutual Fund Incubation .................................................................................................................................184
Fall (2010) ............................................................................................................................185

Big Bad Banks? The Winners and Losers from Bank Deregulation in the United States .....................................................185 Price Discovery in Illiquid Markets: Do Financial Asset Prices Rise Faster Than They Fall?..............................................185 Exploring the Nature of "Trader Intuition"............................................................................................................................185 Genetic Variation in Financial Decision-Making ..................................................................................................................186 Diversification and Its Discontents: Idiosyncratic and Entrepreneurial Risk in the Quest for Social Status .........................186 Hedge Fund Contagion and Liquidity Shocks .......................................................................................................................186 Microstructure and Ambiguity .................................................................................................................................187 "Time for a Change": Loan Conditions and Bank Behavior when Firms Switch Banks .......................................................187 Short Sellers and Financial Misconduct.................................................................................................................................187 Luck versus Skill in the Cross-Section of Mutual Fund Returns ...........................................................................................188
11
A Bayesian Approach to Real Options: The Case of Distinguishing between Temporary and Permanent Shocks...............188 Individual Investors and Local Bias .................................................................................................................................188
Winter (2010) .......................................................................................................................189

Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse ..............................................................189 Why Are CEOs Rarely Fired? Evidence from Structural Estimation ....................................................................................189 The Cost of Debt .................................................................................................................................189 The Net Benefits to Leverage .................................................................................................................................190 Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure..........................................................190 Who Blows the Whistle on Corporate Fraud? .......................................................................................................................190 Corporate Fraud and Business Conditions: Evidence from IPOs ..........................................................................................191 Collateral, Risk Management, and the Distribution of Debt Capacity...................................................................................191 Leverage Choice and Credit Spreads when Managers Risk Shift..........................................................................................191 Lucky CEOs and Lucky Directors .................................................................................................................................192 Managerial Legacies, Entrenchment, and Strategic Inertia....................................................................................................192
Journal of Behavioral Finance...........................................................................................194 Spring (2010) .......................................................................................................................195

Role of Affective Reactions to Financial Information in Investors' Stock Price Judgments .................................................195 Effects of Visual Priming on Improving Web Disclosure to Investors..................................................................................195 Investment Decision Making: Do Experienced Decision Makers Fall Prey to the Paradox of Choice?................................196 Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem ....................................196 The Availability Heuristic and Investors' Reaction to Company-Specific Events.................................................................196
12
Summary
To help with the job of keeping track of the latest financial research output from academia we typically compile quarterly collations of the abstracts of academic papers In this reference document we include papers published in Q4 and for completeness also include all papers published in Q1, Q2 and Q3 to create a full 2010 summary report. Specifically we have collated the abstracts from nine popular financial journals. The journals from which articles have been collated are listed below alongside their web address. Please contact the journal directly if you are interested in specific articles.
Figure 1: Summary of Journals Included in this document
Journal Journal of Financial and Quantitative Analysis Journal of Financial Research Journal of Portfolio Management Journal of Alternative Investments Journal of Financial Economics The Financial Review Journal of Econometrics
Web Address http://journals.cambridge.org/action/displayJo urnal?jid=JFQ http://www.wiley.com/bw/journal.asp?ref=02 70-2592 http://www.iijournals.com/toc/jpm/current http://www.iijournals.com/toc/jai/current http://ideas.repec.org/s/eee/jfinec.html http://www.olemissbusiness.com/financialRev iew/index.html http://www.elsevier.com/wps/find/journaldesc ription.cws_home/505575/description#descrip tion http://www.afajof.org/ http://www.journalofbehavioralfinance.org/jou rnals/journals_main.html
Journal of Finance Journal of Behavioral Finance

Source: J.P. Morgan
13
JOURNAL 1
Journal of Financial and Quantitative Analysis
14
Feb (2010)
Is There Shareholder Expropriation in the United States? An Analysis of Publicly Traded Subsidiaries
Vladimir Atanasov, Audra Boone and David Haushalter Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 1-26 This paper examines the relation between the performance and valuations of publicly traded subsidiaries in the United States and the ownership stake of their parent companies. Cross-sectional and time-series tests demonstrate that subsidiaries of parents that own a substantial minority stake exhibit negative peer-adjusted operating performance and are valued at a 23% median discount relative to peers. In contrast, majority-owned and fully divested subsidiaries show no abnormal performance or valuations. The results of our study indicate that the association between parent ownership and subsidiary performance is nonlinear and that some parents behave opportunistically toward their publicly traded subsidiaries.
Clientele Change, Liquidity Shock, and the Return on Financially Distressed Stocks
Zhi Da and Pengjie Gao Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 27-48 We show that the abnormal returns on high default risk stocks documented by Vassalou and Xing (2004) are driven by short-term return reversals rather than systematic default risk. These abnormal returns occur only during the month after portfolio formation and are concentrated in a small subset of stocks that had recently experienced large negative returns. Empirical evidence supports the view that the short-term return reversal arises from a liquidity shock triggered by a clientele change.
Predicting Global Stock Returns

Erik Hjalmarsson Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 49-80 We show that the abnormal returns on high default risk stocks documented by Vassalou and Xing (2004) are driven by short-term return reversals rather than systematic default risk. These abnormal returns occur only during the month after portfolio formation and are concentrated in a small subset of stocks that had recently experienced large negative returns. Empirical evidence supports the view that the short-term return reversal arises from a liquidity shock triggered by a clientele change.
15
The Signaling Hypothesis Revisited: Evidence from Foreign IPOs

Bill B. Francis, Iftekhar Hasan, James R. Lothian and Xian Sun Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 81-106 While the signaling hypothesis has played a prominent role as the economic rationale associated with the initial public offering (IPO) underpricing puzzle (Welch (1989)), the empirical evidence on it has been mixed at best (Jegadeesh, Weinstein, and Welch (1993), Michaely and Shaw (1994)). This paper revisits the issue from the vantage point of close to two decades of additional experience by examining a sample of foreign IPOsfirms from both financially integrated and segmented marketsin U.S. markets. The evidence indicates that signaling does matter in determining IPO underpricing, especially for firms domiciled in countries with segmented markets, which as a result face higher information asymmetry and lack access to external capital markets. We find a significant positive and robust relationship between the degree of IPO underpricing and segmented-market firms seasoned equity offering (SEO) activities. For firms from integrated markets, in contrast, the analyst-coverage purchase hypothesis appears to matter more in explaining IPO underpricing, and the aftermarket price appreciation explains these firms SEO activities. The evidence, therefore, clearly supports the notion that some firms are willing to leave money on the table voluntarily to get a more favorable price at seasoned offerings when they are substantially wealth constrained, a prediction embedded in the signaling hypothesis.
How Does Liquidity Affect Government Bond Yields?

Carlo Favero, Marco Pagano and Ernst-Ludwig von Thadden Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 107-134 The paper explores the determinants of yield differentials between sovereign bonds, using euro-area data. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bonds liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the models prediction and crucial to detect their effect.
Investor Protection, Equity Returns, and Financial Globalization

Mariassunta Giannetti and Yrj Koskinen Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 135-168 We study the effects of investor protection on stock returns and portfolio allocation decisions. In our theoretical model, if investor protection is weak, wealthy investors have an incentive to become controlling shareholders. In equilibrium, the stock price reflects the demand from both controlling shareholders and portfolio investors. Due to the high demand from controlling shareholders, the price of weak corporate
16
governance stocks is not low enough to fully discount the extraction of private benefits. Thus, stocks have lower expected returns when investor protection is weak. This has implications for domestic and foreign investors stockholdings. In particular, we show that portfolio investors participation in the domestic stock market and home equity bias are positively related to investor protection and provide original evidence in their support.
An Epidemic Model of Investor Behavior

Sophie Shive Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 169-198 I test whether social influence affects individual investors trading and stock returns. In each of the 20 most active stocks in Finland over 9 years, the number of owners in a municipality multiplied by the number of investors who do not own a stock, a measure of the rate of transmission of diseases and rumors through social contact, predicts individual investor trading. I control for known determinants of trade, including daily news, and show that competing explanations for the relation are unlikely. Socially motivated trades predict stock returns, and the effects are not reversed, suggesting that individuals share useful information. Individuals susceptibility to social influence has declined during the period, but the opportunities for social influence have increased.
Predicting Hedge Fund Failure: A Comparison of Risk Measures

Bing Liang and Hyuna Park Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 199-222 This paper compares downside risk measures that incorporate higher return moments with traditional risk measures such as standard deviation in predicting hedge fund failure. When controlling for investment strategies, performance, fund age, size, lockup, high-water mark, and leverage, we find that funds with larger downside risk have a higher hazard rate. However, standard deviation loses the explanatory power once the other explanatory variables are included in the hazard model. Further, we find that liquidation does not necessarily mean failure in the hedge fund industry. By reexamining the attrition rate, we show that the real failure rate of 3.1% is lower than the attrition rate of 8.7% on an annual basis during the period of 19952004.
Fund Flow Volatility and Performance

David Rakowski Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 223-237 This paper provides a detailed analysis of the impact of daily mutual fund flow volatility on fund performance. I document a significant negative relationship between the volatility of daily fund flows and cross-sectional differences in riskadjusted performance. This relationship is driven by domestic equity funds, as well as small funds, well-performing funds, and funds that experience inflows over the sample period. My results are consistent with performance differences arising from the transaction costs of nondiscretionary trading driven by daily fund flows, but not
17
with performance differences arising from the suboptimal cash holdings that arise from fund flows.
Pharmaceutical R&D Spending and Threats of Price Regulation

Joseph Golec, Shantaram Hegde and John A. Vernon Journal of Financial and Quantitative Analysis Volume 45, Issue 01, April 2010, pp 239-264 Do threats of pharmaceutical price regulation affect subsequent research and development (R&D) spending? This study uses the Clinton administrations Health Security Act (HSA) of 1993 as a natural experiment to study this issue. We link events surrounding the HSA to pharmaceutical stock price changes and then examine the cross-sectional relation between firms stock price changes and their subsequent unexpected R&D spending changes. Results show that the HSA had significant negative effects on stock prices and firm-level R&D spending. Conservatively, the HSA reduced R&D spending by about $1 billion even though it never became law.
18
Apr (2010)
Corporate Governance and Liquidity
Kee H. Chung, John Elder and Jang-Chul Kim Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 265-291 We investigate the empirical relation between corporate governance and stock market liquidity. We find that firms with better corporate governance have narrower spreads, higher market quality index, smaller price impact of trades, and lower probability of information-based trading. In addition, we show that changes in our liquidity measures are significantly related to changes in the governance index over time. These results suggest that firms may alleviate information-based trading and improve stock market liquidity by adopting corporate governance standards that mitigate informational asymmetries. Our results are remarkably robust to alternative model specifications, across exchanges, and to different measures of liquidity.
Factoring Information into Returns

David Easley, Soeren Hvidkjaer and Maureen OHara Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 293-309 We examine the potential profits of trading on a measure of private information (PIN) in a stock. A zero-investment portfolio that is size-neutral but long in high PIN stocks and short in low PIN stocks earns a significant abnormal return. The FamaFrench, momentum, and liquidity factors do not explain this return. However, significant covariation in returns exists among high PIN stocks and among low PIN stocks, suggesting that PIN might proxy for an underlying factor. We create a PIN factor as the monthly return on the zero-investment portfolio above and show that it is successful in explaining returns to independent PIN-size portfolios. We also show that it is robust to inclusion of the Pstor-Stambaugh liquidity factor and the Amihud illiquidity factor. We argue that information remains an important determinant of asset returns even in the presence of these additional factors.
Portfolio Optimization with Mental Accounts

Sanjiv Das, Harry Markowitz, Jonathan Scheid and Meir Statman Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 311-334 We integrate appealing features of Markowitzs mean-variance portfolio theory (MVT) and Shefrin and Statmans behavioral portfolio theory (BPT) into a new mental accounting (MA) framework. Features of the MA framework include an MA structure of portfolios, a definition of risk as the probability of failing to reach the
19
threshold level in each mental account, and attitudes toward risk that vary by account. We demonstrate a mathematical equivalence between MVT, MA, and risk management using value at risk (VaR). The aggregate allocation across MA subportfolios is mean-variance efficient with short selling. Short-selling constraints on mental accounts impose very minor reductions in certainty equivalents, only if binding for the aggregate portfolio, offsetting utility losses from errors in specifying risk-aversion coefficients in MVT applications. These generalizations of MVT and BPT via a unified MA framework result in a fruitful connection between investor consumption goals and portfolio production.
Deviations from Put-Call Parity and Stock Return Predictability

Martijn Cremers and David Weinbaum Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 335-367 Deviations from put-call parity contain information about future stock returns. Using the difference in implied volatility between pairs of call and put options to measure these deviations, we find that stocks with relatively expensive calls outperform stocks with relatively expensive puts by 50 basis points per week. We find both positive abnormal performance in stocks with relatively expensive calls and negative abnormal performance in stocks with relatively expensive puts, which cannot be explained by short sale constraints. Rebate rates from the stock lending market directly confirm that our findings are not driven by stocks that are hard to borrow. The degree of predictability is larger when option liquidity is high and stock liquidity low, while there is little predictability when the opposite is true. Controlling for size, option prices are more likely to deviate from strict put-call parity when underlying stocks face more information risk. The degree of predictability decreases over the sample period. Our results are consistent with mispricing during the earlier years of the study, with a gradual reduction of the mispricing over time.
Dynamic General Equilibrium and T-Period Fund Separation

Anke Gerber, Thorsten Hens and Peter Woehrmann Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 369-400 In a dynamic general equilibrium model, we derive conditions for a mutual fund separation property by which the savings decision is separated from the asset allocation decision. With logarithmic utility functions, this separation holds for any heterogeneity in discount factors, while the generalization to constant relative risk aversion holds only for homogeneous discount factors but allows for any heterogeneity in endowments. The logarithmic case provides a general equilibrium foundation for the growth-optimal portfolio literature. Both cases yield equilibrium asset pricing formulas that allow for investor heterogeneity, in which the return process is endogenous and asset prices are determined by expected discounted relative dividends. Our results have simple asset pricing implications for the time series as well as the cross section of relative asset prices. It is found that on data from
20
the Dow Jones Industrial Average, a risk aversion smaller than in the logarithmic case fits best.
Informational Efficiency and Liquidity Premium as the Determinants of Capital Structure

Chun Chang and Xiaoyun Yu Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 401-440 This paper investigates how a firms capital structure choice affects the informational efficiency of its security prices in the secondary markets. We identify two new determinants of a firms 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 firms 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 firms 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.
How Syndicate Short Sales Affect the Informational Efficiency of IPO Prices and Underpricing
Bjrn Bartling and Andreas Park Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 441-471 When a company goes public, it is standard practice that the underwriting syndicate allocates more shares than are issued. The underwriter thus holds a short position that it commonly fills by aftermarket trading when market prices fall or, when prices rise, by executing the so-called overallotment option. This option is a standard feature of initial public offering (IPO) arrangements that allows the underwriter to purchase more shares from the issuer at the original offer price. We propose a theoretical model to study the implications of this combination of short position and overallotment option on the pricing of the IPO. Maximizing the sum of both the profits from their share of the offer revenue and the potential profits from aftermarket trading, we show that underwriters strategically distort the offer price. This results either in exacerbated underpricing when favorably informed underwriters lower prices to secure a signaling benefit, or in informationally inefficient offer prices when underwriters pool in offer prices irrespective of their information.
21
The Impact of the Euro on Equity Markets

Lorenzo Cappiello, Arjan Kadareja and Simone Manganelli Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 473-502 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.
Forecasting Volatility Using Long Memory and Comovements

George J. Jiang and Yisong S. Tian Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 503-533 Horizon-matched historical volatility is commonly used to forecast future volatility for option valuation under the Statement of Financial Accounting Standards (SFAS) 123R. In this paper, we empirically investigate the performance of using historical volatility to forecast long-term stock return volatility in comparison with a number of alternative forecasting methods. In analyzing forecasting errors and their impact on reported income due to option expensing, we find that historical volatility is a poor forecast for long-term volatility and that shrinkage adjustment toward comparablefirm volatility only slightly improves its performance. Forecasting performance can be improved substantially by incorporating both long memory and comovements with common market factors. We also experiment with a simple mixed-horizon realized volatility model and find its long-term forecasting performance to be more accurate than historical forecasts but less accurate than long-memory forecasts.
Exploitable Predictable Irrationality: The FIFA World Cup Effect on the U.S. Stock Market
Guy Kaplanski and Haim Levy Journal of Financial and Quantitative Analysis Volume 45, Issue 02, April 2010, pp 535-553 In a recently published paper, Edmans, Garca, and Norli (2007) reveal a strong association between results of soccer games and local stock returns. Inspired by their work, we propose a novel approach to exploit this effect on the aggregate international level with the following three unique features: i) The aggregate effect does not depend on the games results; hence, the effect is an exploitable predictable effect. ii) The aggregate effect is based on many games; hence, it is very large and
22
highly significant. We find that the average return on the U.S. market over the World Cups effect period is 2.58%, compared to +1.21% for all-days average returns over the same period length. iii) Exploiting the aggregate effect is involved with trading in a single index for a relatively long period.
23
June (2010)
The Response of Corporate Financing and Investment to Changes in the Supply of Credit
Michael Lemmon and Michael R. Roberts Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 555-587 We examine how shocks to the supply of credit impact corporate financing and investment using the collapse of Drexel Burnham Lambert, Inc.; the passage of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989; and regulatory changes in the insurance industry as an exogenous contraction in the supply of below-investment-grade credit after 1989. A difference-in-differences empirical strategy reveals that substitution to bank debt and alternative sources of capital (e.g., equity, cash balances, and trade credit) was limited, leading to an almost one-for-one decline in net investment with the decline in net debt issuances. Despite this sharp change in behavior, corporate leverage ratios remained relatively stable, a result of the contemporaneous decline in debt issuances and investment. Overall, our findings highlight how even large firms with access to public credit markets are susceptible to fluctuations in the supply of capital.
Financing Frictions and the Substitution between Internal and External Funds
Heitor Almeida and Murillo Campello Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 589-622 Ample evidence points to a negative relation between internal funds (profitability) and the demand for external funds (debt issuance). This relation has been interpreted as evidence supporting the pecking order theory. We show, however, that the negative effect of internal funds on the demand for external financing is concentrated among firms that are least likely to face high external financing costs (firms that distribute large amounts of dividends, that are large, and whose debt is rated). For firms on the other end of the spectrum (low payout, small, and unrated), external financing is insensitive to internal funds. These cross-firm differences hold separately for debt and equity, and they are magnified in the aftermath of macroeconomic movements that tighten financing constraints. We argue that the greater complementarity between internal funds and external financing for constrained firms is a consequence of the interdependence of their financing and investment decisions.
24
Disagreement, Portfolio Optimization, and Excess Volatility

Ran Duchin and Moshe Levy Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 623-640 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 effectsmore 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.
What Does the Individual Option Volatility Smirk Tell Us About Future Equity Returns?
Yuhang Xing, Xiaoyan Zhang and Rui Zhao Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 641-662 The shape of the volatility smirk has significant cross-sectional predictive power for future equity returns. Stocks exhibiting the steepest smirks in their traded options underperform stocks with the least pronounced volatility smirks in their options by 10.9% per year on a risk-adjusted basis. This predictability persists for at least 6 months, and firms with the steepest volatility smirks are those experiencing the worst earnings shocks in the following quarter. The results are consistent with the notion that informed traders with negative news prefer to trade out-of-the-money put options, and that the equity market is slow in incorporating the information embedded in volatility smirks.
A Reexamination of the Causes of Time-Varying Stock Return Volatilities

Chu Zhang Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 663-684 The decline of average stock return volatility in the 20012006 period provides an opportunity to test various theories on why the average return volatility increased in the pre-2000 period. This paper compares fundamentals-based theories with trading
25
volume-based theories. While both fundamentals-based and trading volume-based theories explain the upward trend in the average volatility in U.S. stocks from 1976 to 2000 and international stocks from 1990 to 2000, only the fundamentals-based theories explain the volatility pattern for 20012006. Much of the variation in the stock return volatilities can be explained by the variation in the earnings volatilities and proxies for growth options, but not by trading-related variables. Evidence also shows that the explanatory power of the fundamentals variables is time varying.
The Role of State and Mutual Fund Ownership in the Split Share Structure in China
Michael Firth, Chen Lin and Hong Zou Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 685-706 The recent split share structure reform in China involves the nontradable shareholders proposing a compensation package to the tradable shareholders in exchange for the listing rights of their shares. We find that state ownership (the major owners of nontradable shares) has a positive effect on the final compensation ratio. In contrast, mutual fund ownership (the major institutional owner of tradable shares) has a negative effect on the compensation ratio and especially in state-owned firms. The evidence is consistent with our predictions that state shareholders have incentives to complete the reform quickly and exert political pressure on mutual funds to accept the terms without a fight.
Dynamic Factors and Asset Pricing

Zhongzhi (Lawrence) He, Sahn-Wook Huh and Bong-Soo Lee Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 707-737 This study develops an econometric model that incorporates features of price dynamics across assets as well as through time. With the dynamic factors extracted via the Kalman filter, we formulate an asset pricing model, termed the dynamic factor pricing model (DFPM). We then conduct asset pricing tests in the in-sample and out-of-sample contexts. Our analyses show that the ex ante factors are a key component in asset pricing and forecasting. By using the ex ante factors, the DFPM improves upon the explanatory and predictive power of other competing models, including unconditional and conditional versions of the Fama and French (1993) 3factor model. In particular, the DFPM can explain and better forecast the momentum portfolio returns, which are mostly missed by alternative models.
26
Market Feedback and Equity Issuance: Evidence from Repeat Equity Issues
Armen Hovakimian and Irena Hutton Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 739-762 Higher first-year post-issue returns are associated with a significantly higher probability of follow-on equity issuance over the next 5 years. This result holds when we control for pre-issue returns and other factors known to affect the probability of equity issuance. The result is most consistent with the market feedback hypothesis that a high post-issue return encourages managers to increase the firms investment because it implies that, in the markets view, the marginal return to the project is high.
A Longer Look at the Asymmetric Dependence between Hedge Funds and the Equity Market
Byoung Uk Kang, Francis In, Gunky Kim and Tong Suk Kim Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 763-789 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.
27
Prospect Theory and the Disposition Effect

Markku Kaustia Journal of Financial and Quantitative Analysis Volume 45, Issue 03, June 2010, pp 791-812 This paper shows that prospect theory is unlikely to explain the disposition effect. Prospect theory predicts that the propensity to sell a stock declines as its price moves away from the purchase price in either direction. Trading data, on the other hand, show that the propensity to sell jumps at zero return, but it is approximately constant over a wide range of losses and increasing or constant over a wide range of gains. Further, the pattern of realized returns does not seem to stem from optimal after-tax portfolio rebalancing, a belief in mean-reverting returns, or investors acting on target prices.
28
August (2010)
Estimating the Equity Premium
R. Glen Donaldson, Mark J. Kamstra and Lisa A. Kramer Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 813-846 Existing empirical research investigating the size of the equity premium has largely consisted of a series of innovations around a common theme: producing a better estimate of the equity premium by using better data or a better estimation technique. The equity premium estimate that emerges from most of this work matches one moment of the data alone: the mean difference between an estimate of the return to holding equity and a risk-free rate. We instead match multiple moments of U.S. market data, exploiting the joint distribution of the dividend yield, return volatility, and realized excess returns, and find that the equity premium lies within 50 basis points of 3.5%, a range much narrower than was achieved in previous studies. Additionally, statistical tests based on the joint distribution of these moments reveal that only those models of the conditional equity premium that embed time variation, breaks, and/or trends are supported by the data. In order to develop the joint distribution of the dividend yield, return volatility, and excess returns, we need a model of price and return fundamentals. We document that even recently developed analytically tractable models that permit autocorrelated dividend growth rates and discount rates impose restrictions that are rejected by the data. We therefore turn to a wider range of models, requiring numerical solution methods and parameter estimation by the simulated method of moments.
Rational Cross-Sectional Differences in Market Efficiency: Evidence from Mutual Fund Returns
Paul Schultz Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 847-881 Markets should be inefficient enough to allow returns to security analysis to adequately compensate the marginal analyst for his efforts. Cross-sectional differences in the costs of analysis therefore imply cross-sectional differences in market efficiency and in before-cost returns to smart investors. Small growth stocks are difficult to analyze and costly to trade. I find that the abnormal returns of mutual fund investments in small growth stocks from 1980 to 2006 averaged 0.76% per month. Large value stocks are easier to analyze and cheaper to trade. Mutual funds earned average monthly abnormal returns of only 0.05% in large value stocks during the same period.
29
Idiosyncratic Risk, Long-Term Reversal, and Momentum

R. David McLean Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 883-906 This paper tests whether the persistence of the momentum and reversal effects is the result of idiosyncratic risk limiting arbitrage. Idiosyncratic risk deters arbitrage, regardless of the arbitrageurs diversification. Reversal is prevalent only in high idiosyncratic risk stocks, suggesting that idiosyncratic risk limits arbitrage in reversal mispricing. This finding is robust to controls for transaction costs, informed trading, and systematic relations between idiosyncratic risk and subsequent returns. Momentum is not related to idiosyncratic risk. Momentum generates a smaller aggregate return than reversal, so the findings along with those in related studies suggest that transaction costs are sufficient to prevent arbitrageurs from eliminating momentum mispricing.
Arbitrage Risk and Stock Mispricing

John A. Doukas, Chansog (Francis) Kim and Christos Pantzalis Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 907-934 In this paper we examine the relation between equity mispricing and arbitrage risk and find that stocks with high arbitrage risk have higher estimated mispricing than stocks with low arbitrage risk. These results are not limited to high book-to-market or small capitalization stocks, and they are not sensitive to transaction and shortselling costs. In addition, they remain robust to alternative multifactor return generating specification models and mispricing measures. Overall, our empirical results are consistent with the conjecture that mispricing is a manifestation of the inability of arbitrageurs to hedge idiosyncratic risk, a major deterrent to arbitrage activity.
Behavioral Explanations of Stock Price Performance Decomposition of Market-to-Book Ratios

Michael G. Hertzela1 and Zhi Li Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 935-958 We examine the extent to which investment opportunities and/or mispricing motivate equity issuance and contribute to post-issue stock underperformance. We decompose market-to-book ratios into misvaluation and growth option components and find that issuing firms are both overvalued and have greater growth opportunities relative to nonissuers. Firms with greater growth opportunities invest more in capital expenditures and research and development (R&D) after issuance but do not experience lower post-issue stock returns. In contrast, issuing firms with greater mispricing tend to decrease long-term debt and/or increase cash holdings and do earn
30
lower returns. Our findings are consistent with behavioral explanations for post-issue stock price underperformance.
Incorporating Economic Objectives into Bayesian Priors: Portfolio Choice under Parameter Uncertainty
Jun Tua1 and Guofu Zhou Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 959-986 This paper proposes a way to allow Bayesian priors to reflect the objectives of an economic problem. That is, we impose priors on the solution to the problem rather than on the primitive parameters whose implied priors can be backed out from the Euler equation. Using monthly returns on the Fama-French 25 size and book-tomarket portfolios and their 3 factors from January 1965 to December 2004, we find that investment performances under the objective-based priors can be significantly different from those under alternative priors, with differences in terms of annual certainty-equivalent returns greater than 10% in many cases. In terms of an out-ofsample loss function measure, portfolio strategies based on the objective-based priors can substantially outperform both strategies under alternative priors and some of the best strategies developed in the classical framework.
Cross-Sectional Return Dispersion and Time Variation in Value and Momentum Premiums
Chris Stivers and Licheng Sun Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 987-1014 We find that the markets recent cross-sectional dispersion in stock returns is positively related to the subsequent value book-to-market premium and negatively related to the subsequent momentum premium. The partial relation between return dispersion (RD) and the subsequent value and momentum premiums remains strong when controlling for macroeconomic state variables suggested by the literature. Our findings are consistent with recent theoretical insights and empirical evidence that suggest that the markets RD may serve as a leading countercyclical state variable, that the value premium is countercyclical, and that the momentum premium is procyclical.
31
Multiple Risky Assets-Allocation Rules and Implications for U.S. Investors

Anthony W. Lynch and Sinan Tan Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 1015-1053 This paper numerically solves the decision problem of a multiperiod constant relative risk aversion individual who faces transaction costs and has access to two risky assets, both with predictable returns. With proportional transaction costs and independent and identically distributed returns, we numerically find the rebalancing rule to be a no-trade region for the portfolio weights with rebalancing to the boundary. The shape of the no-trade region depends on the correlation between the two risky assets. With predictable returns, there is instead a no-trade region for each state. We also examine several important economic questions, including the utility cost of not being able to buy on margin or short stock.
Longer-Term Time-Series Volatility Forecasts

Louis H. Ederingtona1 and Wei Guan Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 1055-1076 Option pricing models and longer-term value-at-risk (VaR) models generally require volatility forecasts over horizons considerably longer than the data frequency. The typical recursive procedure for generating longer-term forecasts keeps the relative weights of recent and older observations the same for all forecast horizons. In contrast, we find that older observations are relatively more important in forecasting at longer horizons. We find that the Ederington and Guan (2005) model and a modified EGARCH (exponential generalized autoregressive conditional heteroskedastic) model in which parameter values vary with the forecast horizon forecast better out-of-sample than the GARCH (generalized autoregressive conditional heteroskedastic), EGARCH, and Glosten, Jagannathan, and Runkle (GJR) models across a wide variety of markets and forecast horizons.
Stock Returns and the Volatility of Liquidity

Joo Pedro Pereiraa1 and Harold H. Zhang Journal of Financial and Quantitative Analysis Volume 45, Issue 04, August 2010, pp 1077-1110 This paper offers a rational explanation for the puzzling empirical fact that stock returns decrease with an increase in the volatility of liquidity. We model liquidity as a stochastic price impact process and define the liquidity premium as the additional return necessary to compensate a multiperiod investor for the adverse price impact of trading. The model demonstrates that a fully rational, utility maximizing, risk-averse investor can take advantage of time-varying liquidity by adapting his trades to the state of liquidity. We provide new empirical evidence supportive of the model.
32
33
Can Mutual Fund Managers Pick Stocks? Evidence from Their Trades Prior to Earnings Announcements
Malcolm Baker, Lubomir Litov, Jessica A. Wachter and Jeffrey Wurgler Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1111-1131 Recent research finds that the stocks that mutual fund managers buy outperform the stocks that they sell (e.g., Chen, Jegadeesh, and Wermers (2000)). We study the nature of this stock-picking ability. We construct measures of trading skill based on how the stocks held and traded by fund managers perform at subsequent corporate earnings announcements. This approach increases the power to detect skilled trading and sheds light on its source. We find that the average funds recent buys significantly outperform its recent sells around the next earnings announcement, and that this accounts for a disproportionate fraction of the total abnormal returns to fund trades estimated in prior work. We find that mutual fund trades also forecast earnings surprises. We conclude that mutual fund managers are able to trade profitably in part because they are able to forecast earnings-related fundamentals.
Seasonality in the Cross Section of Stock Returns: The International Evidence

Steven L. Heston and Ronnie Sadka Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1133-1160 This paper studies seasonal predictability in the cross section of international stock returns. Stocks that outperform the domestic market in a particular month continue to outperform the domestic market in that same calendar month for up to 5 years. The pattern appears in Canada, Japan, and 12 European countries. Global trading strategies based on seasonal predictability outperform similar nonseasonal strategies by over 1% per month. Abnormal seasonal returns remain after controlling for size, beta, and value, using global or local risk factors. In addition, the strategies are not highly correlated across countries. This suggests they do not reflect return premiums for systematic global risk.
Debt Capacity and Tests of Capital Structure Theories

Michael L. Lemmon and Jaime F. Zender Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1161-1187 We examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt capacity largely explain the use of new external equity financing by publicly traded firms. Finally, we present evidence that reconciles the frequent equity issues by small, high-growth firms with the pecking
34
order. After accounting for debt capacity, the pecking order theory appears to give a good description of financing behavior for a large sample of firms examined over an extended time period.
Transparency, Price Informativeness, and Stock Return Synchronicity: Theory and Evidence
Sudipto Dasgupta, Jie Gan and Ning Gao Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1189-1220 This paper argues that, contrary to the conventional wisdom, stock return synchronicity (or R2) can increase when transparency improves. In a simple model, we show that, in more transparent environments, stock prices should be more informative about future events. Consequently, when the events actually happen in the future, there should be less surprise (i.e., less new information is impounded into the stock price). Thus a more informative stock price today means higher return synchronicity in the future. We find empirical support for our theoretical predictions in 3 settings: namely, firm age, seasoned equity offerings (SEOs), and listing of American Depositary Receipts (ADRs).
Information, Expected Utility, and Portfolio Choice

Jun Liu, Ehud Peleg and Avanidhar Subrahmanyam Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1221-1251 We study the consumption-investment problem of an agent with a constant relative risk aversion preference function, who possesses noisy information about the future prospects of a stock. We also solve for the value of information to the agent in closed form. We find that information can significantly alter consumption and asset allocation decisions. For reasonable parameter ranges, information increases consumption in the vicinity of 25%. Information can shift the portfolio weight on a stock from 0% to around 70%. Thus, depending on the stock beta, the weight on the market portfolio can be considerably reduced with information, causing the appearance of underdiversification. The model indicates that stock holdings of informed agents are positively related to wealth, unrelated to systematic risk, and negatively related to idiosyncratic uncertainty. We also show that the dollar value of information to the agent depends linearly on his wealth and decreases with both the propensity to intermediate consumption and risk aversion.
35
What Drove the Increase in Idiosyncratic Volatility during the Internet Boom?
Jason Fink, Kristin E. Fink, Gustavo Grullon and James P. Weston Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1253-1278 Aggregate idiosyncratic volatility spiked nearly fivefold during the Internet boom of the late 1990s, dwarfing in magnitude a moderately increasing trend. While some researchers argue that this rise in idiosyncratic risk was the result of changes in the characteristics of public firms, others argue that it was driven by the changing sentiment of irrational traders. We present evidence that the marketwide decline in maturity of the typical public firm can explain most of the increase in firm-specific risk during the Internet boom. Controlling for firm maturity, we find no evidence that investor sentiment drives idiosyncratic risk throughout the Internet boom.
The Term Structure of Variance Swap Rates and Optimal Variance Swap Investments
Daniel Egloff, Markus Leippold and Liuren Wu Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1279-1310 This paper performs specification analysis on the term structure of variance swap rates on the S&P 500 index and studies the optimal investment decision on the variance swaps and the stock index. The analysis identifies 2 stochastic variance risk factors, which govern the short and long end of the variance swap term structure variation, respectively. The highly negative estimate for the market price of variance risk makes it optimal for an investor to take short positions in a short-term variance swap contract, long positions in a long-term variance swap contract, and short positions in the stock index.
Level-Dependent Annuities: Defaults of Multiple Degrees

Aksel Mjs and Svein-Arne Persson Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1311-1339 Motivated by the effect on valuation of stopped or reduced debt coupon payments from a company in financial distress, we value a level-dependent annuity contract where the annuity rate depends on the value of an underlying asset process. The range of possible values of this asset is divided into a finite number of regions, with constant annuity rates within each region. We present closed-form formulas for the market value of level-dependent annuities contracts when the market value of the underlying asset is assumed to follow a geometric Brownian motion. Such annuities occur naturally in models of debt with credit risk in financial economics. Our results are applied for valuing both corporate debt with suspended interest payments under
36
the U.S. Chapter 11 provisions and loans with contractual level-dependent interest rates.
Affine Models of the Joint Dynamics of Exchange Rates and Interest Rates
Bing Anderson, Peter J. Hammond and Cyrus A. Ramezani Journal of Financial and Quantitative Analysis Volume 45, Issue 05, August 2010, pp 1341-1365 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.
37
38
JOURNAL 2
Journal of Financial Research
39
Spring (2010)
The Economic Gains Of Trading Stocks Around Holidays
Ilias Tsiakas Journal of Financial Research Published Online: Feb 2010 Volume 33 Issue 1, Pages 1-26 I assess the economic gains of strategies that account for the effect of holiday calendar effects on the daily returns and volatility of the 30 stocks in the Dow Jones Industrial Average index. The dynamic strategies use forecasts from stochastic volatility models that distinguish between regular trading days and different types of holidays. More important, I assess the economic value of conditioning on holiday effects and find that a risk-averse investor will pay a high performance fee to switch from a dynamic portfolio strategy that does not account for the effect of holidays on daily conditional expected returns and volatility to a strategy that does. This result is robust to reasonable transaction costs.
Dynamic Order Submission And Herding Behavior In Electronic Trading

Wing Lon Ng Journal of Financial Research Published Online: Feb 2010 Volume 32 Issue 1, Pages 27-43 I analyze the dynamic trading behavior of market participants by developing a bivariate modeling framework for describing the arrival process of buy and sell orders in a limit order book. The model contains an extended autoregressive conditional duration model with a flexible generalized Beta distribution to explain the duration process, combined with a dynamic logit model to capture the traders' order submission strategy. I find that the state of the order book as well as the speed of the order arrival have a significant influence on the order placement, inducing temporal asymmetric market movements.
Switching To A Temporary Call Auction In Times Of High Uncertainty

David Abad, Roberto Pascual Journal of Financial Research Published Online: Feb 2010 Volume 32 Issue 1, Pages 45-75 We evaluate a stock-specific circuit breaker implemented in several European stock exchanges, which consists of a short-lived call auction triggered by intraday stockspecific price limits. It differs from U.S. trading halts in that it is short-lived and nondiscretionary, and a trading mechanism (continuous or discrete) is always going. It differs from daily price limits in that trade prices are not restricted once the limit is hit. Intraday price ranges are smaller and adjusted to the recent volatility, so that limit hits are more frequent. We contribute to the debate about circuit breakers by enlarging the span of these mechanisms studied.
40
Risk Premium Effects on Implied Volatility Regressions

Leonidas S. Rompolis; Elias Tzavalis Journal of Financial Research Published Online: Feb 2010 Volume 32 Issue 1, Pages 77-102 This paper provides new insights into the sources of bias of option implied volatility to forecast its physical counterpart. It argues that this bias can be attributed to volatility risk premium effects. The latter are found to depend on high order cumulants of the risk neutral density. These cumulants capture the risk averse behavior of investors in the stock and option markets for bearing the investment risk which is reflected in the deviations of the implied risk neutral distribution from the normal distribution. The paper shows that the bias of the implied volatility to forecast its corresponding physical measure can be eliminated when the implied volatility regressions are adjusted for the risk premium effects. The latter are captured mainly by the third order risk neutral cumulant. The paper also shows that a substantial reduction of higher order risk neutral cumulants biases to predict their corresponding physical ones is supported when adjustments for risk premium effects are made.
41
Summer (2010)
Expected Volatility, Unexpected Volatility, And The CrossSection Of Stock Returns
Choong Tze Chua, Jeremy Goh and Zhe Zhang Journal of Financial Research Published Online: Jun 2010 Volume 33 Issue 2, Pages 103-123 The existing literature finds conflicting results on the cross-sectional relation between expected returns and idiosyncratic volatility. We contend that at the firm level, the sample correlation between unexpected returns and expected idiosyncratic volatility can cloud the true relation between the expected return and expected idiosyncratic volatility. We show strong evidence that unexpected idiosyncratic volatility is positively related to unexpected returns. Using unexpected idiosyncratic volatility to control for unexpected returns, we find expected idiosyncratic volatility to be significantly and positively related to expected returns. This result holds after controlling for various firm characteristics, and it is robust across different sample periods.
Risk Premium Effects On Implied Volatility Regressions

Leonidas S. Rompolis, Elias Tzavali Journal of Financial Research Published Online: Jun 2010 Volume 33 Issue 2, Pages 125-151 This article provides new insights into the sources of bias of option implied volatility to forecast its physical counterpart. We argue that this bias can be attributed to volatility risk premium effects. The latter are found to depend on high-order cumulants of the risk-neutral density. These cumulants capture the risk-averse behavior of investors in the stock and option markets for bearing the investment risk that is reflected in the deviations of the implied risk-neutral distribution from the normal distribution. We show that the bias of implied volatility to forecast its corresponding physical measure can be eliminated when the implied volatility regressions are adjusted for risk premium effects. The latter are captured mainly by the third-order risk-neutral cumulant. We also show that a substantial reduction of higher order risk-neutral cumulants biases to predict their corresponding physical cumulants is supported when adjustments for risk premium effects are made.
Trading-Volume Shocks And Stock Returns: An Empirical Analysis

Zhaodan Huang, James B. Heian Journal of Financial Research Published Online: Jun 2010 Volume 33 Issue 2, Pages 153-177 We examine high-volume premiums based on weekly risk-adjusted returns. Significant average weekly abnormal high-volume premiums up to 0.50% per week are documented for 19622005. Most premiums are generated in the first two weeks and monotonically decline as holding periods are extended. Evidence of reversal is found as the holding periods are extended. Premiums depend on realized turnover in the holding period. The last finding supports the theories of Miller and Merton. Finally, we test whether premiums are compensation for taking additional risk.
42
Negative skewness, idiosyncratic risk, and liquidity risk do not explain the highvolume premiums.
On The Robustness Of Range-Based Volatility Estimators

Ozgu (Ozzy) Akay, Mark D.Griffiths, Drew B.Winters Journal of Financial Research Published Online: Jun 2010 Volume 33 Issue 2, Pages 179-199 We empirically examine Parkinson's range-based volatility estimate in the federal funds market, which is unique because institutional regulations create a predictable pattern in interday volatility. We find that range-based volatility estimates and standard deviations produce the expected volatility pattern. We also find that at trading pressure points where microstructure noise should be greatest, range-based estimates are less than the standard deviations. Thus, we support the argument that range-based volatility estimates remove the upward bias created by microstructure noise. We find that the Parkinson method is the most efficient range-based volatility measure among a set of alternates in this market.
43
Fall (2010)
Dynamic Hedge Fund Style Analysis With Errors-InVariables
Laurent Bodson, Alain Con, Georges Hbner3 Journal of Financial Research Published Online: Sep 2010 Volume 33 Issue 3, Pages 201-221 We revisit the traditional return-based style analysis in the presence of time-varying exposures and errors-in-variables (EIV). We apply a benchmark selection algorithm using the Kalman filter and compute the estimated EIV of the selected benchmarks. We adjust them by subtracting their EIV from the initial return series to obtain an estimate of the true uncontaminated benchmarks. Finally, we run the Kalman filter on these adjusted regressors. Analyzing EDHEC alternative index styles, we show that this technique improves the factor loadings and allows more precise identification of the return sources of the considered hedge fund strategy.
Regular(Ized) Hedge Fund Clones

Daniel Giamouridis, Sandra Paterlini Journal of Financial Research Published Online: Sep 2010 Volume 33 Issue 3, Pages 223-247 This article addresses the problem of portfolio construction in the context of efficient hedge fund investments replication. We propose a modification to the standard Sharpe style analysis by introducing a constraint on the asset weights 1-norm and 2-norm. This constraint regularizes the optimization problem, allows efficient selection of relevant factor's and has significant effects on the stability of the resulting asset mix and the riskreturn characteristics of the replicating portfolio. The empirical results suggest that the norm-constrained replicating portfolios exhibit significant correlations with their benchmarks, often higher than 0.9; have a fraction, which is about half to two-thirds, of active positions relative to those determined through the standard method; and are obtained with turnover, which is in some instances about one-fourth of that for the standard method.
Mutual Funds Selection Based On Funds Characteristics

Diana P. Budiono, Martin Martens Journal of Financial Research Published Online: Sep 2010 Volume 33 Issue 3, Pages 249-265 The popular investment strategy in the literature is to use only past performance to select mutual funds. We investigate whether an investor can select superior funds by additionally using fund characteristics. After considering the fund fees, we find that combining information on past performance, turnover ratio, and ability produces a yearly excess net return of 8.0%, whereas an investment strategy that uses only past performance generates 7.1%. Adjusting for systematic risks, and then using fund characteristics, increases yearly alpha significantly from 0.8% to 1.7%. The strategy that also uses fund characteristics requires less turnover.
44
Debt Forgiveness And Stock Price Reaction Of Lending Banks

Nobuyuki Isagawa, Satoru Yamaguchi, Tadayasu Yamashita Journal of Financial Research Published Online: Sep 2010 Volume 33 Issue 3, Pages 267-287 We provide a simple model for analyzing how debt forgiveness affects the stock price of a lending bank. Our model shows that although debt forgiveness increases shareholder wealth of a bank in healthy financial condition, it decreases shareholder wealth of a bank in unhealthy financial condition. We empirically investigate the announcement effect of debt forgiveness on bank stock prices in Japanese markets. On average, lending banks experience a significant negative announcement effect with respect to debt forgiveness. Consistent with the prediction of the model, we find a negative relation between the announcement effect and the net bad loan ratio as a proxy of the unhealthiness of the financial condition of the bank.
State Dependency Of Bank Stock Reaction To Federal Funds Rate Target Changes
Haiyan Yin, Jiawen Yang,William C. Handorf Journal of Financial Research Published Online: Sep 2010 Volume 33 Issue 3, Pages 289-315 We investigate the effects of changes in the federal funds target rate on bank stock returns through an event-study analysis. We examine the state dependency of such effects and focus on the surprise elements of policy changes derived from the federal funds futures market. Although we confirm an inverse relation between bank stock returns and changes in the federal funds target rate previously supported in the literature, we find that bank stock returns only respond to surprise or unexpected changes in the federal funds target rate. We also find that such responses are conditional on the context in which policy changes take place.
45
Winter (2010)
Corporate Hedging And Shareholder Value
Kevin Aretz, Shnke M. Bartra Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 317-371 Although theory suggests that corporate hedging can increase shareholder value in the presence of capital market imperfections, empirical studies show overall mixed support for rationales of hedging with derivatives. Although various empirical challenges and limitations advise some caution with regard to the interpretation of the existing evidence, the results are consistent with derivatives use being just one part of a broader financial strategy that considers the type and level of financial risks, the availability of risk management tools, and the operating environment of the firm. Moreover, corporations rely heavily on pass-through, operational hedging, and foreign currency debt to manage financial risk.
Risk And Hedging Behavior: The Role And Determinants Of Latent Heterogeneity
Joost M. E. Pennings, Philip Garcia Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 373-401 The notion of heterogeneous behavior is well grounded in economic theory. Recently it has been shown in a hedging context that the influence of risk attitudes and risk perceptions varies for different segments using a generalized mixture regression model. Here, using recently developed individual risk attitude measurement techniques and experimental and accounting data from investors with differing decision environments, we examine the determinants of heterogeneity in hedging behavior in a concomitant mixture regression framework. Allowing for latent heterogeneity, we find that risk attitudes and risk perceptions do not influence behavior uniformly and that the heterogeneity is influenced by manager's focus on shareholder value and the firm's capital structure.
The Daylight Saving Time Anomaly In Stock Returns: Fact Or Fiction?

Russell Gregory-Allen, Ben Jacobsen, Wessel Marquering Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 403-427 Stock market returns in 22 markets around the world show no evidence of a daylight saving time effect. Returns on the days following a switch from or to daylight saving time do not behave any differently from stock market returns on any other day of the week or month. These results reject earlier conclusions in the literaturebased on less datathat investors mood changes induced by changes in sleep patterns significantly affect stock returns.
46
Daylight And Investor Sentiment

Jeffrey R. Gerlach Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 429-462 Kamstra, Kramer, and Levi (2000, 2003) describe two stock market behavioral anomalies associated with changes in investor sentiment caused by daylight saving time (DST) changes and seasonal affective disorder (SAD). According to the hypothesized effects, DST changes and SAD affect asset prices by changing investors risk aversion. Although changes in the timing or amount of daylight are correlated with unusual stock market returns, I present evidence they do not cause those unusual returns. Instead, seasonal patterns in market-related information during the sample period are the likely cause of the correlation between stock market returns and DST changes or SAD.
Short Selling And Mispricings When Fundamentals Are Known

Sean Masaki Flynn Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 463-486 The larger a closed-end fund's premium over its portfolio value, the more intensely it is sold short. This behavior should reduce mispricings. However, short selling affects neither the observed rate at which premia revert to fundamental values nor the rate of return on a fund's shares. This apparent contradiction can be explained as follows: short selling does reduce prices, but the effect is impounded into prices by the time short positions are tabulated by the NYSE each month. Consequently, the monthly short selling data do not predict future price movements.
Determinants Of Capital Structure In Business Start-Ups

Tom Franck, Nancy Huyghebaert Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 487-517 According to the finance literature, nonfinancial stakeholders (NFS), such as customers, suppliers, and employees, take into account their expected liquidation costs when dealing with a firm. In this framework, firms can influence their probability of liquidation by choosing an appropriate capital structure. Also, the literature suggests NFS bargaining power may affect firm financing decisions. In the current article we investigate these ideas for initial financing decisions by business start-ups, where ex ante failure risk is high and NFS must decide whether to make relationship-specific investments. We find that start-ups imposing larger costs on their NFS following liquidation significantly reduce leverage. This effect is strengthened when suppliers have greater bargaining power. We also document a marginally negative effect of NFS liquidation costs on the proportion of bank loans. Finally, business start-ups rely less on bank loans when customers and suppliers are in a powerful bargaining position.
47
Sustainable Growth And Stock Returns

Larry Lockwood, Wikrom Prombutr Journal of Financial Research Published Online: Dec 2010 Volume 33 Issue 4, Pages 519-538 We examine relations between sustainable growth and stock returns over 19642007. Findings indicate that high sustainable growth firms tend to have low default risk, low book-to-market ratios, and low subsequent returns. Of the four sustainable growth components, we find that the net profit margin is the major determinant of subsequent returns. Results persist after controlling for asset growth and capital expenditure growth. Additional tests indicate that the sustainable growth effect is attributable to risk and not to mispricing.
48
49
JOURNAL 3
Journal of Portfolio Management
50
Winter (2010)
Portfolio of Risk Premia: A New Approach to Diversification
Jennifer Bender, Remy Briand, Frank Nielsen, Dan Stefek The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 1725 Traditional approaches to structuring policy portfolios for strategic asset allocation have not provided the full potential of diversification. Portfolios based on a 60/40 allocation between equities and bonds remain volatile and dominated by equity risk. In this article, the authors introduce a different approach to portfolio diversification, constructing portfolios using available risk premia within the traditional asset classes or risk premia from systematic trading strategies rather than focusing on classic risk premia, such as equities and bonds. Correlations between many risk premia have historically been low, offering significant diversification potential, particularly during periods of distress. These diversification benefits are illustrated with a simple asset allocation case study. From 1995 to 2009, an equal-weighted allocation across 11 style and strategy premia realized similar returns to a traditional 60/40 allocation, but with 70% less volatility.
Horizon Diversification: Reducing Risk in a Portfolio of Active Strategies

Simon Polbennikov, Albert Descle, Jay Hyman The Journal of Portfolio Management Winter 010, Vol. 36, No. 2: pp. 26-38 A primary mechanism for controlling portfolio risk is diversification. Diversification is typically addressed by distributing assets among investment sectors and issuers, preferably with low correlations among their returns, a process that can be called asset diversification. The risk reduction from this type of diversification can be less than expected in the midst of a crisis as correlations increase across market segments. The authors of this article consider a new approach to managing the active risk profile of a portfolio, an approach that uses active strategies rather than asset allocations as its basic building blocks. The authors show that in this framework, risk reduction is achieved by a combination of two distinct mechanismsasset diversification and signal diversification. Combining alpha strategies based on independent signals can help reduce portfolio risk, even when the returns of the underlying assets are correlated. One way to achieve signal diversification is by combining strategies with various investment horizons or trading frequenciesa technique the authors call horizon diversification. Horizon diversification is an intuitive and robust way to decrease risk in a portfolio of active strategies.
51
Efficient Replication of Factor Returns: Theory and Applications

Dimitris Melas, Raghu Suryanarayanan, Stefano Cavaglia The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 39-51 This article presents alternative methods for constructing factor-replicating portfolios, which include portfolios that have unit exposure to a target factor, zero exposure to other factors, and minimum portfolio risk. The authors provide empirical evidence that constrained factor portfolios, with a limited number of assets and relatively low turnover, tracked several Barra equity risk model pure factor returns reasonably well. They also illustrate how factor-mimicking portfolios could have been utilized in the past to enhance both passive and active investment strategies. Factor-mimicking portfolios can be used to hedge out the unintended factor exposures of conventional benchmarks, which are aimed at targeting a particular beta factor, and thus enable plan sponsors to better manage their optimal allocations to beta factor risks. Additionally, factor-mimicking portfolios can be utilized to hedge out the style exposures of active stock-picking strategies enabling active managers to capture pure alpha.
Know Your VMS Exposure

Roger G Clarke, Harindra De Silva, Steven Thorley The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 52-59 One of the ongoing debates in equity market research is the set of common factors that explains the cross section of individual stock returns. With the influential backing of Fama and French [1993], a three-factor model that includes the market, size, and value factors is frequently cited in academic research and widely used in portfolio management. More recently, momentum has joined the list of accepted factors, resulting in references to a four-factor model. Lately, security volatility has begun to be used, along with the factors just mentioned, in describing portfolio risk. The authors introduce a specific measure of the idiosyncratic volatility factor that mirrors the FamaFrench methodology, calling it VMS for volatile-minus-stable stocks. VMS is calculated for the entire span of the CRSP database and found to have strong credentials. VMS seems to be more important than SMB (small-minusbig market capitalization) and HML (high-minus-low book-to-market ratio), and similar to UMD (up-minus-down past return) in explaining the covariance structure of stock returns. The relative importance of VMS holds over the entire history for which it can be measured in the U.S. market (19312008) and continues to be an important factor in the covariance structure of stock returns in recent decades (1983 2008). Volatility, however, is not very orthogonal to the more well-known factors, a desirable property for new factors. Specifically, VMS is highly correlated to the general market (e.g., volatile stocks outperform stable stocks when the general equity market goes up) despite the fact that the authors measure security volatility in a market-idiosyncratic setting. VMS is also positively correlated with SMB (e.g., volatile stocks tend to outperform when small-cap stocks outperform) despite the FamaFrench process of double sorting on market capitalization. Finally, VMS is negatively correlated with HML (e.g., volatile stocks tend to outperform when growth stocks outperform) although this correlation was not pronounced until the last few decades. In contrast to the other FamaFrench factors, the average return of the VMS factor has been close to zero over time and negative in recent decades.
52
Maybe It Really Is Different This Time

Robert C Jones The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 60-72 It is often said that the most dangerous words an investor can utter are: This time its different. Yet, in this article, the author argues exactly thatthe tried-and-true quantitative stock-selection strategies, such as value and momentum (or at least the simple versions of these strategies), which have been very successful for many years, are unlikely to add much value going forward after adjusting for risks, fees, and trading costs. Before the article culminates with this conclusion, however, the author presents both sides of the argument, analyzes the data from new angles, and provides several reasons why it really might be different going forward before concluding with several suggestions for how managers can help add alpha in the future.
Optimizing Carry Pickup in Real Money Portfolios

Pavan Wadhwa, Christian ODonnell The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 73-79 Earning carry to enhance portfolio performance is a core theme for many fixedincome portfolio managers. In this article, the authors analyze the historical performance of five different carry strategiesyield curve, credit curve, liquidity, FX, and volatility carryin various currencies over the past six years and suggest ways to combine these strategies to earn optimal risk-adjusted returns in fixedincome portfolios by constructing an efficient frontier.The results of the authors research indicate that 1) earning liquidity or volatility carry is alone unlikely to significantly improve portfolio returns, 2) moving up the yield curve and down the credit curve are key sources of carry in fixed-income portfolios, 3) diversifying across carry strategies should significantly improve the average information ratio, and 4) diversifying across currencies within a carry strategy is unlikely to result in significantly reduced risk.
Finding Fair Value in Global Equities: Part I

Jessica Binder, Anders Ersbak Bang Nielsen, Peter Oppenheimer The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 80-93 This article, the first of a two-part series, develops a framework for comparative valuation of major equity markets around the world. The authors outline four stages of a dividend discount model and the sensitivity of the models valuation results to key assumptions.They then summarize their results using the following three valuation scenarios: 1) central scenariovalues the market taking the bond yield as a given and using an equity risk premium (ERP) adjusted for the economic environment; 2) fair value scenariovalues the market assuming that the ERP and the bond yield are at their fair value levels given the economic environment; and 3) equilibrium value scenariovalues the market assuming the long-run average ERP and a real bond yield of 2%; this scenario is a not a measure of current fair value, but a measure of the upside potential for markets if the discount rate were to normalize.
53
Regimes: Nonparametric Identification and Forecasting

Hakan Kaya , Wai Lee , Bobby Pornrojnangkool The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 94-105 The practice of categorizing individual time periods with economic regimes, such as recession, depression, and expansion, is commonplace and has a strong influence on the return assumptions employed as inputs in asset allocation models. Unfortunately, methodologies used to determine whether a period belongs to a given regime vary in their effectiveness and can be inexact. In this article, the authors offer an alternative nonparametric approach that emphasizes current conditions rather than preset regime characteristics and draws on probabilities to reflect the reality that no two economic periods are identical.The authors also include case studies through which they illustrate and apply their recommendations.
The Ps of Pricing and Risk Management, Revisited

Vineer Bhansali The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 106-112 Traditional pricing and risk management principles have to be reconsidered in the light of the involvement of large public and private participants in the securities markets. The author explores the impact of the actions of participants on the building blocks of asset pricing models as well as the emergence of the impact of the policy factor on asset pricing and risk measurement. This discussion re-emphasizes the need for simple principles for asset selection and portfolio construction.
Correlation and Volatility Dynamics in REIT Returns: Performance and Portfolio Considerations
Peng Fei, Letian Ding, Yongheng Deng The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 113-125 In this article, the authors examine the dynamics of the correlation and volatility of REITs, stocks, and direct real estate returns using monthly data from January 1987 to May 2008. In order to explore asymmetries in conditional correlation, the authors use a multivariate asymmetric dynamic diagonal conditional correlation (AD-DCC) GARCH specification. They document that the time-varying conditional correlations can be explained by macroeconomic variables, such as term and credit spreads, inflation, and the unemployment rate, and they find a strong relationship between correlations and REIT returns and that the patterns are distinguishable for different types of REITs. Interestingly, when the correlation between REITs and the S&P 500 is at its lowest, the future performance of REITs is at its highest. For equity REITs, a robust relationship exists between correlations and future returns; that is, the higher (lower) correlation between equity REITs and direct real estate, the higher (lower) the future returns of equity REITs. The authors results have economic implications regarding the time-dependent diversification benefits of REITs in a mixed-asset portfolio and the unique risk and return characteristics of REITs.
54
Illiquidity and Portfolio Risk of Thinly Traded Assets

Ping Cheng , Zhenguo Lin , Yingchun Liu The Journal of Portfolio Management Winter 2010, Vol. 36, No. 2: pp. 126-138 This article addresses two major issues with the current practice of real estate investment analysis: 1) applying finance theory without modification and 2) ignoring illiquidity in formal analysis.The authors develop a new, closedform ex ante risk metric that quantifies illiquidity risk and integrates it with real estate price risk.Such integration provides a formal and easy-to-use analytical tool for real estate pricing and enables an apples-to-apples comparison between the performances of real estate and financial assets. Using commercial real estate data, the authors demonstrate that the conventional risk measure significantly understates the true risk of real estate.Their results also reveal the relative importance of price and illiquidity risk components to the total ex ante risk
Spring (2010)
Crisis and Innovation
Robert J. Shiller The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 1419 In this article, Shiller articulates the need for innovation enhancing regulation, not regulation that arbitrarily ties markets down. In the several years since the crisis began in 2007, only the first couple of stages of crisis response have been experienced. Other stages are expected. The next stage will be one in which the markets are made fundamentally more resilient and less prone to crisis.The final stage of response will be one in which the scope and depth of financial markets are expanded in order to move closer to completing the fundamental task of risk management, broadly construed.Together, all of these stages of response might take 10 years or longer.
Risk Management Lessons Worth Remembering from the Credit Crisis of 20072009
Bennett W. Golub and Conan C. Crum The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 2144 This article by Golub and Crum presents six important lessons worth remembering from the credit crisis of 20072009.The recent credit crisis revealed the inadequacy of many standard methods in quantitative risk management and called into question the general efficiency of markets. Golub and Crums analysis of the six lessons learned provides insights into what went wrong and offers advice on steps that institutions can take to avoid similar failures in the future.The authors present
55
detailed analysis on risk management issues relating to liquidity, securitized products, certification,market risk, and policy risk.
Accentuated Intraday Stock Price Volatility: What is the Cause?

Deniz Ozenbas , Michael S. Pagano and Robert A. Schwartz The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 4555 In equity markets, the opening and closing of trading are particularly stressful periods. Ozenbas, Pagano, and Schwartz investigate the quality of price determination at these times (compared to midday periods) for large-, mid-, and small capitalization stocks on the NYSE, NASDAQ, and London Stock Exchange. Using three different metrics, they consistently find lower quality at both the open and the close. The deterioration of market quality at openings is greatest for large-cap stocks, but no systematic association with cap size is observed at the close. Large-cap stocks evidently lead smaller-cap stocks in finding new equilibrium values, and accentuated volatility at the open is in large part attributable to the complexities of price discovery.
Finding Fair Value in Global Equities: Part IIForecasting Returns

Kevin Daly , Anders Ersbak Bang Nielsen and Peter Oppenheimer The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 5670 This article is the second of a two-part series that develops a framework for comparative valuation of major equity markets around the world. In this article, the authors invert the dividend discount model (DDM) discussed in Fair Value in Global Equities: Part I, published in the preceding issue of this journal, in order to extract a time series of the implied equity risk premium (ERP) and the real required return (RRR).They estimate regression equations to find the macroeconomic drivers of these series. The ERP increases with the output gap at home and abroad, as well as with high past values of the ERP. This relationship allows for benchmarking the ERP and the RRR to the current economic environment and to forecasts of the future economic environment. The authors compare the use of these tools with other ways to forecast returns. At a five-year horizon, valuation alone is a good predictor of future returns, and the current value of the RRR works particularly well in this regard. At a one-year horizon, forecasts based on the benchmarking of the RRR to the future economic environment work significantly better than traditional valuation metrics, if the economic outlook is correct.
56
Stocks of Admired and Spurned Companies

Deniz Anginer and Meir Statman The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 7177 Do stocks of admired companies yield admirable returns? Are increases in admiration followed by high stock returns, and how reliable is the relation between admiration and returns? These questions are answered by Anginer and Statman based on their study of Fortune magazines annual list Americas Most Admired Companies. They find that from April 1983 through December 2007 stocks of admired companies had lower returns, on average, than stocks of spurned companies and that increases in admiration were followed, on average, by lower returns. The authors also find that the dispersion of returns is high, especially in the portfolio of spurned company stocks, implying that investors who would like to benefit from the return advantage of spurned company stocks must diversify widely among them.
A Valuation Study of Stock Market Seasonality and the Size Effect

Zhiwu Chen and Jan Jindra The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 7892 Existing studies on market seasonality and the size effect are largely based on realized returns. In this article, Chen and Jindra investigate seasonal variations and size-related differences in a cross-stock valuation distribution. They use three stock valuation measures, two derived from structural models and one from the book-tomarket ratio. The authors find that the average valuation level is highest in midsummer and lowest in mid-December. Furthermore, the valuation dispersion (kurtosis) across stocks increases toward year-end and reverses direction after the turn of the year, suggesting increased movements in both the under and overvaluation directions. Among size groups, small-cap stocks exhibit the sharpest decline in valuation from June to December and the highest rise from December to January. For most months, small-cap stocks have the lowest valuation among all size groups and show the widest cross-stock valuation dispersion, meaning that they are also the hardest to value. Overall, large-cap stocks enjoy the highest valuation uniformity and are the least subject to valuation seasonality.
Do Seasonal Anomalies Still Work?

Constantine Dzhabarov and William T. Ziemba The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 93104 Dzhabarov and Ziemba investigate whether traditional seasonal anomalies, such as the January effect, monthly effect, January barometer, sell-in-May-and-go-away phenomenon, holiday effect, and turn-of-the-month effect, still exist in the turbulent
57
markets of the early part of the 21st century.The evidence indicates that there is still value in these anomalies. In their study, the authors use futures data from 1993 to 2009 and from 2004 to 2009 for small-cap stocks measured by the Russell 2000 Index and for large-cap stocks measured by the S&P 500 Index.As was true in the 1990s, the effects tend to be stronger in small-cap stocks.The results are useful for investors who wish to tilt portfolios and for speculators who wish to trade the effects.
Volatility Exposure for Strategic Asset Allocation

Marie Brire , Alexandre Burgues and Ombretta Signori The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 105-116 Brire, Burgues, and Signori examine the advantages of incorporating strategic exposure to equity volatility into the investment opportunity set of a long-term equity investor. They consider two standard volatility investments: implied volatility and volatility risk premium strategies. An analytical framework, which offers pragmatic solutions for longterm investors who seek exposure to volatility, is used to calibrate and assess the riskreturn profiles of portfolios. The benefit of volatility exposure for a conventional portfolio is shown through a mean-modified Value at Risk portfolio optimization. A pure volatility investment makes it possible to partially hedge downside equity risk and thus reduce the risk profile of a portfolio, while an investment in the volatility risk premium substantially increases returns for a given level of risk. A well-calibrated combination of the two strategies enhances both the absolute and risk-adjusted returns of a portfolio.
Valuation-Indifferent Weighting for Bonds

Robert D. Arnott , Jason C. Hsu , Feifei Li and Shane D. Shepherd The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 117-130 In historical testing, valuation-indifferent weighting applied to U.S. and global equities has produced statistically significant and economically large outperformance when compared with traditional capitalization-weighted benchmarks. In this article, the authors apply valuation-indifferent weighting to U.S. investment-grade corporate bonds, U.S. high-yield bonds, and hard-currency emerging market bonds.They find that fixed-income portfolios constructed using valuation-indifferent weighting outperform their corresponding cap-weighted benchmarks. The authors also find that the outperformance is higher for markets in which more inefficiencies and greater volatilities would be expected to occur. Both findings are consistent with the empirical evidence produced in the equity applications of valuation-indifferent weighting, as well as in the proposed noise-in-price theoretical rationale for the results.
58
A Bond-Picking Model for Corporate Bond Allocation

Mathieu LHoir and Mustafa Boulhabel The Journal of Portfolio Management Spring 2010, Vol. 36, No. 3: pp. 131139 An active investment process in corporate bonds requires an approach that explicitly takes into account the diversification benefits that can be derived from a combination of alpha signals. The main challenge is to find indicators that fulfill at least two conditions. First, each individual alpha signal should achieve consistent performance on a univariate basis, and second, each should exhibit relatively low performance correlation because low correlation is a necessary condition for generating a diversification effect. LHoir and Boulhabel show that the combination of three types of signalsvaluation signals, equity return signals, and earning momentum signalsfulfills the aforementioned conditions and delivers consistent and stable risk-adjusted returns. The authors present the results of their study for the U.K. corporate bond market.
59
Summer (2010)
Active Portfolio Management and Positive Alphas: Fact or Fantasy?
Robert A. Jarrow The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 17-22 It is commonly believed that active portfolio management can generate positive alphas. This is partly based on the belief that positive alphas represent disequilibrium returns, which can exist in complex financial markets. In contradiction, this article shows that positive alphas represent arbitrage opportunities, not just disequilibrium returns.As persistent and frequent arbitrage opportunities are much rarer, even in complex markets, Jarrow argues that positive alphas are more fantasy than fact. He introduces the notion of an unobservable factor that can generate false positive alphas, and which resolves the inconsistency between common belief and the sparsity of positive alphas.
Signal Weighting
Richard Grinold The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 2434 Signal weighting is the name commonly used for the allocation of risk between several potential sources, or themes, each of which is assumed to have some potential for adding value. The signal-weighting decision is an important facet of any investment process. Grinold presents a portfolio-based approach to the choice of signal weights in the presence of trading costs. In the absence of costs, the weights depend on the assessed strength of the signalsthe correlations between the signal and the desired level of portfolio risk. In the presence of costs, the method also depends critically on the rate that new information arrives for each of the signals as well as the rate of change (trading speed) of the portfolio. The resulting model is robust and relatively simple to use. The model also forces portfolio managers to view their portfolios and their respective drivers as objects in motion. That change of perspective alone is valuable. Technical material is contained in two appendices that can be obtained from the author.
60
Thinking about Indices and Passive versus Active Management

Russell J. Fuller , Bing Han , and Yining Tung The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 3547 Trillions of dollars are indexed to various benchmarks, which the authors refer to as paper indices. Paper indices are based on a surprisingly large number of arbitrary, active decisions that are made by the organizations that sponsor them. Fuller, Han, and Tung investigate the importance of these active decisions on benchmark returns by constructing their own paper index, allowing them to estimate the amount of shortfall relative to their index that an indexer would incur due to transaction costs related to mimicking the index. The estimated shortfall is 2 to 4 basis points a year, depending upon the assumptions made regarding transaction costs. The authors also show that traditional indexing, relative to the benchmark they constructed, can be improvedusing only market value data available to any indexerby about 25 to 30 basis points a year after transaction costs. The authors conclude that no investment strategy is passive. Although the strategy of traditional indexing has a number of attractive attributes, it is not passive in the sense that the word passive is commonly used.
Constraint Attribution
Robert A. Stubbs and Dieter Vandenbussche The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 4859 Constraints are now an integral part of the portfolio construction process. With constraints comes the challenge of understanding how they cause the optimal portfolio to deviate from a trade-off dictated by the forecasts of risk and return. Stubbs and Vandenbussche describe the theory and application of a technique that is able to quantify the impact of individual constraints in several different ways, including decomposing the difference between the optimal constrained and unconstrained portfolios as well as the difference between alphas and implied alphas as described in earlier work by Grinold and others. The authors also introduce a new technique that applies these decompositions on an ex post basis, thus providing an understanding of how constraints actually impact realized risk and return.
61
The Properties of Equally Weighted Risk Contribution Portfolios

Sbastien Maillard , Thierry Roncalli , and Jrme Teletche The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 6070 Minimum-variance portfolios and equally weighted portfolios have recently prompted great interest from both academic researchers and market practitioners because their construction does not rely on expected average returns and, therefore, is assumed to be robust. In this article, the authors consider a related approach in which the risk contribution from each portfolio component is made equal, maximizing the diversification of risk, at least, on an ex ante basis. Roughly speaking, the resulting portfolio is similar to a minimum-variance portfolio subject to a diversification constraint on the weights of its components. The authors derive the theoretical properties of such a portfolio and show that its volatility is located between those of minimum-variance and equally weighted portfolios. Empirical applications confirm that ranking. Equally weighted risk contribution portfolios appear to be an attractive alternative to minimum-variance and equally weighted portfolios and, therefore, could be considered a good trade-off between the two approaches in terms of absolute risk level, risk budgeting, and diversification.
Rewarding Fundamentals
Eric H. Sorensen and Sanjoy Ghosh The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 7176 Over the decades there has been an ubiquitous fixation on earnings power, earnings momentum, earnings announcements, earnings surprises, and the like. The clear explanation is that stock valuations and prices are impacted by earnings changes more than any other phenomenon. Sorensen and Ghosh analyze the hypothetical value of accurate (perfect) earnings forecasting over the past 20 years with lead horizons of 3 to 15 months. The returns for top-quintile stocks ranked by positive earnings relative to forecasts are consistently higher than bottom-quintile stocks that posted earnings below ex ante expectations. The return differentials are extraordinary, consistent over the years, larger with longer forecast horizons, and larger for stocks with tighter ex ante forecasts.
Portfolios Weighted by Repurchase and Total Payout

Jack Clark Francis , Christopher Hessel , Jun Wang , and Ge Zhang The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 7783 Portfolios weighted by fundamental measures of company size, such as assets, dividends, sales, earnings, and employees, have recently attracted a lot of attention. Pioneering research has showed that these fundamental valueweighted portfolios, especially dividend-weighted portfolios, can achieve better mean returns and better
62
Sharpe ratios than could be attained with the traditional market value weighted portfolio. In this article, the authors examine three portfolios weighted by the additional fundamental measures of firm sizeshare repurchases, total payout, and earnings retentionand find that the repurchase-weighted portfolios and total payoutweighted portfolios have higher excess returns and higher Sharpe ratios than the other fundamental valueweighted portfolios, including the dividend-weighted portfolio. The repurchase-weighted portfolio shows a positive and statistically significant alpha of 2.77% after controlling for the FamaFrench factors (market, size, and book-to-market) and Carharts momentum variable. The total payout weighted portfolio also has a positive and significant alpha, albeit smaller than that of the repurchase-weighted portfolio.
Reflections on Buy-Side Risk Management after (or Between) the Storms

Bennett W. Golub and Conan C. Crum The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 8492 This article highlights and emphasizes the importance of eight specific principles of risk management. The credit crisis of 20072009 has clearly reaffirmed the importance of a strong and effective risk management function, and these eight principles will help buy-side institutions think through their risk management organizations. In this article, Golub and Crum make the case for the importance of institutional buy-in, alignment and management of institutional interests, getting risk takers to think like risk managers, a fully engaged but independent risk management organization, understanding fiduciary obligations, bottom-up risk management, and constant monitoring of risk models for accuracy and relevanceand that risk management does not mean risk avoidance.
The Problems and Challenges of High-Yield Bond Benchmarking

Robert Levine , Eve Drucker , and Steven Rosenthal The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 9398 High-yield bond benchmarks are often the major factor considered when evaluating the performance of high-yield bond managers. Levine, Drucker, and Rosenthal show that major indices are sometimes hard to beat and at other times easy to beat, and offer several reasons in support of their contention. The authors discuss the structural differences between the high-yield bond and equity markets as well as the properties of high-yield bond indices that make appropriate benchmarking in the high-yield bond market very challenging. The authors also provide a summary of the inclusion rules of several primary indices used as high-yield bond benchmarks. The conclusion reached by the authors is that the limitations of benchmarks, especially of high-yield benchmarks, should be kept in mind when a high-yield bond fund is compared to a high-yield bond index, and that high-yield bond fund performance is best judged within the context of the investors investment guidelines. Because plan sponsors
63
often rely on benchmarks in compensating managers who beat the benchmark, in 2009 very few high-yield bond management professionals likely received bonuses despite great performance because they did not beat their benchmarks. In 2008, however, many managers received bonuses despite the high-yield bond markets 26% loss, because the majority of funds outperformed their benchmarks. Something seems to be amiss. Beating major high-yield bond indices is sometimes difficult and sometimes easy, and plan sponsors should be aware of this phenomenon when compensating managers based upon their performance relative to their benchmarks.
Market-Based Default Rate Forecasting

Karen Sterling and Martin Fridson The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 99-106 Forecasting the speculative-grade default rate provides an informational edge in managing both corporate bond risk and loan default risk. Credit analysts have developed three types of models for this purpose: actuarial, econometric, and marketbased. Fridson and Sterling introduce a market-based model derived from the distress ratio, which is defined as the percentage of issues within the high-yield bond index quoted at spreads greater than 1,000 basis points, or 10 percentage points, over the rate on U.S. Treasuries. The Default Rate Projector estimates the one-year-forward default rate using historical default rates on distressed and non-distressed issues. Comparison of the models forecasts with subsequent, actual default rates shows that the markets assessment of default risk is generally accurate.
Warren Buffett, BlackScholes, and the Valuation of LongDated Options

Bradford Cornell The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 107111 In his 2008 letter to Berkshire shareholders, Warren Buffett presented a critique of the BlackScholes option pricing model as a tool for valuing long-dated options, including options that Berkshire had written. Given Mr. Buffetts track record, it is worth investigating precisely why he thinks the BlackScholes model fails to provide a fair value for long-dated options. The alleged deficiencies in the model are, unfortunately, not transparent, because Mr. Buffetts letter does not develop his viewpoint in terms of option pricing theory. In this article, Cornell fills the gap by interpreting Mr. Buffetts argument in the context of option pricing theory and reveals that Mr. Buffett is really making a statement about political economics more than about option pricing.
64
Educational Endowments in Crises

William N. Goetzmann , John Griswold , and Yung-Fang (Ayung) Tseng The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 112-123 Whether measured by institutional failures, asset price declines, or shocks to the real economy, the financial crisis of 2008 is widely viewed as the worst since the Great Depression. The turmoil has been particularly acute for institutions that rely heavily on financial assets to fund operations. Consequently, some universities with large allocations to illiquid alternative asset classes have disclosed liquidity problems as a reason for basic changes in strategy and services. Goetzmann, Griswold, and Tseng explore whether these effects on institutions will be long lasting, particularly if the global economic recovery is slow to materialize. In this article, the authors review data from previous studies on educational endowments extending back into the 1920s, examining the allocation policies from the early 20th century, and exploring the policies effects on asset values and endowment spending. Although similarities are noted between the endowment environments then and now, differences exist as well. In the late 1970s and early 1980s, the modern endowment model, which employs broad diversification, invests for total return with a strong equity bias, maintains a low cash allocation, and spends a percentage of total return, began to be widely adopted. The modern endowment model has recently undergone a paradigm shift away from publicly traded securities toward alternative assets, and a similar change in thinkingthe decision to embrace new era equity investing to achieve diversificationoccurred in the period of the authors study. The authors consider whether the adoption of a new philosophy of investing benefited endowments during the Great Depression and if the adoption of a new philosophy of investing would provide a useful decision framework for managers today.
A Style-Based Market Risk Model for Hedge Fund Portfolios

Xuelong Zhou , Adam Litke , and Michael Mclaughlin The Journal of Portfolio Management Summer 2010, Vol. 36, No. 4: pp. 124-131 In this article, the authors develop a market risk model for hedge fund portfolios by integrating cluster analysis, extreme value theory (EVT), and copula modeling. Because the cluster model is exclusively based on fund returns, cluster classifications are more objective than self-reported styles. The EVT contribution considers the fattailed distribution of hedge fund returns, implicitly accounting for jump risk. The copula method accounts for the dependence between clusters. Two Gumbel copulas are constructedone on the average returns of funds in the clusters, and the other on returns of all funds in the clusters. The first copula is directly applicable to a highly diversified portfolio and the authors show how to apply this copula to a general hedge fund portfolio. The second copula is suitable for simulations on nondiversified portfolios and also provides a tool for stress tests. Monte Carlo simulations indicate that investing in a broadly diversified hedge fund portfolio is not riskier than investing in a traditional diversified portfolio.
65
Fall (2010)
On the Persistence of Style Returns
Stan Beckers and Jolly Ann Thomas The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 15-30 Most actively managed portfolios have either a transient or a permanent style bias. The question of whether style returns can be forecasted or timed is therefore intriguing. In this study, Beckers and Thomas focus on the persistence and predictability of the Barra style returns in the U.S., Europe, and Japan. Most of these style factors have, at times, been rewarded with significant risk premia. The authors show that actively betting on the persistence of historically significant style returns leads to noticeable outperformance as demonstrated by high information ratios. Exactly capturing the style returns is not straightforward, however. The authors thus analyze whether long-only and 130/30 style-tilted portfolios can approximate the desired style effects. Although these portfolios cannot fully replicate the pure style return, they are still extremely useful as part of a diversified style overlay strategy. The authors results indicate that style-tilted overlays can enhance the arsenal of active portfolio managers and that a judiciously diversified exposure to style-tilted overlays would have added significant value in the past.
Finding Better Securities while Holding Portfolios: Is Stochastic Dominance the Answer?
Haim Shalit The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 31-42 Investment managers always look for securities to improve their portfolio performance and a common mechanism is the mean-variance (MV) model. As an alternative, Shalit proposes using marginal conditional stochastic dominance (MCSD), which ensures that all risk-averse investors benefit from the selection process by establishing the relative preference among stocks conditional on holding a specific portfolio. He describes the basic MCSD rules and applies them to large portfolios. The resulting preferred stocks are compared to the selection obtained using the mean-variance criterion and the CAPM.
66
Designing the New Policy Portfolio: A Smart, but Humble Approach

Frederick E. Dopfel The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 43-52 Is the policy portfolio dead? Should investors replace strategic policy with tactical portfolios? These challenging questions have arisen lately as investors have suffered rare downside events and are facing a more uncertain future. In this article, Dopfel attributes the recently experienced, surprisingly wide dispersion of investment returns to the presence of economic and financial market regimesboth good and bad. A regime framework, though, presents new challenges for a strategic policy portfolio because optimal portfolios vary greatly depending on the presumed regime and its underlying investment assumptions. In this setting, the investment performances of two strategic investorsNave and Smart, but Humbleare compared with the performances of two tactical investorsMyopic and Prophetic. As their nicknames suggest, the hypothetical investors possess differing levels of skill in their abilities to forecast regimes. The Smart, but Humble investor provides a model for the new policy portfolio by setting a strategic policy that accounts for the additional uncertainty associated with regime shifts (i.e., smart), while declining to time the market (i.e., humble).
A Scenarios Approach to Asset Allocation

Susan Gosling The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 53-66 A number of different approaches to asset allocation are used by practitioners, including purely qualitative assessment, simple mean-variance analysis, and more complex multifactor modeling. Since Markowitz published his seminal paper in 1952, however, approaches that rely on the selection of particular parametric return distributions, on summary measures of risk, and on historical data as an indicator of the future still remain widespread. Little doubt exists that such reliance has resulted in serious mismeasurement of risk and misallocation of assets. In this article, Gosling proposes an alternative approach that is important in its implications for investment philosophy and practice. The approach makes more complete use of the information available about the future and virtually forces serious consideration of different time frames, alternate outcomes, and tail risk. The depth of information provided about risk and diversification is also a principal benefit of the approach. The information is not provided by forecasting the future, but by describing what could happen. These changes have the potential to make a significant difference to long-term investment outcomes.
67
Measuring Global Systemic Risk: What Are Markets Saying about Risk?
Rodney N. Sullivan , Steven P. Peterson , and David T. Waltenbaugh The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 67-77 Extreme market movements, especially in recent years, have prompted efforts to better understand the complexities of market dynamics. In this article, Sullivan, Peterson, and Waltenbaugh explore the features that characterize market environments through time. The authors first demonstrate how market distress impacts return distributions and then propose a global systemic risk indicator that jointly connects market conditions across asset classes using a multivariate failure model. The systemic risk barometer the authors devise determines how a set of complex, interconnected attributes coordinate to describe turbulent market environments and the likelihood that markets are either in or entering a crisis phase. By combining high-frequency information that measures changes in key variables across time and across markets, the proposed risk hazard model yields valuable insight into the changing nature of market risks over time, both within and across markets.
Offensive Risk Management II: The Case for Active Tail Hedging
Vineer Bhansali and Joshua M. Davis The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 78-91 Bhansali and Davis define offensive risk management as the use of tail hedges in a portfolio as a way for investors to allocate more capital to risky assets and simultaneously reduce the risk of large investment losses. If the hedge is purchased at the right price, the portfolio with tail risk hedges may have a more attractive risk return profile than a buy-and-hold portfolio. The authors show, in the context of the 80-year history of the Standard & Poors Index, that intuitive rules of thumb for monetization can be justified and that the active management of tail hedges is consistent with the cyclical behavior of the economy and the markets.
On the Consistent Use of VaR in Portfolio Performance Evaluation: A Cautionary Note

Valeri Zakamouline The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 92-104 The portfolio performance measures based on the Value at Risk (VaR) concept have gained widespread popularity and are often used in empirical studies. In the majority of empirical studies, however, a VaR-based performance measure is inconsistently used. In this article, Zakamouline emphasizes how to consistently use VaR in
68
portfolio performance evaluation. He also elaborates on a simple framework that allows the derivation of a general formula for a portfolio performance measure that is not limited to the use of VaR-based reward and risk measures, but is valid for all reward and risk measures that satisfy a few plausible properties.
Is Patience a Virtue? The Unsentimental Case for the Long View in Evaluating Returns
David L. Donoho, Robert A. Crenian, and Matthew H. Scanlan The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 105-120 In this article, Donoho, Crenian, and Scanlan report the results of their study into the cost of institutional investor impatience. Using Monte Carlo simulation techniques, the authors construct an idealized world with a universe of investment managers of precisely quantified skill, with skill levels varying among the managers. Although many institutions base manager hiring decisions heavily on the managers performance in the most recent months or years, the authors simulations show that institutions that rely on longer performance horizons of 510 years are more likely to find and stick with the better managers. This happens because on shorter time scales, the relatively few highly skilled managers are often temporarily outperformed by one of the many lesser-skilled managers, specifically, unskilled managers who have recently happened to simply be lucky. Hence, if a plan that previously was long-term oriented starts to hire managers based on short-term results, it will often find that the newly chosen manager underperforms both his own previous performance and also the manager previously managing the plans funds. It can, however, truly take patience to keep a skilled manager in a fund portfolio. In the authors simulations, skilled managers have deeper, longer, and more frequent drawdowns than many investors would expect.
The Empirical Law of Active Management: Perspectives on the Declining Skill of U.S. Fund Managers
Edouard Snchal The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 121-132 Snchal proposes a new analytical frameworkthe empirical law of active managementto assess the breadth, or diversification, and the skill of a portfolio manager. The framework requires no assumptions regarding a managers asset return expectations or investment process. The framework generalizes the fundamental law of active management introduced by Grinold in 1989 and creates an analytical framework for measuring skill and diversification in a consistent manner for large cross sections of funds. The author applies this framework to analyze the evolution of skill and of diversification since 1980 for 2,798 U.S. mutual funds. He finds that skill has been declining among U.S. mutual funds while diversification has been increasing. The author suggests two explanations for the observed decrease in skill. First, the growth in mutual fund assets has made it more difficult for the industry as a whole to outperform the market. Second, based on the authors analysis of the
69
relationship between skill and diversification, he concludes that the U.S. mutual fund industry responded to an increase in the demand for its products by creating funds with low information content.
The Sustainability of Endowment Spending Levels: A Wakeup Call for University Endowments
Gregory P. Ho, Haim A. Mozes , and Pavel Greenfield The Journal of Portfolio Management Fall 2010, Vol. 37, No. 1: pp. 133-146 Ho, Mozes, and Greenfield provide an analysis of the interplay between endowment spending policy and the volatility of investments. A key feature of their analysis is a formula that gives an upper bound for volatility, given the endowments spending policy, expected rate of return on investment, and risk parameters. Their analysis shows that the investment performance necessary to support spending rates of 4% to 5%, and to maintain reasonable risk guidelines, is considerably greater than the performance that individual markets and common blends of those markets have generated over the past 20 years. Thus, the authors conclude that, in the absence of a unique ability to significantly outperform the financial markets over long periods of time, endowments with high spending rates must either reduce those rates or accept a higher probability of suffering a significant loss. .
70
71
JOURNAL 4
Journal of Alternative Investments
72
Spring (2010)
Madoff: A Returns-Based Analysis
Thomas Schneeweis , Edward Szado The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 7-19 A fundamental question with regard to the Madoff scandal is whether there were any reasonable means by which typical investors and/or their consultants could have determined that the various investment vehicles by which investors accessed Madoff were in fact not offering what they claimed. While a detailed due diligence analysis of the Madoff infrastructure which included various feeder funds as well as Madoffs auditing, custodial, and prime brokerage relationships may well have dissuaded investors or their consultants from investing in Madoff, most individual investors have neither the financial resources nor the skill to conduct such an analysis. For the most part, investors depend on the various funds and/or consultants to conduct adequate due diligence. Ex post, it is obvious that many such funds or consultants did not adequately conduct such analyses. In this article the authors examine a number of empirical characteristics derived from return streams of several Madoff feeder funds whose return data were available in various databases. Results show that potential problems were evident in the footprint of the returns, but unfortunately those footprints were well hidden.
Hedge Fund Transparency: Where Do We Stand?

Felix Goltz , David Schrder The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 20-35 Unlike mutual funds, hedge funds are reluctant to provide detailed information on their investment portfolios. Since hedge funds may use niche investment strategies in narrow market segments, fund managers portend that thorough disclosure of their portfolio holdingswhich are important to assessing future returnswould crowd out their trades, thus decreasing opportunities to generate outsized returns. However, incomplete disclosure can have some undesirable side effects. It might encourage hedge fund managers to take positions that are riskier than provided for by the managers mandate. Investors even risk fraudulent behavior, since the action of hedge fund management may be detected only when a fund has failed. This article presents the results of a comprehensive survey of hedge fund managers and investors on current hedge fund reporting practices. The authors find that the quality of hedge fund reporting is considered an important investment criterion. In analyzing the spectrum of opinions, the authors identify critical points of conflict between investors and managers. They find that investors are especially dissatisfied with the quality of information on liquidity and operational risk exposure. The survey also reveals that inappropriate performance measures are prevalent.
73
Stock Market and Agricultural Futures Diversification: An International Perspective

K. Smimou The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 36-57 Academic and practitioner research has presented strong evidence in support of the addition of commodity futures contracts to a diversified stock portfolio to enhance the risk-return characteristics of the portfolio. Moreover, it is well documented that diversification among risky assets in a particular country leads to risk reduction, but the potential gains are limited due to high correlations within an economy. Therefore, international portfolio diversification, primarily in stocks and bonds, has been advocated as a way of enhancing average returns while reducing portfolio risk for an investor who may consider holding foreign securities. This article expands on this initial conjecture by adding foreign agricultural futures contracts to the international dimension. The findings lend support to the arguments in favor of international diversification of agricultural commodities and present results on the long-term, historical risks and returns of agri-commodity futures and their relationship to the risks of other equity assets. Furthermore, since correlation stability is crucial to the size of the potential benefits from such diversification, additional insights into the inter-temporal stability of international return correlations are discussed.
Exit Strategies of Buyout Investments: An Empirical Analysis

Daniel M Schmidt , Sascha Steffen , Franziska Szab The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 58-84 Although buyout investments represent a considerable proportion of private equity volume, so far little research has been done on the exit strategies of buyout investments. This article takes a step in this direction by investigating buyouts in more detail focusing particularly on the divestment process. Since exiting enables the realization of returns and is thus the most important factor for private equity investors, it is important to understand the motivation behind and the determinants influencing this decision. The authors analyze three main exit routes for exiting buyout investments: initial public offerings (IPO), sales and write-offs, using a unique data set for U.S. and European buyout transactions. They examine the determinants influencing the choice of an exit channel by employing a multinomial logit model. The results strongly support the view that private equity investors writeoff investments that turn out to be non-performing early, showing their ability to filter out bad investments. They also analyze how the internal rate of return (IRR) influences which exit route is chosen. The results show that only the most profitable ventures are taken public. The results have implications for exiting buyout investments during financial crises.
74
Can CDO Equity Be Short on Correlation?

enay Aca , Saiyid Islam The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 85-96 Collateralized debt obligations (CDO) became very popular investment vehicles in recent yearsuntil the financial crisis started unfolding in summer 2007. As evidenced by the recent crisis, there was a failure by market participants to understand the complex relationships between various risk drivers, such as correlations and their impact on the credit worthiness of different tranches across a CDO capital structure. As a step in the direction of understanding these risks, this article examines the impact of correlation on the value of a CDO equity tranche. By examining the impact of an increase in correlation among underlying assets on the value of a collateralized debt obligation (CDO) equity tranche, the authors show that, contrary to general perception, CDO equity can be short on correlation. Specifically, when the underlying reference portfolio comprises high quality assets (assets with low probability of default) or diverse assets (assets with low correlations), the upfront price of a CDO equity tranche can increase with correlation. The implication of these findings is that not all senior and equity tranche trade combinations provide effective correlation hedging. In fact, in some cases, this type of hedge might actually increase the correlation risk.
Dual Offerings of ETFs on the Same Stock Index: U.S. vs. Swiss ETFs
Nikolaos T Milonas , Gerasimos G Rompotis The Journal of Alternative Investments Spring 2010, Vol. 12, No. 4: pp. 97-113 According to the law of one price, two identical securities traded in different places at the same time should command the same price. This law applies not only on original securities but on any other synthetic, derivative, or portfolio of securities. In particular, with regard to multiple offerings of the same security this law further implies that their returns should be similar for all investors as long as differential transaction costs are not imposed. Differences in transaction cost lead investors to abandon the overvalued securities in favor of the undervalued ones causing the extinction of the former. This article examines the characteristics of numerous pairs of U.S. and Swiss ETFs written on the same stock index. Focusing on the institutional characteristics of the U.S. and Swiss markets the authors show that expense ratio, volume of trading, and trading frequency differ markedly between the two markets. The results also show that the U.S. ETF market dominates the Swiss ETF market in all cases in the sample. This finding supports the argument that dual or multiple offerings originated in countries with differences in institutional characteristics, in currencies, and in time zones are likely to differ.
75
Summer (2010)
The Long-Horizon Benefits of Traditional and New Real Assets in the Institutional Portfolio
George A. Martin The Journal of Alternative Investments Summer 2010, Vol. 13, No. 4: pp. 6-29 This article analyzes the potential role of an expansive set of real asset classes in reducing inflation risk in the portfolios of long-horizon institutional investors. The author proposes a simple model of the evolution of asset returns that can be parameterized by key variables, such as 1) the sensitivity of asset returns to expected and unexpected changes in inflation, and 2) the degree of persistence in inflation. Each of the variables is a significant determinant of the long-horizon inflation properties of assets. Using his model and research, coupled with research available in the academic literature, Martin provides insight into the viability of various real asset classes as potential hedges for inflation.
The Role of the Constant Recovery Assumption in the Sub prime Bubble
Donald R. Chambers, Michael A. Kelly, Qin Lu The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 30-40 Securitization of mortgages is believed to have contributed to the recent boom and bust in real estate. In particular, structured products with wide tranches of AAA-rated derivative securities are retrospectively vilified. A key issue has been to understand how such large tranches of securities could have been viewed as safe despite the apparent high risks of the underlying mortgages. In this article, the authors analyze the complex models and the modelsparameters to estimate the risks of the structured securities.They find that the models themselves, not the inputted parameters, such as expected default rates and correlations, were responsible for inappropriate ratings. In particular, they find that the assumption of a constant recovery rate generated generous ratings for large tranches of securities even with reasonable parameter estimates.
Modeling the Cash Flow Dynamics of Private Equity Funds: Theory and Empirical Evidence
Axel Buchner, Christoph Kaserer, Niklas Wagner The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 41-54 This article presents a novel continuous-time approach to modeling the typical cash flow dynamics of private equity funds. The model consists of two independent components. First is a mean-reverting square-root process applied to model the rate at which capital is drawn over time. Second is the stream of capital distributions, which is assumed to follow an arithmetic Brownian motion with a time-dependent drift component that incorporates the typical time-pattern of the repayments of private equity funds. The empirical analysis shows that the model can easily be calibrated to real-world fund data by the method of conditional least squares and nicely fits historical data. The authors use a data set of mature European private equity funds provided by Thomson Venture Economics. Their model explains up to
76
99.6% of the variation in average cumulated net fund cash flows and provides a good approximation of the empirical distribution of private equity fund cash flows over a typical funds lifetime. Overall, the empirical results indicate that the model is of economic relevance in an effort to accurately model the cash flow dynamics of private equity funds.
Alternative Asset Pricing: Momentum and the Hedge Fund Puzzle

Stephen Bond, Lew Johnson The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 55-71 This article examines the effect of including hedge funds in the investment pool on the asset return bounds implied by established finance theory. Bounds are violated in a way that is difficult to explain in the usual manner, thus suggesting that a modified framework is needed. The authors include commodities as well as stocks among the set of investable assets. Empirical tests of the momentum strategy consistently outperform the market over the past 10 years, including the meltdown of 2008. The results have implications for current regulations and their effectiveness with respect to the stated goal of protecting the public. The authors findings support the idea of relaxing regulations based on the free-rider effect, which provides an efficient solution to the risk minimization problem, given that a smaller information set is available to the common investor.
An Early Look at the Deutsche Bank Alternative Investment Survey, 20022009

Erik Benrud The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 72-78 This article presents a time-series analysis of the evolution of hedge fund investor characteristics and expectations based on the Deutsche Bank Alternative Investment Survey (DBAIS): 20022009. Interesting findings include the following: 1) new hedge fund allocations are primarily determined by a common factor, rather than by specific views on particular strategies; 2) allocations to credit-sensitive strategies are negatively correlated with allocations to noncredit strategies;3) investor strategy allocations tend to chase returns and do a poor job of timing future strategy returns; and 4) the use of managed accounts has dramatically increased.
Sources of Return within an Emerging Markets FixedIncome and Foreign Exchange Portfolio
Amer Bisat The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 79-86 Over the past decade, emerging market investments have increasingly become the focus of investor interest. Numerous academic and practitioner studies have emphasized the potential for excess return and risk reduction when adding emerging market investments to a traditional portfolio. Much of the research, however, has focused on empirical analyses rather than on highlighting the long-term structural arguments for emerging market investments. Moreover, much of the research has tended to focus on the equity markets rather than on other forms of emerging market investment, such as fixed income and foreign exchange (FX).This practitioner note
77
introduces the reader to the non-equities emerging market (EM) investment universe, describes a prototypical EMfixed-income/FX portfolio, and quantitatively works out the expected annualized returns on such a portfolio, distinguishing between beta and alpha as the sources of returns.
Ethics: A Guiding Tenet of the CAIA Association Garners Broad Support within Academic Community
E. Craig Asche The Journal of Alternative Investments Summer 2010, Vol. 12, No. 4: pp. 87 Motivated by the many acts of unconscionable greed and avarice that have outraged, even disgusted the public at large, elite academic institutions around the world have begun incorporating ethics and social responsibility into their MBA programs, even going so far as to ask their students to commit to the MBA equivalent of medicines Hippocratic Oath.CAIA Association Executive Director Craig Asche applauds these efforts and makes the case for all investment professionals to similarly commit to professionalism. Asche points out there already exists a globally-recognized and respected set of principles, encompassed in the CFA Standards of Professional Conduct, which is precisely why the CAIA Association has required all its members to learn and abide by these guiding principles since launching the CAIA Program in 2003.
78
Fall (2010)
Insurance-Linked Securities: What Drives Their Returns?
Lars Jaeger, Stephan Mller, and Samuel Scherling The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 9-34 In this article, insurance-linked securities (ILS) are identified as a source of alternative beta. Against the payment of a risk premium, investors assume natural catastrophe and other insurance risks. Not only is the ILS risk premium generally relatively generous in comparison to the probability of loss, but, more importantly, the occurrence of an earthquake or hurricane event is independent from financial market events. This offers attractive opportunities for diversification.While the story of ILS being an advantageous addition to most investment portfolios is easily and convincingly told, there remains considerable market confusion about the precise identity and characteristics of ILS return drivers. The aim of this article is to address this and related questions, decompose ILS return into various return sources, distinguish between their alpha and beta parts, and analyze each in detail.
On Understanding Bear Market Funds

Nelson Lacey and Qiang Bu The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 35-46 Despite poor performance, bear market funds have been growing rapidly in recent years. The authors find that while bear funds exhibit timing ability, this surprisingly does not translate into enhanced return performance. They also find that bear funds tend to be risk-seeking at a time when market volatility is high. The results are consistent with viewing these funds not in the more traditional context of return maximization, but instead in the context of risk management. In other words, bear market funds decrease return volatility of the fund family at the cost of a slightly lower fund-family return.
Portfolios of ETFs: Applications to Absolute Return Funds and Tactical Asset Allocation
Nol Amenc , Felix Goltz, and Adina Grigoriu The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 47-57 Asset managers generally focus on diversification or returns prediction to create added value in portfolios of exchange-traded funds (ETFs). This article draws on dynamic risk-budgeting techniques to emphasize the importance of risk management when decisions to allocate to ETFs are made. Absolute return funds, in which the low-risk profiles of government-bond ETFs and conditional allocations to riskier equity ETFs can be combined to obtain portfolios thatbeyond the natural diversification between stocks and bondsprovide upside potential while protecting investors from downside risk, are an initial application of ETFs to allocation decisions. A second application is risk control of tactical strategies. Dynamic risk budgeting is used to provide risk-controlled exposuretaking the managers forecasts as a givento an asset class. This article shows that, even if the manager is
79
an excellent forecaster, this approach yields intra-horizon and end-of-horizon riskcontrol benefits considerably greater than those of standard tactical asset allocation.
Optimal Portfolios with Traditional Investments: An Empirical Investigation

Edwin O. Fischer and Susanne Lind-Braucher The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 58-77
and
Alternative
This article empirically investigates the diversification effects on a traditional portfolio by introducing alternative investments (hedge funds, managed futures, real estate, private equities, and commodities). The authors analyze two portfolios: the one with the lowest risk (Minimum Risk Portfolio, or MRP) and the one with the highest (modified) Sharpe Ratio (Maximum Relative Performance Portfolio, or MRPP) for the period April 1999 to April 2009. This article is the first attempt to incorporate a variety of risk measures (Volatility, Value at Risk, and Conditional Value at Risk) as the objective function for portfolio optimization and for different estimates for the expected return (historical estimates, robust Bayes-Stein estimates, Capital Asset Pricing Model (CAPM) estimates, and Black-Litterman estimates). Furthermore, the alternative risk measures are additionally modified for the skewness and the kurtosis: modified VaR and modified CVaR. The influences of the higher moments on asset allocation are also examined in connection with different risk measures and various estimators for expected returns.
Does a Contagion Effect Exist Between Equity Markets and Hedge Funds in Periods of Extreme Stress?
Jan Viebig and Thorsten Poddig The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 78-103 Previous researchers have argued that there is no empirical evidence in support of contagion between equity markets and hedge funds. Unlike previous researchers, the authors of this article assess whether extreme increases in volatility transmit from equities to hedge funds. Using kernel density estimation, they show that the volatility spillover effect between equities and hedge funds is significant at the 99% level of confidence for several hedge-fund strategies. Conducting tests for correlation asymmetry and applying Vector Autoregressive (VAR) models, they find evidence confirming that a contagion effect exists between equity markets and several hedgefund strategies. The impact of financial crises on hedge funds varies substantially across hedge-fund styles.
Emerging Markets During the Crisis

Jennifer Bender , Frank Nielsen , and Madhusudan Subramanian The Journal of Alternative Investments Fall 2010, Vol. 13, No. 2: pp. 104-112 The 2008 economic crisis has offered another look at how emerging-market stocks have behaved relative to developed markets. In the aftermath of the crisis, the authors of this article take a fresh look at emerging markets to explore these questions: Have emerging markets matched growth forecasts? Which segments have performed well? How have emerging markets behaved relative to developed markets? While in the aggregate emerging market stocks were not immune to the crisis, there were some clear differences between emerging and developed markets in the performance of particular sectors and styles.
80
Winter (2011)
The StressVaR: A New Risk Concept for Extreme Risk and Fund Allocation
Cyril Coste, Raphal Douady, and Ilija I. Zovko The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 10-23 In this article the authors introduce an approach to risk estimation based on nonlinear factormodelsthe StressVaR (SVaR). Developed to evaluate the risk of hedge funds, the SVaR appears to be applicable to a wide range of investments. The computation of the StressVaR is a three-step procedure whose main component is to use the fairly short and sparse history of the hedge fund returns to identify relevant risk factors among a very broad set of possible risk sources. This risk profile is obtained by calibrating a polymodel, which is a collection of nonlinear single-factor models, as opposed to a single multi-factor model. The authors then use the risk profile and the very long and rich history of the factors to assess the possible impact of known past crises on the funds, unveiling their hidden risks and so called black swans.
Portfolio Choice for Oil-Based Sovereign Wealth Funds

Bernd Scherer The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 24-34 Given recent interest in the activities of sovereign wealth funds (SWF), this article reviews the financial economics of portfolio choice for oil based investors. The author views the optimal asset allocation problem of a sovereign wealth fund as the decision making problem of an investor with non-tradable endowed wealth (oil reserves). Optimal portfolios combine speculative demand (optimal growth) as well as hedging demand (hedging resource fluctuation risk) and their level of risk taking should depend both on the fraction of financial wealth to resource wealth as well as the oil shock hedging properties of its investments. As an additional factor, the author introduces background risk for a SWF in the form of oil reserve uncertainty. SWF with large uncertainty about the size of their reserves should invest less aggressively and vice versa. The article also identifies the optimal speed of the extraction policy (oil to equity transformation) as a driving force for portfolio adjustments across time and presents a dynamic programming approach to approximate portfolio adjustments.
Limited Liability Leverage : A New Measure of Leverage

Philippe Jorion and Mayer Cherem The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 35-42 Average leverage is often used as a measure of risk. However, average leverage in a limited liability context should not be computed as a simple arithmetic average of the underlying constituents. In fact, using a simple arithmetic average can give misleading results. For example, the simple arithmetic average leverage may give results which run counter to the actual risk exposure for certain portfolios. This article introduces a new measure, Limited Liability Leverage (L3), which corrects
81
the simple average for the limited liability framework. This new measure is discussed in the context of a portfolio of hedge funds and compared to a multi-strategy hedge fund structure, where trading units do not have limited liability. This perspective can also be extended to reflect the lower risk of a financial system with many small institutions relative to a system with large, too-big-to-fail institutions.
Protection Potential of Commodity Hedge Funds

Pierre Jeanneret, Pierre Monnin, and Stefan Scholz The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 43-52 In this article, the authors show that investing in a portfolio of commodity hedge funds yields higher returns and a better control of downside risk than investing in long-only commodity indices. They also show that, contrary to a widespread belief, long-only commodity indices do not necessarily provide an efficient inflation hedge during periods of high inflation and may induce a cost in low inflation periods. Commodity hedge funds do not provide a better hedge in periods of high inflation but they do not bear any cost in low inflation periods.
Spillover Effects of Counter-Cyclical Market Regulation: Evidence from the 2008 Ban on Short Sales
Abraham Lioui The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 53-66 In this article the author looks at the impact of the ban on broad market indices in the U.S. and in Europe (the United Kingdom, France, and Germany). Since these indices and their performance are of great concern to the asset management and hedge fund industries, it is important for practitioners and policy makers to understand the impact of changing the rules of the game (banning short sales) on the return distribution of these indices and to assess the potential spillover effects of a countercyclical regulation affecting only one segment of the financial market. He examines the ban on a broad range of market and strategy risk factors and shows that while the ban may be responsible for a substantial increase in market volatility, its impact on higher moments of index returns is not systematic (skewness and kurtosis of the return distribution of only a few indices were affected) or robust (using some robust measures of higher moments makes the impact of the ban disappear).
The Iconic Boom in Modern Russian Art

Luc Renneboog and Christophe Spaenjers The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 67-80 Motivated by the fast growth of personal wealth in emerging economies like Russia, the authors investigate the investment performance of modern Russian art. A hedonic analysis of more than 50,000 art transactions results in a geometric average return of 3.97%, in real USD terms, between 1967 and 2007. The Russian art index shows an impressive annualized return of 12.37% since 1997. This is roughly double the average yearly appreciation of a global art market index over the same period. Art from the nineteenth century has performed especially well.The returns on Russian art correlate positively with the returns on global equities, gold, and (especially) London real estate. Also, they seem to be affected more by trends in oil prices than are global art prices. The results illustrate how the new wealth created in fast-developing economies has an impact on the demand for art from these countries, which reflects a home bias in taste.
82
Asset Class and Strategy Investment Tracking Based Approaches

Garry B. Crowder, Hossein Kazemi, and Thomas Schneeweis The Journal of Alternative Investments Winter 2011, Vol. 13, No. 3: pp. 81-101 In recent years, there has been a dramatic increase in the number of systematic algorithmic products that attempt to capture the risk and return of a particular asset class or fund strategy. These products may be stand-alone investments created to provide direct replication (e.g., almost identical securities) of a comparison benchmark or they may be constructed expressly to track (e.g., similar but not identical securities) an existing non-investable or investable benchmark. Various approaches exist in the creation of these tracker products. In this article, the authors review alternative approaches to the creation of investment trackers. The authors concentrate on the underlying rationale for fund tracker products, the alternative approaches often employed to create such products, and practical concerns related to strategy or fund tracking based products. They also provide a brief review of the performance of existing tracker products as well as examples of tracker products use in multi-asset allocation.
83
84
JOURNAL 5
Journal of Financial Economics
85
Spring (2010)
O/S: The relative trading activity in options and stock
Roll, Richard, Schwartz, Eduardo,,Subrahmanyam, Avanidhar Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 1-17 Relatively little is known about the trading volume in derivatives relative to the volume in underlying stocks. We study the time-series properties and the determinants of the options/stock trading volume ratio (O/S) using a comprehensive cross-section and time-series of data on equities and their listed options. O/S is related to many intuitive determinants such as delta and trading costs, and it also varies with institutional holdings, analyst following, and analyst forecast dispersion. O/S is higher around earnings announcements, suggesting increased trading in the options market. Further, post-announcement absolute returns are positively related to pre-announcement O/S, which suggests that at least part of the pre-announcement options trading is informed.
Performance persistence in entrepreneurship

Gompers, Paul,Kovner, Anna,Lerner, Josh,Scharfstein, David Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 18-32 This paper presents evidence of performance persistence in entrepreneurship. We show that entrepreneurs with a track record of success are much more likely to succeed than first-time entrepreneurs and those who have previously failed. In particular, they exhibit persistence in selecting the right industry and time to start new ventures. Entrepreneurs with demonstrated market timing skill are also more likely to outperform industry peers in their subsequent ventures. This is consistent with the view that if suppliers and customers perceive the entrepreneur to have market timing skill, and is therefore more likely to succeed, they will be more willing to commit resources to the firm. In this way, success breeds success and strengthens performance persistence.
Quantifying private benefits of control from a structural model of block trades

Albuquerque, Rui; Schroth, Enrique Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 33-55 We study the ability of three-factor affine term-structure models to extract conditional volatility using interest rate swap yields for 19912005 and Treasury yields for 19702003. For the Treasury sample, the correlation between modelimplied and EGARCH volatility is between 60% and 75%. For the swap sample, this correlation is rather low or negative. We find that these differences in model performance are primarily due to the timing of the swap sample, and not to institutional differences between swap and Treasury markets. We conclude that the ability of multifactor affine models to extract conditional volatility depends on the sample period, but that overall these models perform better than has been argued in the literature.
86
A resolution of the distress risk and leverage puzzles in the cross section of stock returns
George, Thomas J.;Hwang, Chuan-Yang Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 56-79 We revisit findings that returns are negatively related to financial distress intensity and leverage. These are puzzles under frictionless capital markets assumptions but are consistent with optimizing firms that differ in their exposure to financial distress costs. Firms with high costs choose low leverage to avoid distress, but they retain exposure to the systematic risk of bearing such costs in low states. Empirical results are consistent with this explanation. The return premiums to low leverage and low distress are significant in raw returns, and even stronger in risk-adjusted returns. When in distress, low-leverage firms suffer more than high-leverage firms as measured by a deterioration in accounting operating performance and heightened exposure to systematic risk. The connection between return premiums and distress costs is apparent in subperiod evidence. Both are small or insignificant prior to 1980 and larger and significant thereafter.
The good news in short interest

Boehmer, Ekkehart;Huszar, Zsuzsa R.;Jordan, Bradford D. Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 80-97 Stocks with relatively high short interest subsequently experience negative abnormal returns, but the effect can be transient and of debatable economic significance. In contrast, relatively heavily traded stocks with low short interest experience both statistically and economically significant positive abnormal returns. These positive returns are often larger (in absolute value) than the negative returns observed for heavily shorted stocks. Thus, the positive information associated with low short interest, which is publicly available, is only slowly incorporated into prices, which raises a broader market efficiency issue. Our results also cast doubt on existing theories of the impact of short sale constraints.
Institutional investors, intangible information, and the bookto-market effect

Jiang, Hao Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 98-126 This paper establishes a robust link between the trading behavior of institutions and the book-to-market effect. Building on work by Daniel and Titman (2006), who argue that the book-to-market effect is driven by the reversal of intangible returns, I find that institutions tend to buy (sell) shares in response to positive (negative) intangible information and that the reversal of the intangible return is most pronounced among stocks for which a large proportion of active institutions trade in the direction of intangible information. Furthermore, the book-to-market effect is large and significant in stocks with intense past institutional trading but nonexistent in stocks with moderate institutional trading. This influence of institutional trading on the book-to-market effect is distinct from that of firm size. These results are consistent with the view that the tendency of institutions to trade in the direction of
87
intangible information exacerbates price overreaction, thereby contributing to the value premium.
The effect of state anti takeover laws on the firm's bondholders

Francis, Bill B; Hasan, Iftekhar;John, Kose;Waisman, Maya Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 127-154 We examine how state antitakeover laws affect bondholders and the cost of debt, and report four findings. First, bonds issued by firms incorporated in takeover-friendly states have significantly higher at-issue yield spreads than bonds issued by firms in states with restrictive antitakeover laws. Second, firms in takeover friendly states have significantly higher leverage than their counterparts in restrictive law states. Third, bond issues are associated with negative average stock price reactions among firms in takeover-friendly states, but positive stock price reactions among firms in restrictive law states. Fourth, existing bond values increase, on average, upon the introduction of Business Combination antitakeover law. These results indicate that state antitakeover laws tend to decrease bond yields and increase bond values, which is the opposite of their effect on equity values. This, in turn, implies that state laws help mitigate the agency cost of debt by shielding bondholders from expropriation in takeovers. Overall, the empirical evidence suggests that the effect of antitakeover provisions on firm value must take into account the impacts of both bondholders and stockholders.
How does law affect finance? An examination of equity tunneling in Bulgaria

Atanasov, Vladimir; Black, Bernard; Ciccotello, Conrad; Gyoshev, Stanley Journal of Financial Economics Volume 96, Issue 1, Feb 2010, Pages 155-173 We model and test the mechanisms through which law affects tunneling and tunneling affects firm valuation. In 2002, Bulgaria adopted legal changes which limit equity tunneling through dilutive equity offerings and freezeouts. Following the changes, minority shareholders participate equally in equity offerings, where before they suffered severe dilution; freezeout offer price ratios quadruple; and Tobin's q rises sharply for firms at high risk of tunneling. The paper shows the importance of legal rules in limiting equity tunneling, the role of equity tunneling risk as a factor in determining equity prices, and substitution by controlling shareholders between different forms of tunneling.
Seasoned equity offerings, market timing, and the corporate lifecycle

De Angelo Harry; Linda; Stulz, Ren M. Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 275-295 Both a firm's market-timing opportunities and its corporate lifecycle stage exert statistically and economically significant influences on the probability that it conducts a seasoned equity offering (SEO), with the lifecycle effect empirically stronger. Neither effect adequately explains SEO decisions because a near-majority
88
of issuers are not growth firms and the vast majority of firms with high M/B ratios and high recent and poor future stock returns fail to issue stock. Since without the offer proceeds 62.6% of issuers would run out of cash (81.1% would have subnormal cash balances) the year after the SEO, a near-term cash need is the primary SEO motive, with market-timing opportunities and lifecycle stage exerting only ancillary influences.
Bailouts, the incentive to manage risk, and financial crises

Panageas, Stavros Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 296-311 A firm's termination leads to bankruptcy costs. This may create an incentive for outside stakeholders or the firm's debtholders to bail out the firm as bankruptcy looms. Because of this implicit guarantee, firm shareholders have an incentive to increase volatility in order to exploit the implicit protection. However, if they increase volatility too much they may induce the guarantee-extending parties to "walk away." I derive the optimal risk management rule in such a framework and show that it allows high volatility choices, while net worth is high. However, risk limits tighten abruptly when the firm's net worth declines below an endogenously determined threshold. Hence, the model reproduces the qualitative features of existing risk management rules, and can account for phenomena such as "flight to quality."
Does corporate governance matter in competitive industries?

Giroud, Xavier;Mueller, Holger M. Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 312-331 By reducing the threat of a hostile takeover, business combination (BC) laws weaken corporate governance and increase the opportunity for managerial slack. Consistent with the notion that competition mitigates managerial slack, we find that while firms in non-competitive industries experience a significant drop in operating performance after the laws' passage, firms in competitive industries experience no significant effect. When we examine which agency problem competition mitigates, we find evidence in support of a "quiet-life" hypothesis. Input costs, wages, and overhead costs all increase after the laws' passage, and only so in non-competitive industries. Similarly, when we conduct event studies around the dates of the first newspaper reports about the BC laws, we find that while firms in non-competitive industries experience a significant stock price decline, firms in competitive industries experience a small and insignificant stock price impact.
89
The pecking order, debt capacity, and information asymmetry

Leary, Mark T.;Roberts, Michael R. Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 332-355 We quantify the empirical relevance of the pecking order hypothesis using a novel empirical model and testing strategy that addresses statistical power concerns with previous tests. While the classificatory ability of the pecking order varies significantly depending on whether one interprets the hypothesis in a strict or liberal (e.g., "modified" pecking order) manner, the pecking order is never able to accurately classify more than half of the observed financing decisions. However, when we expand the model to incorporate factors typically attributed to alternative theories, the predictive accuracy of the model increases dramatically--accurately classifying over 80% of the observed debt and equity issuances. Finally, we show that what little pecking order behavior can be found in the data is driven more by incentive conflicts, as opposed to information asymmetry.
Institutional monitoring through shareholder litigation

Agnes Cheng, C.S.;He Huang, Henry;Li, Yinghua;Lobo, Gerald Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 356-383 This paper investigates the effectiveness of using securities class action lawsuits in monitoring defendant firms by institutional lead plaintiffs from two aspects: (1) immediate litigation outcomes, including the probability of surviving the motion to dismiss and the settlement amount, and (2) subsequent governance improvement such as changes in board independence. Using a large sample of securities lawsuits from 1996 to 2005, we show that institutional investors are more likely to serve as the lead plaintiff for lawsuits with certain characteristics. After controlling for these determinants of having an institutional lead plaintiff, we show that securities class actions with institutional owners as lead plaintiffs are less likely to be dismissed and have larger monetary settlements than securities class actions with individual lead plaintiffs. This effect exists for various types of institutions including public pension funds. We also find that, after the lawsuit filings, defendant firms with institutional lead plaintiffs experience greater improvement in their board independence than defendant firms with individual lead plaintiffs. Our study suggests that securities litigation is an effective disciplining tool for institutional owners.
Renegotiation of cash flow rights in the sale of VC-backed firms

Broughman, Brian;Fried, Jesse Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 384-399 Incomplete contracting theory suggests that venture capitalist (VC) cash flow rights, including liquidation preferences, could be subject to renegotiation. Using a handcollected data set of sales of Silicon Valley firms, we find common shareholders do sometimes receive payment before VCs' liquidation preferences are satisfied. However, such deviations from VCs' cash flow rights tend to be small. We also find that renegotiation is more likely when governance arrangements, including the firm's
90
choice of corporate law, give common shareholders more power to impede the sale. Our study provides support for incomplete contracting theory, improves understanding of VC exits, and suggests that choice of corporate law matters in private firms.
When should firms share credit with employees?

Massa, Massimo;Reuter, Jonathan;Zitzewitz, Eric Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 400-424 We study the choice between named and anonymous mutual fund managers. We argue that fund families weigh the benefits of naming managers against the cost associated with their increased future bargaining power. Named managers receive more media mentions, have greater inflows, and suffer less return diversion due to within family cross-subsidization, but departures of named managers reduce net flows. Naming managers became less common between 1993 and 2004. This was especially true in the asset classes and cities most affected by the hedge fund boom, which increased outside opportunities for, and the cost of retaining, successful named managers.
Ownership concentration, foreign shareholding, audit quality, and stock price synchronicity: Evidence from China
Gul, Ferdinand A.;Kim, Jeong-Bon;Qiu, Annie A. Journal of Financial Economics Volume 95, Issue 3, Feb 2010, Pages 425-442 This paper investigates the effects of largest-shareholder ownership concentration, foreign ownership, and audit quality on the amount of firm-specific information incorporated into share prices, as measured by stock price synchronicity, of Chineselisted firms over the 1996-2003 period. We show that synchronicity is a concave function of ownership by the largest shareholder with its maximum at an approximate 50% level. Further, we find that synchronicity is higher when the largest shareholder is government related. We also find that foreign ownership and auditor quality are inversely associated with synchronicity. Finally, we show that the amount of earnings information reflected in stock returns is lower for firms with high synchronicity.
Escape from New York: The market impact of loosening disclosure requirements
Fernandes, Nuno;Lel, Ugur;Miller, Darius P Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 129-147 We examine the first significant deregulation of U.S. disclosure requirements since the passage of the 1933/1934 Exchange and Securities Acts: the 2007 Securities and Exchange Commission (SEC) Rule 12h-6. Rule 12h-6 has made it easier for foreign firms to deregister with the SEC and thereby terminate their U.S. disclosure obligations. We show that the market reacted negatively to the announcement by the SEC that firms from countries with weak disclosure and governance regimes could more easily opt out of the stringent U.S. reporting and legal environment. We also find that since the rule's passage, an unprecedented number of firms have
91
deregistered, and these firms often had been previous targets of U.S. class action securities lawsuits or SEC enforcement actions. Our findings suggest that shareholders of non-U.S firms place significant value on U.S. securities regulations, especially when the home country investor protections are weak.
Resolving the exposure puzzle: The many facets of exchange rate exposure
Bartram, Shnke M.;Brown, Gregory W.;Minton, Bernadette A Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 148-173 Theory predicts sizeable exchange rate (FX) exposure for many firms. However, empirical research has not documented such exposures. To examine this discrepancy, we extend prior theoretical results to model a global firm's FX exposure and show empirically that firms pass through part of currency changes to customers and utilize both operational and financial hedges. For a typical sample firm, pass-through and operational hedging each reduce exposure by 10-15%. Financial hedging with foreign debt, and to a lesser extent FX derivatives, decreases exposure by about 40%. The combination of these factors reduces FX exposures to observed levels.
Sentiment and stock prices: The case of aviation disasters

Kaplanski, Guy;Levy, Haim Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 174-201 Behavioral economic studies reveal that negative sentiment driven by bad mood and anxiety affects investment decisions and may hence affect asset pricing. In this study we examine the effect of aviation disasters on stock prices. We find evidence of a significant negative event effect with an average market loss of more than $60 billion per aviation disaster, whereas the estimated actual loss is no more than $1 billion. In two days a price reversal occurs. We find the effect to be greater in small and riskier stocks and in firms belonging to less stable industries. This event effect is also accompanied by an increase in the perceived risk: implied volatility increases after aviation disasters without an increase in actual volatility.
Political rights and the cost of debt

Qi, Yaxuan;Roth, Lukas; Wald, John K Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 202-226 We examine the impact of country-level political rights on the cost of debt for corporate bonds issued by firms incorporated in 39 countries. Similar to, but separate from, the relation for creditor rights, greater political rights are associated with lower yield spreads. A one standard deviation increase in political rights is associated with an 18.6% decline in bond spreads. We find evidence that political and legal institutions are substitutes; marginal improvements in political rights produce greater reductions in the cost of debt for firms from countries with weaker creditor rights. We examine potential factors through which political rights may affect the cost of debt and find that greater freedom of the press provides an important channel for reducing bond risks. Moreover, debt of firms with cross-listed equity trades at a premium in U.S. markets, but this relation appears to be more consistent with improved visibility than with bonding effects.
92
Reduced-form valuation of callable corporate bonds: Theory and evidence

Jarrow, Robert; Li, Haitao; Liu, Sheen; Wu, Chunchi Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 227-248 We develop a reduced-form approach for valuing callable corporate bonds by characterizing the call probability via an intensity process. Asymmetric information and market frictions justify the existence of a call-arrival intensity from the market's perspective. Our approach both extends the reduced-form model of Duffie and Singleton (1999) for defaultable bonds to callable bonds and captures some important differences between call and default decisions. A comprehensive empirical analysis of callable bonds using both our model and the more traditional American option approach for valuing callable bonds shows that the reduced-form model fits callable bond prices well and that it outperforms the traditional approach both in- and out-of-sample.
Capital structure decisions: Evidence from deregulated industries

Ovtchinnikov, Alexei V Journal of Financial Economics Volume 95, Issue 2, Feb 2010, Pages 249-274 Deregulation significantly affects the firms' operating environment and leverage decisions. Firms experience a significant decline in profitability, asset tangibility and a significant increase in growth opportunities following deregulation. Firms respond by reducing leverage. Deregulation also significantly affects the cross-sectional relation between leverage and its determinants. Leverage is much less negatively correlated with profitability and market-to-book and much more positively (negatively) correlated with firm size (earnings volatility) following deregulation. These results are consistent with the dynamic tradeoff theory of capital structure. Also consistent with the dynamic tradeoff theory, those firms that are more likely to be above their target capital structure issue significantly more equity in the first few years following deregulation.
Activist arbitrage: A study of open-ending attempts of closed-end funds

Bradley, Michael;Brav, Alon;Goldstein, Itay;Jiang, Wei Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 1-19 This paper documents frequent attempts by activist arbitrageurs to open-end discounted closed-end funds, particularly after the 1992 proxy reform which reduced the costs of communication among shareholders. Open-ending attempts have a substantial effect on discounts, reducing them, on average, to half of their original level. The size of the discount is a major determinant of whether a fund gets attacked. Other important factors include the costs of communication among shareholders and the governance structure of the targeted fund. Our study contributes to the understanding of the actions undertaken by arbitrageurs in financial markets beyond just pure trading.
93
First-passage probability, jump models, and intra-horizon risk

Bakshi, Gurdip;Panayotov, George Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 20-40 This paper proposes a risk measure, based on first-passage probability, which reflects intra-horizon risk in jump models with finite or infinite jump activity. Our empirical investigation shows, first, that the proposed risk measure consistently exceeds the benchmark value-at-risk (VaR). Second, jump risk tends to amplify intra-horizon risk. Third, we find large variation in our risk measure across jump models, indicative of model risk. Fourth, among the jump models we consider, the finitemoment log-stable model provides the most conservative risk estimates. Fifth, imposing more stringent VaR levels accentuates the impact of intra-horizon risk in jump models. Finally, using an alternative benchmark VaR does not dilute the role of intra-horizon risk. Overall, we contribute by showing that ignoring intra-horizon risk can lead to underestimation of risk exposures.
Are family firms more tax aggressive than non-family firms?

Chen, Shuping;Chen, Xia;Cheng, Qiang;Shevlin, Terry Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 41-61 Taxes represent a significant cost to the firm and shareholders, and it is generally expected that shareholders prefer tax aggressiveness. However, this argument ignores potential non-tax costs that can accompany tax aggressiveness, especially those arising from agency problems. Firms owned/run by founding family members are characterized by a unique agency conflict between dominant and small shareholders. Using multiple measures to capture tax aggressiveness and founding family presence, we find that family firms are less tax aggressive than their non-family counterparts, ceteris paribus. This result suggests that family owners are willing to forgo tax benefits to avoid the non-tax cost of a potential price discount, which can arise from minority shareholders' concern with family rent-seeking masked by tax avoidance activities [Desai and Dharmapala, 2006. Corporate tax avoidance and high-powered incentives. Journal of Financial Economics 79, 145-179]. Our result is also consistent with family owners being more concerned with the potential penalty and reputation damage from an IRS audit than non-family firms. We obtain similar inferences when using a small sample of tax shelter cases.
Asset liquidity and financial contracts: Evidence from aircraft leases

Gavazza, Alessandro Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 62-84 Financial contracting theories agree that more-liquid assets decrease the expected cost of external financing, thus making leasing more attractive and reducing lessors' equilibrium return. However, the literature has ambiguous predictions about the effect of liquidity on the maturity of leases. These predictions are further complicated by the existence of two types of lease contracts--operating and capital--that differ in
94
whether asset ownership transfers to the lessee at the end of the contract. Using data from commercial aircraft, I find that more-liquid assets (1) make leasing, operating leasing in particular, more likely; (2) have shorter operating leases; (3) have longer capital leases; and (4) command lower markups of operating lease rates.
Informed trading before analyst downgrades: Evidence from short sellers

Christophe, Stephen E.;Ferri, Michael G. Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 85-106 This paper studies short-selling prior to the release of analyst downgrades in a sample of 670 downgrades of Nasdaq stocks between 2000 and 2001. We find abnormal levels of short-selling in the three days before downgrades are publicly announced. Further, we show that this pre-announcement abnormal short-selling is significantly related to the subsequent share price reaction to the downgrade, and especially so for downgrades that prompt the most substantial price declines. Our findings are robust to various controls that might also affect short-selling such as preannouncement momentum, three-day pre-announcement returns, and announcementday share price. In addition, the results are independent of scheduled earnings announcements, analyst herding, and non-routine events near downgrades. Further evidence suggests that tipping is more consistent with the data than the prediction explanation which posits that short sellers successfully predict downgrades on the basis of public information about firms' financial health. Finally, we present evidence that downgraded stocks with high abnormal short-selling perform poorly over the subsequent six months by comparison with those with low abnormal short-selling. Overall, our results support the hypothesis that short sellers are informed traders and exploit profitable opportunities provided by downgrade announcements.
Market liquidity, asset prices, and welfare

Huang, Jennifer;Wang, Jiang Journal of Financial Economics Volume 95, Issue 1, Feb 2010, Pages 107-127 This paper represents an equilibrium model for the demand and supply of liquidity and its impact on asset prices and welfare. We show that, when constant market presence is costly, purely idiosyncratic shocks lead to endogenous demand of liquidity and large price deviations from fundamentals. Moreover, market forces fail to lead to efficient supply of liquidity, which calls for potential policy interventions. However, we demonstrate that different policy tools can yield different efficiency consequences. For example, lowering the cost of supplying liquidity on the spot (e.g., through direct injection of liquidity or relaxation of ex post margin constraints) can decrease welfare while forcing more liquidity supply (e.g., through coordination of market participants) can improve welfare.
95
Summer (2010)
A skeptical appraisal of asset pricing tests
Lewellen, Jonathan; Nagel, Stefan, Shanken, Jay Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 175-194 It has become standard practice in the cross-sectional asset pricing literature to evaluate models based on how well they explain average returns on size-B/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) can provide quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models do not work as well as originally advertised.
When are outside directors effective?

Duchin, Ran;Matsusaka John G.;Ozbas, Oguzhan Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 195-214 This paper uses recent regulations that have required some companies to increase the number of outside directors on their boards to generate estimates of the effect of board independence on performance that are largely free from endogeneity problems. Our main finding is that the effectiveness of outside directors depends on the cost of acquiring information about the firm: when the cost of acquiring information is low, performance increases when outsiders are added to the board, and when the cost of information is high, performance worsens when outsiders are added to the board. The estimates provide some of the cleanest estimates to date that board independence matters, and the finding that board effectiveness depends on information cost supports a nascent theoretical literature emphasizing information asymmetry. We also find that firms compose their boards as if they understand that outsider effectiveness varies with information costs.
Liquidity biases in asset pricing tests

Asparouhova, Elena; Bessembinder, Hendrik; Kalcheva, Ivalina Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 215-237 Microstructure noise in security prices biases the results of empirical asset pricing specifications, particularly when security-level explanatory variables are crosssectionally correlated with the amount of noise. We focus on tests of whether measures of illiquidity, which are likely to be correlated with the noise, are priced in the cross-section of stock returns, and show a significant upward bias in estimated return premiums for an array of illiquidity measures in Center for Research in Security Prices (CRSP) monthly return data. The upward bias is larger when illiquid securities are included in the sample, but persists even for NYSE/Amex stocks after decimalization. We introduce a methodological correction to eliminate the biases that
96
simply involves weighted least squares (WLS) rather than ordinary least squares (OLS) estimation, and find evidence of smaller, but still significant, return premiums for illiquidity after implementing the correction.
The performance of emerging hedge funds and managers

Aggarwal, Rajesh; K.Jorion, Philippe Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 238-256 This paper provides the first systematic analysis of performance patterns for emerging funds and managers in the hedge fund industry. Emerging funds and managers have particularly strong financial incentives to create investment performance and, because of their size, may be more nimble than established ones. Performance measurement, however, needs to control for the usual biases afflicting hedge fund databases. After adjusting for such biases and using a novel event time approach, we find strong evidence of outperformance during the first two to three years of existence. Each additional year of age decreases performance by 42 basis points, on average. Cross-sectionally, early performance by individual funds is quite persistent, with early strong performance lasting for up to five years.
Inside the black box: The role and composition of compensation peer groups
Faulkender, Michael ;Yang, Jun. Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 257-270 This paper considers the features of the newly disclosed compensation peer groups and demonstrates their significant role in explaining variations in chief executive officer (CEO) compensation beyond that of other benchmarks such as the industrysize peers. After controlling for industry, size, visibility, CEO responsibility, and talent flows, we find that firms appear to select highly paid peers to justify their CEO compensation and this effect is stronger in firms where the compensation peer group is smaller, where the CEO is the chairman of the board of directors, where the CEO has longer tenure, and where directors are busier serving on multiple boards.
Detecting jumps from Lvy jump diffusion processes

Jiang, Hao Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 271-290 Recent asset-pricing models incorporate jump risk through Lvy processes in addition to diffusive risk. This paper studies how to detect stochastic arrivals of small and big Lvy jumps with new nonparametric tests. The tests allow for robust analysis of their separate characteristics and facilitate better estimation of return dynamics. Empirical evidence of both small and big jumps based on these tests suggests that models for individual equities and overall market indices require incorporating Lvytype jumps. The evidence of small jumps also helps explain why jumps in the market index are uncorrelated with jumps in its component equities.
97
The Sarbanes-Oxley act and corporate investment: A structural assessment

Kang, Qiang; Liu, Qiao; Qi, Rong Journal of Financial Economics Volume 96, Issue 2, May 2010, Pages 291-305 We assess the impact of the Sarbanes-Oxley Act of 2002 on corporate investment in an investment Euler equation framework. We allow a dummy for the passage of the Act to affect the rate at which managers discount future investment payoffs. Using generalized method of moments estimators, we find that the rate U.S. firm managers apply to discount investment projects rises significantly after 2002, while the discount rate for U.K. firms remains unchanged. The effects of the legislation on corporate investment are asymmetric, and are much more significant among relatively small firms. We also find that well-governed firms, firms with a credit rating, and accelerated filers of Section 404 of the Act have become more cautious about investment.
The role of private equity group reputation in LBO financing

Demiroglu Cem; James, Christopher M Journal of Financial Economics Volume 96, Issue 2, May 2010,Pages 306-330 This paper investigates whether the reputation of acquiring private equity groups (PEGs) is related to the financing structure of leveraged buyouts (LBOs). Using a sample of 180 public-to-private LBOs in the US between January 1, 1997 and August 15, 2007, we find that reputable PEGs are more active in the LBO market when credit risk spreads are low and lending standards in the credit markets are lax. We also find that reputable PEGs pay narrower bank and institutional loan spreads, have longer loan maturities, and rely more on institutional loans. In addition, while we find that PEG reputation is positively related to buyout leverage (i.e., LBO debt divided by pre-LBO earnings before interest, taxes, and amortization (EBITDA) of the target), and leverage is significantly positively related to buyout pricing, we do not find any direct relation between PEG reputation and buyout valuations. The evidence suggests that PEG reputation is related to LBO financing structure not only because reputable PEGs are more likely to take advantage of market timing in credit markets and but also because PEG reputation reduces agency costs of LBO debt.
Limited participation and consumption-saving puzzles: A simple explanation and the role of insurance
Gormley, Todd; Liu, Hong; Zhou, Guofu. Journal of Financial Economics Volume 96, Issue 2, May 2010,Pages 331-334 In this paper, we show that the existence of a large, negative wealth shock and insufficient insurance against such a shock could explain both the limited stock market participation puzzle and the low-consumption-high-savings puzzle. We then conduct an empirical analysis on the relation between household portfolio choices and access to private insurance and various types of government safety nets. The empirical results demonstrate that a lack of insurance against large, negative wealth shocks is positively correlated with lower participation rates and higher saving rates.
98
Overall, the evidence suggests an important role of insurance in household investment and savings decisions.
Going public to acquire? The acquisition motive in IPOs

Celikyurt, Ugur; Sevilir, Merih; Shivdasani, Anil Journal of Financial Economics Volume 96, Issue 3, June 2010, pages 345-363 Newly public firms make acquisitions at a torrid pace. Their large acquisition appetites reflect the concentration of initial public offerings (IPOs) in mergers and acquisitions-(M&A-) intensive industries, but acquisitions by IPO firms also outpace those by mature firms in the same industry. IPO firms' acquisition activity is fueled by the initial capital infusion at the IPO and through the creation of an acquisition currency used to raise capital for both cash- and stock-financed acquisitions along with debt issuance subsequent to the IPO. IPO firms play a bigger role in the M&A process by participating as acquirers than they do as takeover targets, and acquisitions are as important to their growth as research and development (R&D) and capital expenditures (CAPEX). The pattern of acquisitions following an IPO shapes the evolution of ownership structure of newly public firms.
Average correlation and stock market returns

Pollet , Joshua M. & Wilson , Mungo. Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 364-380 If the Roll critique is important, changes in the variance of the stock market may be only weakly related to changes in aggregate risk and subsequent stock market excess returns. However, since individual stock returns share a common sensitivity to true market return shocks, higher aggregate risk can be revealed by higher correlation between stocks. In addition, a change in stock market variance that leaves aggregate risk unchanged can have a zero or even negative effect on the stock market risk premium. We show that the average correlation between daily stock returns predicts subsequent quarterly stock market excess returns. We also show that changes in stock market risk holding average correlation constant can be interpreted as changes in the average variance of individual stocks. Such changes have a negative relation with future stock market excess returns.
Risk and CEO turnover

Bushman, Robert; Dai, Zhonglan ;Wang, Xue. Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 381-398 This paper investigates how performance risk impacts a board's ability to learn about the unknown talent of a chief executive officer (CEO). We theorize that the information content of performance is increasing in idiosyncratic risk and decreasing in systematic risk. We provide robust empirical evidence that the likelihood of CEO turnover is increasing in idiosyncratic risk and decreasing in systematic risk and that turnover-performance-sensitivity is also increasing in idiosyncratic risk and decreasing in systematic risk. We further investigate relations between the threat of termination and CEO compensation, showing that for retained CEOs, both subsequent pay-performance-sensitivity and pay levels decrease in the probability of turnover.
99
Profiting from government stakes in a command economy: Evidence from Chinese asset sales
Calomiris, Charles W. ; Fisman, Raymond ; Wang, Yongxiang Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 399-412 We examine the market response to an unexpected announcement of the sale of government-owned shares in China. In contrast to earlier work, we find a negative effect of government ownership on returns at the announcement date and a symmetric positive effect from the policy's cancellation. We suggest that this results from the absence of a Chinese political transition to accompany economic reforms, so that the benefits of political ties outweigh the efficiency costs of government shareholdings. Companies managed by former government officials have positive abnormal returns, suggesting that personal ties can substitute for government ownership as a source of connections.
Trade credit, collateral liquidation, and borrowing constraints

Fabbri , Daniela ; Menichini, Anna Maria C. Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 413-432 Assuming that firms' suppliers are better able to extract value from the liquidation of assets in default and have an information advantage over other creditors, the paper derives six predictions on the use of trade credit. (1) Financially unconstrained firms (with unused bank credit lines) take trade credit to exploit the supplier's liquidation advantage. (2) If inputs purchased on account are sufficiently liquid, the reliance on trade credit does not depend on credit rationing. (3) Firms buying goods make more purchases on account than those buying services, while suppliers of services offer more trade credit than those of standardized goods. (4) Suppliers lend inputs to their customers but not cash. (5) Greater reliance on trade credit is associated with more intensive use of tangible inputs. (6) Better creditor protection decreases both the use of trade credit and input tangibility.
Dynamic asset allocation with stochastic income and interest rates

Munk, Claus & Srensen, Carsten Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 433-462 We solve for optimal portfolios when interest rates and labor income are stochastic with the expected income growth being affine in the short-term interest rate in order to encompass business cycle variations in wages. Our calibration based on the Panel Study of Income Dynamics (PSID) data supports this relation with substantial variation across individuals in the slope of this affine function. The slope is crucial for the valuation and riskiness of human capital and for the optimal stock/bond/cash allocation both in an unconstrained complete market and in an incomplete market with liquidity and short-sales constraints.
100
Uncertainty about average profitability and the diversification discount

Hund , John & Monk, Donald & Tice, Sheri. Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 463-484 The diversification discount (multiple segment firm value below the value imputed using single segment firm multiples) is commonly thought to be generated by agency problems, a lack of transparency, or lackluster future prospects for diversified firms. If multiple segment firms have lower uncertainty about mean profitability than single segment firms, rational learning about mean profitability provides an alternative explanation for the diversification discount that does not rely on suboptimal managerial decisions or a poor firm outlook. Empirical tests which examine changes in firm value across the business cycle and idiosyncratic volatility are consistent with lower uncertainty about mean profitability for multiple segment firms.
Creditor rights, information sharing, and bank risk taking

Houston, Joel F. & Lin, Chen & Lin, Ping & Ma, Yue Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 485-512 Looking at a sample of nearly 2,400 banks in 69 countries, we find that stronger creditor rights tend to promote greater bank risk taking. Consistent with this finding, we also show that stronger creditor rights increase the likelihood of financial crisis. On the plus side, we find that stronger creditor rights are associated with higher growth. In contrast, we find that the benefits of information sharing among creditors appear to be universally positive. Greater information sharing leads to higher bank profitability, lower bank risk, a reduced likelihood of financial crisis, and higher economic growth.
CFOs and CEOs: Who have the most influence on earnings management?
(Xuefeng) Jiang, John & Petroni, Kathy R. & Yanyan Wang, Isabel Journal of Financial Economics Volume 96, Issue 3, June 2010, Pages 513-526 This study examines the association between chief financial officer (CFO) equity incentives and earnings management. Chief executive officer (CEO) equity incentives have been shown to be associated with accruals management and the likelihood of beating analyst forecasts (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005). Because CFOs' primary responsibility is financial reporting, CFO equity incentives should play a stronger role than those of the CEO in earnings management. We find that the magnitude of accruals and the likelihood of beating analyst forecasts are more sensitive to CFO equity incentives than to those of the CEO. Our evidence supports the Securities and Exchange Commission's (SEC) new disclosure requirement on CFO compensation.
101
Liquidity and valuation in an uncertain world

Easley, David & O'Hara, Maureen Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 1-11 During the 2007-2009 financial crisis there was little or no trading in a variety of financial assets, even though bid and ask prices existed for many of these assets. We develop a model in which this illiquidity arises from uncertainty, and we argue that this new form of illiquidity makes bid and ask prices unsuitable as metrics for establishing "fair value" for these assets. We show how the extreme uncertainty that traders face can be characterized by incomplete preferences over portfolios, and we use Bewley's (2002) model of decision making under uncertainty to derive equilibrium quotes and the nonexistence of trading at these quotes. We then suggest alternatives for valuing assets in illiquid markets.
Why do firms appoint CEOs as outside directors?

Fahlenbrach, Rdiger & Low, Angie & Stulz, Ren M Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 12-32 Companies actively seek to appoint outside CEOs to their boards. Consistent with our matching theory of outside CEO board appointments, we show that such appointments have a certification benefit for the appointing firm. CEOs are more likely to join boards of large established firms that are geographically close, pursue similar financial and investment policies, and have comparable governance to their own firms. The first outside CEO director appointment has a higher stock-price reaction than the appointment of another outside director. Except for a decrease in operating performance following the appointment of an interlocked director, CEO directors do not affect the appointing firm's operating performance, decision-making, and CEO compensation.
The marketing of seasoned equity offerings

Gao, Xiaohui & Ritter, Jay R Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 33-52 In an accelerated seasoned equity offering (SEO), an issuer foregoes the investment bank's marketing efforts in return for a lower fee. To explain why many issuing firms choose a higher cost fully marketed offer, we posit that the marketing effort flattens the issuer's short-run demand curve. Alternatively stated, with a fully marketed offer, the issuer is paying investment bankers to create demand, making the elasticity of demand at the time of issuance an endogenous choice variable. Empirical analysis shows that both the pre-issue elasticity of the issuing firm's demand curve and the offer size are important determinants of the offer method choice. We find evidence of a large transitory increase in the elasticity of demand for issuers conducting fully marketed SEOs.
102
Multi-market trading and arbitrage

Gagnon, Louis & Andrew Karolyi, G Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 53-80 We measure arbitrage opportunities by comparing the intraday prices and quotes of American Depositary Receipts (ADRs) and other types of cross-listed shares in U.S. markets with synchronous prices of their home-market shares on a currency-adjusted basis for a sample of 506 U.S. cross-listed stocks from 35 different countries. Deviations from price parity average an economically small 4.9 basis points, but they are volatile and can reach large extremes. Price parity deviations and their daily changes are positively related to proxies for holding costs that can impede arbitrage, even after controlling for transactions costs and foreign investment restrictions.
Local institutional investors, information asymmetries, and equity returns

Baik, Bok & Kang, Jun-Koo & Kim, Jin-Mo Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 81-106 We examine the informational role of geographically proximate institutions in stock markets. We find that both the level of and change in local institutional ownership predict future stock returns, particularly for firms with high information asymmetry; in contrast, such predictive abilities are relatively weak for nonlocal institutional ownership. The local advantage is especially evident for local investment advisors, high local ownership institutions, and high local turnover institutions. We also find that the stocks that local institutional investors hold (trade) earn higher excess returns around future earnings announcements than those that nonlocal institutional investors hold (trade).
Co-movement, information production, and the business cycle

Brockman, Paul & Liebenberg, Ivonne & Schutte, Maria Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 107-129 Recent theoretical research suggests that information production is a positive externality of aggregate economic activity (Veldkamp, 2005). Both the quantity and quality of information increase during periods of economic expansion and decrease during periods of contraction. Based on this insight, we hypothesize and confirm that time-varying information production drives the comovement patterns observed in stock returns. We examine stock return comovement in 36 countries from 1980 to 2007 and show that, consistent with the theory, comovement patterns are countercyclical; that is, when information production is high (low), comovement is low (high). We also find that the relation between comovement and the business cycle is stronger in countries that experience large intertemporal swings in information production. Finally, we show that the relation between business cycle and comovement is stronger in poor countries, countries with less developed financial markets, and countries with weaker accounting and transparency standards. These results suggest that financial development and transparency are conducive to a steady flow of financial information over the business cycle.
103
Returns of claims on the upside and the viability of Ushaped pricing kernels
Bakshi, Gurdip & Madan, Dilip & Panayotov, George Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 130-154 When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing region of the kernel. Using returns of (i) S&P 500 index calls, (ii) calls on major international equity indexes, (iii) digital calls, (iv) upside variance contracts, and (v) a theoretical construct that we denote as kernel call, we find broad support for the implications of U-shaped pricing kernels. A possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and shortselling.
Preferred risk habitat of individual investors

Dorn, Daniel & Huberman, Gur Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 155-173 The preferred risk habitat hypothesis, introduced here, is that individual investors select stocks whose volatilities are commensurate with their risk aversion. The data, 1995-2000 holdings of over 20,000 clients at a large German broker, are consistent with the predictions of the hypothesis: the returns of stocks within each portfolio have remarkably similar volatilities, when stocks are sold they are replaced by stocks of similar volatilities, and the more risk-averse customers indeed hold less volatile stocks. Greater volatility specialization is associated with lower Sharpe ratios, primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk.
Board interlocks and the propensity to be targeted in private equity transactions

Stuart , Toby E. & Yim, Soojin. Journal of Financial Economics Volume 97, Issue 1, July 2010, Pages 1-11 We examine how board networks affect change-of-control transactions by investigating whether directors' deal exposure acquired through board service at different companies affect their current firms' likelihood of being targeted in a private equity-backed, take-private transaction. In our sample of all US publicly traded firms in 2000-2007, we find that companies which have directors with private equity deal exposure gained from interlocking directorships are approximately 42% more likely to receive private equity offers. The magnitude of this effect varies with the influence of directors on their current boards and the quality of these directors' previous take-private experience, and it is robust to the most likely classes of alternative explanations--endogenous matching between directors and firms and proactive stacking of board composition by management. The analysis shows that board members and their social networks influence which companies become targets in change-of-control transactions.
104
The world price of home bias

Lau, Sie Ting & Ng, Lilian & Zhang, Bohui Journal of Financial Economics Volume 97, Issue 2, August 2010, Pages 191-217 Theoretical arguments suggest that as the degree of a country's home bias increases, the global risk sharing between domestic and foreign investors will reduce and thereby increase the country's cost of capital. Consistent with this prediction, we find international differences in the cost of capital to be strongly and positively related to varying degrees of home bias for 38 markets. This finding is robust to different cost of capital proxies, different control variables, alternative home-bias measures, international tradability of stocks, and alternative specifications. Therefore, the overall evidence implies that countries may enjoy a significantly lower cost of capital by reducing the extent of their home bias and hence, increasing global risk sharing.
Optimal compensation contracts when managers can hedge

Gao, Huasheng Journal of Financial Economics Volume 97, Issue 2, August 2010, Pages 218-238 This paper examines optimal compensation contracts when executives can hedge their personal portfolios. In a simple principal-agent framework, I predict that the Chief Executive Officer's (CEO's) pay-performance sensitivity decreases with the executive-hedging cost. Empirically, I find evidence supporting the model's prediction. Providing further support for the theory, I show that shareholders also impose a high sensitivity of CEO wealth to stock volatility and increase financial leverage to resolve the executive-hedging problem. Moreover, executives with lower hedging costs hold more exercisable in-the-money options, have weaker incentives to cut dividends, and pursue fewer corporate diversification initiatives. Overall, the manager's ability to hedge the firm's risk affects governance mechanisms and managerial actions.
Payoff complementarities and financial fragility: Evidence from mutual fund outflows
Chen, Qi & Goldstein, Itay & Jiang, Wei Journal of Financial Economics Volume 97, Issue 2, August 2010, Pages 239-262 The paper provides empirical evidence that strategic complementarities among investors generate fragility in financial markets. Analyzing mutual fund data, we find that, consistent with a theoretical model, funds with illiquid assets (where complementarities are stronger) exhibit stronger sensitivity of outflows to bad past performance than funds with liquid assets. We also find that this pattern disappears in funds where the shareholder base is composed mostly of large investors. We present further evidence that these results are not attributable to alternative explanations based on the informativeness of past performance or on clientele effects. We analyze the implications for funds' performance and policies.
105
CEOs versus CFOs: Incentives and corporate policies

Chava, Sudheer & Purnanandam, Amiyatosh Journal of Financial Economics Volume 97, Issue 2, August 2010, Pages 263-278 We undertake a broad-based study of the effect of managerial risk-taking incentives on corporate financial policies and show that the risk-taking incentives of chief executive officers (CEOs) and chief financial officers (CFOs) significantly influence their firms' financial policies. In particular, we find that CEOs' risk-decreasing (increasing) incentives are associated with lower (higher) leverage and higher (lower) cash balances. CFOs' risk-decreasing (-increasing) incentives are associated with safer (riskier) debt-maturity choices and higher (lower) earnings-smoothing through accounting accruals. We exploit the stock option expensing regulation of 2004 to establish a causal link between managerial incentives and corporate policies. Our findings have important implications for optimal corporate compensation design.
Evaluating asset pricing models using the second HansenJagannathan distance

Li, Haitao & Xu, Yuewu & Zhang, Xiaoyan Journal of Financial Economics Volume 97, Issue 2, August 2010, Pages 279-301 We develop a specification test and a sequence of model selection procedures for non-nested, overlapping, and nested models based on the second HansenJagannathan distance, which requires a good asset pricing model to not only have small pricing errors but also be arbitrage free. Our methods have reasonably good finite sample performances and are more powerful than existing ones in detecting misspecified models with small pricing errors but are not arbitrage-free and in differentiating models that have similar pricing errors of a given set of test assets. Using the Fama and French size and book-to-market portfolios, we reach dramatically different conclusions on model performances based on our approach and existing methods.
Unstable banking
Shleifer, Andrei & Vishny, Robert W Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 306-318 We propose a theory of financial intermediaries operating in markets influenced by investor sentiment. In our model, banks make, securitize, distribute, and trade loans, or they hold cash. They also borrow money, using their security holdings as collateral. Banks maximize profits, and there are no conflicts of interest between bank shareholders and creditors. The theory predicts that bank credit and real investment will be volatile when market prices of loans are volatile, but it also points to the instability of banks, especially leveraged banks, participating in markets. Profit-maximizing behavior by banks creates systemic risk.
106
Bank lending during the financial crisis of 2008

Ivashina, Victoria & Scharfstein, David Journal of Financial Economics Volume 97, Issue 3, September 2010,Pages 319-338 This paper shows that new loans to large borrowers fell by 47% during the peak period of the financial crisis (fourth quarter of 2008) relative to the prior quarter and by 79% relative to the peak of the credit boom (second quarter of 2007). New lending for real investment (such as working capital and capital expenditures) fell by only 14% in the last quarter of 2008, but contracted nearly as much as new lending for restructuring (LBOs, M&As, share repurchases) relative to the peak of the credit boom. After the failure of Lehman Brothers in September 2008, there was a run by short-term bank creditors, making it difficult for banks to roll over their short term debt. We find that there was a simultaneous run by borrowers who drew down their credit lines, leading to a spike in commercial and industrial loans reported on bank balance sheets. We examine whether these two stresses on bank liquidity led them to cut lending. In particular, we show that banks cut their lending less if they had better access to deposit financing and thus, they were not as reliant on short-term debt. We also show that banks that were more vulnerable to credit-line drawdowns because they co-syndicated more of their credit lines with Lehman Brothers reduced their lending to a greater extent.
Paulson's gift
Veronesi, Pietro & Zingales, Luigi Journal of Financial Economics Volume 97, Issue 3, September 2010,Pages 339-368 We calculate the costs and benefits of the largest ever US government intervention in the financial sector announced during the 2008 Columbus-day weekend. We estimate that this intervention increased the value of banks' financial claims by $130 billion (bn) at a taxpayers' cost of $21-$44 billion with a net benefit between $86 and $109 bn. By looking at the limited cross section, we infer that this net benefit arises from a reduction in the probability of bankruptcy, which we estimate would destroy 22% of the enterprise value. The big winners of the plan were the bondholders of the three former investment banks and Citigroup, while the losers were JP Morgan shareholders and the US taxpayers.
Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis
Piskorski, Tomasz & Seru, Amit & Vig, Vikrant Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 369-397 We examine whether securitization impacts renegotiation decisions of loan servicers, focusing on their decision to foreclose a delinquent loan. Conditional on a loan becoming seriously delinquent, we find a significantly lower foreclosure rate associated with bank-held loans when compared to similar securitized loans: across various specifications and origination vintages, the foreclosure rate of delinquent bank-held loans is 3% to 7% lower in absolute terms (13% to 32% in relative terms). There is a substantial heterogeneity in these effects with large effects among borrowers with better credit quality and small effects among lower quality borrowers.
107
A quasi-experiment that exploits a plausibly exogenous variation in securitization status of a delinquent loan confirms these results.
Will the U.S. bank recapitalization succeed? Eight lessons from Japan
Hoshi, Takeo & Kashyap, Anil K Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 398-417 During the financial crisis that started in 2007, the U.S. government has used a variety of tools to try to rehabilitate the U.S. banking industry. Many of those strategies were also used in Japan to combat its banking problems in the 1990s. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis. The Japanese policies were only partially successful in recapitalizing the banks until the economy finally started to recover in 2003. From these unsuccessful attempts, we derive eight lessons. In light of these eight lessons, we assess the policies the U.S. has pursued. The U.S. has ignored three of the lessons and it is too early to evaluate the U.S. policies with respect to four of the others. So far, the U.S. has avoided Japan's problem of having impaired banks prop up zombie firms.
Costly external finance, corporate investment, and the subprime mortgage credit crisis
Duchin, Ran & Ozbas, Oguzhan & Sensoy, Berk A Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 418-435 We study the effect of the recent financial crisis on corporate investment. The crisis represents an unexplored negative shock to the supply of external finance for nonfinancial firms. Corporate investment declines significantly following the onset of the crisis, controlling for firm fixed effects and time-varying measures of investment opportunities. Consistent with a causal effect of a supply shock, the decline is greatest for firms that have low cash reserves or high net short-term debt, are financially constrained, or operate in industries dependent on external finance. To address endogeneity concerns, we measure firms' financial positions as much as four years prior to the crisis, and confirm that similar results do not follow placebo crises in the summers of 2003-2006. Nor do similar results follow the negative demand shock caused by September 11, 2001. The effects weaken considerably beginning in the third quarter of 2008, when the demand-side effects of the crisis became apparent. Additional analysis suggests an important precautionary savings motive for seemingly excess cash that is generally overlooked in the literature.
The subprime credit crisis and contagion in financial markets

Longstaff, Francis A Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 436-450 I conduct an empirical investigation into the pricing of subprime asset-backed collateralized debt obligations (CDOs) and their contagion effects on other markets. Using data for the ABX subprime indexes, I find strong evidence of contagion in the financial markets. The results support the hypothesis that financial contagion was
108
propagated primarily through liquidity and risk-premium channels, rather than through a correlated-information channel. Surprisingly, ABX index returns forecast stock returns and Treasury and corporate bond yield changes by as much as three weeks ahead during the subprime crisis. This challenges the popular view that the market prices of these "toxic assets" were unreliable; the results suggest that significant price discovery did in fact occur in the subprime market during the crisis.
Auction failures and the market for auction rate securities

McConnell, John J. & Saretto, Alessio Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 451-469 The market for auction rate securities (ARS) made headlines during the second week of February 2008 when auctions at which the bonds' interest rates reset experienced a wave of "failures." Contrary to headlines that attribute the failures to a "frozen" market or investors' "irrationality," we find that (1) even at their height, less than 50% of ARS experienced auction failures, (2) the likelihood of auction failure was directly related to the level of the bonds' "maximum auction rates," (3) the implied market clearing yields of bonds with failed auctions were significantly above their maximum auction rates, and (4) ARS yields were generally higher than yields of various cash equivalent investment alternatives. We infer that investors priced the possibility of auctions failures into ARS yields and rationally declined to bid for bonds for which required market yields exceeded their maximum auction rates.
The real effects of financial constraints: Evidence from a financial crisis

Campello , Murillo & Graham, John R. & Harvey, Campbell R. Journal of Financial Economics Volume 97, Issue 3, September 2010, Pages 470-487 We survey 1,050 Chief Financial Officers (CFOs) in the U.S., Europe, and Asia to directly assess whether their firms are credit constrained during the global financial crisis of 2008. We study whether corporate spending plans differ conditional on this survey-based measure of financial constraint. Our evidence indicates that constrained firms planned deeper cuts in tech spending, employment, and capital spending. Constrained firms also burned through more cash, drew more heavily on lines of credit for fear banks would restrict access in the future, and sold more assets to fund their operations. We also find that the inability to borrow externally caused many firms to bypass attractive investment opportunities, with 86% of constrained U.S. CFOs saying their investment in attractive projects was restricted during the credit crisis of 2008. More than half of the respondents said they canceled or postponed their planned investments. Our results also hold in Europe and Asia, and in many cases are stronger in those economies. Our analysis adds to the portfolio of approaches and knowledge about the impact of credit constraints on real firm behavior.
109
110
JOURNAL 6
The Financial Review
111
Spring (2010)
CEO Pay-For-Performance Heterogeneity Using Quantile Regression
Kevin F. Hallock 1*Regina Madalozzo 2 Clayton G. Reck The Financial Review Volume 45, Issue 01, Jan 2010, Pg 1-20 We provide some examples of how quantile regression can be used to investigate heterogeneity in pay-firm size and pay-performance relationships for U.S. CEOs. For example, do conditionally (predicted) high-wage managers have a stronger relationship between pay and performance than conditionally low-wage managers? Our results using data over a decade show, for some standard specifications, there is considerable heterogeneity in the returns-to-firm performance across the conditional distribution of wages. Quantile regression adds substantially to our understanding of the pay-performance relationship. This heterogeneity is masked when using more standard empirical techniques.
Signaling, Free Cash Flow and "Nonmonotonic" Dividends

Kathleen Fuller 1*Benjamin M. Blau The Financial Review Volume 45, Issue 01, Jan 2010, Pg 21-56 Many argue that dividends signal future earnings or dispose of excess cash. Empirical support is inconclusive, potentially because no model combines both rationales. This paper does. Higher quality firms pay dividends to eliminate the free cash-flow problem, while firms that outsiders perceive as lower quality pay dividends to signal future earnings and reduce the free cash-flow problem. In equilibrium, dividends are nonmonotonic with respect to the signal observed by outsiders; the highest quality firms pay smaller dividends than lower perceived quality firms. The model reconciles the existing literature and generates new empirical predictions that are tested and supported..
Dividends versus Share Repurchases Evidence from Canada: 19852003

Maher Kooli Jean-Franois L'Her The Financial Review Volume 45, Issue 01, Jan 2010, Pg 57-81 This paper provides out-of-sample evidence on the payout policy in Canada during the 19852003 period. First, we show that the proportion of nonfinancial firms paying dividends has decreased, while the proportion initiating repurchase programs has increased. We also show that Canadian firms paying dividends and repurchasing shares are extremely concentrated. Second, we focus on the factors that could affect the choice between repurchases and dividends. We find that dividends and repurchases are used by different types of firms. While we do not confirm the financial flexibility hypothesis, our results are consistent with the substitution hypothesis after controlling for selection bias and endogeneity.
112
The Ex-dividend Day: Action On and Off the Danish Exchange

Umid Akhmedov , Keith Jakob The Financial Review Volume 45, Issue 01, Jan 2010,Pg 83-103 We examine ex-dividend day behavior on the Copenhagen Stock Exchange. We report price-drop ratios of 32% and 18% for close-to-close and close-to-open samples, respectively, well below the ratios observed in the United States. Our findings are generally consistent with limit order adjustment explanations from recent literature. In Denmark, a unique average price trading opportunity makes it possible for investors to capture dividends without directly altering supply or demand in the regular market, and therefore not necessarily driving the price-drop ratios toward one.
Debt Issuance in the Face of Tax Loss Carryforwards

Anne-Marie Anderson ,Nandu Nayar The Financial Review Volume 45, Issue 01, Jan 2010, pg 105-127 We examine the market impact of issuances of public and private debt by firms with sizeable tax loss carryforwards (TLCFs). Public issuances are met with a significantly negative stock price reaction, while private placements are associated with a positive marginally significant stock price reaction. After controlling for asymmetric information proxies, the stock price reaction to the debt issuance is more negative, the larger the TLCF. The evidence suggests that debt financing is suboptimal when issuers have large TLCFs, which in turn, supports the relevance of taxes for debt usage.
Investors' Use of Historical Forecast Bias to Adjust Current Expectations

Seung-Woog (Austin) Kwag ,Ronald E. Shrieves The Financial Review Volume 45, Issue 01, Jan 2010, pg 129-152 We explore the extent to which investor response to earnings information differs in the presence of historical bias in earnings forecasts. Overall, the results are consistent with the notion that investors take historical forecast bias into account when interpreting information in earnings announcements and that the market's reaction to forecast errors is larger (less negative) when forecasts are historically more optimistic and suggests that the functional form commonly used in the earnings response literature does not appropriately capture the effect of real unexpected earnings information (i.e., investors' expectation errors as opposed to analysts' forecast errors) on stock returns.
113
Changes in the Information Efficiency of Stock Prices: Additional Evidence

Richard A. DeFusco , Suchi Mishra ,K. Raghunandan The Financial Review Volume 45, Issue 01, Jan 2010, Pg 153-165 Previous research shows, using data from three quarters after the implementation of regulation fair disclosure (Reg FD), that there is an improvement in the informational efficiency of stock prices after Reg FD. We compare the informational efficiency of stock prices in four pre-Reg FD quarters (19992000) and 12 post-Reg FD quarters (20022005). The improvement in the informational efficiency of stock prices previously reported in the immediate aftermath of Reg FD persists in later periods..
Predictability in Consumption Growth and Equity Returns: A Bayesian Investigation

Alex Paseka , George Theocharides The Financial Review Volume 45, Issue 01, Jan 2010, Pg 167-203 We use a Bayesian method to estimate a consumption-based asset pricing model featuring long-run risks. Although the model is generally consistent with consumption and dividend growth moments in annual data, the conditional mean of consumption growth (a latent process) is not persistent enough to satisfy the restriction that the price-dividend ratio be an affine function of the latent process. The model also requires relatively high intertemporal elasticity of substitution to match the low volatility of the risk-free return. These two restrictions lead to the equity volatility puzzle. The model accounts for only 50% of the total variation in asset returns.
A Note on Affordability and the Optimal Share Price

William T. Chittenden , Janet D. Payne , J. Holland Toles The Financial Review Volume 45, Issue 01, Jan 2010, Pg 205-216 Despite the increase in institutional ownership, decreased trading costs, and increased real personal savings, we find that the average stock price is lower today than it was in the 1920s. In the aggregate, the propensity to split is a function of recent market performance, personal savings, and the desirability of appearing to be a small firm. Our results indicate that, after decades of inflation and the average stock price falling, splitting stocks to return to an "affordable" trading range must be rejected as an explanation. This suggests that other economic forces are behind splits, whether traditional or behavioral in nature.
114
Summer (2010)
Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold
Dirk G. Baur, Brian M. Lucey The Financial Review Volume 45, Issue 02, May 2010 Is gold a hedge, defined as a security that is uncorrelated with stocks or bonds on average, or is it a safe haven, defined as a security that is uncorrelated with stocks and bonds in a market crash? We study constant and time-varying relations between U.S., U.K. and German stock and bond returns and gold returns to investigate gold as a hedge and a safe haven. We find that gold is a hedge against stocks on average and a safe haven in extreme stock market conditions. A portfolio analysis further shows that the safe haven property is short-lived.
50+ Years of Diversification Announcements

Mehmet E. Akbulut, John G. Matsusaka The Financial Review Volume 45, Issue 02, May 2010 This paper studies announcement returns from 4,764 mergers over 57 years to shed light on several controversies concerning corporate diversification. One prominent view is that diversification destroys value because of agency problems or internal investment distortions, but we find that combined (acquirer plus target) announcement returns are significantly positive for diversifying mergers throughout the period, and no lower than the returns for related mergers. The returns from diversifying acquisitions fell after 1980, and investors rewarded mergers involving financially constrained firms before but not after 1980, consistent with the idea that the value of internal capital markets declined over time.
Terrorism and Stock Market Sentiment

Jussi Nikkinen, Sami Vahamaa The Financial Review Volume 45, Issue 02, May 2010 This paper examines the effects of terrorism on stock market sentiment by focusing on the behavior of expected probability density functions of the FTSE 100 index around terrorist attacks. We find that terrorism has a strong adverse impact on stock market sentiment. In particular, terrorist attacks are found to cause a pronounced downward shift in the expected value of the FTSE 100 index and a significant increase in stock market uncertainty. Furthermore, our results show that the expected FTSE 100 probability densities became significantly more negatively skewed and fat-tailed in the immediate aftermath of terrorist acts.
115
On Model Testing in Financial Economics

Robert A. Jarrow The Financial Review Volume 45, Issue 02, May 2010 This paper discusses the two different contradicting philosophies for testing models in financial economics (asset pricing, corporate finance, and market-microstructure) using linear regression. We synthesize these two contradicting approaches, document the errors that may occur in the existing estimation methodologies, and suggest a modified procedure that avoids these errors.
Investment Irreversibility, Cash Flow Risk, and ValueGrowth Stock Return Effects
Wikrom Prombutr, Larry Lockwood, J. David Diltz The Financial Review Volume 45, Issue 02, May 2010 We simulate results from a simple real options model to provide insight into the value-growth stock return anomaly. In our model, firms possess either single ("value" firm) or multiple ("growth" firm) investment opportunities. Our model predicts that growth firms: (1) invest sooner, (2) exhibit greater continuity in capital expenditure over time, (3) have lower book-to-market ratios, and (4) generate lower rates of return than value firms.
Does Inclusion in a Smaller S&P Index Create Value?

John R. Becker-Blease, Donna L. Paul The Financial Review Volume 45, Issue 02, May 2010 This study finds overall increases in equity value surrounding addition to the S&P SmallCap and MidCap indexes from 1996 to 2003 and investigates sources of the value gains. Following addition, there are significant increases in proxy variables for stock liquidity and investor recognition, and changes in these variables are impounded into the permanent component of announcement share price revisions. We also find that changes in capital investment intensity are increasing in changes in stock liquidity, consistent with a reduction in the cost of capital following index addition.
The Efficacy of Regulation Fair Disclosure

Praveen Sinha, Christopher Gadarowski The Financial Review Volume 45, Issue 02, May 2010 This paper examines the impact of Securities and Exchange Commission's Regulation Fair Disclosure (FD) on information leakage around voluntary management disclosures. We find a positive correlation between stock returns two days before and after the voluntary disclosure in the pre-Regulation FD period, but not in the post-Regulation FD period. After Regulation FD is implemented, preannouncement abnormal return as a percentage of total return decreases by 26.1% (21.4%) for large firms with good (bad) news, suggesting that the amount of
116
information leakage reduces for these firms. These findings provide support for the premise and the intended purpose of the regulation for large firms.
Yes, The Value Line Enigma Is Still Alive: Evidence from Online Timeliness Rank Changes
Ying Zhang, Giao X. Nguyen, Steven V. Le The Financial Review Volume 45, Issue 02, May 2010 Beginning June 9, 2005, Value Line started announcing its Timeliness changes online at 10:00 a.m. on Thursday, one day earlier than Friday noon's post-delivery. We confirm that the Value Line effect still exists but shifts to Thursday in the Internet era. Unlike previous findings, the next-day abnormal return after the announcement has disappeared, suggesting that the market efficiently priced the change. We find that a portfolio upgraded from rank 5 to 4 gains the highest cumulative abnormal return of 9.07% over a 50-day window. Finally, we find that the post-earnings announcement drift does not explain the Value Line enigma.
Stock Splits and Bond Yields: Isolating the Signaling Hypothesis

David Michayluk, Ruoyun Zhao The Financial Review Volume 45, Issue 02, May 2010 One explanation offered for stock splits is that the split signals positive information by reducing the stock price range in expectation of improved future prospects. Price declines also lead to changes in stock price dynamics, but related securities are not subject to these other changes and therefore can be used to provide a separate assessment of the markets' interpretation of the split. We examine corporate bond issues around stock splits and find a significant decline in the bond yield spread following stock splits, supporting the signaling hypothesis. We also confirm improvements in forecasted and realized earnings subsequent to stock splits.
Does the Quality of Financial Advice Affect Prices?

Arthur Allen, Donna Dudney The Financial Review Volume 45, Issue 02, May 2010 Using a large data sample of 58,562 new municipal issues covering the period from 1984 to 2002, we examine whether the quality of advice provided by a financial advisor affects new issue interest costs. We find that higher-quality financial advisors are associated with statistically significant decreases in new issue yields. The effect of advisor quality on yields is more pronounced for revenue, negotiated, and opaque bond issues than for general obligation and competitively sold issues. However, issuers of revenue or negotiated bonds are more likely to choose a low-quality advisor.
117
The Moving Average Ratio and Momentum

Seung-Chan Park The Financial Review Volume 45, Issue 02, May 2010 I show the ratio of the short-term moving average to the long-term moving average (moving average ratio, MAR) has significant predictive power for future returns. The MAR combined with nearness to the 52-week high explains most of the intermediate-term momentum profits. This suggests that an anchoring bias, in which investors use moving averages or the 52-week high as reference points for estimating fundamental values, is the primary source of momentum effects. Momentum caused by the anchoring bias do not disappear in the long-run even when there are return reversals, confirming that intermediate-term momentum and long-term reversals are separate phenomena.
Arbitrage and the Evaluation of Linear Factor Models in UK Stock Returns

Jonathan Fletcher The Financial Review Volume 45, Issue 02, May 2010 I examine the impact of the no arbitrage restriction on the estimation and evaluation of linear factor models in UK stock returns. The no arbitrage restriction reduces volatility and eliminates most of the negative values of the fitted stochastic discount factor models. All of the factor models are rejected and there are significant differences in the pricing performance between models under the no arbitrage restriction. The no arbitrage restriction can have a significant impact on both the parameter estimates and pricing errors for some models.
Short-Horizon Return Predictability in International Equity Markets

Abul Shamsuddin, Jae H. Kim The Financial Review Volume 45, Issue 02, May 2010 This study measures the degree of short-horizon return predictability of 50 international equity markets and examines how its variation is related to the indicators of equity market development. Two multiple-horizon variance ratio tests are employed to measure the degree of return predictability. We find evidence that return predictability is negatively correlated with publicly available indicators of equity market development. Our cross-sectional regression analysis shows that the per capita gross domestic product, market turnover, investor protection, and absence of short-selling restrictions are correlated with cross-market variations in return predictability.
118
Asset Pricing and Welfare Analysis with Bounded Rational Investors

Lei Lu The Financial Review Volume 45, Issue 02, May 2010 Motivated by the fact that investors have limited ability to process information, I model investors' bounded rational behavior in processing information and investigate its implications for asset pricing. Investors can make mistakes in processing information and thus have inaccurate estimates of fundamentals. This process generates "bounded rational risk." I find that the volatility of stock and bond return increases in the presence of bounded rational investors, which can help explain the excessive volatility puzzle. The stock-bond return correlation becomes time varying and even negative and rational investors benefit from the trading with bounded rational investors.
119
Fall (2010)
Anonymity, Stealth Trading and the Information Content of Broker Identity
Alex Frino, David Johnstone, and Hui Zheng The Financial Review Volume 45, Issue 03, August 2010 This paper examines whether the identity of a broker involved in transactions contains information. Using a sample of transactions from the Australian Stock Exchange where broker identity is transparent we provide evidence that consecutive buyer/seller-initiated transactions by the same broker have a relatively high permanent price impact. This implies that broker identity conveys information to market participants, and that markets in which broker identity is disclosed are likely to be more efficient. We also find that medium-sized trades by the same broker convey greater information than large and small trades, which is consistent with stealth-trading by informed investors.
Evidence from Decimalization on the NYSE

Wei Huang, S. Ghon Rhee, and Ning Tang The Financial Review Volume 45, Issue 03, August 2010 We examine the impact of decimalization on preferenced trading in NYSE-listed stocks and show a significant decline in preferenced trading around decimalization. For the largest NYSE stocks, the total decline is nearly 22%. We also find a negative correlation between the changes in preferenced trading and the changes in quote competition intensity, and a positive correlation between the changes in preferenced trading and the changes in spreads. Consistent with the cream skimming hypothesis, we find that abnormal changes in information asymmetry cost for NYSE trades are positively correlated with the changes in preferenced trading.
Risk Changes around Calls of Convertible Bonds

Luis Garca-Feijo, Scott Beyer, and Robet R. Johnson The Financial Review Volume 45, Issue 03, August 2010 We examine changes in equity and asset betas around convertible bond calls and report two major findings. First, calling firms exhibit an increase in asset betas following the call. We argue that the finding is consistent with the implications of the sequential financing theory but not of the backdoor equity financing theory. Second, abnormal returns at call announcements are negative only for the subsample of firms that also exhibit an increase in equity beta. We conclude that risk changes help explain the market reaction to convertible bond calls.
120
Syndication in Venture Capital Financing

Daniel N. Deli and Mukunthan Santhanakrishnan The Financial Review Volume 45, Issue 03, August 2010 We examine syndication in venture capital investments between 1980 and 2005. We argue that VC firms syndicate investments to mitigate human capital and financial constraints within individual VC firms and to reduce uncertainty about firm value. Our results are consistent with those arguments. We find that syndication is more likely for firms in the earliest stage of development and firms in the last stage of development as private firms (when human capital investments are greatest), for firms requiring the largest amounts of financial capital, and for firms with greater growth opportunities (those that are most difficult to value).
Bond Market Access, Credit Quality, and Capital Structure: Canadian Evidence
Usha R. Mittoo and Zhou Zhang The Financial Review Volume 45, Issue 03, August 2010 We examine the impact of bond market access (measured by having a credit rating) on leverage for Canadian high credit quality (HQ) and low credit quality (LQ) firms, and find that the leverage impact is more pronounced for LQ firms. The results are similar for U.S. firms. Our results are confirmed when we control for the firms credit quality, examine the change in leverage around rating initiation, and account for the issue size effect. A similar leverage impact for Canadian and U.S. LQ firms suggests that the Canada-U.S. bond market integration has mitigated the financial constraints for Canadian LQ firms.
Debt Maturity, Credit Risk, and Information Asymmetry: The case of Municipal Bonds
Kenneth Daniels, Demissew Diro Ejara, Jayaraman Vijayakumar The Financial Review Volume 45, Issue 03, August 2010 Using a system of equations approach, this paper empirically tests the impact of credit quality, asset maturity, and other issuer and issue characteristics on the maturity of municipal bonds. We find that under conditions of lower information asymmetry that prevails in the municipal sector, higher-rated bonds have longer maturities than low-rated bonds. This result differs from that observed in the corporate sector. Overall, our results support the asset maturity hypothesis. In addition, our analysis finds that fundamentals matter. Issue features that provide additional protection or convenience to the investor tend to increase debt maturity.
121
Industry Structure and Corporate Debt Maturity

Otgontsetseg Erhemjamts, Kartik Raman, Husayn Shahrur The Financial Review Volume 45, Issue 03, August 2010 We examine how industry competition affects firms choice of short-term debt. We find that the percentage of short-term debt is positively related to industry concentration at low levels of concentration, and inversely related to industry concentration at higher levels of concentration. This non-linear relation is stronger in industries where firms are either more homogeneous or compete more aggressively. Moreover, we find that firms with shorter-maturity debt are less aggressive than their rivals in the product market. The overall evidence suggests that although financial contracts alleviate agency problems, they exacerbate the risk of predation.
Earnings Management Surrounding New Debt Issues

Yixin Liu, Yixi Ning, Wallace N. Davidson III The Financial Review Volume 45, Issue 03, August 2010 We examine whether firms manage earnings before issuing bonds to achieve a lower cost of borrowing. We find significant income-increasing earnings management prior to bond offerings. We also find that firms that manage earnings upward issue debt at a lower cost, after controlling for various bond issuer and issue characteristics. Our results are consistent with studies that report earnings management around equity issuance. The results indicate that, like equity holders, bondholders fail to see through the inflated earnings numbers in pricing new debt.
Information Transfer Effects of Bond Rating Downgrades

Philippe Jorion and Gaiyan Zhang The Financial Review Volume 45, Issue 03, August 2010 This paper investigates information transfer effects of bond rating downgrades measured by equity abnormal returns for industry portfolios. Industry rivals can be subject to two opposing effects, the contagion effect and the competition effect. We find that the net effect is strongly dependent on the original bond rating of the downgraded firm. For investment-grade (speculative-grade) firms, industry abnormal equity returns are negative (positive), which implies a predominant contagion (competition) effect. The analysis reveals a rich pattern of positive and negative correlations across negative credit events, which can be used to improve our understanding of portfolio credit risk models.
Treasury bond Volatility and Uncertainty about Monetary Policy

Ivo J.M. Arnold and Evert B. Vrugt The Financial Review Volume 45, Issue 03, August 2010 We show that dispersion-based uncertainty about the future course of monetary policy is the single most important determinant of Treasury bond volatility across all maturities. The link between Treasury bond volatility and uncertainty about
122
macroeconomic variables is much stronger than for the more traditional time-series measures of macroeconomic volatility and adds beyond the information contained in lagged bond market volatility. Uncertainty about monetary policy subsumes the uncertainty about future inflation (CPI and the deflator) and economic activity (unemployment, real and nominal GDP and industrial production). In addition, causality clearly runs one way: from monetary policy uncertainty to Treasury bond volatility.
SEO Cycles
John S. Howe and Shaorong Zhang The Financial Review Volume 45, Issue 03, August 2010 Public equity offerings by seasoned firms (SEOs) exhibit similar but less volatile cycles than initial public offerings of newly public firms. Our paper provides a comprehensive examination of the factors that cause variation in the number of firms issuing SEOs. Specifically, we use four factors from studies of IPOs as potential determinants of SEO cycles. We find that whether tested separately or collectively, only the demand for capital and market timing hypotheses receive strong empirical support in explaining SEO volume. Investor sentiment is not an important factor in explaining SEO volume, nor is information asymmetry.
Partial Price Adjustments and Equity Carve-Outs

Thomas H. Thompson The Financial Review Volume 45, Issue 03, August 2010 We examine the extent to which market-adjusted ex-date returns reflect public information for 271 equity carve-outs in 1988-2006. Although prior studies focus on ex-post determinants of equity carve-out and IPO returns, our study is the first to explore ex-ante predictors of equity carve-out returns. We use three primary variables: filing range adjustments, the percentage of the offering used to retire subsidiary debt or to pay dividends, and the CBOE Volatility Index (VXO) to predict initial returns. We show that 11%-35% of the variation in market-adjusted equity carve-out returns can be predicted using public information known prior to the offer date.
Price Movers on the Stock Exchange of Thailand: Evidence from a Fully Automated Order-Driven Market
Charlie Charoenwong, David K. Ding, and Nattawut Jenwittayaroje The Financial Review Volume 45, Issue 03, August 2010 This study examines which trade sizes move stock prices on the Stock Exchange of Thailand (SET), a pure limit order market, over two distinct market conditions of bull and bear. Using intraday data, the study finds that large sized trades (i.e., those larger than the 75th percentile) account for a disproportionately large impact on changes in traded and quoted prices. The finding remains even after it has been subjected to a battery of robustness checks. In contrast, the results of studies conducted in the United States show that informed traders employ trade sizes falling between the 40th and 95th percentiles (Barclay and Warner 1993; Chakravarty 2001). Our results support the hypothesis that informed traders in a pure limit order
123
market such as the SET, where there are no market makers, also use larger-size trades than those employed by informed traders in the United States.
Prior Payment Status and the Likelihood to Pay Dividends: International Evidence
Mia Twu The Financial Review Volume 45, Issue 03, August 2010 By using the signaling model and the life-cycle theory, I examine the importance of prior payment status in determining the likelihood to pay dividends. I categorize firms into those that paid dividends previously and those that did not. My results show that strong dividend stickiness exists and the determinants to pay differ significantly for the two groups of firms. High growth and low insider holdings make prior payers more likely to pay but prior non-payers less likely to pay. Furthermore, prior payers are more sensitive to profitability and earned/contributed equity mix, while prior non-payers are more sensitive to risk and dividend premiums. Finally, taking the prior payment status into account eliminates the problem of overestimating the portion of payers put forth by previous studies.
Corporate Hedging Policy and Equity Mispricing

J. Barry Lin, Christos Pantzalis, and Jung Chul Park The Financial Review Volume 45, Issue 03, August 2010 We show that firms use of derivatives is negatively associated with stock mispricing. This result is consistent with the notion that hedging improves the transparency and predictability of firms cash flows resulting in less misvaluation. Furthermore, we show that the negative relationship between mispricing and hedging is particularly strong when market value is below fundamental value, which is consistent with prior evidence that hedging has a positive impact on firm valuation. Finally, we provide evidence that a spread-out hedging policy that entails the use of a variety of derivative contracts can be more effective in reducing mispricing.
Restructuring Using Operating Asset Exchanges: Issues and Evidence

Kaysia Campbell and James E. Owers The Financial Review Volume 45, Issue 03, August 2010 This study examines restructuring in which a firm divests an operating asset in exchange for another operating asset. Since liquidity, capital structure, and distributional issues are not immediately associated with tax-free asset-for-asset exchanges, they are well suited for examining the competing hypotheses related to divestitures. We find that the abnormal returns associated with asset exchanges are generally smaller than those associated with other divestiture restructurings except when indications of value are provided. Our analysis identifies positive valuation effects for firms undertaking focus-enhancing exchanges, but a dominating consideration is whether the value of the units traded is indicated.
124
What are the capital structure determinants for tax-exempt organizations?

Geoffrey Peter Smith The Financial Review Volume 45, Issue 03, August 2010 We examine the extent to which market-adjusted ex-date returns reflect public information for 271 equity carve-outs in 1988-2006. Although prior studies focus on ex-post determinants of equity carve-out and IPO returns, our study is the first to explore ex-ante predictors of equity carve-out returns. We use three primary variables: filing range adjustments, the percentage of the offering used to retire subsidiary debt or to pay dividends, and the CBOE Volatility Index (VXO) to predict initial returns. We show that 11%-35% of the variation in market-adjusted equity carve-out returns can be predicted using public information known prior to the offer date.
Political Risk and Purchases of Privatized State Owned Enterprises

Mina C. Glambosky, Kimberly C. Gleason, and Jeff Madura The Financial Review Volume 45, Issue 03, August 2010 We assess the valuation effects and risk for acquirers of privatized state owned enterprises (SOEs). The valuation effects of purchasers are positive and significant, they increase for purchasers that have recent high performance, better access to capital, and have engaged in larger acquisitions. The acquirer valuation effects are lower when the selling government is more corrupt, more bureaucratic and a weaker financial performer. Acquirers total and unsystematic risk increases, indicating that purchasers of SOEs realize diversification benefits. Systematic risk increases for purchasers when the government is characterized by high political risk.
125
126
JOURNAL 7
Journal of Econometrics
127
Spring (2010)
A new instrumental method for dealing with endogenous selection
Xavier dHaultfoeuille Journal of Econometrics Volume 154, Issue 1, January 2010 This paper develops a new method for dealing with endogenous selection. The usual instrumental strategy based on the independence between the outcome and the instrument is likely to fail when selection is directly driven by the dependent variable. Instead, we suggest to rely on the independence between the instrument and the selection variable, conditional on the outcome. This approach may be particularly suitable for nonignorable nonresponse, binary models with missing covariates or Roy models with an unobserved sector. The nonparametric identification of the joint distribution of the variables is obtained under a completeness assumption, which has been used recently in several nonparametric instrumental problems. Even if the conditional independence between the instrument and the selection variable fails to hold, the approach provides sharp bounds on parameters of interest under weaker monotonicity conditions. Apart from identification, nonparametric and parametric estimations are also considered. Finally, the method is applied to estimate the effect of grade retention in French primary schools.
A comparison of meanvariance efficiency tests

Dante Amengua, Enrique Sentanal Journal of Econometrics Volume 154, Issue 1, January 2010 We analyse the asymptotic properties of meanvariance efficiency tests based on generalised methods of moments, and parametric and semiparametric likelihood procedures that assume elliptical innovations. We study the trade-off between efficiency and robustness, and prove that the parametric estimators provide asymptotically valid inferences when the conditional distribution of the innovations is elliptical but possibly misspecified and heteroskedastic. We compare the small sample performance of the alternative tests in a Monte Carlo study, and find some discrepancies with their asymptotic properties. Finally, we present an empirical application to US stock returns, which rejects the meanvariance efficiency of the market portfolio.
A constrained maximum likelihood approach to estimating switching regressions

Jianjun Xu, Xianming Tan, Runchu Zhang Journal of Econometrics Volume 154, Issue 1, January 2010 Phillips [Phillips R.F., 1991. A constrained maximum likelihood approach to estimating switching regressions. Journal of Econometrics 48, 241262] proposed a constrained maximum-likelihood approach to estimating the parameters in a switching regression model. In this note, we propose a new approach which leads to a proof of a more general result than Phillipss. Specifically, we prove that the Constrained MLE (CMLE) is still strongly consistent when the constant c decreases
128
to 0 at the rate of as n increases to , with >1. We also suggest a suitable , hence cn, for practice based on simulation results.
Short and long run causality measures: Theory and inference

Jean-Marie Dufour, Abderrahim Taamouti Journal of Econometrics Volume 154, Issue 1, January 2010 The concept of causality introduced by Wiener [Wiener, N., 1956. The theory of prediction, In: E.F. Beckenback, ed., The Theory of Prediction, McGraw-Hill, New York (Chapter 8)] and Granger [Granger, C. W.J., 1969. Investigating causal relations by econometric models and cross-spectral methods, Econometrica 37, 424 459] is defined in terms of predictability one period ahead. This concept can be generalized by considering causality at any given horizon h as well as tests for the corresponding non-causality [Dufour, J.-M., Renault, E., 1998. Short-run and longrun causality in time series: Theory. Econometrica 66, 10991125; Dufour, J.-M., Pelletier, D., Renault, ., 2006. Short run and long run causality in time series: Inference, Journal of Econometrics 132 (2), 337362]. Instead of tests for noncausality at a given horizon, we study the problem of measuring causality between two vector processes. Existing causality measures have been defined only for the horizon 1, and they fail to capture indirect causality. We propose generalizations to any horizon h of the measures introduced by Geweke [Geweke, J., 1982. Measurement of linear dependence and feedback between multiple time series. Journal of the American Statistical Association 77, 304313]. Nonparametric and parametric measures of unidirectional causality and instantaneous effects are considered. On noting that the causality measures typically involve complex functions of model parameters in VAR and VARMA models, we propose a simple simulation-based method to evaluate these measures for any VARMA model. We also describe asymptotically valid nonparametric confidence intervals, based on a bootstrap technique. Finally, the proposed measures are applied to study causality relations at different horizons between macroeconomic, monetary and financial variables in the US.
Adaptive estimation of the dynamics of a discrete time stochastic volatility model

F. Comte, C. Lacour, , Y. Rozenholc Journal of Econometrics Volume 154, Issue 1, January 2010 This paper is concerned with the discrete time stochastic volatility model Yi=exp(Xi/2)i, Xi+1=b(Xi)+(Xi)i+1, where only (Yi) is observed. The model is rewritten as a particular hidden model: Zi=Xi+i, Xi+1=b(Xi)+(Xi)i+1, where (i) and (i) are independent sequences of i.i.d. noise. Moreover, the sequences (Xi) and (i) are independent and the distribution of is known. Then, our aim is to estimate the functions b and 2 when only observations Z1,,Zn are available. We propose to estimate bf and (b2+2)f and study the integrated mean square error of projection estimators of these functions on automatically selected projection spaces. By ratio strategy, estimators of b and 2 are then deduced. The mean square risk of the resulting estimators are studied and their rates are discussed. Lastly, simulation experiments are provided: constants in the penalty functions defining the estimators are calibrated and the quality of the estimators is checked on several examples.
129
Testing semiparametric conditional moment restrictions using conditional martingale transforms

Kyungchul Song Journal of Econometrics Volume 154, Issue 1, January 2010 This paper studies conditional moment restrictions that contain unknown nonparametric functions, and proposes a general method of obtaining asymptotically distribution-free tests via martingale transforms. Examples of such conditional moment restrictions are single index restrictions, partially parametric regressions, and partially parametric quantile regressions. This paper introduces a conditional martingale transform that is conditioned on the variable in the nonparametric function, and shows that we can generate distribution-free tests of various semiparametric conditional moment restrictions using this martingale transform. The paper proposes feasible martingale transforms using series estimation and establishes their asymptotic validity. Some results from a Monte Carlo simulation study are presented and discussed.
Stochastic model specification search for Gaussian and partial non-Gaussian state space models
Sylvia Frhwirth-Schnatter, Helga Wagner Journal of Econometrics Volume 154, Issue 1, January 2010 Model specification for state space models is a difficult task as one has to decide which components to include in the model and to specify whether these components are fixed or time-varying. To this aim a new model space MCMC method is developed in this paper. It is based on extending the Bayesian variable selection approach which is usually applied to variable selection in regression models to state space models. For non-Gaussian state space models stochastic model search MCMC makes use of auxiliary mixture sampling. We focus on structural time series models including seasonal components, trend or intervention. The method is applied to various well-known time series.
The Hausman test and weak instruments

Jinyong Hahn, John C. Ham, Hyungsik Roger Moon Journal of Econometrics Volume 154, Issue 1, January 2010 We consider the following problem. There is a structural equation of interest that contains an explanatory variable that theory predicts is endogenous. There are one or more instrumental variables that credibly are exogenous with regard to this structural equation, but which have limited explanatory power for the endogenous variable. Further, there is one or more potentially strong instruments, which has much more explanatory power but which may not be exogenous. Hausman (1978) provided a test for the exogeneity of the second instrument when none of the instruments are weak. Here, we focus on how the standard Hausman test does in the presence of weak instruments using the StaigerStock asymptotics. It is natural to conjecture that the standard version of the Hausman test would be invalid in the weak instrument case, which we confirm. However, we provide a version of the Hausman test that is valid even in the presence of weak IV and illustrate how to implement the test in the presence of heteroskedasticity. We show that the situation we analyze occurs in
130
several important economic examples. Our Monte Carlo experiments show that our procedure works relatively well in finite samples. We should note that our test is not consistent, although we believe that it is impossible to construct a consistent test with weak instruments.
On the distribution of the sample autocorrelation coefficients

Raymond Kan, Xiaolu Wang Journal of Econometrics Volume 154, Issue 2, February 2010 Sample autocorrelation coefficients are widely used to test the randomness of a time series. Despite its unsatisfactory performance, the asymptotic normal distribution is often used to approximate the distribution of the sample autocorrelation coefficients. This is mainly due to the lack of an efficient approach in obtaining the exact distribution of sample autocorrelation coefficients. In this paper, we provide an efficient algorithm for evaluating the exact distribution of the sample autocorrelation coefficients. Under the multivariate elliptical distribution assumption, the exact distribution as well as exact moments and joint moments of sample autocorrelation coefficients are presented. In addition, the exact mean and variance of various autocorrelation-based tests are provided. Actual size properties of the BoxPierce and LjungBox tests are investigated, and they are shown to be poor when the number of lags is moderately large relative to the sample size. Using the exact mean and variance of the BoxPierce test statistic, we propose an adjusted BoxPierce test that has a far superior size property than the traditional BoxPierce and LjungBox tests.
Testing for heteroskedasticity and serial correlation in a random effects panel data model
Badi H. Baltagi, Byoung Cheol Jung, Seuck Heun Song Journal of Econometrics Volume 154, Issue 2, February 2010 This paper considers a panel data regression model with heteroskedastic as well as serially correlated disturbances, and derives a joint LM test for homoskedasticity and no first order serial correlation. The restricted model is the standard random individual error component model. It also derives a conditional LM test for homoskedasticity given serial correlation, as well as, a conditional LM test for no first order serial correlation given heteroskedasticity, all in the context of a random effects panel data model. Monte Carlo results show that these tests along with their likelihood ratio alternatives have good size and power under various forms of heteroskedasticity including exponential and quadratic functional forms.
Activity signature functions for high-frequency data analysis

Viktor Todorov, George Tauchen Journal of Econometrics Volume 154, Issue 2, February 2010 We define a new concept termed activity signature function, which is constructed from discrete observations of a continuous-time process, and derive its asymptotic properties as the sampling frequency increases. We show that the function is a useful
131
device for estimating the activity level of the underlying process and in particular for deciding whether the process contains a continuous martingale. An application to $ /DM exchange rate over 19861999 indicates that a jump-diffusion model is more plausible than a pure-jump model. A second application to internet traffic at NASA servers shows that an infinite variation pure-jump model is appropriate for its modeling.
A comparison of two model averaging techniques with an application to growth empirics

Jan R. Magnus, Owen Powell, Patricia Prfer Journal of Econometrics Volume 154, Issue 2, February 2010 Parameter estimation under model uncertainty is a difficult and fundamental issue in econometrics. This paper compares the performance of various model averaging techniques. In particular, it contrasts Bayesian model averaging (BMA) currently one of the standard methods used in growth empirics with a new method called weighted-average least squares (WALS). The new method has two major advantages over BMA: its computational burden is trivial and it is based on a transparent definition of prior ignorance. The theory is applied to and sheds new light on growth empirics where a high degree of model uncertainty is typically present.
Estimating a class of triangular simultaneous equations models without exclusion restrictions

Roger Klein, Francis Vella Journal of Econometrics Volume 154, Issue 2, February 2010 This paper provides a control function estimator to adjust for endogeneity in the triangular simultaneous equations model where there are no available exclusion restrictions to generate suitable instruments. Our approach is to exploit the dependence of the errors on exogenous variables (e.g. heteroscedasticity) to adjust the conventional control function estimator. The form of the error dependence on the exogenous variables is subject to restrictions, but is not parametrically specified. In addition to providing the estimator and deriving its large-sample properties, we present simulation evidence which indicates the estimator works well.
Estimation of spatial autoregressive panel data models with fixed effects

Lung-fei Lee, Jihai Yu Journal of Econometrics Volume 154, Issue 2, February 2010 This paper establishes asymptotic properties of quasi-maximum likelihood estimators for SAR panel data models with fixed effects and SAR disturbances. A direct approach is to estimate all the parameters including the fixed effects. Because of the incidental parameter problem, some parameter estimators may be inconsistent or their distributions are not properly centered. We propose an alternative estimation method based on transformation which yields consistent estimators with properly centered distributions. For the model with individual effects only, the direct approach does not yield a consistent estimator of the variance parameter unless T is large, but the estimators for other common parameters are the same as those of the
132
transformation approach. We also consider the estimation of the model with both individual and time effects.
An improved bootstrap test of stochastic dominance

Oliver Linton, Kyungchul Song, and Yoon-Jae Whang Journal of Econometrics Volume 154, Issue 2, February 2010 We propose a new method of testing stochastic dominance that improves on existing tests based on the standard bootstrap or subsampling. The method admits prospects involving infinite as well as finite dimensional unknown parameters, so that the variables are allowed to be residuals from nonparametric and semiparametric models. The proposed bootstrap tests have asymptotic sizes that are less than or equal to the nominal level uniformly over probabilities in the null hypothesis under regularity conditions. This paper also characterizes the set of probabilities so that the asymptotic size is exactly equal to the nominal level uniformly. As our simulation results show, these characteristics of our tests lead to an improved power property in general. The improvement stems from the design of the bootstrap test whose limiting behavior mimics the discontinuity of the original tests limiting distribution.
133
Summer (2010)
Testing for unobserved heterogeneity in exponential and Weibull duration models
Jin Seo Choa and Halbert White Journal of Econometrics Volume 156, Issue 2, Mar 2010 We examine use of the likelihood ratio (LR) statistic to test for unobserved heterogeneity in duration models, based on mixtures of exponential or Weibull distributions. We consider both the uncensored and censored duration cases. The asymptotic null distribution of the LR test statistic is not the standard chi-square, as the standard regularity conditions do not hold. Instead, there is a nuisance parameter identified only under the alternative, and a null parameter value on the boundary of the parameter space, as in Cho and White (2007a). We accommodate these and provide methods delivering consistent asymptotic critical values. We conduct a number of Monte Carlo simulations, comparing the level and power of the LR test statistic to an information matrix (IM) test due to Chesher (1984) and Lagrange multiplier (LM) tests of Kiefer (1985) and Sharma (1987). Our simulations show that the LR test statistic generally outperforms the IM and LM tests. We also revisit the work of van den Berg and Ridder (1998) on unemployment durations and of Ghysels, Gourieroux, and Jasiak (2004) on interarrival times between stock trades, and, as it turns out, affirm their original informal inferences.
Structural measurement errors in non separable models

Stefan Hoderlein, Joachim Winter Journal of Econometrics Volume 156, Issue 2, Mar 2010 This paper considers measurement error from a new perspective. In surveys, response errors are often caused by the fact that respondents recall past events and quantities imperfectly. We explore the consequences of limited recall for the identification of marginal effects. Our identification approach is entirely nonparametric, using Matzkin-type nonseparable models that nest a large class of potential structural models. We show that measurement error due to limited recall will generally exhibit nonstandard behavior, in particular be nonclassical and differential, even for left-hand side variables in linear models. We establish that information reduction by individuals is the critical issue for the severity of recall measurement error. In order to detect information reduction, we propose a nonparametric test statistic. Finally, we propose bounds to address identification problems resulting from recall errors. We illustrate our theoretical findings using real-world data on food consumption.
Non-negativity conditions for the hyperbolic GARCH model

Christian Conrad Journal of Econometrics Volume 156, Issue 2, Mar 2010 In this article we derive conditions which ensure the non-negativity of the conditional variance in the Hyperbolic GARCH(p,d,q) (HYGARCH) model of Davidson (2004).
134
The conditions are necessary and sufficient for p=1 and sufficient for p2 and emerge as natural extensions of the inequality constraints derived in Nelson and Cao (1992) and Tsai and Chan (2008) for the GARCH model and in Conrad and Haag (2006) for the FIGARCH model. As a by-product we obtain a representation of the ARCH() coefficients which allows computationally efficient multi-step-ahead forecasting of the conditional variance of a HYGARCH process. We also relate the necessary and sufficient parameter set of the HYGARCH to the necessary and sufficient parameter sets of its GARCH and FIGARCH components. Finally, we analyze the effects of erroneously fitting a FIGARCH model to a data sample which was truly generated by a HYGARCH process. Empirical applications of the HYGARCH(1,d,1) model to daily NYSE and DAX30 data illustrate the importance of our results.
Semi parametric estimation of a simultaneous game with incomplete information

Andres Aradillas-Lopez Journal of Econometrics Volume 156, Issue 2, Mar 2010 This paper studies the problem of estimating the normal-form payoff parameters of a simultaneous, discrete game where the realization of such payoffs is not common knowledge. The paper contributes to the existing literature in two ways. First, by making a comparison with the complete information case it formally describes a set of conditions under which allowing for private information in payoffs facilitates the identification of various features of the game. Second, focusing on the incomplete information case it presents an estimation procedure based on the equilibrium properties of the game that relies on weak semiparametric assumptions and a relatively flexible information structures which allow players to condition their beliefs on signals whose exact distribution function is unknown to the researcher. The proposed estimators recover unobserved beliefs by solving a semiparametric sample analog of the population Bayesian-Nash equilibrium conditions. The asymptotic features of such estimators are studied for the case in which the distribution of unobserved shocks is known and the case in which it is unknown. In both instances, equilibrium uniqueness is assumed to holdonly in a neighborhood of the true parameter value and for a subset of realizations of the signals. Multiple equilibria are allowed elsewhere in the parameter space and no equilibrium selection theory is involved. Extensions to games where beliefs are conditioned on unobservables as well as general games with many players and actions are also discussed. An empirical application of a simple capital investment game is included.
Nonparametric least squares estimation in derivative families

Peter Hall, Adonis Yatchew Journal of Econometrics Volume 156, Issue 2, Mar 2010 Cost function estimation often involves data on a function and a family of its derivatives. Such data can substantially improve convergence rates of nonparametric estimators. We propose series-type estimators which incorporate the various derivative data into a single nonparametric least-squares procedure. Convergence rates are obtained and it is shown that for low-dimensional cases, much of the beneficial impact is realized even if only data on ordinary first-order partials are available. In instances where root-n consistency is attained, smoothing parameters
135
can often be chosen very easily, without resort to cross-validation. Simulations and an illustration of cost function estimation are included.
Robust penalized quantile regression estimation for panel data?

Carlos Lamarche Journal of Econometrics Volume 156, Issue 2, Mar 2010 This paper investigates a class of penalized quantile regression estimators for panel data. The penalty serves to shrink a vector of individual specific effects toward a common value. The degree of this shrinkage is controlled by a tuning parameter . It is shown that the class of estimators is asymptotically unbiased and Gaussian when the individual effects are drawn from a class of zero-median distribution functions. The tuning parameter, , can thus be selected to minimize estimated asymptotic variance. Monte-Carlo evidence reveals that the estimator can significantly reduce the variability of the fixed- effect version of the estimator without introducing bias.
Bayesian non-parametric signal extraction for Gaussian time series

Christian Macaro Journal of Econometrics Volume 156, Issue 2, Mar 2010 We consider the problem of unobserved components in time series from a Bayesian non-parametric perspective. The identification conditions are treated as unknown and analyzed in a probabilistic framework. In particular, informative prior distributions force the spectral decomposition to be in an identifiable region. Then, the likelihood function adapts the prior decompositions to the data. A full Bayesian analysis of unobserved components will be presented for financial high frequency data. Particularly, a three component model (long-term, intra-daily and short-term) will be analyzed to emphasize the importance and the potential of this work when dealing with the Value-at-Risk analysis. A second astronomical application will show how to deal with multiple periodicities.
A spatio-temporal model of house prices in the US

Sean Holly, M. Hashem Pesaran, Takashi Yamagata Journal of Econometrics Volume 156, Issue 2, Mar 2010 This paper provides an empirical analysis of changes in real house prices in the US using State level data. It examines the extent to which real house prices at the State level are driven by fundamentals such as real per capita disposable income, as well as by common shocks, and determines the speed of adjustment of real house prices to macroeconomic and local disturbances. We take explicit account of both cross sectional dependence and heterogeneity. This allows us to find a cointegrating relationship between real house prices and real per capita incomes with coefficients, as predicted by the theory. We are also able to identify a significant negative effect for a net borrowing cost variable, and a significant positive effect for the State level population growth on changes in real house prices. Using this model we then examine the role of spatial factors, in particular the effect of contiguous states by use of a weighting matrix. We are able to identify a significant spatial effect, even after
136
controlling for State specific real incomes, and allowing for a number of unobserved common factors. We do, however, find evidence of departures from long run equilibrium in the housing markets in a number of States notably California, New York, Massachusetts, and to a lesser extent Connecticut, Rhode Island, Oregon and Washington State.
137
Fall (2010)
Some thoughts on the development of co integration
Clive W.J. Granger Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 3-6 This paper describes how the notion of cointegration came about, and discusses some generalizations to indicate where the topic may go next. In particular, some issues in the analysis of possibly co integrated quantile time series are discussed.
Testing for co-integration in vector auto regressions with non-stationary volatility

Giuseppe Cavaliere, Anders Rahbek A.M. Robert Taylor Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 7-24 Many key macroeconomic and financial variables are characterized by permanent changes in unconditional volatility. In this paper we analyse vector autoregressions with non-stationary (unconditional) volatility of a very general form, which includes single and multiple volatility breaks as special cases. We show that the conventional rank statistics computed as in (Johansen, 1988) and (Johansen, 1991) are potentially unreliable. In particular, their large sample distributions depend on the integrated covariation of the underlying multivariate volatility process which impacts on both the size and power of the associated co-integration tests, as we demonstrate numerically. A solution to the identified inference problem is provided by considering wild bootstrap-based implementations of the rank tests. These do not require the practitioner to specify a parametric model for volatility, or to assume that the pattern of volatility is common to, or independent across, the vector of series under analysis. The bootstrap is shown to perform very well in practice.
Forecasting with equilibrium-correction models during structural breaks

Jennifer L. Castle, Nicholas W.P. Fawcett, David F. Hendry Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 25-36 When location shifts occur, cointegration-based equilibrium-correction models (EqCMs) face forecasting problems. We consider alleviating such forecast failure by updating, intercept corrections, differencing, and estimating the future progress of an internal break. Updating leads to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, but helps when collinearities are changed by an external break with the EqCM staying constant. Both mechanistic corrections help compared to retaining a pre-break estimated model, but an estimated model of the break process could outperform. We apply the approaches to EqCMs for UK M1, compared with updating a learning function as the break evolves.
138
Model-based asymptotic inference on the effect of infrequent large shocks on co-integrated variables
Iliyan Georgiev Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 37-50 Quasi-maximum-likelihood (QML) estimation of a model combining cointegration in the conditional mean and rare large shocks (outliers) with a factor structure in the innovations is studied. The goal is not only to robustify inference on the conditionalmean parameters, but also to find regularities and conduct inference on the instantaneous and long-run effect of the large shocks. Given the cointegration rank and the factor order, 2 asymptotic inference is obtained for the cointegration vectors, the short-run parameters, and the direction of each column of both the factor loading matrix and the matrix of long-run impacts of the large shocks. Large shocks, whose location is assumed unknown a priori, can be detected and classified consistently into the factor components.
Likelihood inference for a nonstationary fractional autoregressive model

Sren Johansen, Morten rregaard Nielsen Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 51-66 This paper discusses model-based inference in an autoregressive model for fractional processes which allows the process to be fractional of order d or db. Fractional differencing involves infinitely many past values and because we are interested in nonstationary processes we model the data X1,,XT given the initial values , as is usually done. The initial values are not modeled but assumed to be bounded. This represents a considerable generalization relative to previous work where it is assumed that initial values are zero. For the statistical analysis we assume the conditional Gaussian likelihood and for the probability analysis we also condition on initial values but assume that the errors in the autoregressive model are i.i.d. with suitable moment conditions. We analyze the conditional likelihood and its derivatives as stochastic processes in the parameters, including d and b, and prove that they converge in distribution. We use these results to prove consistency of the maximum likelihood estimator for d,b in a large compact subset of {1/2<b<d<}, and to find the asymptotic distribution of the estimators and the likelihood ratio test of the associated fractional unit root hypothesis. The limit distributions contain the fractional Brownian motion of type II.
Likelihood based testing for no fractional cointegration

Katarzyna asak Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 67-77 We consider two likelihood ratio tests, the so-called maximum eigenvalue and trace tests, for the null of no cointegration when fractional cointegration is allowed under the alternative, which is a first step to generalize the so-called Johansens procedure to the fractional cointegration case. The standard cointegration analysis only considers the assumption that deviations from equilibrium can be integrated of order zero, which is very restrictive in many cases and may imply an important loss of power in the fractional case. We consider the alternative hypotheses with equilibrium
139
deviations that can be mean reverting with order of integration possibly greater than zero. Moreover, the degree of fractional cointegration is not assumed to be known, and the asymptotic null distribution of both tests is found when considering an interval of possible values. The power of the proposed tests under fractional alternatives and size accuracy provided by the asymptotic distribution in finite samples are investigated.
Likelihood-based inference for cointegration with nonlinear error-correction

Dennis Kristensen, Anders Rahbek Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 78-94 We consider a class of nonlinear vector error correction models where the transfer function (or loadings) of the stationary relationships is nonlinear. This includes in particular the smooth transition models.A general representation theorem is given which establishes the dynamic properties of the process in terms of stochastic and deterministic trends as well as stationary components. In particular, the behavior of the cointegrating relations is described in terms of geometric ergodicity. Despite the fact that no deterministic terms are included, the process will have both stochastic trends and a linear trend in general.Gaussian likelihood-based estimators are considered for the long-run cointegration parameters, and the short-run parameters. Asymptotic theory is provided for these and it is discussed to what extend asymptotic normality and mixed normality can be found. A simulation study reveals that cointegration vectors and the shape of the adjustment are quite accurately estimated by maximum likelihood. At the same time, there is very little information in data about some of the individual parameters entering the adjustment function if care is not taken in choosing a suitable specification.
Modelling and measuring price discovery in commodity markets

Isabel Figuerola-Ferretti ,Jess Gonzalo Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 95-107 In this paper we present an equilibrium model of commodity spot ( ) and futures ( ) prices, with finite elasticity of arbitrage services and convenience yields. By explicitly incorporating and modelling endogenously the convenience yield, our theoretical model is able to capture the existence of backwardation or contango in the long-run spot-futures equilibrium relationship, . When the slope of the cointegrating vector 2>1(2<1) the market is under long run backwardation (contango). It is the first time in this literature in which the theoretical possibility of finding a cointegrating vector different from the standard 2=1 is formally considered.Independent of the value of 2, this paper shows that the equilibrium model admits an economically meaningful Error Correction Representation, where the linear combination of ( ) and ( ) characterizing the price discovery process in the framework of Garbade and Silber (1983), coincides exactly with the permanent component of the Gonzalo and Granger (1995) PermanentTransitory decomposition. This linear combination depends on the elasticity of arbitrage services and is determined by the relative liquidity traded in the spot and futures markets. Such outcome not only provides a theoretical justification for this PermanentTransitory decomposition; but it offers a simple way of detecting which of the two prices is dominant in the price discovery process.All the results are
140
testable, as can be seen in the application to spot and futures non-ferrous metals prices (Al, Cu, Ni, Pb, Zn) traded in the London Metal Exchange (LME). Most markets are in backwardation and futures prices are information dominant in highly liquid futures markets (Al, Cu, Ni, Zn).
Co integration, long-run structural modelling and weak exogeneity: Two models of the UK economy
Jan P.A.M. Jacobs, Kenneth F. Wallis Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 108-116 Cointegration ideas as introduced by Granger in 1981 are commonly embodied in empirical macroeconomic modelling through the vector error correction model (VECM). It has become common practice in these models to treat some variables as weakly exogenous, resulting in conditional VECMs. This paper studies the consequences of different approaches to weak exogeneity for the dynamic properties of such models, in the context of two models of the UK economy, one a nationaleconomy model, the other the UK submodel of a global model. Impulse response and common trend analyses are shown to be sensitive to these assumptions and other specification choices.
An analysis of the persistent long swings in the Dmk/$ rate

Sren Johansen, Katarina Juselius, Roman Frydman, Michael Goldberg Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 117-129 This paper discusses the I(2) model with breaks in the deterministic component and illustrates the model with an analysis of German and US prices, exchange rates, and interest rates in the period 19751999. It provides new results on the likelihood ratio test of overidentifying restrictions on the cointegrating relations when they contain piecewise linear trends. One important aim of the paper is to demonstrate that a structured I(2) analysis is useful for a better understanding of the empirical regularities underlying the persistent swings in nominal exchange rates, typical in periods of floating exchange rates.
Speed of adjustment in cointegrated systems

Luca Fanelli, Paolo Paruolo Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 130-141 This paper discusses summary measures for the speed of adjustment in possibly cointegrated Vector Autoregressive Processes (VAR). In particular we propose longrun half-lives, based on interim and total multipliers. We discuss their relation with Granger-noncausality and other types of half-life, which are shown to convey different information, except in the univariate AR(1) case. We present likelihoodbased inference on long-run half-lives, regarded as discrete functions of parameters in the VAR model. It is shown how asymptotic confidence regions can be defined. An empirical illustration concerning speed of adjustment to purchasing-power parity is provided.
141
Averaging estimators for auto regressions with a near unit root

Bruce E. Hansen Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 142-155 This paper uses local-to-unity theory to evaluate the asymptotic mean-squared error (AMSE) and forecast expected squared error from least-squares estimation of an autoregressive model with a root close to unity. We investigate unconstrained estimation, estimation imposing the unit root constraint, pre-test estimation, model selection estimation, and model average estimation. We find that the asymptotic risk depends only on the local-to-unity parameter, facilitating simple graphical comparisons. Our results strongly caution against pre-testing. Strong evidence supports averaging based on Mallows weights. In particular, our Mallows averaging method has uniformly and substantially smaller risk than the conventional unconstrained estimator, and this holds for autoregressive roots far from unity. Our averaging estimator is a new approach to forecast combination.
Co integration in a historical perspective

H. Peter Boswijk, Philip Hans Franses, Dick van Dijk Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 156-159 We analyse the impact of the Engle and Granger (1987) article by means of its citations over time, and find evidence of a second life starting in the new millennium. Next, we propose a possible explanation of the success of this citation classic. We argue that the conditions for its success were just right at the time of its appearance, because of the growing emphasis on time series properties in econometric modelling, the empirical importance of stochastic trends, the availability of sufficiently long macroeconomic time series, and the availability of personal computers and econometric software for carrying out the new techniques.
A spatio-temporal model of house prices in the USA

Sean Holly , M. Hashem Pesaran, Takashi Yamagata Journal of Econometrics Volume 158, Issue 1, Sep 2010, Pages 160-173 This paper provides an empirical analysis of changes in real house prices in the USA using State level data. It examines the extent to which real house prices at the State level are driven by fundamentals such as real per capita disposable income, as well as by common shocks, and determines the speed of adjustment of real house prices to macroeconomic and local disturbances. We take explicit account of both crosssectional dependence and heterogeneity. This allows us to find a cointegrating relationship between real house prices and real per capita incomes with coefficients (1,1), as predicted by the theory. We are also able to identify a significant negative effect for a net borrowing cost variable, and a significant positive effect for the State level population growth on changes in real house prices. Using this model we then examine the role of spatial factors, in particular, the effect of contiguous states by use of a weighting matrix. We are able to identify a significant spatial effect, even after controlling for State specific real incomes, and allowing for a number of unobserved common factors. We do, however, find evidence of departures from long run equilibrium in the housing markets in a number of States notably California, New
142
York, Massachusetts, and to a lesser extent Connecticut, Rhode Island, Oregon and Washington State.
On the asymptotic optimality of the LIML estimator with possibly many instruments
T.W. Anderson , Naoto Kunitomo, Yukitoshi Matsushita Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 191-204 We consider the estimation of the coefficients of a linear structural equation in a simultaneous equation system when there are many instrumental variables. We derive some asymptotic properties of the limited information maximum likelihood (LIML) estimator when the number of instruments is large; some of these results are new as well as old, and we relate them to results in some recent studies. We have found that the variance of the limiting distribution of the LIML estimator and its modifications often attain the asymptotic lower bound when the number of instruments is large and the disturbance terms are not necessarily normally distributed, that is, for the micro-econometric models of some cases recently called many instruments and many weak instruments.
Econometric modeling of technical change

Hui Jin, Dale W. Jorgenson Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 205-219 The purpose of this paper is to present a new approach to econometric modeling of substitution and technical change. Substitution is determined by observable variables, such as prices of output and inputs and shares of inputs in the value of output. Our principal innovation is to represent the rate and biases of technical change by unobservable or latent variables. This representation is considerably more flexible than the constant time trends employed in the previous literature. An added advantage of the new representation is that the latent variables can be projected into the future, so that the rate and bias of technical change can be incorporated into econometric projections.
Jumps and betas: A new framework for disentangling and estimating systematic risks
Viktor Todorov, Tim Bollerslev Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 220-235 We provide a new theoretical framework for disentangling and estimating the sensitivity towards systematic diffusive and jump risks in the context of factor models. Our estimates of the sensitivities towards systematic risks, or betas, are based on the notion of increasingly finer sampled returns over fixed time intervals. We show consistency and derive the asymptotic distributions of our estimators. In an empirical application of the new procedures involving high-frequency data for forty individual stocks, we find that the estimated monthly diffusive and jump betas with respect to an aggregate market portfolio differ substantially for some of the stocks in the sample.
143
Robust confidence sets in the presence of weak instruments

Anna Mikusheva Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 236-247 This paper considers instrumental variable regression with a single endogenous variable and the potential presence of weak instruments. I construct confidence sets for the coefficient on the single endogenous regressor by inverting tests robust to weak instruments. I suggest a numerically simple algorithm for finding the Conditional Likelihood Ratio (CLR) confidence sets. Full descriptions of possible forms of the CLR, AndersonRubin (AR) and Lagrange Multiplier (LM) confidence sets are given. I show that the CLR confidence sets have nearly the shortest expected arc length among similar symmetric invariant confidence sets in a circular model. I also prove that the CLR confidence set is asymptotically valid in a model with nonnormal errors.
On Bahadur efficiency of empirical likelihood

Taisuke Otsu Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 248-256 This paper studies the Bahadur efficiency of empirical likelihood for testing moment condition models. It is shown that under mild regularity conditions, the empirical likelihood overidentifying restriction test is Bahadur efficient, i.e., its p-value attains the fastest convergence rate under each fixed alternative hypothesis. Analogous results are derived for parameter hypothesis testing and set inference problems.
Nonparametric estimation for a class of Lvy processes

Song X. Chen, Aurore Delaigle, Peter Hall Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 257-271 We consider estimation for a class of Lvy processes, modelled as a sum of a drift, a symmetric stable process and a compound Poisson process. We propose a nonparametric approach to estimating unknown parameters of our model, including the drift, the scale and index parameters in the stable law, the mean of the Poisson process and the underlying jump size distribution. We show that regression and nonparametric deconvolution methods, based on the empirical characteristic function, can be used for inference. Interesting connections are shown to exist between properties of our estimators and of those found in conventional deconvolution.
144
Efficient estimation in dynamic conditional quantile models

Ivana Komunjer, Quang Vuong Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 272-285 In this paper we consider the problem of semi parametric efficient estimation in conditional quantile models with time series data. We construct an M-estimator which achieves the semi parametric efficiency bound recently derived by Komunjer and Vuong (forthcoming). Our efficient M-estimator is obtained by minimizing an objective function which depends on a nonparametric estimator of the conditional distribution of the variable of interest rather than its density. The estimator is new and not yet seen in the literature. We illustrate its performance through a Monte Carlo experiment.
Estimating fixed-effect panel stochastic frontier models by model transformation

Hung-Jen Wang, Chia-Wen Ho Journal of Econometrics Volume 157, Issue 2, Sep 2010, Pages 286-296 Traditional panel stochastic frontier models do not distinguish between unobserved individual heterogeneity and inefficiency. They thus force all time-invariant individual heterogeneity into the estimated inefficiency. Greene (2005) proposes a true fixed-effect stochastic frontier model which, in theory, may be biased by the incidental parameters problem. The problem usually cannot be dealt with by model transformations owing to the nonlinearity of the stochastic frontier model. In this paper, we propose a class of panel stochastic frontier models which create an exception. We show that first-difference and within-transformation can be analytically performed on this model to remove the fixed individual effects, and thus the estimator is immune to the incidental parameters problem. Consistency of the estimator is obtained by either N or T, which is an attractive property for empirical researchers.
A generalized asymmetric Student-t distribution with application to financial econometrics

Dongming Zhu, John W. Galbraith Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 297-305 This paper proposes a new class of asymmetric Student-t (AST) distributions, and investigates its properties, gives procedures for estimation, and indicates applications in financial econometrics. We derive analytical expressions for the cdf, quantile function, moments, and quantities useful in financial econometric applications such as the Expected Shortfall. A stochastic representation of the distribution is also given. Although the AST density does not satisfy the usual regularity conditions for maximum likelihood estimation, we establish consistency, asymptotic normality and efficiency of ML estimators and derive an explicit analytical expression for the asymptotic covariance matrix. A Monte Carlo study indicates generally good finitesample conformity with these asymptotic properties.
145
Bayesian semi parametric stochastic volatility modeling

Mark J. Jensen, John M. Maheu Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 306-316 This paper extends the existing fully parametric Bayesian literature on stochastic volatility to allow for more general return distributions. Instead of specifying a particular distribution for the return innovation, nonparametric Bayesian methods are used to flexibly model the skewness and kurtosis of the distribution while the dynamics of volatility continue to be modeled with a parametric structure. Our semi parametric Bayesian approach provides a full characterization of parametric and distributional uncertainty. A Markov chain Monte Carlo sampling approach to estimation is presented with theoretical and computational issues for simulation from the posterior predictive distributions. An empirical example compares the new model to standard parametric stochastic volatility models.
Inference on parameter ratios with application to discrete choice models

Denis Bolduc, Lynda Khalaf, Clment Ylou Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 317-327 We study the problem of building confidence sets for ratios of parameters, from an identification robust perspective. In particular, we address the simultaneous confidence set estimation of a finite number of ratios. Results apply to a wide class of models suitable for estimation by consistent asymptotically normal procedures. Conventional methods (e.g. the delta method) derived by excluding the parameter discontinuity regions entailed by the ratio functions and which typically yield bounded confidence limits, break down even if the sample size is large (Dufour, 1997). One solution to this problem, which we take in this paper, is to use variants of Fiellers (1940, 1954) method. By inverting a joint test that does not require identifying the ratios, Fieller-based confidence regions are formed for the full set of ratios. Simultaneous confidence sets for individual ratios are then derived by applying projection techniques, which allow for possibly unbounded outcomes. In this paper, we provide simple explicit closed-form analytical solutions for projectionbased simultaneous confidence sets, in the case of linear transformations of ratios. Our solution further provides a formal proof for the expressions in Zerbe et al. (1982) pertaining to individual ratios. We apply the geometry of quadrics as introduced by (Dufour and Taamouti, 2005) and (Dufour and Taamouti, 2007), in a different although related context. The confidence sets so obtained are exact if the inverted test statistic admits a tractable exact distribution, for instance in the normal linear regression context. The proposed procedures are applied and assessed via illustrative Monte Carlo and empirical examples, with a focus on discrete choice models estimated by exact or simulation-based maximum likelihood. Our results underscore the superiority of Fieller-based methods.
146
Estimating first-price auctions with an unknown number of bidders

Yonghong An, Yingyao Hu, Matthew Shum Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 328-341 In this paper, we consider nonparametric identification and estimation of first-price auction models when N*, the number of potential bidders, is unknown to the researcher, but observed by bidders. Exploiting results from the recent econometric literature on models with misclassification error, we develop a nonparametric procedure for recovering the distribution of bids conditional on the unknown N*. Monte Carlo results illustrate that the procedure works well in practice. We present illustrative evidence from a dataset of procurement auctions, which shows that accounting for the unobservability of N* can lead to economically meaningful differences in the estimates of bidders profit margins.
Robust methods for detecting multiple level breaks in autocorrelated time series
David I. Harvey, Stephen J. Leybourne, A.M. Robert Taylor Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 342-358 In this paper we propose tests for the null hypothesis that a time series process displays a constant level against the alternative that it displays (possibly) multiple changes in level. Our proposed tests are based on functions of appropriately standardized sequences of the differences between sub-sample mean estimates from the series under investigation. The tests we propose differ notably from extant tests for level breaks in the literature in that they are designed to be robust as to whether the process admits an autoregressive unit root (the data are I(1)) or stable autoregressive roots (the data are I(0)). We derive the asymptotic null distributions of our proposed tests, along with representations for their asymptotic local power functions against Pitman drift alternatives under both I(0) and I(1) environments. Associated estimators of the level break fractions are also discussed. We initially outline our procedure through the case of non-trending series, but our analysis is subsequently extended to allow for series which display an underlying linear trend, in addition to possible level breaks. Monte Carlo simulation results are presented which suggest that the proposed tests perform well in small samples, showing good size control under the null, regardless of the order of integration of the data, and displaying very decent power when level breaks occur.
The LIML estimator has finite moments!

T.W. Anderson Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 359-361 The Limited Information Maximum Likelihood estimator of the vector of coefficients of a structural equation in a simultaneous equation model is the vector that defines the linear combination maximizing the effect variance relative to the error variance. If this eigenvector solution is normalized by setting a designated coefficient equal to 1, the second-order moment of the estimator may be unbounded. However, the second-order moment is finite if the normalization sets the sample error variance of the linear combination equal to 1.
147
Nonparametric least squares estimation in derivative families

Peter Hall, Adonis Yatchew Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 362-374 Cost function estimation often involves data on a function and a family of its derivatives. Such data can substantially improve convergence rates of nonparametric estimators. We propose series-type estimators which incorporate the various derivative data into a single nonparametric least-squares procedure. Convergence rates are obtained and it is shown that for low-dimensional cases, much of the beneficial impact is realized even if only data on ordinary first-order partials are available. In instances where root-n consistency is attained, smoothing parameters can often be chosen very easily, without resort to cross-validation. Simulations and an illustration of cost function estimation are included.
Estimating panel data models in the presence of endogeneity and selection

Anastasia Semykina, Jeffrey M. Wooldridge Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 375-380 We consider estimation of panel data models with sample selection when the equation of interest contains endogenous explanatory variables as well as unobserved heterogeneity. Assuming that appropriate instruments are available, we propose several tests for selection bias and two estimation procedures that correct for selection in the presence of endogenous regressors. The tests are based on the fixed effects two-stage least squares estimator, thereby permitting arbitrary correlation between unobserved heterogeneity and explanatory variables. The first correction procedure is parametric and is valid under the assumption that the errors in the selection equation are normally distributed. The second procedure estimates the model parameters semiparametrically using series estimators. In the proposed testing and correction procedures, the error terms may be heterogeneously distributed and serially dependent in both selection and primary equations. Because these methods allow for a rather flexible structure of the error variance and do not impose any nonstandard assumptions on the conditional distributions of explanatory variables, they provide a useful alternative to the existing approaches presented in the literature.
Bayesian non-parametric signal extraction for Gaussian time series

Christian Macaro Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 381-395 We consider the problem of unobserved components in time series from a Bayesian non-parametric perspective. The identification conditions are treated as unknown and analyzed in a probabilistic framework. In particular, informative prior distributions force the spectral decomposition to be in an identifiable region. Then, the likelihood function adapts the prior decompositions to the data.A full Bayesian analysis of unobserved components will be presented for financial high frequency data. Particularly, a three component model (long-term, intra-daily and short-term) will be analyzed to emphasize the importance and the potential of this work when dealing
148
with the Value-at-Risk analysis. A second astronomical application will show how to deal with multiple periodicities.
Robust penalized quantile regression estimation for panel data

Carlos Lamarche Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 396-408 This paper investigates a class of penalized quantile regression estimators for panel data. The penalty serves to shrink a vector of individual specific effects toward a common value. The degree of this shrinkage is controlled by a tuning parameter . It is shown that the class of estimators is asymptotically unbiased and Gaussian, when the individual effects are drawn from a class of zero-median distribution functions. The tuning parameter, , can thus be selected to minimize estimated asymptotic variance. Monte Carlo evidence reveals that the estimator can significantly reduce the variability of the fixed-effect version of the estimator without introducing bias.
Semi parametric estimation of a simultaneous game with incomplete information

Andres Aradillas-Lopez Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 409-431 This paper studies the problem of estimating the normal-form payoff parameters of a simultaneous, discrete game where the realization of such payoffs is not common knowledge. The paper contributes to the existing literature in two ways. First, by making a comparison with the complete information case it formally describes a set of conditions under which allowing for private information in payoffs facilitates the identification of various features of the game. Second, focusing on the incomplete information case it presents an estimation procedure based on the equilibrium properties of the game that relies on weak semiparametric assumptions and relatively flexible information structures which allow players to condition their beliefs on signals whose exact distribution function is unknown to the researcher. The proposed estimators recover unobserved beliefs by solving a semiparametric sample analog of the population BayesianNash equilibrium conditions. The asymptotic features of such estimators are studied for the case in which the distribution of unobserved shocks is known and the case in which it is unknown. In both instances equilibrium uniqueness is assumed to hold only in a neighborhood of the true parameter value and for a subset of realizations of the signals. Multiple equilibria are allowed elsewhere in the parameter space and no equilibrium selection theory is involved. Extensions to games where beliefs are conditioned on unobservables as well as general games with many players and actions are also discussed. An empirical application of a simple capital investment game is included.
149
Structural measurement errors in non separable models

Stefan Hoderlein, Joachim Winter Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 432-440 This paper considers measurement error from a new perspective. In surveys, response errors are often caused by the fact that respondents recall past events and quantities imperfectly. We explore the consequences of limited recall for the identification of marginal effects. Our identification approach is entirely nonparametric, using Matzkin-type nonseparable models that nest a large class of potential structural models. We show that measurement error due to limited recall will generally exhibit nonstandard behavior, in particular be nonclassical and differential, even for left-hand side variables in linear models. We establish that information reduction by individuals is the critical issue for the severity of recall measurement error. In order to detect information reduction, we propose a nonparametric test statistic. Finally, we propose bounds to address identification problems resulting from recall errors. We illustrate our theoretical findings using real-world data on food consumption.
Non-negativity conditions for the hyperbolic GARCH model

Christian Conrad Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 441-457 In this article we derive conditions which ensure the non-negativity of the conditional variance in the Hyperbolic GARCH(p,d,q) (HYGARCH) model of Davidson (2004). The conditions are necessary and sufficient for p=1 and sufficient for p2 and emerge as natural extensions of the inequality constraints derived in Nelson and Cao (1992) and Tsai and Chan (2008) for the GARCH model and in Conrad and Haag (2006) for the FIGARCH model. As a by-product we obtain a representation of the ARCH() coefficients which allows computationally efficient multi-step-ahead forecasting of the conditional variance of a HYGARCH process. We also relate the necessary and sufficient parameter set of the HYGARCH to the necessary and sufficient parameter sets of its GARCH and FIGARCH components. Finally, we analyze the effects of erroneously fitting a FIGARCH model to a data sample which was truly generated by a HYGARCH process. Empirical applications of the HYGARCH(1,d,1) model to daily NYSE and DAX30 data illustrate the importance of our results.
Testing for unobserved heterogeneity in exponential and Weibull duration models

Jin Seo Cho, Halbert White Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 458-480 We examine the use of the likelihood ratio (LR) statistic to test for unobserved heterogeneity in duration models, based on mixtures of exponential or Weibull distributions. We consider both the uncensored and censored duration cases. The asymptotic null distribution of the LR test statistic is not the standard chi-square, as the standard regularity conditions do not hold. Instead, there is a nuisance parameter identified only under the alternative, and a null parameter value on the boundary of the parameter space, as in Cho and White (2007a). We accommodate these and
150
provide methods delivering consistent asymptotic critical values. We conduct a number of Monte Carlo simulations, comparing the level and power of the LR test statistic to an information matrix (IM) test due to Chesher (1984) and Lagrange multiplier (LM) tests of Kiefer (1985) and Sharma (1987). Our simulations show that the LR test statistic generally outperforms the IM and LM tests. We also revisit the work of van den Berg and Ridder (1998) on unemployment durations and of Ghysels et al. (2004) on interarrival times between stock trades, and, as it turns out, affirm their original informal inferences.
Intelligible factors for the yield curve

Yvan Lengwiler, Carlos Lenz Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 481-491 We construct a factor model of the yield curve and specify time series processes for these factors, so that the innovations are mutually orthogonal. At the same time, the factors are such that they assume clear, intuitive interpretations. The resulting intelligible factors should prove useful for investment professionals to discuss expectations about yield curves and the implied dynamics. Moreover, they allow us to distinguish announced changes of the monetary policy stance versus monetary policy surprises, which we find to be rare. We identify two such events, namely September 11, 2001, and the Fed reaction to the sub-prime crisis of 2007.
Semi parametric inference in multivariate fractionally co integrated systems

J. Hualde, P.M. Robinson Journal of Econometrics Volume 157, Issue 2, Aug 2010, Pages 492-511 A semiparametric multivariate fractionally cointegrated system is considered, integration orders possibly being unknown and I(0) unobservable inputs having nonparametric spectral density. Two estimates of the vector of cointegrating parameters are considered. One involves inverse spectral weighting and the other is unweighted but uses a spectral estimate at frequency zero. Both corresponding Wald statistics for testing linear restrictions on are shown to have a standard null 2 limit distribution under quite general conditions. Notably, this outcome is irrespective of whether cointegrating relations are strong (when the difference between integration orders of observables and cointegrating errors exceeds 1/2), or weak (when that difference is less than 1/2), or when both cases are involved. Finite-sample properties are examined in a Monte Carlo study and an empirical example is presented.
151
Winter (2010)
Testing the correlated random coefficient model
James J. Heckman, Daniel Schmierer, and Sergio Urzua Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 177-203 The recent literature on instrumental variables (IV) features models in which agents sort into treatment status on the basis of gains from treatment as well as on baselinepretreatment levels. Components of the gains known to the agents and acted on by them may not be known by the observing economist. Such models are called correlated random coefficient models. Sorting on unobserved components of gains complicates the interpretation of what IV estimates. This paper examines testable implications of the hypothesis that agents do not sort into treatment based on gains. In it, we develop new tests to gauge the empirical relevance of the correlated random coefficient model to examine whether the additional complications associated with it are required. We examine the power of the proposed tests. We derive a new representation of the variance of the instrumental variable estimator for the correlated random coefficient model. We apply the methods in this paper to the prototypical empirical problem of estimating the return to schooling and find evidence of sorting into schooling based on unobserved components of gains.
Model selection versus statistical model specification

Aris Spanos Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages204-220 Since the 1990s, the Akaike Information Criterion (AIC) and its various modifications/extensions, including BIC, have found wide applicability in econometrics as objective procedures that can be used to select parsimonious statistical models. The aim of this paper is to argue that these model selection procedures invariably give rise to unreliable inferences, primarily because their choice within a prespecified family of models (a) assumes away the problem of model validation, and (b) ignores the relevant error probabilities. This paper argues for a return to the original statistical model specification problem, as envisaged by Fisher (1922), where the task is understood as one of selecting a statistical model in such a way as to render the particular data a truly typical realization of the stochastic process specified by the model in question. The key to addressing this problem is to replace trading goodness-of-fit against parsimony with statistical adequacy as the sole criterion for when a fitted model accounts for the regularities in the data.
The Bierens test for certain nonstationary models

Ioannis Kasparis Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages221-230 We adapt the Bierens (1990) test to the I-regular models of Park and Phillips (2001). Bierens (1990) defines the test hypothesis in terms of a conditional moment condition. Under the null hypothesis, the moment condition holds with probability one. The probability measure used is that induced by the variables in the model, that
152
are assumed to be strictly stationary. Our framework is nonstationary and this approach is not always applicable. We show that the Lebesgue measure can be used instead in a meaningful way. The resultant test is consistent against all I-regular alternatives.
A low-dimension portmanteau test for non-linearity

Jennifer L. Castlea and David F. Hendry Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 231-245 A new test for non-linearity in the conditional mean is proposed using functions of the principal components of regressors. The test extends the non-linearity tests based on KolmogorovGabor polynomials ([Thursby and Schmidt, 1977], [Tsay, 1986] and [Tersvirta et al., 1993]), but circumvents problems of high dimensionality, is equivariant to collinearity, and includes exponential functions, so is a portmanteau test with power against a wide range of possible alternatives. A Monte Carlo analysis compares the performance of the test to the optimal infeasible test and to alternative tests. The relative performance of the test is encouraging: the test has the appropriate size and has high power in many situations.
Regression models with mixed sampling frequencies

Elena Andreou, Eric Ghysels, Andros Kourtellos Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 246-261 We study regression models that involve data sampled at different frequencies. We derive the asymptotic properties of the NLS estimators of such regression models and compare them with the LS estimators of a traditional model that involves aggregating or equally weighting data to estimate a model at the same sampling frequency. In addition we propose new tests to examine the null hypothesis of equal weights in aggregating time series in a regression model. We explore the above theoretical aspects and verify them via an extensive Monte Carlo simulation study and an empirical application.
Some identification problems in the cointegrated vector autoregressive model

Sren Johansen Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 262-273 The paper analyses some identification problems in the cointegrated vector autoregressive model. A criteria for identification by linear restrictions on individual relations is given. The asymptotic distribution of the estimators of and is derived when they are identified by linear restrictions on , and when they are identified by linear restrictions on . It it shown that, in the latter case, a component of is asymptotically Gaussian. Finally we discuss identification of shocks by introducing the contemporaneous and permanent effect of a shock and the distinction between permanent and transitory shocks, which allows one to identify permanent shocks from the long-run variance and transitory shocks from the short-run variance.
153
Smoothing local-to-moderate unit root theory

Peter C.B. Phillips, Tassos Magdalinose and Liudas Giraitis Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 274-279 A limit theory is established for autoregressive time series that smooths the transition between local and moderate deviations from unity and provides a transitional form that links conventional unit root distributions and the standard normal. Edgeworth expansions of the limit theory are given. These expansions show that the limit theory that holds for values of the autoregressive coefficient that are closer to stationarity than local (i.e. deviations of the form , where n is the sample size and c<0) holds up to the second order. Similar expansions around the limiting Cauchy density are provided for the mildly explosive case.
Bootstrapping I (1) data

Peter C.B. Phillips Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 280-284 A functional law is given for an I(1) sample data version of the continuous-path block bootstrap of Paparoditis and Politis (2001a). The results provide an alternative demonstration that continuous-path block bootstrap unit root tests are consistent under the null.
Applications of sub sampling, hybrid, and size-correction methods

Donald W.K. Andrews, Patrik Guggenberger, Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 285-305 This paper analyzes the properties of subsampling, hybrid subsampling, and sizecorrection methods in two non-regular models. The latter two procedures are introduced in Andrews and Guggenberger (2009a). The models are non-regular in the sense that the test statistics of interest exhibit a discontinuity in their limit distribution as a function of a parameter in the model. The first model is a linear instrumental variables (IV) model with possibly weak IVs estimated using two-stage least squares (2SLS). In this case, the discontinuity occurs when the concentration parameter is zero. The second model is a linear regression model in which the parameter of interest may be near a boundary. In this case, the discontinuity occurs when the parameter is on the boundary.The paper shows that in the IV model onesided and equal-tailed two-sided subsampling tests and confidence intervals (CIs) based on the 2SLS t statistic do not have correct asymptotic size. This holds for both fully- and partially-studentized t statistics. But, subsampling procedures based on the partially-studentized t statistic can be size-corrected. On the other hand, symmetric two-sided subsampling tests and CIs are shown to have (essentially) correct asymptotic size when based on a partially-studentized t statistic. Furthermore, all types of hybrid subsampling tests and CIs are shown to have correct asymptotic size in this model. The above results are consistent with impossibility results of Dufour (1997) because subsampling and hybrid subsampling CIs are shown to have infinite length with positive probability. Subsampling CIs for a parameter that may be near a lower boundary are shown to have incorrect asymptotic size for upper one-sided and equal-tailed and symmetric
154
two-sided CIs. Again, size-correction is possible. In this model as well, all types of hybrid subsampling CIs are found to have correct asymptotic size.
Understanding aggregate crime regressions

Steven N. Durlauf, Salvador Navarro, David A. Rivers Journal of Econometrics Volume 158, Issue 2, Oct 2010, Pages 306-317 This paper provides a general description of the relationship between individual decision problems and aggregate crime regressions. The analysis is designed to elucidate the behavioral and statistical assumptions that are implicit in the use of aggregate crime regressions for both the analysis of crime determinants as well in counterfactual policy evaluation. We apply our general arguments to the question of the deterrent effect of capital punishment and show how alternative assumptions affect estimates of the deterrent effect.
The (mis)specification of discrete duration models with unobserved heterogeneity

Cheti Nicoletti, Concetta Rondinelli Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 1-13 Empirical researchers usually prefer statistical models that can be easily estimated with the help of commonly available software packages. Sequential binary models with or without normal random effects are an example of such models that can be adopted to estimate discrete duration models with unobserved heterogeneity. But an easy-to-implement estimation may incur a cost. In this paper we conduct a Monte Carlo simulation to evaluate the consequences of omitting or misspecifying the unobserved heterogeneity distribution in single-spell discrete duration models.
A dynamic patent intensity model with secret common innovation factors

Szabolcs Blazsek, Alvaro Escribano Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 14-32 During the past two decades, innovations protected by patents have played a key role in business strategies. This fact enhanced studies of the determinants of patents and the impact of patents on innovation and competitive advantage. Sustaining competitive advantages is as important as creating them. Patents help sustaining competitive advantages by increasing the production cost of competitors, by signaling a better quality of products and by serving as barriers to entry. If patents are rewards for innovation, more R&D should be reflected in more patent applications but this is not the end of the story. There is empirical evidence showing that patents through time are becoming easier to get and more valuable to the firm due to increasing damage awards from infringers. These facts question the constant and static nature of the relationship between R&D and patents. Furthermore, innovation creates important knowledge spillovers due to its imperfect appropriability. Our paper investigates these dynamic effects using US patent data from 1979 to 2000 with alternative model specifications for patent counts. We introduce a general dynamic count panel data model with dynamic observable and unobservable spillovers, which encompasses previous models, is able to control for the
155
endogeneity of R&D and therefore can be consistently estimated by maximum likelihood. Apart from allowing for firm specific fixed and random effects, we introduce a common unobserved component, or secret stock of knowledge, that affects differently the propensity to patent of each firm across sectors due to their different absorptive capacity.
A direct Monte Carlo approach for Bayesian analysis of the seemingly unrelated regression model
Arnold Zellner, Tomohiro Ando Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 33-45 Computationally efficient methods for Bayesian analysis of seemingly unrelated regression (SUR) models are described and applied that involve the use of a direct Monte Carlo (DMC) approach to calculate Bayesian estimation and prediction results using diffuse or informative priors. This DMC approach is employed to compute Bayesian marginal posterior densities, moments, intervals and other quantities, using data simulated from known models and also using data from an empirical example involving firms sales. The results obtained by the DMC approach are compared to those yielded by the use of a Markov Chain Monte Carlo (MCMC) approach. It is concluded from these comparisons that the DMC approach is worthwhile and applicable to many SUR and other problems.
A consistent nonparametric test of affiliation in auction models

Sung Jae Jun, Joris Pinkse, Yuanyuan Wan Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 46-54 We propose a new nonparametric test of affiliation, a strong form of positive dependence with independence as a special, knife-edge, case. The test is consistent against all departures from the null of affiliation, and its null distribution is standard normal. Like most nonparametric tests, a sample-size dependent input parameter is needed. We provide an informal procedure for choosing the input parameter and evaluate the tests performance using a simulation study. Our test can be used to test the fundamental assumptions of the auctions literature. We implement our test empirically using the Outer Continental Shelf (OCS) auction data.
Efficient estimation of a multivariate multiplicative volatility model

Christian M. Hafner, Oliver Linton Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 55-73 We propose a multivariate generalization of the multiplicative volatility model of Engle and Rangel (2008), which has a nonparametric long run component and a unit multivariate GARCH short run dynamic component. We suggest various kernelbased estimation procedures for the parametric and nonparametric components, and derive the asymptotic properties thereof. For the parametric part of the model, we obtain the semiparametric efficiency bound. Our method is applied to a bivariate stock index series. We find that the univariate model of Engle and Rangel (2008)
156
appears to be violated in the data whereas our multivariate model is more consistent with the data.
Realised quantile-based estimation of the integrated variance

Kim Christensen, Roel Oomen, Mark Podolskij Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 74-98 In this paper, we propose a new jump-robust quantile-based realised variance measure of ex post return variation that can be computed using potentially noisy data. The estimator is consistent for the integrated variance and we present feasible central limit theorems which show that it converges at the best attainable rate and has excellent efficiency. Asymptotically, the quantile-based realised variance is immune to finite activity jumps and outliers in the price series, while in modified form the estimator is applicable with market microstructure noise and therefore operational on high-frequency data. Simulations show that it has superior robustness properties in finite sample, while an empirical application illustrates its use on equity data.
GMM estimation of social interaction models with centrality

Xiaodong Liu, Lung-fei Lee Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 99-115 This paper considers the specification and estimation of social interaction models with network structures and the presence of endogenous, contextual, correlated, and group fixed effects. When the network structure in a group is captured by a graph in which the degrees of nodes are not all equal, the different positions of group members as measured by the Bonacich (1987) centrality provide additional information for identification and estimation. In this case, the Bonacich centrality measure for each group can be used as an instrument for the endogenous social effect, but the number of such instruments grows with the number of groups. We consider the 2SLS and GMM estimation for the model. The proposed estimators are asymptotically efficient, respectively, within the class of IV estimators and the class of GMM estimators based on linear and quadratic moments, when the sample size grows fast enough relative to the number of instruments.
Pre-averaging estimators of the ex-post covariance matrix in noisy diffusion models with non-synchronous data
Kim Christensen, Silja Kinnebrock, Mark Podolskij Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 116-133 We show how pre-averaging can be applied to the problem of measuring the ex-post covariance of financial asset returns under microstructure noise and non-synchronous trading. A pre-averaged realised covariance is proposed, and we present an asymptotic theory for this new estimator, which can be configured to possess an optimal convergence rate or to ensure positive semi-definite covariance matrix estimates. We also derive a noise-robust HayashiYoshida estimator that can be implemented on the original data without prior alignment of prices. We uncover the finite sample properties of our estimators with simulations and illustrate their practical use on high-frequency equity data.
157
A flexible approach to parametric inference in nonlinear and time varying time series models
Gary Koop, Simon Potter Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 134-150 Many structural break and regime-switching models have been used with macroeconomic and financial data. In this paper, we develop an extremely flexible modeling approach which can accommodate virtually any of these specifications. We build on earlier work showing the relationship between flexible functional forms and random variation in parameters. Our contribution is based around the use of priors on the time variation that is developed from considering a hypothetical reordering of the data and distance between neighboring (reordered) observations. The range of priors produced in this way can accommodate a wide variety of nonlinear time series models, including those with regime-switching and structural breaks. By allowing the amount of random variation in parameters to depend on the distance between (reordered) observations, the parameters can evolve in a wide variety of ways, allowing for everything from models exhibiting abrupt change (e.g. threshold autoregressive models or standard structural break models) to those which allow for a gradual evolution of parameters (e.g. smooth transition autoregressive models or time varying parameter models). Bayesian econometric methods for inference are developed for estimating the distance function and types of hypothetical reordering. Conditional on a hypothetical reordering and distance function, a simple reordering of the actual data allows us to estimate our models with standard state space methods by a simple adjustment to the measurement equation. We use artificial data to show the advantages of our approach, before providing two empirical illustrations involving the modeling of real GDP growth.
Inconsistency of the MLE and inference based on weighted LS for LARCH models
Christian Francq, Jean-Michel Zakoan Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 151-165 This paper considers a class of finite-order autoregressive linear ARCH models. The model captures the leverage effect, allows the volatility to be arbitrarily close to zero and to reach its minimum for non-zero innovations, and is appropriate for long memory modeling when infinite orders are allowed. However, the (quasi-)maximum likelihood estimator is, in general, inconsistent. A self-weighted least-squares estimator is proposed and is shown to be asymptotically normal. A score test for conditional homoscedasticity and diagnostic portmanteau tests are developed. Their performance is illustrated via simulation experiments. It is also investigated whether stock market returns exhibit some of the characteristic features of the linear ARCH model.
158
No-arbitrage macroeconomic determinants of the yield curve

Ruslan Bikbov, Mikhail Chernov Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 166-182 No-arbitrage macro-finance models use variance decompositions to gauge the extent of association between the macro variables and yields. We show that results generated by this approach are sensitive to the order of variables in the recursive identification scheme. In a four-factor model, one may obtain 18 different sets of answers out of 24 possible. We propose an alternative measure that is based on levels of macro variables as opposed to shocks. We account for the correlation between the macro and latent factors via projection of the latter onto the former. As a result, the association between macro variables and yields can be computed uniquely via an R2. Macro variables explain 80% of the variation in the short rate and 50% of the slope, and 54% to 68% of the term premia.
Wavelet analysis of change-points in a non-parametric regression with heteroscedastic variance

Yong Zhou, Alan T.K. Wan, Shangyu Xie, Xiaojing Wang Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 183-201 In this paper we develop wavelet methods for detecting and estimating jumps and cusps in the mean function of a non-parametric regression model. An important characteristic of the model considered here is that it allows for conditional hetero scedastic variance, a feature frequently encountered with economic and financial data. Wavelet analysis of change-points in this model has been considered in a limited way in a recent study by Chen et al. (2008) with a focus on jumps only. One problem with the aforementioned paper is that the test statistic developed there has an extreme value null limit distribution. The results of other studies have shown that the rate of convergence to the extreme value distribution is usually very slow, and critical values derived from this distribution tend to be much larger than the true ones. Here, we develop a new test and show that the test statistic has a convenient null limit N(0,1) distribution. This feature gives the proposed approach an appealing advantage over the existing approach. Another attractive feature of our results is that the asymptotic theory developed here holds for both jumps and cusps. Implementation of the proposed method for multiple jumps and cusps is also examined. The results from a simulation study show that the new test has excellent power and the estimators developed also yield very accurate estimates of the positions of the discontinuities.
The effects of dynamic feedbacks on LS and MM estimator accuracy in panel data models: Some additional results
Kazuhiko Hayakawa Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 202-208 In this paper, we show that the order of magnitude of the finite sample bias of the estimator of Bun and Kiviet (2006) reduces from O(T/N) to O(1/N) if the original level model is transformed by the upper triangular Cholesky factorization of the inverse of the pseudo variance matrix of error component ui wherein true values of
159
the variances of individual effects and disturbances may not be used. Some variants of the system GMM estimator that are associated with the Cholesky-transformed model are also discussed.
Specification tests of parametric dynamic conditional quantiles

Juan Carlos Escanciano, Carlos Velasco Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 209-221 This article proposes omnibus specification tests of parametric dynamic quantile models. In contrast to the existing procedures, we allow for a flexible specification, where a possible continuum of quantiles is simultaneously specified under fairly weak conditions on the serial dependence in the underlying data-generating process. Since the null limit distribution of tests is not pivotal, we propose a subsampling approximation of the asymptotic critical values. A Monte Carlo study shows that the asymptotic results provide good approximations for small sample sizes. Finally, an application suggests that our methodology is a powerful alternative to standard backtesting procedures in evaluating market risk.
Root-N-consistent estimation of fixed-effect panel data transformation models with censoring

Songnian Chen Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 222-234 This paper considers semiparametric -consistent estimation of the parameters of the generalized panel data transformation model with fixed effects under various forms of censoring, without parametric specification for the transformation function or the error distribution. While the approach in Abrevaya (1999) is -consistent, it is not applicable when censoring is present. For the case with fixed censoring, existing approaches such as those of Manski (1987) and Abrevaya (2000) apply, but their estimators converge at rates slower than , thus possessing zero efficiency -consistent estimators. While the approaches by Honor (1992) compared with -consistent estimators under fixed and and Ridder and Tunali (1999) do produce independent censoring respectively, they require either the error distribution or the transformation function to be completely known. Our -consistent estimator for the fixed censoring case could be extended to the cases with independent and dependent censoring. Under dependent censoring, in contrast to our method, the existing approaches (e.g., Horowitz and Lee (2003), Lee (2008) and Das and Ying (2005)) require parametric specification for the transformation function or the error distribution. Large sample properties of the proposed estimators are presented. We also provide a simulation study to illustrate our estimation methods in finite samples.
160
Quasi-maximum likelihood estimation of volatility with high frequency data

Dacheng Xiu Journal of Econometrics Volume 159, Issue 1, Nov 2010, Pages 235-250 This paper investigates the properties of the well-known maximum likelihood estimator in the presence of stochastic volatility and market microstructure noise, by extending the classic asymptotic results of quasi-maximum likelihood estimation. When trying to estimate the integrated volatility and the variance of noise, this parametric approach remains consistent, efficient and robust as a quasi-estimator under misspecified assumptions. Moreover, it shares the model-free feature with nonparametric alternatives, for instance realized kernels, while being advantageous over them in terms of finite sample performance. In light of quadratic representation, this estimator behaves like an iterative exponential realized kernel asymptotically. Comparisons with a variety of implementations of the TukeyHanning2 kernel are provided using Monte Carlo simulations, and an empirical study with the Euro/US Dollar future illustrates its application in practice..
Characterization of the asymptotic distribution of semiparametric M-estimators

Hidehiko Ichimura, Sokbae Lee Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 252-266 This paper develops a concrete formula for the asymptotic distribution of two-step, possibly non-smooth semiparametric M-estimators under general misspecification. Our regularity conditions are relatively straightforward to verify and also weaker than those available in the literature. The first-stage nonparametric estimation may depend on finite dimensional parameters. We characterize: (1) conditions under which the first-stage estimation of nonparametric components do not affect the asymptotic distribution, (2) conditions under which the asymptotic distribution is affected by the derivatives of the first-stage nonparametric estimator with respect to the finite-dimensional parameters, and (3) conditions under which one can allow non-smooth objective functions. Our framework is illustrated by applying it to three examples: (1) profiled estimation of a single index quantile regression model, (2) semiparametric least squares estimation under model misspecification, and (3) a smoothed matching estimator.
Semiparametric bounds on treatment effects

Richard C. Chiburis Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 267-275 We present a variety of semiparametric models that produce bounds on the average causal effect of a binary treatment on a binary outcome. The semiparametric assumptions exploit variation in observable covariates to narrow the bounds. In our main model, the outcome is determined by a generalized linear model, but the treatment may be arbitrarily endogenous. Our bounding strategy does not require the existence of an instrument, but incorporating an instrument narrows the bounds. The bounds are further improved by combining the semiparametric model with the joint threshold-crossing assumption of Shaikh and Vytlacil (2005).
161
Threshold bipower variation and the impact of jumps on volatility forecasting

Fulvio Corsi, Davide Pirino, Roberto Ren Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 276-288 This study reconsiders the role of jumps for volatility forecasting by showing that jumps have a positive and mostly significant impact on future volatility. This result becomes apparent once volatility is separated into its continuous and discontinuous components using estimators which are not only consistent, but also scarcely plagued by small sample bias. With the aim of achieving this, we introduce the concept of threshold bipower variation, which is based on the joint use of bipower variation and threshold estimation. We show that its generalization (threshold multipower variation) admits a feasible central limit theorem in the presence of jumps and provides less biased estimates, with respect to the standard multipower variation, of the continuous quadratic variation in finite samples. We further provide a new test for jump detection which has substantially more power than tests based on multipower variation. Empirical analysis (on the S&P500 index, individual stocks and US bond yields) shows that the proposed techniques improve significantly the accuracy of volatility forecasts especially in periods following the occurrence of a jump.
Dominating estimators for minimum-variance portfolios

Gabriel Frahm, Christoph Memmel Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 289-302 In this paper, we derive two shrinkage estimators for minimum-variance portfolios that dominate the traditional estimator with respect to the out-of-sample variance of the portfolio return. The presented results hold for any number of assets d4 and number of observations nd+2. The small-sample properties of the shrinkage estimators as well as their large-sample properties for fixed d but n and n,d but n/dq are investigated. Furthermore, we present a small-sample test for the question of whether it is better to completely ignore time series information in favor of naive diversification.
An efficient GMM estimator of spatial autoregressive models

Xiaodong Liu, Lung-fei Lee, Christopher R. Bollinger Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 303-319 In this paper, we consider GMM estimation of the regression and MRSAR models with SAR disturbances. We derive the best GMM estimator within the class of GMM estimators based on linear and quadratic moment conditions. The best GMM estimator has the merit of computational simplicity and asymptotic efficiency. It is asymptotically as efficient as the ML estimator under normality and asymptotically more efficient than the Gaussian QML estimator otherwise. Monte Carlo studies show that, with moderate-sized samples, the best GMM estimator has its biggest advantage when the disturbances are asymmetrically distributed. When the diagonal elements of the spatial weights matrix have enough variation, incorporating kurtosis of the disturbances in the moment functions will also be helpful.
162
A primal Divisia technical change index based on the output distance function
Guohua Feng, Apostolos Serletis Journal of Econometrics Volume 159, Issue 2, Dec 2010, Pages 320-330 We derive a primal Divisia technical change index based on the output distance function and further show the validity of this index from both economic and axiomatic points of view. In particular, we derive the primal Divisia technical change index by total differentiation of the output distance function with respect to a time trend. We then show that this index is dual to the Jorgenson and Griliches (1967) dual Divisia total factor productivity growth (TFPG) index when both the output and input markets are competitive; dual to the Diewert and Fox (2008) markup-adjusted revenue-share-based dual Divisia technical change index when market power is limited to output markets; dual to the Denny et al. (1981) and Fuss (1994) costelasticity-share-based dual Divisia TFPG index when market power is limited to output markets and constant returns to scale is present; and also dual to a markupand-markdown-adjusted Divisia technical change index when market power is present in both output and input markets. Finally, we show that the primal Divisia technical change index satisfies the properties of identity, commensurability, monotonicity, and time reversal. It also satisfies the property of proportionality in the presence of path independence, which in turn requires separability between inputs and outputs and homogeneity of subaggregator functions.
163
164
JOURNAL 8
Journal of Finance
165
Spring (2010)
Product Market Competition, Insider Trading, and Stock Market Efficiency
Joel Peress Journal of Finance Published on Feb 2010, Volume 65, Issue 1 How does competition in firms' product markets influence their behavior in equity markets? Do product market imperfections spread to equity markets? We examine these questions in a noisy rational expectations model in which firms operate under monopolistic competition while their shares trade in perfectly competitive markets. Firms use their monopoly power to pass on shocks to customers, thereby insulating their profits. This encourages stock trading, expedites the capitalization of private information into stock prices and improves the allocation of capital. Several implications are derived and tested.
Real and Financial Industry Booms and Busts

Gerard Hoberg, Gordon Phillips Journal of Finance Published on Feb 2010, Volume 65, Issue 1 We examine how product market competition affects firm cash flows and stock returns in industry booms and busts. Our results show how real and financial factors interact in industry business cycles. In competitive industries, we find that high industry-level stock market valuation, investment, and financing are followed by sharply lower operating cash flows and abnormal stock returns. Analyst estimates are positively biased and returns comove more. In concentrated industries these relations are weak and generally insignificant. Our results are consistent with participants in competitive industries not fully internalizing the negative externality of industry competition on cash flows and stock returns.
Global Currency Hedging

John Y. Campbell, Karine Serfaty-De Medeiros, Luis M. Viceira Journal of Finance Published on Feb 2010, Volume 65, Issue 1 Over the period 1975 to 2005, the U.S. dollar (particularly in relation to the Canadian dollar), the euro, and the Swiss franc (particularly in the second half of the period) moved against world equity markets. Thus, these currencies should be attractive to risk-minimizing global equity investors despite their low average returns. The riskminimizing currency strategy for a global bond investor is close to a full currency hedge, with a modest long position in the U.S. dollar. There is little evidence that risk-minimizing investors should adjust their currency positions in response to movements in interest differentials.
166
A Habit-Based Explanation of the Exchange Rate Risk Premium

Adrien Verdelhan Journal of Finance Published on Feb 2010, Volume 65, Issue 1 This paper presents a model that reproduces the uncovered interest rate parity puzzle. Investors have preferences with external habits. Countercyclical risk premia and procyclical real interest rates arise endogenously. During bad times at home, when domestic consumption is close to the habit level, the representative investor is very risk averse. When the domestic investor is more risk averse than her foreign counterpart, the exchange rate is closely tied to domestic consumption growth shocks. The domestic investor therefore expects a positive currency excess return. Because interest rates are low in bad times, expected currency excess returns increase with interest rate differentials.
Collateral Spread and Financial Development

Jos M. Liberti, Atif R. Mian Journal of Finance Published on Feb 2010, Volume 65, Issue 1 We show that institutions that promote financial development ease borrowing constraints by lowering the collateral spread and shifting the composition of acceptable collateral towards firm-specific assets. Collateral spread is defined as the difference in collateralization rates between high- and low-risk borrowers. The average collateral spread is large but declines rapidly with improvements in financial development driven by stronger institutions. We also show that the composition of collateralizable assets shifts towards non-specific assets (e.g., land) with borrower risk. However, the shift is considerably smaller in developed financial markets, enabling risky borrowers to use a larger variety of assets as collateral.
False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas

Laurent Barras,Olivier Scaillet,Russ Wermers Journal of Finance Published on Feb 2010, Volume 65, Issue 1 This paper develops a simple technique that controls for "false discoveries," or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit zero alpha (net of expenses), consistent with the Berk and Green equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find the few funds with persistent performance.
167
Do Hot Hands Exist among Hedge Fund Managers? An Empirical Evaluation

Ravi Jagannathan,Alexey Malakhov,Dmitry Novikov Journal of Finance Published on Feb 2010, Volume 65, Issue 1 In measuring performance persistence, we use hedge fund style benchmarks. This allows us to identify managers with valuable skills, and also to control for option-like features inherent in returns from hedge fund strategies. We take into account the possibility that reported asset values may be based on stale prices. We develop a statistical model that relates a hedge fund's performance to its decision to liquidate or close in order to infer the performance of a hedge fund that left the database. Although we find significant performance persistence among superior funds, we find little evidence of persistence among inferior funds.
Stock Market Declines and Liquidity

Allaudeen Hameed,Wenjin Kang,S. Viswanathan Journal of Finance Published on Feb 2010, Volume 65, Issue 1 Consistent with recent theoretical models where binding capital constraints lead to sudden liquidity dry-ups, we find that negative market returns decrease stock liquidity, especially during times of tightness in the funding market. The asymmetric effect of changes in aggregate asset values on liquidity and commonality in liquidity cannot be fully explained by changes in demand for liquidity or volatility effects. We document interindustry spillover effects in liquidity, which are likely to arise from capital constraints in the market making sector. We also find economically significant returns to supplying liquidity following periods of large drops in market valuations.
Time Variation in Liquidity: The Role of Market-Maker Inventories and Revenues

Carole Comerton-Forde;Terrence Moulton;Mark S. Seasholes Journal of Finance Published on Feb 2010, Volume 65, Issue 1 We show that market-maker balance sheet and income statement variables explain time variation in liquidity, suggesting liquidity-supplier financing constraints matter. Using 11 years of NYSE specialist inventory positions and trading revenues, we find that aggregate market-level and specialist firm-level spreads widen when specialists have large positions or lose money. The effects are nonlinear and most prominent when inventories are big or trading results have been particularly poor. These sensitivities are smaller after specialist firm mergers, consistent with deep pockets easing financing constraints. Finally, compared to low volatility stocks, the liquidity of high volatility stocks is more sensitive to inventories and losses. Hendershott;Charles M. Jones;Pamela C.
168
The Impact of Deregulation and Financial Innovation on Consumers: The Case of the Mortgage Market
Kristopher S. Gerardi;Harvey S. Rosen;Paul S. Willen Journal of Finance Published on Feb 2010, Volume 65, Issue 1 We develop a technique to assess the impact of changes in mortgage markets on households, exploiting an implication of the permanent income hypothesis: The higher a household's expected future income, the higher its desired consumption, ceteris paribus. With perfect credit markets, desired consumption matches actual consumption and current spending forecasts future income. Because credit market imperfections mute this effect, the extent to which house spending predicts future income measures the "imperfectness" of mortgage markets. Using micro-data, we find that since the early 1980s, mortgage markets have become less imperfect in this sense, and securitization has played an important role.
Individualism and Momentum around the World

Andy C.W. Chui,Sheridan Titman,K.C. John Wei Journal of Finance Published on Feb 2010, Volume 65, Issue 1 This paper examines how cultural differences influence the returns of momentum strategies. Cross-country cultural differences are measured with an individualism index developed by Hofstede (2001), which is related to overconfidence and selfattribution bias. We find that individualism is positively associated with trading volume and volatility, as well as to the magnitude of momentum profits. Momentum profits are also positively related to analyst forecast dispersion, transaction costs, and the familiarity of the market to foreigners, and negatively related to firm size and volatility. However, the addition of these and other variables does not dampen the relation between individualism and momentum profits.
Correlation Risk and Optimal Portfolio Choice

Andrea Buraschi;Paolo Porchia;Fabio Trojani Journal of Finance Published on Feb 2010, Volume 65, Issue 1 We develop a new framework for multivariate intertemporal portfolio choice that allows us to derive optimal portfolio implications for economies in which the degree of correlation across industries, countries, or asset classes is stochastic. Optimal portfolios include distinct hedging components against both stochastic volatility and correlation risk. We find that the hedging demand is typically larger than in univariate models, and it includes an economically significant covariance hedging component, which tends to increase with the persistence of variancecovariance shocks, the strength of leverage effects, the dimension of the investment opportunity set, and the presence of portfolio constraints.
169
The Variability of IPO Initial Returns

Michelle Lowry;Micah S. Officer;G. William Schwert Journal of Finance Published on Apr 2010, Volume 65, Issue 2 The monthly volatility of IPO initial returns is substantial, fluctuates dramatically over time, and is considerably larger during "hot" IPO markets. Consistent with IPO theory, the volatility of initial returns is higher for firms that are more difficult to value because of higher information asymmetry. Our findings highlight underwriters' difficulty in valuing companies characterized by high uncertainty, and raise serious questions about the efficacy of the traditional firm-commitment IPO process. One implication of our results is that alternate mechanisms, such as auctions, could be beneficial for firms that value price discovery over the auxiliary services provided by underwriters.
Levered Returns
Joao F. Gomes;Lukas Schmid Journal of Finance Published on Apr 2010, Volume 65, Issue 2 This paper revisits the theoretical relation between financial leverage and stock returns in a dynamic world where both corporate investment and financing decisions are endogenous. We find that the link between leverage and stock returns is more complex than static textbook examples suggest, and depends on the investment opportunities available to the firm. In the presence of financial market imperfections, leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. A quantitative version of our model matches several stylized facts about leverage and returns.
The New Game in Town: Competitive Effects of IPOs

Hung-Chia Hsu;Adam V. Reed;Jrg Rocholl Journal of Finance Published on Apr 2010, Volume 65, Issue 2 We analyze the effect of initial public offerings (IPOs) on industry competitors and provide evidence that companies experience negative stock price reactions to completed IPOs in their industry and positive stock price reactions to their withdrawal. Following a successful IPO in their industry, they show significant deterioration in their operating performance. These results are consistent with the existence of IPO-related competitive advantages through the loosening of financial constraints, financial intermediary certification, and the presence of knowledge capital. These aspects of competitiveness are significant in explaining the crosssection of underperformance as well as survival probabilities for competing firms.
170
Financial Structure, Acquisition Opportunities, and Firm Locations

Andres Almazan;Adolfo De Motta;Sheridan Titman;Vahap Uysal Journal of Finance Published on Apr 2010, Volume 65, Issue 2 This paper investigates the relation between firms' locations and their corporate finance decisions. We develop a model where being located within an industry cluster increases opportunities to make acquisitions, and to facilitate those acquisitions, firms within clusters maintain more financial slack. Consistent with our model we find that firms located within industry clusters make more acquisitions, and have lower debt ratios and larger cash balances than their industry peers located outside clusters. We also document that firms in high-tech cities and growing cities maintain more financial slack. Overall, the evidence suggests that growth opportunities influence firms' financial decisions.
Taxes on Tax-Exempt Bonds

Andrew Ang;Vineer Bhansali;Yuhang Xing Journal of Finance Published on Apr 2010, Volume 65, Issue 2 Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified because a portion of secondary market municipal bond trades involves income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.
Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models
Mark J. Torben G. Anderson; Luca Benzoni Journal of Finance Published on Apr 2010, Volume 65, Issue 2 We propose using model-free yield quadratic variation measures computed from intraday data as a tool for specification testing and selection of dynamic term structure models. We find that the yield curve fails to span realized yield volatility in the U.S. Treasury market, as the systematic volatility factors are largely unrelated to the cross-section of yields. We conclude that a broad class of affine diffusive, quadratic Gaussian, and affine jump-diffusive models cannot accommodate the observed yield volatility dynamics. Hence, the Treasury market per se is incomplete, as yield volatility risk cannot be hedged solely through Treasury securities.
171
Personal Bankruptcy and Credit Market Competition

Astrid A. Dick; Andreas Lehnert Journal of Finance Published on Apr 2010, Volume 65, Issue 2 We document a link between U.S. credit supply and rising personal bankruptcy rates. We exploit the exogenous variation in market contestability brought on by banking deregulationthe relaxation of entry restrictions in the 1980s and 1990sat the state level. We find deregulation explains at least 10% of the rise in bankruptcy rates. We also find that deregulation leads to increased lending, lower loss rates on loans, and higher lending productivity. Our findings indicate that increased competition prompted banks to adopt sophisticated credit rating technology, allowing for new credit extension to existing and previously excluded households.
Corporate Political Contributions and Stock Returns

Michael J. Cooper;Huseyin Gulen;Alexei V. Ovtchinnikov Journal of Finance Published on Apr 2010, Volume 65, Issue 2 We develop a new and comprehensive database of firm-level contributions to U.S. political campaigns from 1979 to 2004. We construct variables that measure the extent of firm support for candidates. We find that these measures are positively and significantly correlated with the cross-section of future returns. The effect is strongest for firms that support a greater number of candidates that hold office in the same state that the firm is based. In addition, there are stronger effects for firms whose contributions are slanted toward House candidates and Democrats.
The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities
Vladimir A. Gatchev;Todd Pulvino;Vefa Tarhan Journal of Finance Published on Apr 2010, Volume 65, Issue 2 We develop a dynamic multiequation model where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates, and that models that do not acknowledge the interdependence among decision variables produce inefficient estimates and provide an incomplete and potentially misleading view of financial behavior. We use our model to examine whether firms are constrained from accessing capital markets. Unlike static singleequation studies that find firms underinvest given cash flow shortfalls, we conclude that firms maintain investment by borrowing.
172
Performance and Persistence in Institutional Investment Management

Jeffery A. Busse,Amit Goyal,Sunil Wahal Journal of Finance Published on Apr 2010, Volume 65, Issue 2 Using new, survivorship bias-free data, we examine the performance and persistence in performance of 4,617 active domestic equity institutional products managed by 1,448 investment management firms between 1991 and 2008. Controlling for the FamaFrench (1993) three factors and momentum, aggregate and average estimates of alphas are statistically indistinguishable from zero. Even though there is considerable heterogeneity in performance, there is only modest evidence of persistence in three-factor models and little to none in four-factor models.
173
Summer (2010)
The Variability of IPO Initial Returns
Michelle Lowry,Micah S. Officer,G. William Schwert Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 425-465 The monthly volatility of IPO initial returns is substantial, fluctuates dramatically over time, and is considerably larger during "hot" IPO markets. Consistent with IPO theory, the volatility of initial returns is higher for firms that are more difficult to value because of higher information asymmetry. Our findings highlight underwriters' difficulty in valuing companies characterized by high uncertainty, and raise serious questions about the efficacy of the traditional firm-commitment IPO process. One implication of our results is that alternate mechanisms, such as auctions, could be beneficial for firms that value price discovery over the auxiliary services provided by underwriters.
Levered Returns
Joao F. Gomes,Lukas Schmid Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 467-494 This paper revisits the theoretical relation between financial leverage and stock returns in a dynamic world where both corporate investment and financing decisions are endogenous. We find that the link between leverage and stock returns is more complex than static textbook examples suggest, and depends on the investment opportunities available to the firm. In the presence of financial market imperfections, leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. A quantitative version of our model matches several stylized facts about leverage and returns.
The New Game in Town: Competitive Effects of IPOs

Hung-Chia Hsu, Adam V. Reed, Jrg Rocholl Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 495 - 528 We analyze the effect of initial public offerings (IPOs) on industry competitors and provide evidence that companies experience negative stock price reactions to completed IPOs in their industry and positive stock price reactions to their withdrawal. Following a successful IPO in their industry, they show significant deterioration in their operating performance. These results are consistent with the existence of IPO-related competitive advantages through the loosening of financial constraints, financial intermediary certification, and the presence of knowledge capital. These aspects of competitiveness are significant in explaining the crosssection of underperformance as well as survival probabilities for competing firms.
174
Financial Structure, Acquisition Opportunities, and Firm Locations

Andres Almazan, Adolfo De Motta, Sheridan Titman, Vahap Uysal Published on Apr 2010, Volume 65: Issue 2, Pages 529 - 563 This paper investigates the relation between firms' locations and their corporate finance decisions. We develop a model where being located within an industry cluster increases opportunities to make acquisitions, and to facilitate those acquisitions, firms within clusters maintain more financial slack. Consistent with our model we find that firms located within industry clusters make more acquisitions, and have lower debt ratios and larger cash balances than their industry peers located outside clusters. We also document that firms in high-tech cities and growing cities maintain more financial slack. Overall, the evidence suggests that growth opportunities influence firms' financial decisions.
Taxes on Tax-Exempt Bonds

Andrew Ang, Vineer Bhansali, Yuhang Xing Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 565 - 601 Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified because a portion of secondary market municipal bond trades involves income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.
Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models
Torben G. Andersen, Luca Benzoni Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 603 - 653 We propose using model-free yield quadratic variation measures computed from intraday data as a tool for specification testing and selection of dynamic term structure models. We find that the yield curve fails to span realized yield volatility in the U.S. Treasury market, as the systematic volatility factors are largely unrelated to the cross-section of yields. We conclude that a broad class of affine diffusive, quadratic Gaussian, and affine jump-diffusive models cannot accommodate the observed yield volatility dynamics. Hence, the Treasury market per se is incomplete, as yield volatility risk cannot be hedged solely through Treasury securities.
Personal Bankruptcy and Credit Market Competition

Astrid A. Dick, Reas Lehnert Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 655 - 686 We document a link between U.S. credit supply and rising personal bankruptcy rates. We exploit the exogenous variation in market contestability brought on by banking
175
deregulationthe relaxation of entry restrictions in the 1980s and 1990sat the state level. We find deregulation explains at least 10% of the rise in bankruptcy rates. We also find that deregulation leads to increased lending, lower loss rates on loans, and higher lending productivity. Our findings indicate that increased competition prompted banks to adopt sophisticated credit rating technology, allowing for new credit extension to existing and previously excluded households.
Corporate Political Contributions and Stock Returns

Michael J. Cooper, Huseyin Gulen, Alexei V. Ovtchinnikov Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 687 - 724 We develop a new and comprehensive database of firm-level contributions to U.S. political campaigns from 1979 to 2004. We construct variables that measure the extent of firm support for candidates. We find that these measures are positively and significantly correlated with the cross-section of future returns. The effect is strongest for firms that support a greater number of candidates that hold office in the same state that the firm is based. In addition, there are stronger effects for firms whose contributions are slanted toward House candidates and Democrats.
The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities
Vladimir A. Gatchev, Todd Pulvino, Vefa Tarhan Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 725 - 763 We develop a dynamic multiequation model where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates, and that models that do not acknowledge the interdependence among decision variables produce inefficient estimates and provide an incomplete and potentially misleading view of financial behavior. We use our model to examine whether firms are constrained from accessing capital markets. Unlike static singleequation studies that find firms underinvest given cash flow shortfalls, we conclude that firms maintain investment by borrowing.
Performance and Persistence in Institutional Investment Management

Jeffrey A. Busse, Amit Goyal, Sunil Wahal Journal of Finance Published on Apr 2010, Volume 65: Issue 2, Pages 765 - 790 Using new, survivorship bias-free data, we examine the performance and persistence in performance of 4,617 active domestic equity institutional products managed by 1,448 investment management firms between 1991 and 2008. Controlling for the FamaFrench (1993) three factors and momentum, aggregate and average estimates of alphas are statistically indistinguishable from zero. Even though there is considerable heterogeneity in performance, there is only modest evidence of persistence in three-factor models and little to none in four-factor models.
176
Information and Incentives Inside the Firm: Evidence from Loan Officer Rotation
Andrew Hertzberg, Jose Maria Liberti, Daniel Paravisini Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 795 - 828 We present evidence that reassigning tasks among agents can alleviate moral hazard in communication. A rotation policy that routinely reassigns loan officers to borrowers of a commercial bank affects the officers' reporting behavior. When an officer anticipates rotation, reports are more accurate and contain more bad news about the borrower's repayment prospects. As a result, the rotation policy makes bank lending decisions more sensitive to officer reports. The threat of rotation improves communication because self-reporting bad news has a smaller negative effect on an officer's career prospects than bad news exposed by a successor.
Networking as a Barrier to Entry and the Competitive Supply of Venture Capital

Yael V. Hochberg, Alexander Ljungqvist, Yang Lu Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 829 - 859 We examine whether strong networks among incumbent venture capitalists (VCs) in local markets help restrict entry by outside VCs, thus improving incumbents' bargaining power over entrepreneurs. More densely networked markets experience less entry, with a one-standard deviation increase in network ties among incumbents reducing entry by approximately one-third. Entrants with established ties to targetmarket incumbents appear able to overcome this barrier to entry; in turn, incumbents react strategically to an increased threat of entry by freezing out any incumbents who facilitate entry into their market. Incumbents appear to benefit from reduced entry by paying lower prices for their deals.
Does Credit Competition Affect Small-Firm Finance

Tara Rice, Philip E. Strahan Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 861 - 889 While relaxation of geographical restrictions on bank expansion permitted banking organizations to expand across state lines, it allowed states to erect barriers to branch expansion. These differences in states' branching restrictions affect credit supply. In states more open to branching, small firms borrow at interest rates 80 to 100 basis points lower than firms operating in less open states. Firms in open states also are more likely to borrow from banks. Despite this evidence that interstate branch openness expands credit supply, we find no effect of variation in state restrictions on branching on the amount that small firms borrow.
177
Human Capital, Bankruptcy, and Capital Structure

Jonathan B. Berk,Richard Stanton, Josef Zechner Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 891 - 926 We derive the optimal labor contract for a levered firm in an economy with perfectly competitive capital and labor markets. Employees become entrenched under this contract and so face large human costs of bankruptcy. The firm's optimal capital structure therefore depends on the trade-off between these human costs and the tax benefits of debt. Optimal debt levels consistent with those observed in practice emerge without relying on frictions such as moral hazard or asymmetric information. Consistent with empirical evidence, persistent idiosyncratic differences in leverage across firms also result. In addition, wages should have explanatory power for firm leverage.
Stapled Finance
Paul Povel, Rajdeep Singh Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 927 - 953 "Stapled finance" is a loan commitment arranged by a seller in an M&A setting. Whoever wins the bidding contest has the option (not the obligation) to accept this loan commitment. We show that stapled finance increases bidding competition by subsidizing weak bidders, who raise their bids and thereby the price that strong bidders (who are more likely to win) must pay. The lender expects not to break even and must be compensated for offering the loan. This reduces but does not eliminate the seller's benefit. It also implies that stapled finance loans will show poorer performance than other buyout loans.
Cash Holdings and Corporate Diversification

Ran Duchin Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 955 - 992 This paper studies the relation between corporate liquidity and diversification. The key finding is that multidivision firms hold significantly less cash than stand-alone firms because they are diversified in their investment opportunities. Lower crossdivisional correlations in investment opportunity and higher correlations between investment opportunity and cash flow correspond to lower cash holdings, even after controlling for cash flow volatility. The effects are strongest in financially constrained firms and in well-governed firms, and correspond to efficient fund transfers from low- to high-productivity divisions. Taken together, these results bring forth an efficient link between diversification and corporate liquidity.
A Gap-Filling Theory of Corporate Debt Maturity Choice

Robin Greenwood, Samuel Hanson, Jeremy C. Stein Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 993 - 1028 We argue that time variation in the maturity of corporate debt arises because firms behave as macro liquidity providers, absorbing the supply shocks associated with changes in the maturity structure of government debt. We document that when the
178
government funds itself with more short-term debt, firms fill the resulting gap by issuing more long-term debt, and vice versa. This type of liquidity provision is undertaken more aggressively: (1) when the ratio of government debt to total debt is higher and (2) by firms with stronger balance sheets. Our theory sheds new light on market timing phenomena in corporate finance more generally.
The Political Economy of Financial Regulation: Evidence from U.S. State Usury Laws in the 19th Century
Efraim Benmelech, Tobias J. Moskowitz Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1029 - 1073 Financial regulation was as hotly debated a political issue in the 19th century as it is today. We study the political economy of state usury laws in 19th century America. Exploiting the wide variation in regulation, enforcement, and economic conditions across states and time, we find that usury laws when binding reduce credit and economic activity, especially for smaller firms. We examine the motives of regulation and find that usury laws coincide with other economic and political policies favoring wealthy political incumbents, particularly when they have more voting power. The evidence suggests financial regulation is driven by private interests capturing rents from others rather than public interests protecting the underserved.
Risk and the Corporate Structure of Banks

Giovanni Dell'ariccia, Robert Marquez Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1075 - 1096 We identify different sources of risk as important determinants of banks' corporate structures when expanding into new markets. Subsidiary-based corporate structures benefit from greater protection against economic risk because of affiliate-level limited liability, but are more exposed to the risk of capital expropriation than are branches. Thus, branch-based structures are preferred to subsidiary-based structures when expropriation risk is high relative to economic risk, and vice versa. Greater cross-country risk correlation and more accurate pricing of risk by investors reduce the differences between the two structures. Furthermore, a bank's corporate structure affects its risk taking and affiliate size.
Financial Strength and Product Market Behavior: The Real Effects of Corporate Cash Holdings
Laurent Fresard Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1097 - 1122 This paper shows that large cash reserves lead to systematic future market share gains at the expense of industry rivals. Using shifts in import tariffs to identify exogenous intensification of competition, difference-in-difference estimations support the causal impact of cash on product market performance. Moreover, the analysis reveals that the "competitive" effect of cash is markedly distinct from the strategic effect of debt on product market outcomes. This effect is stronger when rivals face tighter financing constraints and when the number of interactions between
179
competitors is large. Overall, the results suggest that cash policy encompasses a substantial strategic dimension.
Executive Compensation and the Maturity Structure of Corporate Debt

Paul Brockman, Xiumin Martin, Emre Unlu Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1123 - 1161 Executive compensation influences managerial risk preferences through executives' portfolio sensitivities to changes in stock prices (delta) and stock return volatility (vega). Large deltas discourage managerial risk-taking, while large vegas encourage risk-taking. Theory suggests that short-maturity debt mitigates agency costs of debt by constraining managerial risk preferences. We posit and find evidence of a negative (positive) relation between CEO portfolio deltas (vegas) and short-maturity debt. We also find that short-maturity debt mitigates the influence of vega- and deltarelated incentives on bond yields. Overall, our empirical evidence shows that shortterm debt mitigates agency costs of debt arising from compensation risk.
The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices
Peter Iliev Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1163 - 1196 This paper exploits a natural quasi-experiment to isolate the effects that were uniquely due to the SarbanesOxley Act (SOX): U.S. firms with a public float under $75 million could delay Section 404 compliance, and foreign firms under $700 million could delay the auditor's attestation requirement. As designed, Section 404 led to conservative reported earnings, but also imposed real costs. On net, SOX compliance reduced the market value of small firms.
Capital Structure as a Strategic Variable: Evidence from Collective Bargaining

David A. Matsa Journal of Finance Published on Jun 2010, Volume 65: Issue 3, Pages 1197 - 1232 I analyze the strategic use of debt financing to improve a firm's bargaining position with an important supplierorganized labor. Because maintaining high levels of corporate liquidity can encourage workers to raise their wage demands, a firm with external finance constraints has an incentive to use the cash flow demands of debt service to improve its bargaining position with workers. Using both firm-level collective bargaining coverage and state changes in labor laws to identify changes in union bargaining power, I show that strategic incentives from union bargaining appear to have a substantial impact on corporate financing decisions.
180
Presidential Address: Asset Price Dynamics with SlowMoving Capital

Darrell Duffie Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1237-1267 I describe asset price dynamics caused by the slow movement of investment capital to trading opportunities. The pattern of price responses to supply or demand shocks typically involves a sharp reaction to the shock and a subsequent and more extended reversal. The amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect institutional impediments to immediate trade, such as search costs for trading counterparties or time to raise capital by intermediaries. I discuss special impediments to capital formation during the recent financial crisis that caused asset price distortions, which subsided afterward. After presenting examples of price reactions to supply shocks in normal market settings, I offer a simple illustrative model of price dynamics associated with slow-moving capital due to the presence of inattentive investors.
Disagreement and Learning: Dynamic Patterns of Trade

Snehal Banerjee, Ilan Kremer Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1269-1302 The empirical evidence on investor disagreement and trading volume is difficult to reconcile in standard rational expectations models. We develop a dynamic model in which investors disagree about the interpretation of public information. We obtain a closed-form linear equilibrium that allows us to study which restrictions on the disagreement process yield empirically observed volume and return dynamics. We show that when investors have infrequent but major disagreements, there is positive autocorrelation in volume and positive correlation between volume and volatility. We also derive novel empirical predictions that relate the degree and frequency of disagreement to volume and volatility dynamics.
Generalized Disappointment Aversion and Asset Prices

Bryan R. Routledge, Stanley E. Zin Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1303 - 1332 We characterize generalized disappointment aversion (GDA) risk preferences that can overweight lower-tail outcomes relative to expected utility. We show in an endowment economy that recursive utility with GDA risk preferences generates effective risk aversion that is countercyclical. This feature comes from endogenous variation in the probability of disappointment in the representative agent's intertemporal consumption-saving problem that underlies the asset pricing model. The variation in effective risk aversion produces a large equity premium and a riskfree rate that is procyclical and has low volatility in an economy with a simple autoregressive endowment-growth process.
181
Information Quality and Long-Run Risk: Asset Pricing Implications

Hengjie Ai Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1333 - 1367 I study the asset pricing implications of the quality of public information about persistent productivity shocks in a general equilibrium model with KrepsPorteus preferences. Low information quality is associated with a high equity premium, a low volatility of consumption growth, and a low volatility of the risk-free interest rate. The relationship between information quality and the equity premium differs from that in endowment economies. My calibration improves substantially upon the BansalYaron model in terms of the moments of the wealthconsumption ratio and the return on aggregate wealth.
Intraday Patterns in the Cross-section of Stock Returns

Steven L. Heston, Robert A. Korajczyk, Ronnie Sadka Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1369 - 1407 Motivated by the literature on investment flows and optimal trading, we examine intraday predictability in the cross-section of stock returns. We find a striking pattern of return continuation at half-hour intervals that are exact multiples of a trading day, and this effect lasts for at least 40 trading days. Volume, order imbalance, volatility, and bid-ask spreads exhibit similar patterns, but do not explain the return patterns. We also show that short-term return reversal is driven by temporary liquidity imbalances lasting less than an hour and bid-ask bounce. Timing trades can reduce execution costs by the equivalent of the effective spread.
Sell-Side School Ties

Lauren Cohen, Andrea Frazzini, Christopher Malloy Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1409 - 1437 We study the impact of social networks on agents' ability to gather superior information about firms. Exploiting novel data on the educational background of sellside analysts and senior corporate officers, we find that analysts outperform by up to 6.60% per year on their stock recommendations when they have an educational link to the company. Pre-Reg FD, this school-tie return premium is 9.36% per year, while post-Reg FD it is nearly zero. In contrast, in an environment that did not change selective disclosure regulation (the U.K.), the school-tie premium is large and significant over the entire sample period.
Predictive Regressions: A Present-Value Approach

Jules H. Van Binsbergen, Ralph S. J. Koijen Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1439 - 1471 We propose a latent variables approach within a present-value model to estimate the expected returns and expected dividend growth rates of the aggregate stock market. This approach aggregates information contained in the history of price-dividend
182
ratios and dividend growth rates to predict future returns and dividend growth rates. We find that returns and dividend growth rates are predictable with values ranging from 8.2% to 8.9% for returns and 13.9% to 31.6% for dividend growth rates. Both expected returns and expected dividend growth rates have a persistent component, but expected returns are more persistent than expected dividend growth rates.
Do Limit Orders Alter Inferences about Investor Performance and Behavior?

Juhani T. Linnainmaa Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1473 - 1506 Individual investors lose money around earnings announcements, experience poor posttrade returns, exhibit the disposition effect, and make contrarian trades. Using simulations and trading records of all individual investors in Finland, I find that these trading patterns can be explained in large part by investors' use of limit orders. These patterns arise mechanically because limit orders are price-contingent and suffer from adverse selection. Reverse causality from behavioral biases to order choices does not appear to explain my findings. I propose a simple method for measuring a data set's susceptibility to this limit order effect.
Why Do Foreign Firms Leave U.S. Equity Markets?

Craig Doidge, G. Andrew Karolyi, Ren M. Stulz Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1507 - 1553 Foreign firms terminate their Securities and Exchange Commission registration in the aftermath of the SarbanesOxley Act (SOX) because they no longer require outside funds to finance growth opportunities. Deregistering firms' insiders benefit from greater discretion to consume private benefits without having to raise higher cost funds. Foreign firms with more agency problems have worse stock-price reactions to the adoption of Rule 12h-6 in 2007, which made deregistration easier, than those firms more adversely affected by the compliance costs of SOX. Stockprice reactions to deregistration announcements are negative, but less so under Rule 12h-6, and more so for firms that raise fewer funds externally.
Market Segmentation and Cross-predictability of Returns

Lior Menzly, Oguzhan Ozbas Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1555 - 1580 We present evidence supporting the hypothesis that due to investor specialization and market segmentation, value-relevant information diffuses gradually in financial markets. Using the stock market as our setting, we find that (i) stocks that are in economically related supplier and customer industries cross-predict each other's returns, (ii) the magnitude of return cross-predictability declines with the number of informed investors in the market as proxied by the level of analyst coverage and institutional ownership, and (iii) changes in the stock holdings of institutional investors mirror the model trading behavior of informed investors.
183
Mutual Fund Incubation

Richard B. Evans Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1581 - 1611 Incubation is a strategy for initiating new funds, where multiple funds are started privately, and, at the end of an evaluation period, some are opened to the public. Consistent with incubation being used by fund families to increase performance and attract flows, funds in incubation outperform nonincubated funds by 3.5% riskadjusted, and when they are opened to the public they attract higher flows. Postincubation, however, this outperformance disappears. This performance reversal imparts an upward bias to returns that is not removed by a fund size filter. Fund age and ticker creation date filters, however, eliminate the bias.
184
Fall (2010)
Big Bad Banks? The Winners and Losers from Bank Deregulation in the United States
Thorsten Beck Ross Levine, Alexey Levkov Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1637-1667 We assess the impact of bank deregulation on the distribution of income in the United States. From the 1970s through the 1990s, most states removed restrictions on intrastate branching, which intensified bank competition and improved bank performance. Exploiting the cross-state, cross-time variation in the timing of branch deregulation, we find that deregulation materially tightened the distribution of income by boosting incomes in the lower part of the income distribution while having little impact on incomes above the median. Bank deregulation tightened the distribution of income by increasing the relative wage rates and working hours of unskilled workers.
Price Discovery in Illiquid Markets: Do Financial Asset Prices Rise Faster Than They Fall?
Richard C. Green, Dan Li, Norman Schrhoff Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1669-1702 We study price discovery in municipal bonds, an important OTC market. As in markets for consumer goods, prices "rise faster than they fall." Round-trip profits to dealers on retail trades increase in rising markets but do not decrease in falling markets. Further, effective half-spreads increase or decrease more when movements in fundamentals favor dealers. Yield spreads relative to Treasuries also adjust with asymmetric speed in rising and falling markets. Finally, intraday price dispersion is asymmetric in rising and falling markets, as consumer search theory would predict.
Exploring the Nature of "Trader Intuition"

Antoine J. Bruguier, Steven R. Quartz, Peter Bossaerts Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1703 - 1723 Experimental evidence has consistently confirmed the ability of uninformed traders, even novices, to infer information from the trading process. After contrasting brain activation in subjects watching markets with and without insiders, we hypothesize that Theory of Mind (ToM) helps explain this pattern, where ToM refers to the human capacity to discern malicious or benevolent intent. We find that skill in predicting price changes in markets with insiders correlates with scores on two ToM tests. We document GARCH-like persistence in transaction price changes that may help investors read markets when there are insiders.
185
Genetic Variation in Financial Decision-Making

Davidcesarini, Magnusjohannesson,Paullichtenstein,rjan Sandewall,Bjrn Wallace Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1725 - 1754 Individuals differ in how they construct their investment portfolios, yet empirical models of portfolio risk typically account only for a small portion of the crosssectional variance. This paper asks whether genetic variation can explain some of these individual differences. Following a major pension reform Swedish adults had to form a portfolio from a large menu of funds. We match data on these investment decisions with the Swedish Twin Registry and find that approximately 25% of individual variation in portfolio risk is due to genetic variation. We also find that these results extend to several other aspects of financial decision-making.
Diversification and Its Discontents: Idiosyncratic and Entrepreneurial Risk in the Quest for Social Status
Nikolai Roussanov Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1755 - 1788 Social status concerns influence investors' decisions by driving a wedge in attitudes toward aggregate and idiosyncratic risks. I model such concerns by emphasizing the desire to "get ahead of the Joneses," which implies that aversion to idiosyncratic risk is lower than aversion to aggregate risk. The model predicts that investors hold concentrated portfolios in equilibrium, which helps rationalize the small premium for undiversified entrepreneurial risk. In the model, status concerns are more important for wealthier households. Consequently, these households own a disproportionate share of risky assets, particularly private equity, and experience greater volatility of consumption, consistent with empirical evidence.
Hedge Fund Contagion and Liquidity Shocks

Nicolemboyson,Christofw.Stahel, Ren M. Stulz Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1789 - 1816 Defining contagion as correlation over and above that expected from economic fundamentals, we find strong evidence of worst return contagion across hedge fund styles for 1990 to 2008. Large adverse shocks to asset and hedge fund liquidity strongly increase the probability of contagion. Specifically, large adverse shocks to credit spreads, the TED spread, prime broker and bank stock prices, stock market liquidity, and hedge fund flows are associated with a significant increase in the probability of hedge fund contagion. While shocks to liquidity are important determinants of performance, these shocks are not captured by commonly used models of hedge fund returns.
186
Microstructure and Ambiguity

Davideasley,Maureen O'hara Journal of Finance Published on Aug 2010, Volume 65: Issue 4, Pages 1817 - 1846 A goal for stock exchanges is to increase participation by firms and investors. We show how specific features of the microstructure can reduce perceived ambiguity, and induce participation by both investors and issuers. We develop a model with sophisticated traders, who we view as expected utility maximizers with rational expectations, and unsophisticated traders, who we view as rational traders facing ambiguity about the payoffs to participating in the market. We show how designing markets to reduce ambiguity can benefit investors through greater liquidity, exchanges through greater volume, and issuing firms through a lower cost of capital.
"Time for a Change": Loan Conditions and Bank Behavior when Firms Switch Banks
Vassoioannidou,Steven Ongena Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1847 - 1877 This paper studies loan conditions when firms switch banks. Recent theoretical work on bankfirm relationships motivates our matching models. The dynamic cycle of the loan rate that we uncover is as follows: a loan granted by a new (outside) bank carries a loan rate that is significantly lower than the rates on comparable new loans from the firm's current (inside) banks. The new bank initially decreases the loan rate further but eventually ratchets it up sharply. Other loan conditions follow a similar economically relevant pattern. This bank strategy is consistent with the existence of hold-up costs in bankfirm relationships.
Short Sellers and Financial Misconduct

Jonathanm.Karpoff, Xiaoxia Lou Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1879 - 1913 We examine whether short sellers detect firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the misrepresentation is publicly revealed, particularly when the misconduct is severe. Short selling is associated with a faster time-to-discovery, and it dampens the share price inflation that occurs when firms misstate their earnings. These results indicate that short sellers anticipate the eventual discovery and severity of financial misconduct. They also convey external benefits, helping to uncover misconduct and keeping prices closer to fundamental values.
187
Luck versus Skill in the Cross-Section of Mutual Fund Returns

Eugenef.Fama, Kenneth R. French Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1915 - 1947 The aggregate portfolio of actively managed U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark-adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expense ratios, there is evidence of inferior and superior performance (nonzero true ) in the extreme tails of the cross-section of mutual fund estimates.
A Bayesian Approach to Real Options: The Case of Distinguishing between Temporary and Permanent Shocks
Stevenr.Grenadier, Andrey Malenko Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1949 - 1986 Traditional real options models demonstrate the importance of the "option to wait" due to uncertainty over future shocks to project cash flows. However, there is often another important source of uncertainty: uncertainty over the permanence of past shocks. Adding Bayesian uncertainty over the permanence of past shocks augments the traditional option to wait with an additional "option to learn." The implied investment behavior differs significantly from that in standard models. For example, investment may occur at a time of stable or decreasing cash flows, respond sluggishly to cash flow shocks, and depend on the timing of project cash flows.
Individual Investors and Local Bias

Marks.Seasholes, Ning Zhu Journal of Finance Published on Oct 2010, Volume 65: Issue 5, Pages 1987 - 2010 The paper tests whether individuals have value-relevant information about local stocks (where "local" is defined as being headquartered near where an investor lives). Our methodology uses two types of calendar-time portfoliosone based on holdings and one based on transactions. Portfolios of local holdings do not generate abnormal performance (alphas are zero). When studying transactions, purchases of local stocks significantly underperform sales of local stocks. The underperformance remains when focusing on stocks with potentially high levels of information asymmetries. We conclude that individuals do not help incorporate information into stock prices. Our conclusions directly contradict existing studies.
188
Winter (2010)
Sticks or Carrots? Optimal CEO Compensation when Managers Are Loss Averse
Ingolfdittmann, Ernstmaug, Oliver Spalt Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2015-2050 This paper analyzes optimal executive compensation contracts when managers are loss averse. We calibrate a stylized principal-agent model to the observed contracts of 595 CEOs and show that this model can explain observed option holdings and high base salaries remarkably well for a range of parameterizations. We also derive and calibrate the general shape of the optimal contract that is increasing and convex for medium and high outcomes and that drops discontinuously to the lowest possible payout for low outcomes. Finally, we identify the critical features of the lossaversion model that render optimal contracts convex.
Why Are CEOs Rarely Fired? Evidence from Structural Estimation

Lucian A. Taylor Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2051-2087 I evaluate the forced CEO turnover rate and quantify effects on shareholder value by estimating a dynamic model. The model features learning about CEO ability and costly turnover. To fit the observed forced turnover rate, the model needs the average board of directors to behave as if replacing the CEO costs shareholders at least $200 million. This cost mainly reflects CEO entrenchment rather than a real cost to shareholders. The model predicts that shareholder value would rise 3% if we eliminated this perceived turnover cost, all else equal. The model also helps explain the relation between CEO firings, tenure, and profitability.
The Cost of Debt

Julesh.Vanbinsbergen,Johnr.Graham Jie Yang Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2089 - 2136 We use exogenous variation in tax benefit functions to estimate firm-specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book-to-market. By integrating the area between the benefit and cost functions, we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit (cost) of debt equal to 10.4% (6.9%) of asset value. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute only half of the total ex ante costs of debt.
189
The Net Benefits to Leverage

Arthur Korteweg Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2137 - 2170 I estimate the market's valuation of the net benefits to leverage using panel data from 1994 to 2004, identified from market values and betas of a company's debt and equity. The median firm captures net benefits of up to 5.5% of firm value. Small and profitable firms have high optimal leverage ratios, as predicted by theory, but in contrast to existing empirical evidence. Companies are on average slightly underlevered relative to the optimal leverage ratio at refinancing. This result is mainly due to zero leverage firms. I also look at implications for financial policy.
Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure
Hui Chen Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2171 - 2212 I build a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the credit spread puzzle and the underleverage puzzle in a unified framework. The model generates interesting dynamics for financing and defaults, including market timing in debt issuance and credit contagion. It also provides a novel procedure to estimate state-dependent default losses.
Who Blows the Whistle on Corporate Fraud?

Alexanderdyckadairmorse, Luigi Zingales Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2213 - 2253 To identify the most effective mechanisms for detecting corporate fraud, we study all reported fraud cases in large U.S. companies between 1996 and 2004. We find that fraud detection does not rely on standard corporate governance actors (investors, SEC, and auditors), but rather takes a village, including several nontraditional players (employees, media, and industry regulators). Differences in access to information, as well as monetary and reputational incentives, help to explain this pattern. In-depth analyses suggest that reputational incentives in general are weak, except for journalists in large cases. By contrast, monetary incentives help explain employee whistleblowing.
190
Corporate Fraud and Business Conditions: Evidence from IPOs

Tracyyuewang,Andrewwinton,Xiaoyun Yu Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2255 - 2292 We examine how a firm's incentive to commit fraud when going public varies with investor beliefs about industry business conditions. Fraud propensity increases with the level of investor beliefs about industry prospects but decreases when beliefs are extremely high. We find that two mechanisms are at work: monitoring by investors and short-term executive compensation, both of which vary with investor beliefs about industry prospects. We also find that monitoring incentives of investors and underwriters differ. Our results are consistent with models of investor beliefs and corporate fraud, and suggest that regulators and auditors should be vigilant for fraud during booms.
Collateral, Risk Management, and the Distribution of Debt Capacity

Adrianoa.Rampini,S. Viswanathan Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2293 - 2322 Collateral constraints imply that financing and risk management are fundamentally linked. The opportunity cost of engaging in risk management and conserving debt capacity to hedge future financing needs is forgone current investment, and is higher for more productive and less well-capitalized firms. More constrained firms engage in less risk management and may exhaust their debt capacity and abstain from risk management, consistent with empirical evidence and in contrast to received theory. When cash flows are low, such firms may be unable to seize investment opportunities and be forced to downsize. Consequently, capital may be less productively deployed in downturns.
Leverage Choice and Credit Spreads when Managers Risk Shift

Murraycarlson,Ali Lazrak Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2323 - 2362 We model the debt and asset risk choice of a manager with performance-insensitive pay (cash) and performance-sensitive pay (stock) to theoretically link compensation structure, leverage, and credit spreads. The model predicts that optimal leverage trades off the tax benefit of debt against the utility cost of ex-post asset substitution and that credit spreads are increasing in the ratio of cash-to-stock. Using a large cross-section of U.S.-based corporate credit default swaps (CDS) covering 2001 to 2006, we find a positive association between cash-to-stock and CDS rates, and between cash-to-stock and leverage ratios.
191
Lucky CEOs and Lucky Directors

Luciana.Bebchuk,Yanivgrinstein,Urs Peyer Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2363 - 2401 We study the relation between opportunistic timing of option grants and corporate governance failures, focusing on "lucky" grants awarded at the lowest price of the grant month. Option grant practices were designed to provide lucky grants not only to executives but also to independent directors. Lucky grants to both CEOs and directors were the product of deliberate choices, not of firms' routines, and were timed to make them more profitable. Lucky grants are associated with higher CEO compensation from other sources, no majority of independent directors, no outside blockholder on the compensation committee, and a long-serving CEO.
Managerial Legacies, Entrenchment, and Strategic Inertia

Catherinecasamatta,Alexander Guembel Journal of Finance Published on Dec 2010, Volume 65: Issue 6, Pages 2403 - 2436 This paper argues that the legacy potential of a firm's strategy is an important determinant of CEO compensation, turnover, and strategy change. A legacy makes CEO replacement expensive, because firm performance can only partially be attributed to a newly employed manager. Boards may therefore optimally allow an incumbent to be entrenched. Moreover, when a firm changes strategy it is optimal to change the CEO, because the incumbent has a vested interest in seeing the new strategy fail. Even though CEOs have no specific skills in our model, legacy issues can explain the empirical association between CEO and strategy change.
192
193
JOURNAL 9
Journal of Behavioral Finance
194
Spring (2010)
Role of Affective Reactions to Financial Information in Investors' Stock Price Judgments
Lisa M. Victoravich - University of Denver; Journal of Behavioral Finance Published in 2010, Volume 11, Issue 1 This study investigates the difference in unsophisticated and sophisticated investors' affective reactions to a firm's positive earnings announcement. The study also investigates the variation in the stock price judgments of these two groups as a result of a differential reliance on the affective reaction. It contributes to the literature by providing a further understanding of the differential interpretation and reaction to financial data by investors with varying levels of knowledge and experience. In the experiment, participants were asked to review background financial information about a company, evaluate the company's earnings announcement and make stock price judgments. Results indicate that unsophisticated investors interpret a positive earnings announcement as more favorable than do sophisticated investors. The affective reaction to the earnings announcement was more influential on the stock price judgments of unsophisticated investors when compared to the stock price judgments made by sophisticated investors. This differential effect leads unsophisticated investors to make stock price judgments that exceed stock price judgments made by sophisticated investors. From a back to basics standpoint, these results suggest that investment-related knowledge and experience play a significant role in how individual investors react to and rely on basic financial information, which may be of interest to standard setters and regulators.
Effects of Visual Priming on Improving Web Disclosure to Investors

Alex Wang - University of Connecticut-Stamford; Timothy Dowding - University of Connecticut-Stamfords Journal of Behavioral Finance Published in 2010, Volume 11, Issue 1 This research used online experiments to examine how different types of visual priming affect less knowledgeable and knowledgeable online investors' processing and understanding of disclosure information. It also aimed at addressing what types of visual priming of online disclosure information are most effective at affecting less knowledgeable versus knowledgeable investors regarding their processing and understanding of disclosure information. The results revealed online investors perceived that categorical and semantic priming helped them process and understand the disclosure information better than feature priming. This result was confirmed when investors' knowledge levels did not change how knowledgeable and less knowledgeable investors perceived different types of visual priming. The results concluded that knowledge level did not interact with visual priming to influence investors' processing and understanding of disclosure information.
195
Investment Decision Making: Do Experienced Decision Makers Fall Prey to the Paradox of Choice?
Thomas Kida - University of Massachusetts at Amherst; Kimberly K. Moreno Northeastern University;James F. Smith - University of Massachusetts at Amherst Journal of Behavioral Finance Published in 2010, Volume 11, Issue 1 Psychology research suggests that decision makers fall prey to the paradox of choice phenomenon, where individuals are less likely to make a decision when faced with an extensive choice set than when faced with a limited choice set. This research may have important implications for investment decision makers in circumstances in which many investment options are available. However, the studies in psychology have typically examined the decisions of individuals who have no particular experience in the decision task. In this study, we examine whether individuals' investment decisions are affected by choice-set size (i.e., a limited vs. extensive choice set) and whether the effect is mitigated or changed for individuals who are more experienced with investment decisions. We find that the paradox of choice phenomenon is evident for participants who are less experienced with investing but not for more experienced participants. In fact, individuals who are more experienced with investment decisions were actually less likely to invest when faced with a limited choice set, contrary to the paradox of choice phenomenon. These findings suggest that the paradox of choice may not exist when individuals with investment experience make their decisions.
Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem
Brian Kluger - University of Cincinnati; Daniel Friedman - University of California at Santa Cruz Journal of Behavioral Finance Published in 2010, Volume 11, Issue 1 Financial engineering often involves reconfiguring existing financial assets to create new financial products. This article investigates whether financial engineering can alter the environment so that irrational agents can quickly learn to be rational. We design two financial assets that embed the Monty Hall problem, a well-studied choice anomaly. Our experiment requires each subject to value one of these assets. Although these assets are equivalent in terms of standard choice theory, valuation experience with one of the assets lowers the subjects' cognitive error rates more than valuation experience with the other asset. We conclude that financial engineering can create learning opportunities and reduce cognitive errors.
The Availability Heuristic and Investors' Reaction to Company-Specific Events

Doron Kliger - University of Haifa; Andrey Kudryavtsev - University of Haifa Journal of Behavioral Finance Published in 2010, Volume 11, Issue 1 Contemporary research documents various psychological aspects of economic decision making. The main goal of our study is to analyze the role of the availability heuristic (Tversky and Kahneman [1973, 1974]) in financial markets. The availability heuristic refers to people's tendency to determine the likelihood of an event according to the easiness of recalling similar instances and, thus, to overweight
196
current information as opposed to processing all relevant information. We define and test two aspects of the availability heuristic, which we dub outcome and riskavailability. The former deals with the availability of positive and negative investment outcomes and the latter with the availability of financial risk. We test the availability effect on investors' reactions to analyst recommendation revisions. Employing daily market returns as a proxy for outcome availability, we find that positive stock price reactions to recommendation upgrades are stronger when accompanied by positive stock market index returns, and negative stock price reactions to recommendation downgrades are stronger when accompanied by negative stock market index returns. The magnitude of the outcome availability effect is negatively correlated with firms' market capitalization, and positively correlated with stock beta, as well as with historical return volatility. Regarding risk availability, we find that on days of substantial stock market moves, abnormal stock price reactions to upgrades are weaker, and abnormal stock price reactions to downgrades are stronger. Both availability effects remain significant even after controlling for additional company-specific and event-specific factors, including market capitalization, stock beta, historical volatility of stock returns, cumulative excess stock returns over one month preceding the recommendation revision, rating category before the revision, and number of categories changed in the revision.
197
198
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analysts compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] J.P. Morgan Cazenoves UK Small/Mid-Cap dedicated research analysts use the same rating categories; however, each stocks expected total return is compared to the expected total return of the FTSE All Share Index, not to those analysts coverage universe. A list of these analysts is available on request. The analyst or analysts teams coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.
J.P. Morgan Equity Research Ratings Distribution, as of December 31, 2010 Overweight (buy) 46% 53% 43% 71% Neutral (hold) 42% 50% 49% 63% Underweight (sell) 12% 38% 8% 59%
J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients*
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.
Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on the front of this note or your J.P. Morgan representative. Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.
Other Disclosures
J.P. Morgan ("JPM") is the global brand name for J.P. Morgan Securities LLC ("JPMS") and its affiliates worldwide. J.P. Morgan Cazenove is a marketing name for the U.K. investment banking businesses and EMEA cash equities and equity research businesses of JPMorgan Chase & Co. and its subsidiaries. Options related research: If the information contained herein regards options related research, such information is available only to persons who have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporations Characteristics and Risks of Standardized Options, please contact your J.P. Morgan Representative or visit the OCCs website at http://www.optionsclearing.com/publications/risks/riskstoc.pdf. Legal Entities Disclosures U.S.: JPMS is a member of NYSE, FINRA and SIPC. J.P. Morgan Futures Inc. is a member of the NFA. JPMorgan Chase Bank, N.A. is a
199
member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. U.K.: J.P. Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services Authority. Registered in England & Wales No. 2711006. Registered Office 125 London Wall, London EC2Y 5AJ. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd, Seoul Branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) is regulated by ASIC and J.P. Morgan Securities Australia Limited (ABN 61 003 245 234/AFS Licence No: 238066) is a Market Participant with the ASX and regulated by ASIC. Taiwan: J.P.Morgan Securities (Taiwan) Limited is a participant of the Taiwan Stock Exchange (company-type) and regulated by the Taiwan Securities and Futures Bureau. India: J.P. Morgan India Private Limited, having its registered office at J.P. Morgan Tower, Off. C.S.T. Road, Kalina, Santacruz East, Mumbai - 400098, is a member of the National Stock Exchange of India Limited (SEBI Registration Number - INB 230675231/INF 230675231/INE 230675231) and Bombay Stock Exchange Limited (SEBI Registration Number - INB010675237/INB010675237) and is regulated by Securities and Exchange Board of India. Thailand: JPMorgan Securities (Thailand) Limited is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Indonesia: PT J.P. Morgan Securities Indonesia is a member of the Indonesia Stock Exchange and is regulated by the BAPEPAM LK. Philippines: J.P. Morgan Securities Philippines Inc. is a member of the Philippine Stock Exchange and is regulated by the Securities and Exchange Commission. Brazil: Banco J.P. Morgan S.A. is regulated by the Comissao de Valores Mobiliarios (CVM) and by the Central Bank of Brazil. Mexico: J.P. Morgan Casa de Bolsa, S.A. de C.V., J.P. Morgan Grupo Financiero is a member of the Mexican Stock Exchange and authorized to act as a broker dealer by the National Banking and Securities Exchange Commission. Singapore: This material is issued and distributed in Singapore by J.P. Morgan Securities Singapore Private Limited (JPMSS) [MICA (P) 025/01/2011 and Co. Reg. No.: 199405335R] which is a member of the Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (MAS) and/or JPMorgan Chase Bank, N.A., Singapore branch (JPMCB Singapore) which is regulated by the MAS. Malaysia: This material is issued and distributed in Malaysia by JPMorgan Securities (Malaysia) Sdn Bhd (18146-X) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets Services License issued by the Securities Commission in Malaysia. Pakistan: J. P. Morgan Pakistan Broking (Pvt.) Ltd is a member of the Karachi Stock Exchange and regulated by the Securities and Exchange Commission of Pakistan. Saudi Arabia: J.P. Morgan Saudi Arabia Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and custody, with respect to securities business under licence number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. Dubai: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial Services Authority (DFSA) and its registered address is Dubai International Financial Centre - Building 3, Level 7, PO Box 506551, Dubai, UAE. Country and Region Specific Disclosures U.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL's policies for managing conflicts of interest arising as a result of publication and distribution of investment research. Many European regulators require a firm to establish, implement and maintain such a policy. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to wholesale clients only. JPMSAL does not issue or distribute this material to retail clients. The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms wholesale client and retail client have the meanings given to them in section 761G of the Corporations Act 2001. Germany: This material is distributed in Germany by J.P. Morgan Securities Ltd., Frankfurt Branch and J.P.Morgan Chase Bank, N.A., Frankfurt Branch which are regulated by the Bundesanstalt fr Finanzdienstleistungsaufsicht. Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider/market maker for derivative warrants, callable bull bear contracts and stock options listed on the Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk. Japan: There is a risk that a loss may occur due to a change in the price of the shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case of share trading, JPMorgan Securities Japan Co., Ltd., will be receiving a brokerage fee and consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed between JPMorgan Securities Japan Co., Ltd., and the customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. 82 Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul Branch. Singapore: JPMSS and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. New Zealand: This material is issued and distributed by JPMSAL in New Zealand only to persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. JPMSAL does not issue or distribute this material to members of "the public" as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must not distribute it to any third party or outside New Zealand without the prior written consent of JPMSAL. Canada: The information contained herein is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only
200
by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules. General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analysts involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. Other Disclosures last revised January 8, 2011.
Copyright 2011 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan.#$J&098$#*P
201

JPMorgan 2010 Academic Reference

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

JPMorgan 2010 Academic Reference

Uploaded by

Copyright:

Available Formats

Asia Pacific Equity Research

2010 Academic Reference

(44-20) 7325-8647 marco.x.dion@jpmorgan.com J.P. Morgan Securities Ltd.

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Apr (2010) ..............................................................................................................................19

June (2010) ............................................................................................................................24

August (2010) ........................................................................................................................29

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Journal of Financial Research .............................................................................................39 Spring (2010) .........................................................................................................................40

Summer (2010) ......................................................................................................................42

Fall (2010) ..............................................................................................................................44

Winter (2010) .........................................................................................................................46

Journal of Portfolio Management ........................................................................................50 Winter (2010) .........................................................................................................................51

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Spring (2010) .........................................................................................................................55

Summer (2010) ......................................................................................................................60

Fall (2010) ..............................................................................................................................66

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Journal of Alternative Investments .....................................................................................72 Spring (2010) .........................................................................................................................73

Summer (2010) ......................................................................................................................76

Fall (2010) ..............................................................................................................................79

Winter (2011) .........................................................................................................................81

Journal of Financial Economics ..........................................................................................85 Spring (2010) .........................................................................................................................86

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Summer (2010) ......................................................................................................................96

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

The Financial Review..........................................................................................................111 Spring (2010) .......................................................................................................................112

Summer (2010) ....................................................................................................................115

Fall (2010) ............................................................................................................................120

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Journal of Econometrics....................................................................................................127 Spring (2010) .......................................................................................................................128

Summer (2010) ....................................................................................................................134

Fall (2010) ............................................................................................................................138

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Winter (2010) .......................................................................................................................152

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Journal of Finance ..............................................................................................................165 Spring (2010) .......................................................................................................................166

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Summer (2010) ....................................................................................................................174

Fall (2010) ............................................................................................................................185

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Winter (2010) .......................................................................................................................189

Journal of Behavioral Finance...........................................................................................194 Spring (2010) .......................................................................................................................195

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Journal of Finance Journal of Behavioral Finance

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com

Asia Pacific Equity Research 18 January 2011

Predicting Global Stock Returns

Steve Malin (852) 2800 8568 steven.j.malin@jpmorgan.com