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Volume 44: Issue 2 (June 1989)

Front Matter

Pages: i-vi  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb00503.x  |  Cited by: 0

Back Matter

Pages: vii-xix  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb00504.x  |  Cited by: 0


Pages: 229-229  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05055.x  |  Cited by: 0

Empirical Tests of the Consumption-Oriented CAPM

Pages: 231-262  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05056.x  |  Cited by: 9


The empirical implications of the consumption‐oriented capital asset pricing model (CCAPM) are examined, and its performance is compared with a model based on the market portfolio. The CCAPM is estimated after adjusting for measurement problems associated with reported consumption data. The CCAPM is tested using betas based on both consumption and the portfolio having the maximum correlation with consumption. As predicted by the CCAPM, the market price of risk is significantly positive, and the estimate of the real interest rate is close to zero. The performances of the traditional CAPM and the CCAPM are about the same.

The Arbitrage Pricing Theory and Supershares

Pages: 263-282  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05057.x  |  Cited by: 3


In a single‐period model with options on the market portfolio, linear factor pricing holds if and only if the variance of the market conditional on the factors is zero. There is no need for factors other than nonlinear functions of the market. For accurate linear pricing of all payoff patterns the factors must be rotationally equivalent to Hakansson's “supershares.” In a multiperiod model, a similar set of results holds, but with consumption replacing the market payoff. The methodology of the empirical Arbitrage Pricing Theory literature is not consistent with either the single‐period model or the multiperiod model.

New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates

Pages: 283-305  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05058.x  |  Cited by: 74


Survey data on interest rate expectations permit separate testing of the two alternative hypotheses in traditional term structure tests: that the expectations hypothesis fails, and that expected future interest rates are ex post inefficient forecasts. We find that the source of the spread's poor predictions of future interest rates varies with maturity. At short maturities the expectations hypothesis fails. At long maturities, however, changes in the yield curve reflect changes in expected future rates one‐for‐one, an implication of the expectations hypothesis. This result confirms earlier findings that long rates underreact to short rates, but now it cannot be attributed to term premia.

The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets

Pages: 307-325  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05059.x  |  Cited by: 41


This paper attempts to determine whether the fluctuations of conditional first and second moments—which are observed for many assets—are consistent with the Sharpe‐Lintner‐Mossin capital asset pricing model. We test the mean‐variance model under several different assumptions about the time variation of conditional second moments of returns, using weekly data from July 1974 to December 1986, that include returns on a portfolio composed of dollar, Deutsche mark, sterling, and Swiss franc assets, together with the U.S. stock market. The results indicate that estimated conditional variances cannot explain the observed time variation of risk premia.

Tax-Induced Trading: The Effect of the 1986 Tax Reform Act on Stock Market Activity

Pages: 327-344  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05060.x  |  Cited by: 5


The end of favorable tax treatment for long‐term capital gains caused investors to reassess traditional tax‐induced trading strategies. This study compares trading behavior in December 1986 and January 1987 with previous years. Our results indicate that these tax code changes had a powerful effect on trading behavior. Relative trading volume was considerably higher in December 1986 for long‐term winners but not significantly lower for long‐term losers. Results also indicate altered trading patterns based on short‐term gains in December 1986 and for long‐term winners in January 1987.

Valuing Commercial Mortgages: An Empirical Investigation of the Contingent-Claims Approach to Pricing Risky Debt

Pages: 345-373  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05061.x  |  Cited by: 3


This paper empirically investigates a contingent‐claims model of commercial mortgage pricing. We find that the magnitude of the observed default premia for a sample of nonprepayable fixed rate bullet mortgages can be explained by the contingent‐claims model. In addition, the model explains a significant proportion of the period‐to‐period changes in the default premia. However, given an assumed negative correlation between building value changes and interest rate changes, the model's risk structure tends to increase less steeply with increasing maturity than the observed risk structure.

Prepayment and the Valuation of Mortgage-Backed Securities

Pages: 375-392  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05062.x  |  Cited by: 131


This paper puts forward a valuation framework for mortgage‐backed securities. Rather than imposing an optimal, value‐minimizing call condition, we assume that at each point in time there exists a probability of prepaying; this conditional probability depends upon the prevailing state of the economy. To implement our valuation procedure, we use maximum‐likelihood techniques to estimate a prepayment function in light of recent aggregate GNMA prepayment experience. By integrating this empirical prepayment function into our valuation framework, we provide a complete model to value mortgage‐backed securities.

Signalling and the Pricing of New Issues

Pages: 393-420  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05063.x  |  Cited by: 244


This paper develops a signalling model with two signals, two attributes, and a continuum of signal levels and attribute types to explain new issue underpricing. Both the fraction of the new issue retained by the issuer and its offering price convey to investors the unobservable “intrinsic” value of the firm and the variance of its cash flows. Many of the model's comparative statics results are novel, empirically testable, and consistent with the existing empirical evidence on new issues. In particular, the degree of underpricing, which can be inferred from observable variables, is positively related to the firm's post‐issue share price.

Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings

Pages: 421-449  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05064.x  |  Cited by: 278


This paper presents a signalling model in which high‐quality firms underprice at the initial public offering (IPO) in order to obtain a higher price at a seasoned offering. The main assumptions are that low‐quality firms must invest in imitation expenses to appear to be high‐quality firms, and that with some probability this imitation is discovered between offerings. Underpricing by high‐quality firms at the IPO can then add sufficient signalling costs to these imitation expenses to induce low‐quality firms to reveal their quality voluntarily. The model is consistent with several documented empirical regularities and offers new testable implications. In addition, the paper provides empirical evidence that many firms raise substantial amounts of additional equity capital in the years after their IPO.

Information Effects Associated with Debt-for-Equity and Equity-for-Debt Exchange Offers

Pages: 451-468  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05065.x  |  Cited by: 35


This study investigates the information effect caused by a firm's change in capital structure via debt‐for‐equity and equity‐for‐debt exchange offers. The evidence suggests that the former transactions lead to abnormal stock price increases, while the latter lead to abnormal stock price decreases. In addition, findings based on analysis of bond returns and cross‐sectional regressions do not lend support to the wealth‐transfer‐ and tax‐effect hypotheses, but they are consistent with the information‐effect hypothesis.

The Informational Content of Initial Public Offerings

Pages: 469-477  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05066.x  |  Cited by: 16


The ability of capital markets to distinguish firms of different value by the size of their initial equity offerings is attenuated when insiders can sell equity more than once. A model is developed in which there is price risk from holding equity between periods. When the uncertainty is small, there must be pooling in the first period. When uncertainty is large, the pooling equilibria dominate the separating equilibrium.

The Effects of Beta, Bid-Ask Spread, Residual Risk, and Size on Stock Returns

Pages: 479-486  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05067.x  |  Cited by: 107


Merton's [26] recent extension of the CAPM proposed that asset returns are an increasing function of their beta risk, residual risk, and size and a decreasing function of the public availability of information about them. Associating the latter with asset liquidity and following Amihud and Mendelson's [2] proposition that asset returns increase with their illiquidity (measured by the bid‐ask spread), we jointly estimate the effects of these four factors on stock returns.

The Price Effect of Option Introduction

Pages: 487-498  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05068.x  |  Cited by: 93


This paper examines the price effect of option introduction from 1974 to 1980. The introduction of individual options causes a permanent price increase in the underlying security, beginning approximately three days before introduction. The price effect appears to be associated with introduction, and not announcement, throughout the sample period. Excess returns volatility declines with option introduction. Systematic risk is unchanged. There is a positive relation between the price increase and a measure of activity in the options market.

Adverse Selection in a Model of Real Estate Lending

Pages: 499-508  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05069.x  |  Cited by: 19


We provide a rationale for the presence of points in mortgage loan contracts. Our analysis builds on two key features. First, insurance markets are unavailable for labor income. Second, the “due‐on‐sale” clause allows banks to offer loan contracts which partially insure against fluctuations in labor income. If explicit prepayment penalties are prohibited by law, points serve effectively as prepayment penalties. We also examine environments where such penalties are not prohibited and show that points will be used if interest rates cannot depend on the size of the loan.

Institutional Ownership and Changes in the S&P 500

Pages: 509-514  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05070.x  |  Cited by: 41


Several recent articles have provided new evidence for the existence of price pressures by examining the price and volume effects associated with changes in the S&P 500. The present study extends this work by examining actual changes in institutional holdings following both additions to and deletions from the S&P 500. The results show that changes in institutional holdings in response to additions or deletions from the S&P 500 are positively correlated. In addition to providing further evidence for the existence of price pressure effects, the results also provide evidence of the very large institutional elasticities of demand for stock.

The Expected Utility of the Doubling Strategy

Pages: 515-524  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05071.x  |  Cited by: 2


It has been noted that a certain continuous‐time trading strategy, termed the “doubling strategy”, generates a positive net return on borrowed funds, with probability one and within a finite period of time. Since the doubling strategy seems to represent a “free lunch” or arbitrage opportunity, a variety of constraints to render it infeasible have been proposed. In this paper, we show that the doubling strategy generates infinite disutility for a large class of utility functions, and we can think of no utility function for a risk‐averse agent which is a counterexample.

Comment on Forward Markets, Stock Markets, and the Theory of the Firm

Pages: 525-528  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05072.x  |  Cited by: 0


In a recent article, MacMinn [5] argues that the presence of forward markets eliminates the incentives of the firm's manager to choose production levels that maximize firm value. In this comment, we show that his results do not depend on the presence of forward markets. The critical assumptions are that the manager is endowed with money rather than stock in the firm and that there is no competitive labor market for managers. In addition, his results require time‐inconsistent behavior on the part of the firm's manager.

Book Reviews

Pages: 529-538  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05073.x  |  Cited by: 0

Book reviewed in this article:


Pages: 539-540  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05074.x  |  Cited by: 0


Pages: 541-542  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05075.x  |  Cited by: 0


Pages: 543-543  |  Published: 6/1989  |  DOI: 10.1111/j.1540-6261.1989.tb05076.x  |  Cited by: 0