We recover prices of dividend strips on the aggregate stock market using data from derivatives markets. The price of a k-year dividend strip is the present value of the dividend paid in k years. The value of the stock market is the sum of all dividend strip prices across maturities. We study the properties of strips and find that expected returns, Sharpe ratios, and volatilities on short-term strips are higher than on the aggregate stock market, while their CAPM betas are well below one. Short-term strip prices are more volatile than their realizations, leading to excess volatility and return predictability.

Web Appendix for "On the Timing and Pricing of Dividends", AER forthcoming. Our response to a recent paper by Boguth et al. can be found here.

While many researchers and policymakers infer from correlations between eating out and body weight that restaurants are a leading cause of obesity, a basic identification problem challenges these conclusions. We design a natural experiment using highways in rural areas to exploit exogenous variation in the effective price of restaurants and examine the impact on body mass. We find no causal link between restaurant consumption and obesity. Analysis of food-intake micro-data suggests that consumers offset calories from restaurant meals by eating less at other times. We conclude that regulation targeting restaurants is unlikely to reduce obesity but could decrease consumer welfare.

Over the post-decimalization period, we find a predictable pattern of return continuation in equities. Stocks whose relative returns are high in a given half-hour interval today tend to exhibit similar outperformance in the same half-hour period on subsequent days. The effect is stronger at the beginning and end of the trading day, but exists throughout the day. Percentage changes in trading volume exhibit a similar pattern, but do not explain the return pattern. These results suggest that strategically shifting the timing of trades can significantly reduce execution costs for institutional traders.

This paper examines the role of women helping women in corporate America. Using a merged panel of directors and executives for large U.S. corporations between 1997 and 2009, we find a positive association between the female share of the board of directors in the previous year and the female share among current top executives. The relationship’s timing suggests that causality runs from boards to managers and not the reverse. This pattern of women helping women at the highest levels of firm leadership highlights the continued importance of a demand-side “glass ceiling” in explaining the slow progress of women in business.

Aurelia Dimas had been sent to investigate the various properties being offered by the State of California in the form of a sale-leaseback agreement. The opportunity was perfect for her firm, Orrington Financial Partners, which had recently expanded its fixed-income portfolio to include real estate. The wide range of offerings in the Golden State Portfolio provided both diversification and stability over a period of decades. She had spent the last week walking the halls of each and every building to see the offering first hand. Now, the task of valuing the portfolio rested on her shoulders.

This paper analyzes the importance of agency conflicts arising from managers’ exposure to their firms’ risk. In particular, we study how a typical firm responds to an exogenous increase in legal liability arising from its workers’ exposure to newly identified carcinogens. We find that such firms, particularly those with weak balance sheets, tend to undertake aggressive growth through acquisitions. The acquired firms tend to be large, unrelated businesses with relatively high operating cash flows, recent growth, and total payouts. These deals are associated with high takeover premiums and negative abnormal returns. These findings support a managerial agency model: we find that firms with weak external governance, high management ownership, or low institutional ownership are most likely to grow. The results suggest that corporate governance can be particularly important when firms encounter a negative shock.

High-powered incentives may induce higher managerial effort, but they also expose managers to idiosyncratic risk. If managers are risk averse, they might underinvest when firm-specific uncertainty increases, leading to suboptimal investment decisions from the perspective of well-diversified shareholders. We empirically document that, when idiosyncratic risk rises, firm investment falls, and more so when managers own a larger fraction of the firm. This negative effect of managerial risk aversion on investment is mitigated if executives are compensated with options rather than with shares or if institutional investors form a large part of the shareholder base.

I develop a dynamic model that nests the rational expectations (RE) and differences of opinion (DO) approaches to study how investors use prices to update their valuations. I show that when investors condition on prices (RE), investor disagreement is related positively to expected returns, return volatility and market beta, but negatively to return autocorrelation. When investors do not use prices (DO), these relationships are reversed. I test these predictions on the cross-section of stocks using analyst forecast dispersion and volume as proxies for disagreement, and find empirical evidence that is consistent with investors using prices on average.

We study optimal capital structure by first estimating firm-specific cost and benefit functions for debt. The benefit functions are downward sloping reflecting that the incremental value of debt declines as more debt is used. The cost functions are upward sloping, reflecting the rising costs that occur as a firm increases its use of debt. The cost functions vary by firm to reflect the firm’s characteristics such as asset collateral and redeployability, asset size, the book-to-market ratio, profitability, and whether the firm pays dividends.

We use these cost and benefit functions to produce a firm-specific recommendation of the optimal amount of debt that a given company should use. In textbook economics, equilibrium occurs where supply equals demand. Analogously, optimal capital structure occurs where the marginal benefit equals the marginal cost of debt. We illustrate optimal debt choices for specific firms such as Barnes & Noble, Coca-Cola, Six Flags, and Performance Food Group, among others. We also calculate the cost of being underlevered for companies that use too little debt, the cost of being overlevered for companies that use too much debt, and the net benefit of debt usage for those that are correctly levered. Finally, we provide formulas that can be easily used to approximate the cost of debt function, and in turn to determine the optimal amount of debt, for any given firm.

We calculate the present value of state pension liabilities under existing policies and separately under policy changes that would affect pension payouts. If promised payments are viewed as default free, then it is appropriate to use discount rates given by the Treasury yield curve. If plans are frozen at June 2009 levels, then the present value of liabilities would be $4.4 trillion. Under the typical actuarial method of recognizing future service and wage increases, this figure rises to $5.2 trillion. Compared to $1.8 trillion in pension fund assets, the baseline level of unfunded liabilities is therefore around $3 trillion. A 1 percentage point reduction in cost-of-living adjustments (COLAs) would lower total liabilities by 9–11%; implementing actuarially fair early retirement would reduce them by 2–5%; and increasing the retirement age by 1 year would reduce them by 2–4%. Dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets. This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state DB pension plans.

We calculate the present value of state employee pension liabilities as of June 2009 using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is $3.20 trillion. If pensions have higher priority than state debt, the present value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are $4.43 trillion. Liabilities are even larger under broader concepts that account for projected salary growth and future service.

We assess the importance of nominal rigidities using a new weekly scanner data set. We find that nominal rigidities are important but do not take the form of sticky prices. Instead, they take the form of inertia in reference prices and costs, defined as the most common prices and costs within a given quarter. Reference prices are particularly inertial and have an average duration of roughly one year, even though weekly prices change roughly once every two weeks. We document the relation between prices and costs and find sharp evidence of state dependence in the probability of reference price changes and in the magnitude of these changes. We use a simple model to argue that reference prices and costs are useful statistics for macroeconomic analysis.

This paper examines whether debt financing can undermine a supermarket firm’s incentive to provide product quality. In the supermarket industry, product availability is an important measure of quality. Using U.S. consumer price index microdata to track inventory shortfalls, I find that taking on high financial leverage increases shortfalls. Highly leveraged firms appear to be degrading their products’ quality in order to preserve current cash flow for debt service. Although reducing quality can erode both current sales and customer loyalty, firms appear to be willing to risk these outcomes in order to achieve benefits associated with debt finance.

We show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia. Exploiting the special structure of the jump tails and the pricing thereof we identify and estimate a new Investor Fears index. The index reveals large time-varying compensations for fears of disasters. Our empirical investigations involve new extreme value theory approximations and high-frequency intraday data for estimating the expected jump tails under the statistical probability measure, and short maturity out-of-the money options and new model-free implied variation measures for estimating the corresponding risk neutral expectations.

We use survey data to measure households’ propensity to default on mortgages even if they can afford to pay them (strategic default) when the value of the mortgage exceeds the value of the house. The willingness to default increases both in the absolute and in the relative size of the home-equity shortfall. Our evidence suggests that this willingness is affected both by pecuniary and non-pecuniary factors, such as views about fairness and morality. We also find that exposure to other people who strategically defaulted increases the propensity to default strategically because it conveys information about the probability of being sued.

We evaluate the effect of the Federal Reserve’s purchase of long-term Treasuries and other long-term bonds ("QE1" in 2008-2009 and "QE2" in 2010-2011) on interest rates.  Using an event-study methodology that exploits both daily and intra-day data, we find a large and significant drop in nominal interest rates on long-term safe assets (Treasuries, Agency bonds, and highly-rated corporate bonds).  This occurs mainly because there is a unique clientele for long-term safe nominal assets, and the Fed purchases reduce the supply of such assets and hence increase the equilibrium safety-premium.  We find only small effects on nominal (default-adjusted) interest rates on less safe assets such as Baa corporate rates. The impact of quantitative easing on MBS rates is large when QE involves MBS purchases, but not when it involves Treasury purchases, indicating that a second main channel for QE is to affect the equilibrium price of mortgage-specific risk. Evidence from inflation swap rates and TIPS show that expected inflation increased due to both QE1 and QE2, implying that reductions in real rates were larger than reductions in nominal rates. Our analysis implies that (a) it is inappropriate to focus only on Treasury rates as a policy target because QE works through several channels that affect particular assets differently, and (b) effects on particular assets depend critically on which assets are purchased.

 

Wildcat Capital Investors is a small real estate private equity company. Its MBA intern, Jessica Zaski, is asked to develop a financial model for the purchase of Financial Commons, a 90,000 square foot office building in suburban Chicago. By simple metrics, the property seems to be a good value, but with credit conditions tight, Jessica must consider whether outside investors would be comfortable with the risks of investing in the midst of a severe commercial real estate downturn.

Wildcat is designed to give students exposure to both the quantitative and qualitative aspects of investing in commercial real estate through a private equity structure. Beyond the numbers, the case allows for a discussion of the process of finding suitable real estate investments. The importance of the simultaneous negotiations that Wildcat must have with the seller, the lender, and the outside investor can be emphasized.

We define a new concept termed the activity signature function, which is constructed from discrete observations of a process evolving continuously in time. Under quite general regularity conditions, we derive the asymptotic properties of the function as the sampling frequency increases and show that it is a useful device for making inferences about the activity level of an Ito semimartingale. Monte Carlo work confirms the theoretical results. One empirical application is from finance. It indicates that the classical model comprised of a continuous component plus jumps is more plausible than a pure-jump model for the spot $/DM exchange rate over 1986-1999. A second application pertains to internet traffic data at NASA servers. We find that a pure-jump model with no continuous component and paths of infinite variation is appropriate for modeling this data set. In both cases the evidence obtained from the signature functions is quite convincing, and these two very disparate empirical outcomes illustrate the discriminatory power of the methodology.

DM exchange rate over 1986-1999. A second application pertains to internet traffic data at NASA servers. We find that a pure-jump model with no continuous component and paths of infinite variation is appropriate for modeling this data set. In both cases the evidence obtained from the signature functions is quite convincing, and these two very disparate empirical outcomes illustrate the discriminatory power of the methodology.

I describe two amplifications mechanisms that operate during liquidity crises and discuss the scope for
central bank policies during crises as well as preventive policies in advance of crises. The first mechanism
works through asset prices and balance sheets. A negative shock to the balance sheets of asset-holders
causes them to liquidate assets, lowering prices, further deteriorating balance sheets, culminating in a
crisis. The second mechanism involves investors’ Knightian uncertainty. Unusual shocks to untested
financial innovations lead agents to become uncertain about their investments causing them to disengage
from markets and increase their demand for liquidity. This behavior leads to a loss of liquidity and a
crisis.

This paper analyzes the flow of state pension benefit payments relative to asset levels and contributions. Assuming future state contributions fund the full present value of new benefits, many state systems will run out of money in 10-20 years if some attempt is not made to improve the funding of liabilities that have already been accrued. The expected shortfalls raise the possibility that the federal government will be faced with a decision as to whether to bail out states driven to insolvency by their pension programs.

This paper measures how securitized assets, including mortgage-backed securities and other asset-backed securities, have shifted across financial institutions during this crisis and how the availability of financing has accommodated such shifts. Sectors that substantially use repo financing—in particular, the hedge fund and broker-dealer sector—have reduced asset holdings, while the commercial banking sector, which has had access to more stable funding sources, has increased asset holdings. The banking sector also increased its leverage dramatically during this crisis. These findings are important to understand the role played by the government during the crisis as well as to understand the factors determining asset prices and liquidity during the crisis. [JEL: G01, G21, G28, E5]

This study investigated (1) sex differences in hormonal responses to psychosocial stress; (2) the relation between variability in pre-test hormone concentrations and stress-induced hormonal changes; and (3) some possible sources of within-sex variationin pre-test hormone concentrations and in hormonal responses to the test in a large human subject population. To this end, changes in salivary concentrations of testosterone and cortisol in response to a mild psychosocial stressor (a set of computerized economic decision-making tests) were measured in a sample of over 500 MBA students. Males had higher concentrations of testosterone and cortisol than females both before and after the test. After taking effects of time of testing on hormone concentrations into account, testosterone showed a post-test decrease in males but not in females. Cortisol level increased in both sexes but the post-test increase was larger in females than in males. At the individual level, the pre-test concentrations of testosterone and cortisol predicted both the direction and the magnitude of the post-test hormone change, so that low pre-test hormone concentrations showed large post-test increases whereas high pre-test concentrations showed large post-test decreases. Within-sex variation in hormone concentrations was not accounted for by variation in 2D:4D digit length ratio, a marker of prenatal androgen exposure, but by social variables. Single males without a stable romantic partner had higher testosterone level than males with stable partners, and both males and females without a partner showed a greater cortisol response to the test than married individuals with or without children. Studies conducted with large sample sizes such as this one can help understand normative patterns of hormonal responses to psychosocial stimuli as well as  identify the sources of interindividual variation in endocrine function.

Using a novel data set that records individual debt issues on the balance sheet of a large sample of rated public firms, we show that recognition of debt heterogeneity leads to new insights into the determinants of corporate capital structure. We first demonstrate that traditional capital structure studies that ignore debt heterogeneity miss a substantial fraction of capital structure variation. We then show that relative to high credit quality firms, low credit quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants. Further, while high credit quality firms enjoy access to a variety of sources of discretionary flexible sources of finance, low credit quality firms rely on tightly monitored secured bank debt for liquidity. The findings are similar when we focus on plausibly exogenous credit quality variation in a sample of "fallen angels," which are firms that are downgraded from investment grade to speculative grade by Moody's Investors Services. We discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts

I analyze the strategic use of debt financing to improve a firm's bargaining position with an important supplier – organized 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.

Activist shareholders have lately been attempting to assert themselves in a struggle with management and regulators over control of corporate decisions. These efforts have met with mixed success. Meanwhile, shareholders have been pressing for changes in the rules governing access to the corporate proxy process, especially in regard to nominating directors. The key issue which these events have brought to light is whether, in fact, shareholders will be better off with enhanced control over corporate decisions. Proponents of increased shareholder participation argue that such participation is needed to counter the agency problems associated with management decisions. In this view, boards of directors do not exercise sufficient control over self-interested managers because management insiders typically hand-pick directors through their control of the proxy process. Opponents offer several arguments such as that shareholders lack the requisite knowledge and expertise to make effective decisions or that shareholders may have incentives to make value-reducing decisions. In this paper, we investigate what determines the optimality of shareholder control, taking account of some of the above arguments, both pro and con. Our main contribution is to use formal modeling to uncover some factors overlooked in these arguments. For example, we show that the claims that shareholders should not have control over important decisions because they lack sufficient information to make an informed decision or because they have a non-value-maximizing agenda are flawed. On the other hand, it has been argued that, since shareholders have the “correct” objective (value maximization) and can always delegate the decision to insiders when they believe insiders will make a better decision, shareholders should control all major decisions. We show that this argument is also flawed.

Efficient reward seeking is essential for survival and invariably requires overcoming costs, such as physical effort and delay, which are constantly changing in natural settings. Dopamine transmission has been implicated in decisions weighing the benefits and costs of obtaining a reward, but it is still unclear how dynamically changing effort and delay costs affect dopamine signaling to rewards and related stimuli. Using fast-scan cyclic voltammetry, we examined phasic dopamine release in the nucleus accumbens (NAcc) core and shell during reward-seeking behavior in rats. To manipulate the effort and time needed to earn a reward, we used instrumental tasks in which the response requirements (number of lever presses) were either fixed throughout a behavioral session [fixed ratio (FR)] or systematically increased from trial to trial [progressive ratio (PR)]. Dopamine release evoked by cues denoting reward availability was no different between these conditions, indicating insensitivity to escalating effort or delay costs. In contrast, dopamine release to reward delivery in both the NAcc core and shell increased in PR, but not in FR, sessions. This enhancement of reward-evoked dopamine signaling was also observed in sessions in which the response requirement was fixed but the delay to reward delivery increased, yoked to corresponding trials in PR sessions. These findings suggest that delay, and not effort, was principally responsible for the increased reward evoked dopamine release in PR sessions. Together, these data demonstrate that NAcc dopamine release to rewards and their predictors are dissociable and differentially regulated by the delays conferred under escalating costs.

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 interpretations of public information. We obtain a closed-form linear equilibrium that allows us to study what 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 price volatility. We also derive novel empirical predictions that relate the degree and frequency of disagreement to volume and volatility dynamics.

The Namaste case is a story of how Kellogg alumni couple Gary and Denise Gardner grow their Namaste branded hair care line from production at the family’s kitchen table into a formidable $80 million empire within a 14-year period. The Gardners come from a long-time hair-care business lineage, the Soft Sheen dynasty, started by Gary’s father decades earlier. Soft Sheen was ultimately sold to hair care giant L’Oreal for over $100 million. Gardner claims Namaste’s growth occurred through listening to the needs and desires of customers for healing hair care products that reminded them of nourishing household remedies. The hair care line became a leader in its industry, but faced the dilemma of how to expand sales in new markets, especially international markets such as South Africa and Nigeria.

The foundation of modern portfolio theory is the mean-variance portfolio selection approach of Markowitz (1952, 1959). We discuss the role of factor models in implementing portfolio selection, defining the nature of systematic risk, and estimating the premium for risk bearing.

Factor models of security returns decompose the random return on each of a cross-section of assets into pervasive components, affecting almost all assets, and a diversifiable component. We describe four alternative approaches to factor models of asset returns. We also discuss issues related to estimating factor models and testing for the appropriate number of factors.

Motivated by the literature on investment flows and optimal trading, this paper examines intraday predictability in the cross-section of stock returns. We confirm a well-known return reversal commonly associated with bid-ask bounce. Notably, we also find significant continuation of returns at half-hour intervals that are exact multiples of a trading day, and this effect lasts for forty trading days. Percentage changes in volume, order imbalance, and volatility exhibit similar patterns, but do not explain the return patterns. Additionally, bid/ask spreads do not explain the return pattern. The return continuation at daily frequencies is more pronounced for, but not restricted to, the first and last half-hour periods of the day. These effects are not driven by firm size, systematic risk premia, or inclusion in the S&P500 index. The pattern is robust to controlling for a number of documented types of periodicity. Our results suggest that traders may wish to time portfolio rebalancing to account for these persistent intraday patterns.

Fundamental economic principles provide a rationale for requiring financial institutions to use mark-to-market, or fair value, accounting for financial reporting. The recent turmoil in financial markets, however, has raised questions about whether fair value accounting is exacerbating the problems. In this paper we review the history and practice of fair value accounting, and summarize the literature on the channels through which it can adversely affect the real economy. We propose a new model to study the interaction of accounting rules with regulatory capital requirements, and show that even when market prices always reflect fundamental values, the interaction of fair value accounting rules and a simple capital requirement can create inefficiencies that are absent when capital is measured by adjusted book value. These distortions can be avoided, however, by redefining capital requirements to be procyclical rather than by abandoning fair value accounting and the other benefits that it provides.

We provide a new theoretical framework for disentangling and estimating sensitivity towards systematic diffusive and jump risks in the context of factor pricing 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. In addition to establishing consistency of our estimators, we also derive Central Limit Theorems characterizing their asymptotic distributions. In an empirical application of the new procedures using high-frequency data for forty individual stocks and an aggregate market portfolio, we find the estimated diffusive and jump betas with respect to the market to be quite different for many of the stocks. Our findings have direct and important implications for empirical asset pricing finance and practical portfolio and risk management decisions.

Jim Reynolds Jr. founded Loop Capital in 1997 as an investment bank specializing in bond sales for municipalities. Ten years later, with thirteen offices and almost 100 employees, Loop Capital was a national company and had brokered more than $800 billion of underwritings in equity, tax-exempt, and taxable fixed income markets. In the process of building its municipal finance and equity trading businesses, Loop Capital had developed close relationships with a number of government officials, large institutional money managers, and corporate executives. These customers began asking Loop Capital for help with other financial services, leading the firm to build corporate finance, tax-exempt, and taxable fixed-income platforms so it could offer a wider array of investment services.

Municipal and corporate finance as well as equity, taxable, and tax-exempt trading were generating positive cash flow. In a field where failures were frequent, Loop Capital was thriving, and Reynolds saw great but untapped potential in the company’s future. Over the past several years, Loop Capital had served as financial advisor to several municipalities that wanted to lease or sell public assets such as airports, toll roads, and seaports. Now he confronted several intriguing questions: Should he launch a $700 million infrastructure fund to invest in the types of deals the firm had helped structure? Did it make sense to invest in order to staff, market, and support the start-up of this new fund? If the fund was launched, should Loop Capital commit to the 1% investment likely to be required as the fund’s general partner?

We examine whether networks among incumbent venture capital firms help restrict entry into local VC markets in the U.S., thus improving VCs’ bargaining power over entrepreneurs. We show that VC markets with more extensive networking among the incumbent players experience less entry. The effect is sizeable economically and appears robust to plausible endogeneity concerns. Entry is accommodated if the entrant has established relationships with a target-market incumbent in its own home market. In turn, incumbents appear to react strategically to an increased threat of entry, in the sense that they freeze out any incumbent that builds a relationship with a potential entrant. Finally, companies seeking venture capital raise money on worse terms in more densely networked markets while increased entry is associated with higher valuations.