STOCK PRICES AND INFLATION

Numerous empirical studies establish that inflation has a negative short‐run effect on stock returns but few studies report a positive, long‐run Fisher effect for stock returns. Using stock price and goods price data from six industrial countries, we show that long‐run Fisher elasticities of stock prices with respect to goods prices exceed unity and range from 1.04 to 1.65, which tends to support the Fisher effect. We also find that the time path of the response of stock prices to a shock in goods prices exhibits an initial negative response, which turns positive over longer horizons. These results help reconcile previous short‐run and long‐run empirical evidence on stock returns and inflation. Also, they reveal that stock prices have a long memory with respect to inflation shocks, such that investors should expect stocks to be a good inflation hedge over a long holding period. JEL Classification: G12     

Catastrophic Losses and Insurer Profitability: Evidence From 9/11

We examine the effects of 9/11 on the insurance industry, hypothesizing a short‐run claim effect, resulting from insufficient premium ex ante for catastrophic losses, and a long‐run growth effect, resulting from ex post insurance supply reductions and risk updating. Following Yoon and Starks (1995) we use short‐ and long‐run abnormal forecast revisions to measure both effects, analyzing them as a function of firm‐specific characteristics. We find that firm type, loss estimates, reinsurance use, and tax position are important determinants of the short‐run position. Firm type, loss estimates, financial strength, underwriting risk, and reinsurance are key determinants of the firm's long‐run position.     

The Global Financial Architecture: Twenty‐First Century Solutions*

Twentieth‐century global financial architectural solutions are outdated and have been found wanting. They are fundamentally structural solutions and continuing to rely on them would be to run the risk of repeating our mistakes. We must look to twenty‐first century solutions. Solutions created post‐1945 need replacing with networked solutions, reflecting what we see in the Internet and its development. These are not fanciful notions but concepts that have already been successfully modelled, albeit in a relatively narrow sphere. What we need is a mechanism by which global financial standards can be implemented in every jurisdiction around the world. This paper proceeds from the premise that the nexus between investor confidence and financial market stability is a crucial one, and one that a regulatory approach can impact. It discusses the international regulatory environment and the role of key players in the emerging global financial architecture, in particular the International Organization of Securities Commissions ( IOSCO ). It also examines the potential that mutual recognition offers for the trans‐Tasman market.     

Valuation Effects of Short Sale Constraints: the Case of Corporate Takeovers

We examine the relation between the degree of short sale constraints for acquiring firms' equity and post takeover stock performance. We find that negative long‐run abnormal returns appear to decline (in economic and statistical terms) as the extent and persistence of institutional block‐holder ownership increase, after accounting for the size, book‐to‐market and method of payment effects. In the spirit of Miller (1977) , such evidence implies that the degree of short sale constraints serves as an important determinant of acquiring firms' short‐run overpricing. It appears that the presence of concentrated institutional presence mitigates and in most cases eliminates, through effective arbitrage, any short‐run overpricing that may be responsible for the long‐run underperformance of acquirers, preserving in this way efficiency in the takeover markets.     

Optimal incentives for sequential production processes

I study optimal incentive schemes in organizations where agents perform their tasks sequentially. I consider a model in which agents' effort decisions are mapped into the probability of the project's success. An optimal investment‐inducing mechanism allocates rewards to agents so as to induce all of them to exert effort in equilibrium at minimal cost to the principal. I characterize the unique optimal mechanism in several versions of my benchmark model. I also address the problem of allocating individuals with diverse qualifications to different slots of the production process as well as allocating tasks of different importance across different agents.     

Accounting Standards and Earnings Management: Evidence from China

This article examines the effect of an asset impairment–related regulatory reform on earnings management in China. Chinese Accounting Standard No. 8 (CAS No. 8), which prohibits the reversal of long‐lived asset impairments, was promulgated to constrain managerial opportunism with respect to previously recognized impairment loss reversal. CAS No. 8 forbids the reversal of long‐lived asset impairment losses only, while allowing the reversal of short‐term asset impairment losses. Based on a sample of China's A‐share listed companies on the Shanghai and Shenzhen Stock Exchange during the period 2001–2008, we reveal that managers use less current asset write‐downs and more reversals in the post–CAS No. 8 period. However, such reporting practices do not appear to be influenced by managerial incentives to avoid reporting losses and/or for “big bath” accounting purposes.     

Market Cycles and the Performance of Relative Strength Strategies

We study the effect of market cycles on both medium‐run and long‐run relative strength trading strategies. We find that payoffs for both strategies tend to be relatively higher within a market state (rising or falling markets), but substantially lower over transitions between states. Since shorter duration strategies are relatively less likely to include market transitions, our results help reconcile the puzzling fact that medium‐run strategies are profitable, but long‐run strategies are not. We find that the market's cross‐sectional return dispersion: 1) tends to be higher around market transitions, and 2) is negatively related to the subsequent payoffs for both medium‐run and long‐run strategies.     

Defining personalized concepts for XBRL using iPAD‐drawn fuzzy sets

An efficient and effective analysis of business data requires a better understanding of what the data represents, and to what degree. A human‐like way of accomplishing that without being too detailed yet learning more about data content is to summarize and map the data into concepts familiar to a person performing analysis. Processes of summarization help identify the most essential facts that are embedded in the data. All this is of significant importance for analysis of large amounts of business data required to make good and sound financial decisions. There are two aspects enabling more comprehensive yet easier processing of data: a standardized representation format of financial data; and a human‐friendly way of defining concepts and using them for building personalized models representing processing data. The first of the aspects has been addressed by the eXtensible Business Reporting Language (XBRL)—a standardized format of defining, representing and exchanging corporate and financial information. The second aspect is related to providing individuals with the ability to gain understanding of data content via determining a degree of truth of statements summarizing data based on their own perception of concepts they are looking for. In this paper, we introduce a tablet application—Tablet‐based input of Fuzzy Sets (TiFS)—and demonstrate its usefulness for entering personalized definitions of concepts and terms that enable a quick analysis of financial data. Such analysis means utilization of soft queries and operations of aggregation that extract and summarize the data and present it in a form familiar to analysts. The application allows for defining concepts and terms with ‘finger‐made’ drawings representing a person's perception of concepts. Further, these definitions are used to build summarization statements for exploring XBRL data. They are equipped with ‘drawn’ definitions of linguistic terms (e.g. LARGE, SMALL, FAST) and linguistic quantifiers (e.g. ALL, MOSTLY), and enable summarization of data content from the perspective of a user's interests. The ‘drawn’ linguistic terms and quantifiers represent membership functions of fuzzy sets. Utilization of fuzzy sets allows for performing operations of data summarization in a human‐like way. The application of TiFS illustrates ease of inputting personalized definitions of concepts and their influence on the interpretation of data. This introduces aspects of personalization and adaptation of artificial intelligence systems to perceptions and views of individuals. The proposed application is used to perform a basic analysis of an XBRL document.     

Long‐Run Stockholder Consumption Risk and Asset Returns

We provide new evidence on the success of long‐run risks in asset pricing by focusing on the risks borne by stockholders. Exploiting microlevel household consumption data, we show that long‐run stockholder consumption risk better captures cross‐sectional variation in average asset returns than aggregate or nonstockholder consumption risk, and implies more plausible risk aversion estimates. We find that risk aversion around 10 can match observed risk premia for the wealthiest stockholders across sets of test assets that include the 25 Fama and French portfolios, the market portfolio, bond portfolios, and the entire cross‐section of stocks.     

Determining overall risk

The risk journal literature lacks a clear and simple account of the conceptual issues involved in determining the overall risk of an action, and in explaining how risk is additive. This article attempts to bring a measure of clarity to these issues in as basic and non‐technical a way as possible. First of all, the view that risk is ‘expected harm’ is explained. The view that risk is a quantitative concept is then defended. The distinction between the risk run by doing action A in respect of possible outcome x, and the overall risk run by doing action A in general is explained, as is the position that the overall risk of A is determined by summing the risks of each possible harm that A could give rise to. The article then explains how risks can be summed over time, as long as the probabilities involved are determined according to probability theory. Finally, the article explains that in a doing a risk‐benefit analysis of A, positive aspects of a possible outcome x, where x is harmful on balance, must be incorporated into x's level of harm rather than incorporated into the benefit side of the risk‐benefit analysis of A.     

Long‐Run Risk and Its Implications for the Equity Premium Puzzle: New Evidence from a Multivariate Framework

This paper investigates the empirical evidence of long‐run risk and its implications for the equity premium puzzle. We find that the long‐run risk model is generally weakly identified and that standard inferences tend to underestimate the uncertainty of long‐run risk. We extend the LM‐type test of Ma and Nelson (2010) that remains valid under weak identification to the bivariate VARMA‐GARCH model of consumption and dividend growth. The results cast doubt on the validity of long‐run risk as an explanation for the equity premium puzzle. We also evaluate the approach of Bansal, Kiku, and Yaron (2007a), which extracts long‐run risk by regressing consumption growth and its volatility on predictive variables. The results using the Bonferroni Q‐test of Campbell and Yogo (2006) suggest that consumption and dividend growth are generally unpredictable by the price‐dividend ratio and risk‐free rate. This casts doubt on the validity of the BKY approach.     

R2: Does it Matter for Firm Valuation?

A considerable amount of research has been devoted to why R² differs across firms or markets, but little attention has been paid to the consequences of this difference. We fill this gap by investigating how differing R² affects investors’ assessment of firm value. Using a sample of 90,111 firm‐year observations from 1970 to 2004, we find that higher R² leads to higher firm valuation and that, on average, high‐R² firms experience significant underperformance in the long run. These results suggest that high‐R² firms tend to be overpriced.     

Corporate Sell‐offs in the UK: Use of Proceeds,Financial Distress and Long‐run Impact on Shareholder Wealth

This study examines the long‐run return performance following UK corporate sell‐off announcements. We observe significant negative abnormal returns up to five years subsequent to sell‐off announcements. Our finding is robust to various specifications, irrespective of the intended use of proceeds. We also find a significantly positive association between long‐run abnormal returns and the magnitude of cash proceeds for sellers reducing corporate debt as well as for sellers with deeper financial distress or higher growth prospects. Overall, we find that UK corporate sell‐offs are associated with declines in subsequent shareholder wealth.     

The Cost of Short‐Selling Liquid Securities

Standard models of liquidity argue that the higher price for a liquid security reflects the future benefits that long investors expect to receive. We show that short‐sellers can also pay a net liquidity premium if their cost to borrow the security is higher than the price premium they collect from selling it. We provide a model‐free decomposition of the price premium for liquid securities into the net premiums paid by both long investors and short‐sellers. Empirically, we find that short‐sellers were responsible for a substantial fraction of the liquidity premium for on‐the‐run Treasuries from November 1995 through July 2009.     

Fifty years of finance research in the Asia Pacific Basin

In this paper, we review the history of scholarly finance research in the Asia Pacific Basin. We do this by analysing the four leading regional finance journals – Accounting and Finance, Australian Journal of Management, International Review of Finance and the Pacific‐Basin Finance Journal – along five dimensions. The five dimensions are the most cited papers, noted authors, impact in terms of practice, research areas and a breakdown in terms of the development of the field according to Kuhnian concepts of normal science, anomalies and extraordinary science. We show that the Asia Pacific journals make a crucial contribution to research and practice both in the region and internationally.     

Do Domestic Investors Have an Information Advantage? Evidence from Indonesia

Using transaction data from Indonesia, this paper shows that domestic investors have higher profits than foreign investors. In addition, clients of global brokerages have higher long‐term and smaller medium (intramonth) and short (intraday) term profits than clients of local brokerages. This suggests that clients of local brokerages have a short‐lived information advantage, but that clients of global brokerages are better at picking long‐term winners. Finally, domestic clients of global brokerages have higher profits than foreign clients of global brokerages, suggesting that the combination of local information and global expertise leads to higher profits.     

Price discrimination in input markets

We analyze the short‐ and long‐run implications of third‐degree price discrimination in input markets. In contrast to the extant literature, which typically assumes that the supplier is an unconstrained monopolist, in our model input prices are constrained by the threat of demand‐side substitution. In our model, the more efficient buyer receives a discount. A ban on price discrimination thus benefits smaller but hurts more efficient, larger firms. It also stifles incentives to invest and innovate. With linear demand, a ban on price discrimination benefits consumers in the short run but reduces consumer surplus in the long run, which is once again the opposite of what is found without the threat of demand‐side substitution.     

Convergence of Real Capital Market Interest Rates—Evidence from Inflation Indexed Bonds

This paper investigates the convergence of long‐term ex ante real interest rates (RIRs) obtained from Canadian, French, UK, and U.S. inflation indexed government bonds. In contrast to previous research, our evidence suggests full convergence in the long run and, hence, capital market integration. For the same sample period, global convergence is rejected for RIRs measured in conventional terms. From these results, we conclude that previous tests of the long‐run real interest rate parity might have suffered from weak measurement of real capital market interest rates.     

DotCom Mania: The Rise and Fall of Internet Stock Prices

This paper explores a model based on agents with heterogenous beliefs facing short sales restrictions, and its explanation for the rise, persistence, and eventual fall of Internet stock prices. First, we document substantial short sale restrictions for Internet stocks. Second, using data on Internet holdings and block trades, we show a link between heterogeneity and price effects for Internet stocks. Third, arguing that lockup expirations are a loosening of the short sale constraint, we document average, long‐run excess returns as low as ?33 percent for Internet stocks postlockup. We link the Internet bubble burst to the unprecedented level of lockup expirations and insider selling.     

On the asymptotic distribution of the transaction price in a clock model of a multi‐unit,oral, ascending‐price auction within the common‐value paradigm

Using a clock model of a multi‐unit, oral, ascending‐price auction, within the common‐value paradigm, we analyze the behavior of the transaction price as the numbers of bidders and units gets large in a particular way. We find that even though the transaction price is determined by a fraction of losing drop‐out bids, that price converges in probability to the true, but ex ante unknown, value. Subsequently, we demonstrate that the asymptotic distribution of the transaction price is Gaussian. Finally, we apply our methods to data from an auction of taxi license plates held in Shenzhen, China.