Financial Intermediaries and the Cross‐Section of Asset Returns

Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker‐dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single‐factor model prices size, book‐to‐market, momentum, and bond portfolios with an R² of 77% and an average annual pricing error of 1%—performing as well as standard multifactor benchmarks designed to price these assets.     

Strategic transfer pricing,absorption costing,and observability

This paper analyses the use of transfer pricing as a strategic device in divisionalized firms facing duopolistic price competition. When transfer prices are observable, both firms’ headquarters will charge a transfer price above the marginal cost of the intermediate product to induce their marketing managers to behave as softer competitors in the final product market. When transfer prices are not observable, strategic transfer pricing is not an equilibrium and the optimal transfer price equals the marginal cost of the intermediate product. As a strategic alternative, however, the firms can signal the use of transfer prices above marginal cost to their competitors by a publicly observable commitment to an absorption costing system. The paper identifies conditions under which the choice of absorption costing is a dominant strategy equilibrium.     

A retail benchmarking approach to efficient two‐way access pricing: no termination‐based price discrimination†

We study access pricing rules that determine the access prices between two networks as a linear function of marginal costs and (average) retail prices set by both networks. When firms compete in linear prices, there is a unique linear rule that implements the Ramsey outcome as the unique equilibrium, independently of underlying demand conditions. When firms compete in two‐part tariffs, there exists a class of rules under which firms choose the variable price equal to the marginal cost. Therefore, the regulator can choose among these rules to pursue additional objectives such as increasing consumer surplus or promoting socially optimal investment.     

Inventories and the automobile market

This article studies the within‐model‐year pricing, production, and inventory management of new automobiles. Using new monthly data on U.S. transaction prices, we document that, for the typical vehicle, prices fall over the model year at a 9.0% annual rate. Concurrently, both sales and inventories are hump shaped. To explain these time series, we formulate an industry model for new automobiles in which inventory and pricing decisions are made simultaneously. The model predicts that automakers' build‐to‐stock inventory management policy substantially influences the time series of prices and sales, accounting for four tenths of the price decline observed over the model year.     

Do Americans consume too little natural gas? An empirical test of marginal cost pricing

This article measures the extent to which prices exceed marginal costs in the U.S. natural gas distribution market during the period 1991–2007. We find large departures from marginal cost pricing in all 50 states, with residential and commercial customers facing average markups of over 40%. Based on conservative estimates of the price elasticity of demand, these distortions impose hundreds of millions of dollars of annual welfare loss. Moreover, current price schedules are an important preexisting distortion which should be taken into account when evaluating carbon taxes and other policies aimed at addressing external costs.     

Does Greater Firm‐Specific Return Variation Mean More or Less Informed Stock Pricing?

Roll [1988] observes low R² statistics for common asset pricing models due to vigorous firm‐specific return variation not associated with public information. He concludes that this implies “either private information or else occasional frenzy unrelated to concrete information”[p. 56]. We show that firms and industries with lower market model R² statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll's first interpretation: higher firm‐specific return variation as a fraction of total variation signals more information‐laden stock prices and, therefore, more efficient stock markets.     

Transfer Pricing and the Control of Internal Corporate Transactions

One potential weakness of all divisional profitability schemes is their inability to capture synergies among business units. One way of managing this problem is to design a transfer pricing scheme that attempts to assign common costs and benefits to different business units. What makes transfer pricing both so interesting, and such a challenge, is that the solution involves finding a way to encourage divisional managers whose pay is likely to depend on such transfer prices to reveal their private or unbiased information about the firm's costs in a way that serves the interest of the rest of the firm. With that end in view, the authors provide a general analytical framework for setting transfer prices and go on to discuss the costs and benefits of each of the most common transfer‐pricing methods: (1) market pricing; (2) marginal cost pricing; (3) full‐cost pricing; and (4) negotiated prices.     

A Comparison of Option Prices Under Different Pricing Measures in a Stochastic Volatility Model with Correlation

This paper investigates option prices in an incomplete stochastic volatility model with correlation. In a general setting, we prove an ordering result which says that prices for European options with convex payoffs are decreasing in the market price of volatility risk.As an example, and as our main motivation, we investigate option pricing under the class of q-optimal pricing measures. The q-optimal pricing measure is related to the marginal utility indifference price of an agent with constant relative risk aversion. Using the ordering result, we prove comparison theorems between option prices under the minimal martingale, minimal entropy and variance-optimal pricing measures. If the Sharpe ratio is deterministic, the comparison collapses to the well known result that option prices computed under these three pricing measures are the same.As a concrete example, we specialize to a variant of the Hull-White or Heston model for which the Sharpe ratio is increasing in volatility. For this example we are able to deduce option prices are decreasing in the parameter q. Numerical solution of the pricing pde corroborates the theory and shows the magnitude of the differences in option price due to varying q.JEL Classification: D52, G13     

Product Pricing Behaviour Under Different Costing Systems

Product pricing under ex ante imperfect marginal cost information is examined. The major findings indicate that under conditions of increasing (decreasing) average total (variable) cost, absorption (variable) costing results in outcomes closer to economic optimum. In addition, cost accounting systems interact with price elasticity of demand, resulting in greater (lesser) decision deviations from economic optimum under absorption costing when costs are decreasing (increasing).     

Unobservable transfer price exceeds marginal cost when the manager is evaluated using a balanced scorecard

This study investigates the optimal level of transfer prices chosen by managers in a divisionalized firm when they are evaluated based on a balanced scorecard. A unique assumption of our model is that transfer prices are unobservable to a competing firm's managers. In contrast to the findings in several studies that examine strategic transfer pricing, this research shows that a manager who is evaluated using a balanced scorecard chooses a transfer price that exceeds marginal cost given a market competitor in a specific economic environment. This result is caused mainly by our model's assumption that a manager considers the competitor's profit in his/her in decision-making when the objective is to maximize long-term profit. This study makes a significant contribution to the strategic transfer pricing literature by showing that even if the transfer price is unobservable to rivals, the optimal transfer price exceeds marginal cost when the final product market is characterized by price competition, something not shown in previous analytical accounting research.     

External Conditions,the Evolution of Financial Risks,and the Informational Content of Stock Prices: The Case of Chile

ABSTRACT

In this article, we find that the dynamics of local financial risks in the Chilean stock market are associated with the evolution of external economic conditions, with a strong reduction in both idiosyncratic and systematic risks during periods of stable conditions. Despite this, we fail to find any significant change in the traditional measures of stock price synchronicity developed in the R² literature in our sample. We argue that these measures neglect the relationship between stock prices and fundamentals and find that the strength of the association between prices and fundamentals changes during our sample period, being much stronger during times of stable external conditions and diminished stock price volatility.     

Can cost increases increase competition? Asymmetric information and equilibrium prices

We present an analysis of competition under asymmetric information where prices react asymmetrically to changes in firms' marginal costs. When one firm has private information about some customers, an increase in an uninformed firm's marginal cost leads to a price increase, as usual. However, an increase in the informed firm's marginal cost causes the equilibrium price to fall by improving the distribution of customers served by the uninformed firm. The model applies to settings where information asymmetries are important determinants of competition, such as credit, insurance, labor markets, or for the sale of goods where repeat business is important.     

Predation and its rate of return: the sugar industry, 1887–1914

We show that the price wars following two major entry episodes were predatory. Our proof is twofold: by direct comparison of price to marginal cost, and by construction of a lower bound to predicted competitive price‐cost margins that we show to exceed observed margins. Predation occurred only when its relative cost to the dominant firm, the American Sugar Refining Company (ASRC), was small. Its most clear effect was to lower the acquisition price of entrants and small incumbents. It may also have deterred future capacity additions and raised ASRC's share of industry profits. Predation operated by strengthening ASRC's reputation as a willing predator.     

Equilibrium asset prices and no-arbitrage with portfolio constraints

We examine intertemporal asset pricing when short sales areconstrained in proportion to the value of an investor's portfolio.All assets' prices exceed every investor's marginal utilityof consumption-based valuation of the associated dividends ifevery investor finds himself constrained in some asset in somestate; we exhibit such an equilibrium. An asset's price decomposesinto three (investor-specific) components: the consumption valueof its dividends, a speculative value premium, and a collateralvalue premium. The validity of the no-arbitrage pricing approachis shown to depend critically on the difference between realsecurities and their synthetic counterparts.     

External and Internal Pricing in Multidivisional Firms

Multidivisional firms frequently rely on external market prices in order to value internal transactions across profit centers. This paper examines market‐based transfer pricing when an upstream division has monopoly power in selling a proprietary component both to a downstream division within the same firm and to external customers. When internal transfers are valued at the prevailing market price, the resulting transactions are distorted by double marginalization. The imposition of intracompany discounts will always improve overall firm profits provided the supplying division is capacity constrained. Under certain conditions it is then possible to design discount rules so that the resulting prices and sales quantities are efficient from the corporate perspective. In contrast, the impact of intracompany discounts remains ambiguous when the capacity of the selling division is essentially unlimited. It is then generally impossible to achieve fully efficient outcomes by means of market‐based transfer pricing unless the external market for the component is sufficiently large relative to the internal market.     

PARTIAL EXERCISE OF LOAN COMMITMENTS UNDER ADAPTIVE PRICING

The partial takedown phenomenon associated with bank loan commitments is examined in a dynamic context in which banks adjust commitment prices to client takedown behavior. The optimal takedown is an increasing function of client riskiness and a decreasing function of the time the client plans to remain with its present bank and the cost of switching to a new bank. Since the bank's learning is cumulative, the longer a client remains with its bank the smaller is the commitment price adjustment resulting from an aberrant takedown. The enhanced commitment price certainty, obtained with longevity of the client relationship, helps to explain client reluctance to switch banks. Since the optimal takedown is an increasing function of client riskiness under adaptive pricing, such pricing may serve the added purpose of providing information on client risk.     

Price‐matching guarantees

Are price‐matching guarantees anticompetitive? We examine the incentives for price‐matching guarantees in markets where information about prices is costly. The conventional explanation of price matching as facilitating cartel pricing finds some theoretical support, but our model provides an additional explanation. A price‐matching guarantee may be a credible and easily understood means of communicating to uninformed consumers that a firm is low priced. The credibility of the signal is assured by the behavior of informed consumers. We contrast the testable implications of our model with those arising from two theories of price matching as anticompetitive, and show that available evidence supports the signalling theory.     

Aggressive leaders

I characterize the incentives to undertake strategic investments in markets with Nash competition and endogenous entry. Contrary to the case with an exogenous number of firms, when the investment increases marginal profitability, only a “top dog” strategy is optimal. For instance, under both quantity and price competition, a market leader overinvests in cost reductions and overproduces complement products. The purpose of the strategic investment is to allow the firm to be more aggressive in the market and to reduce its price below those of other firms. Contrary to the post‐Chicago approach, this shows that aggressive pricing strategies are not necessarily associated with exclusionary purposes.     

Pricing Model Performance and the Two‐Pass Cross‐Sectional Regression Methodology

Over the years, many asset pricing studies have employed the sample cross‐sectional regression (CSR) R² as a measure of model performance. We derive the asymptotic distribution of this statistic and develop associated model comparison tests, taking into account the impact of model misspecification on the variability of the CSR estimates. We encounter several examples of large R² differences that are not statistically significant. A version of the intertemporal capital asset pricing model (CAPM) exhibits the best overall performance, followed by the Fama–French three‐factor model. Interestingly, the performance of prominent consumption CAPMs is sensitive to variations in experimental design.