Valuation Implications of Investment Opportunities and Earnings Permanence

This study investigates the value-relevance of accounting earnings in the presence of investment (growth) opportunities after making two theoretical and methodological research design refinements. First, we test for the incremental effect of growth on firms earnings response coefficients after controlling for the extent of transitory earnings under the assumption that the value-relevance of earnings with respect to growth should be stronger when earnings are more permanent. Second, we perform comprehensive factor analysis using market-based and accounting-based measures to construct a composite proxy for investment opportunities. We find that firms investment opportunities and the relative permanence of current earnings affect the value-relevance of those earnings. Additionally, we find that the interaction between permanent earnings and investment opportunities produces an even stronger price response to earnings.     

Decomposition of Japanese Yen Interest Rate Data Through Local Regression

Seven different Japanese Yen interest rates recorded on a daily basisfor the period from 1986 to 1992 are simultaneously analyzed. Byintroducing a new concept of short term trend, we decomposeeach interest rate series into three components, long termtrend, short term trend and irregular. It is obtained by atwo step lowess smoothing technique. After that, amultivariate autoregressive model (MAR) is fitted to the vectorvalued time series obtained by combining those seven irregularcomponents. The decomposition and MAR model fitting were quitesatisfactory. It enables us to understand well various aspects ofinterest rate series from the trends, the MAR (2) coefficientsand its residuals. The result is compared with the decompositionthrough sabl and the advantages of our procedure will bedemonstrated in relations to other parametric model fitting likeARCH or GARCH. Based on the decomposition we can have betterdaily prediction and more stable long term forecasting.     

The Marginal Cost of Funds and the Shadow Prices of Public Sector Inputs and Outputs

Existing studies on the marginal cost of funds (MCF) do not incorporate the public sector inputs explicitly. Incorporating labor and capital as public sector inputs raises questions concerning the definition and the usage of the MCF, and its relation to public sector shadow prices. This paper finds that the MCF should be defined based on the excess revenue rather than the gross revenue; that general equilibrium effects on individuals' net income and government's inframarginal expenditures should be incorporated; and that the MCF measures an element in the shadow price that is solely attributable to the marginal financing, justifying the role of the MCF in cost-benefit analysis and tax reform.     

Nonparametric prediction for the time-dependent volatility of the security price

In this paper we consider a continuous time model for the security price with the time-dependent volatility. It is shown that the non-normality and non-linear dependency of the short-term return, the major characteristics observed on many financial assets, can be incorporated into our model. In order to evaluate the option price formula on the model we propose a nonparametric predictor for the volatility function without reference to a specific functional form. We examine the so-called continuous record asymptotics and show that the proposed predictor is asymptotically minimax for a wide class of the volatility functions. One of the most important results is that the application of the Black-Scholes method can be justified by plugging the proposed predictor in the standard Black-Scholes formula even if the volatility changes over time.     

Is the ‘Perfect’ Timing Strategy Truly Perfect?

In the presence of transaction cost, the perfect timing strategy which holds stocks in a period with positive excess return and holds cash in a period with negative excess return is not necessarily perfect. Using the optimal growth criterion, this paper derives the truly perfect timing strategy which can achieve the maximum long term growth. It is found that such a perfect timing strategy can achieve a much higher annual return than the perfect timing strategy under reasonable transaction cost. Also, it can achieve a return of over 80% when a review period is as short as a day and when transaction cost is low. Using the truly perfect timing strategy as a benchmark, the likely gains from imperfect timing can be more accurately assessed. For a less frequent review schedule, a market timer needs a very high correct prediction probability in order to be at par with the buy-and-hold strategy. However, the needed correct prediction probability is much less when the review schedule is more frequent. Also, the correct prediction probability needed to be at par with the buy-and-hold strategy increases with the transaction cost.     

Modeling Spatial and Temporal House Price Patterns: A Comparison of Four Models

This research reports results from a competition on modeling spatial and temporal components of house prices. A large, well-documented database was prepared and made available to anyone wishing to join the competition. To prevent data snooping, out-of-sample observations were withheld; they were deposited with one individual who did not enter the competition, but had the responsibility of calculating out-of-sample statistics for results submitted by the others. The competition turned into a cooperative effort, resulting in enhancements to previous methods including: a localized version of Dubins kriging model, a kriging version of Clapps local regression model, and a local application of Cases earlier work on dividing a geographic housing market into districts. The results indicate the importance of nearest neighbor transactions for out-of-sample predictions: spatial trend analysis and census tract variables do not perform nearly as well as neighboring residuals.     

The Effect of Mortgage Price and Default Risk on Mortgage Spreads

Variations over time in mortgage yield spreads should reflect changes in the underlying prepayment option value; moreover, the relationship between mortgage yield spreads and interest rate dynamics should weaken as the value of the borrowers prepayment option declines. We verify this hypothesis through an empirical analysis of residential mortgage yield spread behavior, and we also present evidence that the strength of the relationship between mortgage spreads and interest rate dynamics weakens (strengthens) as the level of default risk increases (decreases). This result is consistent with the competing risks effect between a borrowers option to prepay or default. Our results demonstrate the importance of accounting for mortgage price discount to par as well as default risk when developing time series of mortgage yields.     

Rational Delays: The Case of Real Estate

Real estate markets, for both commercial real estate and single family homes, typically respond to a large negative demand shock with a period during which the volume of transactions and liquidity of real estate declines. Explanations for these periods have focused on overly optimistic owners, imperfections in real estate markets and/or minimum down payment requirements. These are important characteristics of real estate markets, but they do not provide a satisfying explanation for the long-term declines in the number of transactions and liquidity of real estate that frequently follow negative demand shocks. This paper presents estimates, for a specific real estate market (Los Angeles single family dwellings), of the option-like value of an owners interest in a property. Our estimates imply that when an owner has little or negative equity, the value of waiting to sell is likely to exceed the net carrying cost. Consequently, the option value of a potential sellers interest may eliminate the possibility of an otherwise mutually advantageous transaction.     

Environmental Taxes, International Capital Mobility and Inefficient Tax Systems: Tax Burden vs. Tax Shifting

This paper deals with the so-called double dividend of an environmental tax reform. In a model with only labor and a polluting input as factors of production, we find that society faces a trade-off between internalizing environmental externalities and raising revenues in the least distortionary way. However, if capital enters the production structure, an ecological tax reform may render the tax structure more efficient from a non-environmental point of view, thereby raising not only environmental quality but also private incomes.     

Environmental Taxes and Pre-Existing Distortions: The Normalization Trap

The double-dividend hypothesisclaims that green taxes will both improve the environment andreduce the distortions of existing taxes. According to the earlierliterature on the double dividend the tax rate for pollutinggoods should be higher than the Pigovian tax which fully internalizesthe marginal social damage from pollution, in order to obtaina second dividend. On the contrary, Bovenberg and de Mooij(1994) argue that environmental taxes typically exacerbate, ratherthan alleviate, pre-existing distortions. The optimal pollutiontax should therefore lie below the Pigovian tax. This paper pointsout that there is no real contradiction between these apparentlyopposing policy recommendations. It will be shown that the differencein the results appears because, implicitly, different definitionsof the second-best optimal pollution tax are chosen.