Financial Markets Where Traders Neglect the Informational Content of Prices

We model a financial market where some traders of a risky asset do not fully appreciate what prices convey about others' private information. Markets comprising solely such “cursed” traders generate more trade than those comprising solely rationals. Because rationals arbitrage away distortions caused by cursed traders, mixed markets can generate even more trade. Per‐trader volume in cursed markets increases with market size; volume may instead disappear when traders infer others' information from prices, even when they dismiss it as noisier than their own. Making private information public raises rational and “dismissive” volume, but reduces cursed volume given moderate noninformational trading motives.     

Accounting information,disclosure, and expected utility: Do investors really abhor uncertainty?

Investors are said to “abhor uncertainty,” but if there were no uncertainty they could earn only the risk‐free rate. A fundamental result in the analytical accounting literature shows that investors buying into a CARA‐normal CAPM market pay lower asset prices, gain higher ex‐ante expected returns, and obtain higher expected utility, when the market payoff has higher variance. New investors obtain similar “welfare” gains from risk under a log/power utility CAPM. These results do not imply that investors “abhor information.” To realize investors' ex‐ante expectations, the subjective probability distributions representing market expectations must be accurate. Greater payoff risk can add to investors' expected utility, but higher ex‐post(realized) utility comes from better information and more accurate ex‐ante expectations. An important implication for accounting is that greater disclosure can have the simultaneous effects of (i) exposing more fully or perceptibly firms' payoff uncertainty, thereby increasing new investors' expected utility, and (ii) improving market estimates of firms' payoff parameters (means, variances, covariances), thereby giving investors a better chance of realizing their expectations. Paradoxically, better information can be valuable to new investors by exposing more fully and more accurately the risk in firms' business operations and results–new investors maximizing expected utility want both more risk and better information.     

Information Aggregation via Contracting

When a group of investors with dispersed private information jointly invest in a risky project, how should they divide the project's profit? We show that a simple contract dividing profits in proportion to investors' risk tolerances may facilitate information aggregation by altering investors' risk-taking incentives when they decide on how investment strategies respond to private information. Our results provide a contracting-based approach for information aggregation, which is an alternative to learning from endogenous market variables (e.g., prices) via contingent schedules as seen in well-known rational expectations equilibrium models.     

Capital Gains Tax Overhang and Price Pressure

I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax‐sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax‐exempt clients. Moreover, tax‐related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax‐sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly.     

Asymmetric dynamic relations between stock prices and mutual fund units in Japan. An application of hidden cointegration technique

This paper examines “causality” effects between mutual fund flows and stock index prices in Japan. In particular, both the short and long run dynamics between stock prices and fund units are investigated. The novelty of our paper is the use of the hidden cointegration technique which attempts to capture heterogeneous fund flow reactions when stock index prices move up or down. Moreover, we employ the crouching error correction model (CECM) to assess the relationship between stock market movements and fund flow changes. The results show that stock prices and mutual fund units are cointegrated. In the case of positive movements there is a bi-directional effect interconnecting them, whereas for negative movements, causality runs only from fund flows to stock prices. The dynamics structure provides evidence that market microstructure, taxation and investors' sentiment affect stock price and unit formation.     

Mutual funds' capital gains lock-in and earnings management

Capital gains taxation creates a lock-in effect, increasing investors' incentives to monitor and decreasing portfolio firms' incentives to cater to short-term investors. We show a negative relation between lock-in and portfolio firms' earnings management, and this relation is stronger for capital gains held by tax-sensitive investors. Further, the relation between lock-in and earnings management is stronger when the capital gains tax rate is higher. We show that locked-in funds vote against management and against audit committee members' reappointment following earnings management. Locked-in funds are less likely to exit a position following disappointing earnings announcements, reducing firms' incentive to manage earnings.     

New Evidence That Taxes Affect the Valuation of Dividends

This paper uses British data to examine the effects of dividend taxes on investors' relative valuation of dividends and capital gains. British data offer great potential to illuminate the dividends and taxes question, since there have been two radical changes and several minor reforms in British dividend tax policy during the last 30 years. Studying the relationship between dividends and stock price movements during different tax regimes offers an ideal controlled experiment for assessing the effects of taxes on investors' valuation of dividends. Using daily data on a small sample of firms, and monthly data on a much broader sample, we find clear evidence that taxes affect the equilibrium relationship between dividend yields and market returns. These findings suggest that taxes are important determinants of security market equilibrium and deepen the puzzle of why firms pay dividends.     

Different momentum effects across countries: An explanation based on investors' behavior

We establish a model in which speculators use feedback trading characteristics to infer the behavior of irrational investors and induce them to trade. We also discuss the stability and time series of asset prices. Our results show that: (1) speculators have speculation and arbitrage demands and make “noise” to induce irrational investors to trade, (2) the time series of asset prices show stable momentum and a reversal effect when fundamental traders dominate the market, and (3) momentums are unstable and perform poorly under extreme circumstances. Our article offers a unique approach to understanding the micro mechanism of different momentum effects in various markets and suggests a plausible theoretical framework to illustrate such differences.     

International tax arbitrage,currency options and put-call parity conditions

Using a finite-horizon general equilibrium model with uncertainty and money, we characterize situations where tax arbitrage opportunities may arise for international portfolio investors in an economy with heterogeneous capital income taxation where foreign currency exposure can be hedged using forward contracts and a set of currency options. We obtain tax-modified option prices similar to the no-tax ones, but augmented by tax-induced “risk-premium” terms; tax-modified put-call parity conditions are derived that revert to their standard (no-tax) format if the respective marginal agents in the bond and option markets are in identical tax brackets.     

投资者调研影响上市公司商业信用融资研究——基于深市A股上市公司的实证

以2013-2016年我国深市A股上市公司为研究样本,实证检验投资者调研对商业信用融资的影响,以及环境不确定性对二者关系的调节作用。研究结果表明：投资者调研与商业信用融资显著正相关,在非国有企业中,环境不确定性负向调节了投资者调研与商业信用融资之间的关系;在国有企业中,环境不确定性的调节作用不显著。进一步研究显示：投资者调研会促进企业获得较低成本的商业信用融资。     

A Tax-Induced Clientele for Index-Linked Corporate Bonds

This paper analyzes the circumstances under which tax considerations favor or disfavor the use of index-linked corporate bonds. Using a model similar to Miller's, investors' choices of assets depend on their tax preferences for interest income versus capital gains and their preferences for the timing of returns. It is concluded that the absence of index-linked bonds in the U.S. cannot be attributed solely to tax reasons. However, following the 1986 Tax Reform Act, the tax code is expected to disfavor the use of index-linked bonds.     

Options Arbitrage in Imperfect Markets

Option valuation models are based on an arbitrage strategy—hedging the option against the underlying asset and rebalancing continuously until expiration—that is only possible in a frictionless market. This paper simulates the impact of market imperfections and other problems with the “standard” arbitrage trade, including uncertain volatility, transactions costs, indivisibilities, and rebalancing only at discrete intervals. We find that, in an actual market such as that for stock index options, the standard arbitrage is exposed to such large risk and transactions costs that it can only establish very wide bounds on equilibrium options prices. This has important implications for price determination in options markets, as well as for testing of valuation models.     

International tax arbitrage,financial parity conditions and preferential capital gains taxation

Using a finite-horizon general equilibrium model with uncertainty and money, we characterize situations where tax arbitrage opportunities may arise for international portfolio investors in an economy with heterogeneous capital income taxation when interest income and capital gains/losses are taxed differentially for some agents. We derive tax-modified uncovered interest parity conditions, Fisher conditions and forward prices similar to the no-tax ones, but augmented by tax-induced ‘risk-premium’ terms; covered interest parity and Fisher conditions remain unaffected by the introduction of capital income taxes as we bound tax-based arbitrage without restricting arbitrage per se.     

The Ex-Dividend Day Behavior of Canadian Stock Prices: Tax Changes and Clientele Effects

With some simple assumptions the ex-dividend day price drop and the associated dividend can be used to measure the market's marginal tax rate. Previous research has estimated the implied tax rate for the U.S. This paper extends the analysis to Canada, where the tax treatment of dividends and capital gains is completely different from that in the U.S. The paper also presents estimates from 1970–80 to include four distinct periods when the tax treatment was different. Hence, we include an implied test of market efficiency as well as those for the “relevance” of taxes and the existence of tax based dividend clienteles.     

Price sensitivity of the consumer-investor: Evidence from energy prices and mutual fund fees

This study documents a significant relation between changes in commodity prices and investors' price sensitivity in the market for mutual funds. Specifically, price sensitivity⸺defined as the negative relation between fund-level flows and a fund's cost of ownership⸺is more pronounced in periods when energy commodity prices increase sharply. Aggregate flows into actively managed funds relative to the cheaper passively managed funds decrease (increase) when energy prices rise (fall). The results furnish novel evidence supporting an integrated view of the representative “consumer-investor,” whose price sensitivity in choosing financial products is related to price shocks in household consumption goods.     

Speculate against speculative demand

Measuring individual investors' speculative demand for stocks using the Google search volume index (hereafter “SVI”) on penny stocks, we examine how it relates to the return dynamics of U.S. stock indices. Speculative demand leads to a short-term return reversal. A simple trading strategy that sells a stock index when SVI is high and buys it otherwise generates annual excess returns of up to 20% over the buy-and-hold strategy. Applying the trading strategy to the corresponding ETFs and index futures yields similar results. Transaction costs, liquidity risk and strong time variation of the excess returns can potentially limit the exploitation of arbitrage opportunities.     

Some Results in the Theory of Arbitrage Pricing

This paper derives a stronger version of Huberman's recent “preference free” pricing theorem. This pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model. It must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals. This result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under Huberman's bound. Some applications to empirical tests and performance measurement are also discussed.     

MERTON MILLER'S CONTRIBUTIONS TO MODERN FINANCE

Winner of the 1990 Nobel Prize in Economics, and widely regarded as the “father of modern finance,” the University of Chicago's Merton Miller died last June at age 77. This article attempts to sum up Miller's career in terms of a single governing principle: the role of arbitrage in ensuring the “efficiency” of financial markets and, more generally, the effectiveness of such markets in promoting economic growth and creating social wealth. Starting with the formulation of Proposition I (also known as the capital structure irrelevance proposition) with Franco Modigliani in 1958, Miller's research over the next 40 years is seen as applying—with remarkable clarity and consistency—the principle of arbitrage to the study of many aspects of financial markets. Miller's main accomplishment, according to the author, is to have made arbitrage arguments the cornerstone of modern finance. The arbitrage proof of Proposition I introduced a new standard in finance—namely, that any finding in financial research deserving serious consideration must have the critical property that it cannot represent opportunities for riskless profit by investors. And the article goes on to show that arbitrage is a constant theme in Miller's writings, from his work in corporate finance to his later studies of financial innovation, derivatives markets, and financial crashes and crises. Having started and presided over the transformation of financial studies from a “glorified apprenticeship system” into a scientific discipline, Miller devoted much of the last 15 years of his life to a different, though clearly related undertaking: the defense of financial markets against the attacks of politicians and regulators, as well as businessmen intent on stifling competition (including hostile takeovers). Whether it was the alleged role of the stock index futures markets in the 1987 market crash, the claims of “overleveraging” in the LBOs of the '80s, or the derivatives fiascos in the mid‐'90s, Miller was there to provide careful economic analysis of the problems. In the early '90s, he explained why the “myopia” of the U.S. stock market was likely to cause far fewer problems than the “hyperopia” induced by regulatory distortions of the Japanese market. And in one of his last speeches, Miller showed that the primary cause of the recent Asian crisis was not “too much reliance on financial markets,” as claimed by politicians and the popular press, but “too little”—in particular, the heavy dependence on bank financing (particularly state‐owned banks) and the failure to develop alternative sources of capital that continue to depress the Japanese economy.     

PORTFOLIO CHOICES,CONSUMPTION, AND PRICES IN A MARKET WITH DURABLE ASSETS

Recent research in investments has focused almost exclusively on financial assets such as corporate stocks. Although durable assets constitute an important part of investors' holdings, little effort has been made to explore their role in individuals' investments decisions and on assets pricing. This paper establishes results concerning the role of durable assets in the determination of optimum portfolio choices. The paper explores the effect of consumption considerations related to the service flows generated by durable assets on optimum portfolio considerations and asset prices. The main result is tied to the existence, or lack thereof, of efficient rental markets. In the absence of rental markets (or with restrictions on renting), investors' portfolio choices are not independent of consumption considerations as they are assumed to be in the standard CAPM. Individuals may thus hold different portfolios, and prices reflect the owner's inability to trade consumption flows. Under perfect market assumptions with unrestricted rental markets, optimum portfolio choices are undistinguishable from those implied by the standard CAPM in the sense that they are mean-variance efficient and identical for all individuals. Consumption is adjusted by trading service flows in the rental market. Prices, and the price of risk, however, reflect the existence of durable assets service flows as well as the risks involved in trading these flows in the rental market. In the model, risky rental income is introduced by uncertain rental costs. Equilibrium rental rates, an important part of the return expected from holding durable assets, are determined in the context of the mean-variance framework as a function of return and undiversifiable risk.     

Index Options: The Early Evidence

Index options became the most important traded contracts during their first year of existence. Two contracts, namely those on the S&P100 and the Major Markets Index, have a trading volume which typically surpasses the trading volume in all individual stock option contracts. In this paper, we examine the pricing of the options on the S&P100 and the Major Markets Index. Using intra-day prices, we find the options frequently violate the arbitrage boundary, put/call parity, and are substantially mispriced relative to theoretical values. Our results suggest that tests of option pricing models may be more difficult than previously realized due to nonsynchronous prices, even using “real-time” data from the exchanges.