Adding and subtracting Black-Scholes: A new approach to approximating derivative prices in continuous-time models

We develop a new approach to approximating asset prices in the context of continuous-time models. For any pricing model that lacks a closed-form solution, we provide a closed-form approximate solution, which relies on the expansion of the intractable model around an “auxiliary” one. We derive an expression for the difference between the true (but unknown) price and the auxiliary one, which we approximate in closed-form, and use to create increasingly improved refinements to the initial mispricing induced by the auxiliary model. The approach is intuitive, simple to implement, and leads to fast and extremely accurate approximations. We illustrate this method in a variety of contexts including option pricing with stochastic volatility, computation of Greeks, and the term structure of interest rates.     

Speed of convergence to market efficiency: The role of ECNs

Chordia, Roll and Subrahmanyam (2005, CRS) estimate the speed of convergence to market efficiency based on short-horizon return predictability of the 150 largest NYSE firms. We extend CRS to a broad panel of NYSE stocks and are the first to examine the relation between electronic communication networks (ECNs) and the corresponding informational efficiency of prices. Overall, we confirm CRS's result that price adjustments to new information occur on average within 5–15 min for large NYSE stocks. We further show that it takes about 20 min longer for smaller firms to incorporate information into prices. Most importantly, we demonstrate that the speed of convergence to market efficiency is significantly related to the type of trading platform where orders are executed, even after controlling for relative order flows, trading costs, volatility, informational effects, trading conditions, market quality, institutional trading activity, and other firm-specific characteristics. Our findings provide direct answers and insights to issues raised in a recent SEC concept release document.     

Can incentives mitigate student overconfidence at grade forecasts?

Research shows that college students exhibit bias in their forecasts of exam performance. Most students are overconfident in their forecasts, academically weaker students are the most overconfident, and top-performing students are underconfident. The literature identifies negative repercussions of these biases, including inadequate preparation for exams. A recurring attribute of this literature is the absence of meaningful incentives for students to forecast accurately. We implement an extra credit scheme to incentivize accurate forecasts. Depending on how forecast bias is measured, the scheme mitigates bias by top-performing students and marginally mitigates bias by other students. Our results have several implications. First, we illustrate an extra credit tool instructors can use to incentivize students to make more thoughtful assessments of their future exam performance. Second, we show how the association between incentives and forecast bias differs across student groups. Finally, we show that results in this literature are sensitive to how bias is measured.     

What drives the disappearing dividends phenomenon?

We study the determinants of dividend payout policy and examine the role of liquidity, risk and catering in explaining the changes in propensity to pay. Our results indicate that risk plays a major role in firms’ dividend policy. The evidence substantiates from a large sample of firms representing 18 countries over the sample period from 1989 to 2011. For firms in the US, France, UK and Other European markets, liquidity is additionally an important determinant of dividend policy. We find that, although catering incentives persist only among firms in common law countries and not in civil law countries, after adjusting for risk there is little support for catering theory even among firms incorporated in common law countries. Our results indicate that catering incentives reflect the risk-reward relationship in the changing propensity to pay dividends.     

Raising rivals' costs: The entry of an upstream monopolist into downstream markets

A regulated upstream monopolist provides an input to firms in a downstream market. If the monopolist enters the downstream market, a natural concern is that it will act so as to raise its downstream rivals' costs. An offsetting incentive is that a higher downstream price will reduce demand for the input, which reduces the monopolist's profit. Conditions under which one incentive dominates the other are derived. The monopolist may desire to lower its downstream rivals' costs rather than raise them. These findings suggest that regulatory policy towards such downstream entry should not focus exclusively on the ability to discriminate.     

Informed Trading Around Earnings Announcements: Another Look

This study is an empirical test of the Easley, O'Hara, and Srinivas (1998) multimarket sequential trade model of stock and option markets. We employ two approaches to determine the information content of signed stock and option trades executed around quarterly earnings announcements. The first approach expands the vector autoregression (VAR) technique of Hasbrouck (1991a) to include signed option trade volumes and inter‐trade durations. Estimates from the VAR models provide insight into whether both equity and option trades are viewed as informative by the equity specialist. The second approach focuses on the information content of the earnings releases to determine whether signed equity and option trades executed prior to the announcements are informed. Results indicate that although informed traders prefer to transact in both markets around earnings announcements, option market transactions contain no incremental information.     

Developing a Learning Community Approach to Business Ethics Education

In this paper we discuss a project, still in progress, that moves away from a traditional lecture based educational pedagogy. We present a team taught approach to ethics teaching that embraces a progressive philosophy of education and is focused on the development of a discussion based learning community. We describe our primary pedagogical tools of case discussion and the development of student expert role assignments as a locus, and how they relate to the learning community, course content and course objectives. Finally, we provide our preliminary review of outcomes and emerging issues.