A New Approach to Testing Asset Pricing Models: The Bilinear Paradigm

We propose a new approach to estimating and testing asset pricing models in the context of a bilinear paradigm introduced by Kruskal 18 . This approach is both simple and at the same time quite general. As an illustration we apply it to the special case of the arbitrage pricing model where the number of factors is pre-specified. The data appear to be generally in conflict with a five or seven factor representation of the model used by Roll and Ross 30 . When we consider the number of replications of our test and the large number of observations on which it is performed, the frequency with which we reject the three factor APM does not lead us to conclude that this model is unrepresentative of security returns. Further, the rejection of the five and seven factor versions is to be expected if the three factor version is correct. The paradigm gives insight into the appropriate specification of the model and suggests that there may be a small number of economy wide factors that affect security returns.     

The Book-to-Price Effect in Stock Returns: Accounting for Leverage

This paper lays out a decomposition of book‐to‐price (B/P) that derives from the accounting for book value and that articulates precisely how B/P “absorbs” leverage. The B/P ratio can be decomposed into an enterprise book‐to‐price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book‐to‐price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book‐to‐price, the leverage component of B/P is negatively associated with future stock returns. Further, both enterprise book‐to‐price and leverage explain returns over those associated with Fama and French nominated factors—including the book‐to‐price factor—albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk.     

Information Diversity and Market Behavior

The paper addresses two major issues raised by information diversity in a speculative market. First, we analyze what property of an investor's information leads to an expected speculative profit and show that independence is more important than accuracy. Second, we consider whether the market price must become fully efficient, in the sense that every investor's information is accurately discounted, when traders use it rationally as an information source. We prove that for any information structure there is a unique equilibrium weighting of investor beliefs at which the price is fully efficient and also every trader's expected profit is zero. Except for special structures, however, this equilibrium need not be attained in finite time.     

The Real Effects of FAS 166/167 on Banks’ Mortgage Approval and Sale Decisions

We examine the real effects of FAS 166 and FAS 167 on banks’ loan‐level mortgage approval and sale decisions. Effective in 2010, these standards tightened the accounting for securitizations and consolidation of securitization entities, respectively, causing banks to recognize an estimated $811 billion of securitized assets on balance sheet. We find that banks that recognize more securitized assets exhibit larger decreases in mortgage approval rates and larger increases in mortgage sale rates. These effects significantly exceed those of banks’ off–balance sheet securitized assets, consistent with our results being driven by the consolidation of securitization entities rather than by securitization per se. We conduct tests that help rule out the financial crisis as an alternative explanation for our results. Further analyses suggest that mechanisms underlying the results include consolidating banks’ reduced regulatory capital adequacy, increased market discipline, and consequent desire not to recognize high‐risk mortgages on balance sheet.     

Economics of Automobile Leasing: The Call Option Value

Previous analyses of the automobile lease versus purchase decision have ignored the value of the call option embedded in closed-end leases with guaranteed buy back provisions. This paper shows that ignoring the value of this call option results in a bias against leasing in the lease versus purchase decision. Supporting evidence is provided by an empirical model of automobile lease rates.     

When Recalls Matter: Factors Affecting Owner Response to Automotive Recalls

This paper assesses the impact of recall-specific variables on owner response rates to automotive safety recall campaigns under the National Traffic and Motor Vehicle Safety Act of 1966. Using a multiple regression framework, the paper finds that owner response rates have been significantly higher for owners of American vehicles as compared to European and Japanese vehicles, for owners of newer model vehicles as compared to older ones, and for owners of vehicles with severe safety-related defects as compared to vehicles with lesser problems. The paper concludes with the suggestion that, for vehicles with characteristically lower owner response rates, the issuance of multiple recall notices or the coupling of periodic safety inspections with recall compliance may be advisable.     

AGENCY CONFLICT AND CORPORATE STRATEGY: THE EFFECT OF DIVESTMENT ON CORPORATE VALUE

Among the various stakeholders of a firm, senior managers are the most likely targets for private and public political pressures. Other stakeholder groups are less visible and may be perceived as less influential in corporate strategy formulation and implementation. In some situations, consequently, senior executives may adopt corporate strategies in response to political pressures even if these strategies may be costly to shareholders. In this study, a special case is examined: the effect of divestment of South African business units on firm value. Using data from 1984 through 1990, we examine the impact that announcements of divestments have upon the stock return behavior of publicly traded firms. Our results indicate that significant and negative excess returns accrue to shares of companies announcing divestments of South African operations. These results are supportive of the premise that noneconomic pressures may influence managerial strategies rather than value-enhancement goals. © 1997 by John Wiley & Sons, Ltd.     

COINTEGRATION AND CHANGES IN REGIME: THE JAPANESE CONSUMPTION FUNCTION

In this paper we examine a model of cointegration where long-run parameters are subject to switching between several different cointegrating regimes. These shifts are allowed to be governed by the outcome of an unobserved Markov chain with unknown transition probabilities. We illustrate this approach using Japanese data on consumption and disposable income, and find that the data favour a Markov-switching long-run relationship over a standard temporally stable formulation. © 1997 by John Wiley & Sons, Ltd.     

How Do Firms Respond to Political Uncertainty? Evidence from U.S. Gubernatorial Elections

We examine the joint response to political uncertainty along two margins: changes in real activity and voluntary disclosure. We focus on within-firm variation in exposure to ex ante competitive U.S. gubernatorial elections using data on preelection poll margins and firms’ state exposures. Despite real activity falling in the years leading up to a close election, we find that voluntary disclosure increases both in frequency and content, including mentions of risk in filings that reference states holding elections. Our tests use a decomposition of 8-K filings into real activity and voluntary disclosure to address the endogenous complementarity between these two responses. These results hold when using alternative ex ante measures of political uncertainty based on term-limited incumbents, historically competitive offices, or state legislature gridlock. Both effects of political uncertainty are stronger for firms in highly regulated industries and weaker for those least exposed to the local market, linking the real activity and disclosure responses to uncertainty.