Can stochastic discount factor models explain the cross-section of equity returns?

We propose a multivariate test of the capital asset pricing model (C-CAPM) of the cross-sectional variation in equity returns in which we compare cross-sectional variation in equity returns to the cross-sectional variation in their conditional covariance with stochastic discount factors. We use a multivariate generalized heteroskedasticity in mean model to estimate 25 portfolios that are formed on size and the book-to-market ratio. Each portfolio is allowed to have its own no-arbitrage condition. We find that although the conditional covariances of returns with consumption exhibit negative variation across size, they do not vary across the book-to-market ratio. Thus, C-CAPM can capture the size effect, but not the value effect. The fit is, however, improved by allowing the coefficients on the consumption covariances to be different. The value effect appears to be associated with the book-to-market ratio as well as size. On its own the book-to-market ratio does not generate additional information about average returns to C-CAPM. A possible explanation for these findings is that both small and low book-to-market ratio firms are expected to have higher rates of growth.     

A Primer on Unit Root Testing

The immense literature and diversity of unit root tests can at times be confusing even to the specialist and presents a truly daunting prospect to the uninitiated. In consequence, much empirical work still makes use of the simplest testing procedures because it is unclear from the literature and from recent reviews which tests if any are superior. This paper presents a survey of unit root theory with an emphasis on testing principles and recent developments. The general framework adopted makes it possible to consider tests of stochastic trends against trend stationarity and trend breaks of a general type. The main tests are listed, and asymptotic distributions are given in a simple form that emphasizes commonalities in the theory. Some simulation results are reported, and an extensive list of references and all annotated bibliography are provided.     

Alliances versus Federations: An Extension of Riker's Analysis of Federal Formation

This essay explores the distinction between federations and alliances and asks the question: When will states choose to federate rather than ally? William Riker argues that a necessary condition for a federal state's formation is that those offering the federal bargain must seek to “expand their territorial control, usually either to meet an external military or diplomatic threat or to prepare for military or diplomatic aggression and aggrandizement.” This argument, though, does not tell us why states sometimes respond to threats by forming federations and at other times by forming alliances. Here we address this issue directly and use a formal model of alliance formation to illustrate our arguments. Briefly, that model assumes states have initial endowments of military and economic resources, where economic resources enter utility functions directly and military capability influences preference only insofar as it determines a state's ability to counter or make threats. State can divert economic resources to military spending, and alliances, in turn, are self-enforcing coalitions designed to augment a state's offensive or defensive capabilities. Federations, which serve the same ends as alliances, are coalitions that need to be enforced by the “higher authority” established when the federation is formed. Our assumption is that states form federations in lieu of alliances if and only if (1) a stable alliance partition does not exist or, if one exists, it is dominated by an unstable partition and (2) if the cost of the loss of sovereignty to each state in the federation is offset by the gains from joining it, relative to what that state secures as its security value.     

From Control to Values-Based Management and Accountability

In recent years a series of developments in apparently loosely coupled domains have contributed to the development of new and vital perspectives on how to manage complex social systems such as corporations. These developments include improved communications technologies, increased awareness by constituencies of their potentials for influencing corporate behaviour, increased complexity and reduced transparency in large, heterogeneous organisations, a corresponding reduction in the capacity of traditional accounting and reporting systems to reflect organisational performance, new demands from employees as to their work environments, from customers as to ecological and ethical sensitivity, from civil society and governments as to social and environmental accountability etc. A result is a major shift in the way organisations are choosing to observe themselves and to describe, measure, evaluate and report on their performance. From a focus on efficiency and control to a values-based perspective on management, corporate identity and success. And from a focus on legal compliance and financial performance to a focus on corporate social and ethical responsibility and accountability. The introduction provides a background for this transformation while the body of the paper motivates the on-going shift from control to values-based management. The article concludes with reflections on corporate accountability and the emerging practices of social and ethical accounting, auditing and reporting.     

Firm-specific information and the efficiency of investment

In the three-year period following stock market liberalizations, the growth rate of the typical firm's capital stock exceeds its pre-liberalization mean by an average of 4.1 percentage points. Cross-sectional changes in investment are significantly correlated with the signals about fundamentals embedded in the stock price changes that occur upon liberalization. Panel-data estimations show that a 10-percentage point increase in a firm's expected future sales growth predicts a 2.9- to 3.5-percentage point increase in the growth rate of its capital stock. Country-specific changes in the cost of capital drive changes in investment but firm-specific changes in the cost of capital do not.     

Trust and Understanding,Two Psychological Aspects of Randomized Response

This study examines two different Randomized Response methods to see whether they evoke sufficient understanding and trust, and ensure fewer evasive answers to socially sensitive questions. Two Randomized Response methods were employed by trained interviewers to study fraud: the Forced Response method, using dice, and Kuk's method, using playing cards. Respondents were selected from the files of the social security offices of three Dutch cities. A total of 334 respondents participated voluntarily in this study of two Randomized Response methods. Most respondents were known to have committed some form of fraud, and their answer on the Randomized Response question is validated with this information. The results indicate that subjects who have a better understanding of the Forced Response technique give more socially undesirable answers. The interviewer has a most important role establishing trust and understanding. Respondents who are less able to understand the instructions, e.g., have limited language abilities, develop less trust in the method.     

Single-peakedness and coalition-proofness

We prove that multidimensional generalized median voter schemes are coalition-proof. Received: 16 July 1998 / Accepted 23 March 1999     

The Combination Strategy to Optimal Target Selection and Offer Segmentation in Direct Mail

The optimization of direct mail activities generally focuses separately on the issues of target selection and the selection of the strongest offer. In this paper we propose a combination strategy of the two practices through a response model which makes target selection specific to an offer. This combination strategy promises significantly higher profits than does the typical two-stage strategy.     

Political Stock Markets and Unreliable Polls

A political stock market (PSM) clearly beat the polls in predicting the outcome of a Swedish referendum on whether or not Sweden should join the European Union. In fact, polls were unable to make such predictions since the number of undecided respondents always far exceeded the observed YES/NO margin. However, an obstacle to PSMs serving as a superior forecasting instrument is that they can be sensitive to price distortions - by interest groups that may wish to effectuate, and pay for, such distortions - or forecast competitions tied to PSM trade gains, the latter of which was tested here.