Determinants of the Time Series of Earnings and Implications for Earnings Quality*

This paper examines whether differences in accrual accounting methods across balance sheet accounts influence the time‐series process of earnings. We define earnings quality as the responsiveness of earnings to shifts in permanent earnings and predict that responsiveness will increase in a firm's use of variable rate debt, where accruals move directly with shifts in interest rates. We also predict that responsiveness will decrease in a firm's investment in property plant and equipment because depreciation is largely predetermined and does not respond to shifts in opportunity costs. </P><P>To test these hypotheses, we regress earnings on lagged earnings and a proxy for permanent earnings (that is, the implied dividend annuity in lagged equity value). Within the context of an adjustment cost model, this regression captures the responsiveness of earnings by the coefficient on lagged price and by one minus the coefficient on lagged earnings. Consistent with this framework, we find the unconstrained estimated coefficients on these two variables to be negatively correlated. Furthermore, consistent with our hypotheses, we find that the coefficient on lagged earnings (lagged price) is positively (negatively) associated with the relative magnitude and life of fixed assets on the balance sheet and negatively (positively) associated with the relative magnitude of variable rate debt on the balance sheet.</P>     

ECONOMIC FREEDOM VERSUS POLITICAL FREEDOM: CROSS‐COUNTRY INFLUENCES ON CORRUPTION*

Using a well‐known index of corruption, this paper examines the determinants of corruption for a large sample of countries. Specifically, the present study brings empirical evidence to bear on the question of whether economic freedom or political freedom serves as a deterrent to corrupt activity. In particular, does greater economic freedom or greater political freedom yield a more ‘clean’ society? Our results show that greater economic freedom seems to matter more in this regard. Examining different components of economic freedom, we find that not all these components are equally effective in reducing corruption. For instance, monetary policy seems to have a stronger influence on the level of corrupt activity in a country than fiscal policy. Robustness of these findings is checked and policy implications are discussed.     

Testing Volatility Restrictions on Intertemporal Marginal Rates of Substitution Implied by Euler Equations and Asset Returns

The Euler equations derived from intertemporal asset pricing models, together with the unconditional moments of asset returns, imply a lower bound on the volatility of the intertemporal marginal rate of substitution. This paper develops and implements statistical tests of these lower bound restrictions. While the availability of short time series of consumption data often undermines the ability of these tests to discriminate among different utility functions, we find that the restrictions implied by a number of widely studied financial data sets continue to pose quite a challenge to the current generation of intertemporal asset pricing theories.     

Merger Negotiations with Stock Market Feedback

Do preoffer target stock price runups increase bidder takeover costs? We present model‐based tests of this issue assuming runups are caused by signals that inform investors about potential takeover synergies. Rational deal anticipation implies a relation between target runups and markups (offer value minus runup) that is greater than minus one‐for‐one and inherently nonlinear. If merger negotiations force bidders to raise the offer with the runup—a costly feedback loop where bidders pay twice for anticipated target synergies—markups become strictly increasing in runups. Large‐sample tests support rational deal anticipation in runups while rejecting the costly feedback loop.     

Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve

We show that with a unit root in inflation, the new Keynesian Phillips curve (NKPC) implies an unobserved components model with a stochastic trend component and an inflation gap. Our empirical results suggest that with an increase in trend inflation during the Great Inflation, the response of inflation to real economic activity decreases and the persistence of the inflation gap increases due to an increase in the persistence of the unobserved stationary component. These results are in line with the predictions of Cogley and Sbordone ( 2008 ), who show that the coefficients of the NKPC are functions of time‐varying trend inflation.     

Testing the CAPM with Time-Varying Risks and Returns

This paper draws on Engle's autoregressive conditionally heteroskedastic modeling strategy to formulate a conditional CAPM with time-varying risk and expected returns. The model is estimated by generalized method of moments. A CAPM that allows mean excess returns to shift in January survives generalized method of moments specification tests for a number of omitted variables. However, a residual dividend yield component is found to remain in the excess returns of smaller firms. We find significant monthly and quarterly components in the risk premia and beta estimates.