Option pricing in the presence of natural boundaries and a quadratic diffusion term

This paper uses a probabilistic change-of-numeraire technique to compute closed-form prices of European options to exchange one asset against another when the relative price of the underlying assets follows a diffusion process with natural boundaries and a quadratic diffusion coefficient. The paper shows in particular how to interpret the option price formula in terms of exercise probabilities which are calculated under the martingale measures associated with two specific numeraire portfolios. An application to the pricing of bond options and certain interest rate derivatives illustrates the main results.     

Asset pricing with partial-moments

I bridge the current pricing kernel framework with the early partial-moment pricing models of the beta framework, thereby reconciling and clarifying these bodies of literature. I argue for the inclusion of powers of min and max functions within a generalized kernel, and form a generalized beta model. Polynomial kernels and the kernel underpinning the partial-moment analogue of the Sharpe-Lintner CAPM are nested. I derive the partial-moment analogue to the Black CAPM, thus completing a theoretical parallelism, and compare the kernel-implied and canonical risk-neutral probabilities. A new model involving both lower and upper partial-moments, accommodating various kernel shapes present in the literature, is developed in the context of preference regularity conditions.     

On the relationship between concentration of prospect theory/mental accounting investors,cointegration, and momentum

We examine the role of cointegration between stock prices and their estimated fundamental values in return momentum. We find that the positive relationship between capital gains overhang and future stock returns in Grinblatt and Han (2005) is significantly stronger among the “non-cointegrated” group of stocks as compared with the “cointegrated” group of stocks. Further, for the cointegrated stocks, the slower the speed of adjustment to the cointegrating equilibrium, the greater (smaller) is the future return of stocks with unrealized capital gains (losses). These findings are robust to various firm characteristics including firm size, book-to-market ratio, past returns, idiosyncratic volatility, dispersion in analysts’ earnings forecasts, turnover, individual investor ownership, and industry returns.     

Executive stock options and IPO underpricing

In about one-third of US IPOs between 1996 and 2000, executives received stock options with an exercise price equal to the IPO offer price rather than a market-determined price. Among firms with such “IPO options”, 58% of top executives realize a net benefit from underpricing: the gain from the options exceeds the loss from the dilution of their pre-IPO shareholdings. If executives can influence either the IPO offer price or the timing and terms of their stock option grants, there should be a positive relation between IPO option grants and underpricing. We find no evidence of such a relation. Our results contrast sharply with the emerging literature on managerial self-dealing at shareholder expense.     

Entrenchment,governance, and the stock price reaction to sudden executive deaths

To study managerial entrenchment, I use the stock price reaction to unexpected senior executive deaths. If a highly effective manager dies unexpectedly, the stock price reaction should be negative. If, however, death removes an entrenched manager when the board would or could not, the stock price reaction should be positive. While, individually, age and tenure only weakly correlate with the stock price reaction to a sudden death, the reaction is strongly positive (6.8%) if: (1) the executive’s tenure exceeds 10 years, and (2) abnormal stock returns over the last three years are negative.     

MEASURING EFFECTS ON STOCK RETURNS OF SENTIMENT INDEXES CREATED FROM STOCK MESSAGE BOARDS

Various techniques and sources of information exist to aid investors in predicting future stock returns. However, no effective proxy for retail investors, such as stock message board users, has been established. This study provides guidelines for creating an effective proxy. The heart of such proxies is sentiment indexes, and in the past the indexes have had low predictive power. Introducing four methodological improvements for applying text classifiers and two probability measurements, we contrast eight widely applied text classifiers to stock message board data. Based on the classifier results and incorporating our new methods, the new sentiment index proves to be a significant “same‐day positive but next‐day negative” directional indicator.     

Vertical integration to avoid contracting with potential competitors: Evidence from bankers' banks

We examine a vertical integration decision within the commercial banking industry. During the last quarter of the 20th century, some community banks reduced their traditional reliance on correspondent banks for upstream products and services by joining bankers' banks, a form of business cooperative. Research on vertical integration focuses primarily on firm-specific investment, market power, and government regulation. However, this case is difficult to explain in terms of these standard vertical integration motives. Our evidence suggests that bankers' banks are a response to technological change and deregulation that results in increased costs faced by community banks in dealing with correspondent banks as both suppliers and potential competitors. For instance, loan participations require sharing proprietary information about major loan customers, something a community bank would not want to provide to a potential competitor.     

Consumption-based CAPM models: International evidence

We examine the performance of several types of the consumption-based CAPM (C-CAPM) models to explore if consumption factors matter for determining excess returns across 17 MSCI country indexes. While the classic world C-CAPM does exhibit some power in explaining cross-sectional variations of expected excess returns, the model seems to require an implausibly large coefficient of risk aversion. The more sophisticated models including the heterogeneous C-CAPM, the world surplus consumption and the habit-formation models provide more reasonable estimates and add substantial explanatory power for the variation in the cross section of excess stock returns. Our results suggest that country-specific consumption risk is not fully diversified thus implying that stock returns are related to idiosyncratic consumption risk.     

Does proximity matter in international bond underwriting?

In this study, we analyze a sample of 3982 international bond issues from 31 countries to examine the impact of geographic proximity on the selection of lead underwriter in the international bond market. We find that proximate banks are more likely to lead underwrite risky bonds and non-rated bonds. On average, the total issue cost is lower if the lead underwriter is a proximate bank. The overall results suggest that geographically proximate banks have better access to private information about issuing companies. We also find that the cost reduction effect of proximate underwriting only appears in developed markets. In addition, this cost reduction effect is relatively weak in countries with a legal system that provides good investor protection.