Measurement of market integration and arbitrage

We develop a measurement theory of market integration, basedon two notions of 'integrated markets'. First, two markets cannotbe perfectly integrated in any sense if one can construct twoportfolios, one from each market, that have identical payoffsbut different prices. In that case, the law of one price isviolated across the markets. Second, they cannot be integratedin a stronger sense if there are cross-market arbitrage opportunities.Two measures of market integration are developed, respectivelyreflecting these notions. The smaller the measures, the moreclosely integrated (in the respective senses) the markets. Amongother things, they are interpreted as measuring pricing discrepancybetween markets.     

Managerial Reaction to Takeover Bids: A Theory of Strategic Resistance

This paper develops a theory to explain the frequently observed resistance offered by the management of target firms to high-premium takeover bids. Contrary to the popular perception of managerial entrenchment at the expense of the shareholders' interests, such resistance may be strategically designed to increase shareholder wealth by threatening to initiate an informal auction process fur the target involving other potential bidders. Remarkably, this strategy can be effective even when it is common knowledge that the other bidders do not have a higher reservation price for the target. The analysis also offers insights into division of takeover gains and several other takeover-related issues.     

Timing and Virtual Observability in Ultimatum Bargaining and “Weak Link” Coordination Games

Previous studies have shown that simply knowing one player moves first can affect behavior in games, even when the first-mover's moves are known to be unobservable. This observation violates the game-theoretic principle that timing of unobserved moves is irrelevant, but is consistent with virtual observability, a theory of how timing can matter without the ability to observe actions. However, this previous research only shows that timing matters in games where knowledge that one player moved first can help select that player's preferred equilibrium, presenting an alternative explanation to virtual observability. We extend this work by varying timing of unobservable moves in ultimatum bargaining games and “weak link” coordination games. In the latter, the equilibrium selection explanation does not predict any change in behavior due to timing differences. We find that timing without observability affects behavior in both games, but not substantially.     

A PRICING OPERATOR-BASED TESTING FOUNDATION FOR A CLASS OF FACTOR PRICING MODELS

This paper develops a cross-market version of factor pricing models. It is shown that exact factor pricing holds across two submarkets with respect to their common factors if and only if the unique pricing operator for the first submarket is equal to that for the other submarket with probability 1. We define an APT measure as the squared distance between the two pricing operators. Then, testing whether this measure is zero is equivalent to testing exact factor pricing across the two submarkets. Since the estimation of this measure does not require parameterizing and extracting the underlying factors, one can test factor pricing models without knowing any factors. In addition, we present a randomization procedure so that one can use it to conduct a more comprehensive investigation on the empirical robustness of factor pricing models.     

Portfolio performance measurement: theory and applications

Any admissible portfolio performance measure should satisfyfour minimal conditions: it assigns zero performance to eachreference portfolio and it is linear, continuous, and nontrivial.Such an admissible measure exists if and only if the securitiesmarket obeys the law of one price. A positive admissible measureexists if and only if there is no arbitrage. This article characterizesthe (infinite) set of admissible performance measures. It isshown that performance evaluation is generally quite arbitrary.A mutual fund data set is also used to demonstrate how the measurementmethod developed here can be applied.     

Estimating the profits from trading strategies

Price improvement is the difference between the execution priceof an order and the quoted bid or ask when the order was submitted.We show that expected price improvement falls off dramaticallyas the size of the order approaches the quoted depth, and becomesnegative for larger orders. This is particularly important forsmall firms because the quoted depths are low. Using quotedspreads and depths and our estimate of expected price improvement,we show that trading strategies that attempt to exploit theweekly predictability of small-firm returns would be swampedby transaction costs.