A mean-variance framework for tests of asset pricing models

This article presents a mean-variance framework for likelihood-ratiotests of asset pricing models. A pricing model is tested byexamining the position of one or more reference portfolios insample mean-standard-deviation space. Included are tests ofboth single-beta and multiple-beta relations, with or withouta riskless asset, using either a general or a specific alternativehypothesis. Tests with a factor that is not a portfolio returnare also included. The mean-variance framework is illustratedby testing the zero-beta CAPM, a two-beta pricing model, andthe consumption-beta model.     

Do small shareholders count?

We hypothesize that age similarity among small shareholders acts as an implicit coordinating device for their actions and, thus, could represent an indirect source of corporate governance in firms with dispersed ownership. We test this hypothesis on a sample of Swedish firms during the 1995-2000 period. Consistent with our hypothesis, we find that compared with shareholders of differing ages, same-age noncontrolling shareholders sell more aggressively following negative firm news; firms with more age-similar small shareholders are more profitable and command higher valuation; and an increase (decline) in a firm's small shareholder age similarity brings a significantly large increase (decline) in its stock price. The last effects are more pronounced in the absence of a controlling shareholder.     

Bayesian inference and portfolio efficiency

A Bayesian approach is used to investigate a sample's informationabout a portfolio's degree of inefficiency. With standard diffusepriors, posterior distributions for measures of portfolio inefficiencycan concentrate well away from values consistent with efficiency,even when the portfolio is exactly efficient in the sample.The data indicate the that the NYSE-AMEX market portfolio israther inefficient in the presence of a riskless asset, althoughthis conclusion is justified only after an anslysis using informativepriors. Including a riskless asset significantly reduces anysample's ability to produce posterior distributions supportingsmall degrees of inefficiency.     

The demand for stocks: an analysis of IPO auctions

We analyze a unique dataset that includes the full demand schedulesof 27 Israeli IPOs that were conducted as nondiscriminatory(uniform price) auctions. To the best of our knowledge, thisis the first time the whole demand schedule for any asset isdescribed. The demand schedules are relatively flat around theauction clearing price: The average elasticity is 27. The elasticityis low when the return distribution contains a large uniquecomponent. We also find a significant average abnormal returnof 4.5% on the first trading day and a positive correlationbetween the abnormal return and the elasticity of demand.     

Payments for Order Flow on Nasdaq

We present a model of Nasdaq that includes the two ways in which marketmakers compete for order flow: quotes and direct payments. Brokers in our model can execute small trades through a computerized system, preferencing arrangements with marketmakers, or vertical integration into market making. The comparative statics in our model differ from those of the traditional model of dealer markets, which does not capture important institutional features of Nasdaq. We also show that the empirical evidence is inconsistent with the traditional model, which suggests that preferencing and vertical integration are important components in understanding Nasdaq.     

Expectations and volatility of consumption and asset returns

We find that conditional means and variances of consumptiongrowth vary through time, and this variation appears to be associatedwith the business cycle. A pricing model with fluctuating meansand variances of consumption growth provides implications aboutconditional moments of returns for both short and long investmenthorizons, and these implications are explored empirically. TheU-shaped pattern of first-order autocorrelations of returns,as well as business cycle patterns in the price of risk, appearsto be consistent with the model, but our exploration suggeststhat other implications about conditional return moments areat odds with the data.     

Mutual fund performance evaluation with active peer benchmarks

We propose a simple approach to account for commonalities in mutual fund strategies that relies solely on information on fund returns and investment objectives. Our approach augments commonly used factor models with an additional benchmark that represents an equal investment in all same-category funds, which we call an active peer benchmark (APB). We find that APBs substantially reduce the average time series correlation of residuals between individual funds within a group when added to a four-factor equity model (or to a seven-factor fixed-income model). Importantly, adding this APB significantly improves the selection of funds with future outperformance.     

Limit Order Book as a Market for Liquidity

We develop a dynamic model of a limit order market populatedby strategic liquidity traders of varying impatience. In equilibrium,patient traders tend to submit limit orders, whereas impatienttraders submit market orders. Two variables are the key determinantsof the limit order book dynamics in equilibrium: the proportionof patient traders and the order arrival rate. We offer severaltestable implications for various market quality measures suchas spread, trading frequency, market resiliency, and time toexecution for limit orders. Finally, we show the effect of imposinga minimal price variation on these measures.     

Effects of Market Reform on the Trading Costs and Depths of Nasdaq Stocks

The relative merits of dealer versus auction markets have been a subject of significant and sometimes contentious debate. On January 20, 1997, the Securities and Exchange Commission began implementing reforms that would permit the public to compete directly with Nasdaq dealers by submitting binding limit orders. Additionally, superior quotes placed by Nasdaq dealers in private trading venues began to be displayed in the Nasdaq market. We measure the impact of these new rules on various measures of performance, including trading costs and depths. Our results indicate that quoted and effective spreads fell dramatically without adversely affecting market quality.