We show that corporate investment decisions can explain the conditional dynamics in expected asset returns. Our approach is similar in spirit to Berk, Green, and Naik (1999), but we introduce to the ...investment problem operating leverage, reversible real options, fixed adjustment costs, and finite growth opportunities. Asset betas vary over time with historical investment decisions and the current product market demand. Book-to-market effects emerge and relate to operating leverage, while size captures the residual importance of growth options relative to assets in place. We estimate and test the model using simulation methods and reproduce portfolio excess returns comparable to the data.
We present a rational theory of SEOs that explains a pre-issuance price run-up, a negative announcement effect, and long-run post-issuance underperformance. When SEOs finance investment in a real ...options framework, expected returns decrease endogenously because growth options are converted into assets in place. Regardless of their risk, the new assets are less risky than the options they replace. Although both size and book-to-market effects are present, standard matching procedures fail to fully capture the dynamics of risk and expected return. We calibrate the model and show that it closely matches the primary features of SEO return dynamics.
We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust ...capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.
We model the debt and asset risk choice of a manager with performance-insensitive pay (cash) and performance-sensitive pay (stock) to theoretically link compensation structure, leverage, and credit ...spreads. The model predicts that optimal leverage trades off the tax benefit of debt against the utility cost of ex-post asset substitution and that credit spreads are increasing in the ratio of cash-to-stock. Using a large cross-section of U.S.-based corporate credit default swaps (CDS) covering 2001 to 2006, we find a positive association between cash-to-stock and CDS rates, and between cash-to-stock and leverage ratios.
Abstract
Levered noise occurs when no-arbitrage replication hedges fundamentals but amplifies price errors. Motivated by our theory, we use widely-available end-of-day OptionMetrics data to improve ...accuracy of synthetic dividend strip prices and provide longer samples than prior studies. Term structure point estimates are approximately flat in simple returns (88 bp/month vs. 87 bp/month for short-term dividends vs. index), and upward-sloping in measurement-error-robust logarithmic returns (43 bp/month vs. 77 bp/month). These results from prominent index options show the importance of diagnosing noise in no-arbitrage prices. Prior conclusions of an average downward slope in the equity term structure are not robust.
We characterize linkages between average returns calculated at different horizons. Theoretically, when stocks incorporate information slowly, average short-horizon returns are downward biased. ...Buy-and-hold strategies can amplify the effect. In contrast, existing theories analyze price noises that are independent of fundamentals, and buy-and-hold portfolio returns are unaffected. We document horizon effects as large as 10% annualized in daily and monthly style portfolios and international indices. Slow reaction to market information, identified by gradually declining lagged betas, is an important cause. These findings have natural consequences for performance evaluation.
Unconditional alphas are biased when conditional beta covaries with the market risk premium (market timing) or volatility (volatility timing). We demonstrate an additional bias (overconditioning) ...that can occur any time an empiricist estimates risk using information, such as a realized beta, that is not available to investors ex ante. Calibrating to U.S. equity returns, volatility timing and overconditioning can plausibly impact alphas more than market timing, which has been the focus of prior literature. To correct market- and volatility-timing biases without overconditioning, we show that incorporating realized betas into instrumental variables estimators is effective. Empirically, instrumentation reduces momentum alphas by 20–40%. Overconditioned alphas overstate performance by up to 2.5 times. We explain the sources of both the volatility-timing and overconditioning biases in momentum portfolios.
► Volatility timing can significantly bias unconditional alpha estimates. ► Nonlinear payoffs bias alphas if beta estimates are outside investor information. ► Instrumenting with realized betas is effective in reducing alpha bias. ► Momentum betas are low when expected volatility is high. ► Conditional momentum alphas are 25 basis points lower than unconditional alphas.
SEO Risk Dynamics Carlson, Murray; Fisher, Adlai; Giammarino, Ron
The Review of financial studies,
11/2010, Letnik:
23, Številka:
11
Journal Article
Recenzirano
We theoretically and empirically investigate firm-level risk dynamics around seasoned equity offerings (SEOs). Empirically, beta increases before SEOs and decreases gradually thereafter. Using real ...options theory, commitment-to-invest generates a gradual postissuance beta decline whereas instantaneous investment and time-to-build do not. In a behavioral theory, systematic mispricing can cause increasing pre-issuance and decreasing post-issuance risk but idiosyncratic mispricing cannot. In the empirical cross-section, investment, own-firm runup, SEO proceeds, and primary issuance—associated with the real options theory—predict beta declines. Sentiment proxies have weaker effects in the full sample, but are significant in a post-1996 subsample. SEOs coincide with low firm-and market-volatility, suggesting volatility-timing in corporate decisions.
We develop equilibrium models of exhaustible resource markets with endogenous extraction choices and prices. Our analysis demonstrates how adjustment costs can generate oil and gas forward price ...dynamics with two factors, consistent with the behavior these commodities exhibit in the Schwartz and Smith (2000) calibration. Our two-factor model predicts that stochastic volatility will arise in these markets as a natural consequence of production adjustments, however, and we provide supporting empirical evidence. Differences between endogenous price processes from our general equilibrium model and exogenous processes in earlier papers can generate significant differences in both financial and real option values.
Why constrain your mutual fund manager? Almazan, Andres; Brown, Keith C.; Carlson, Murray ...
Journal of financial economics,
08/2004, Letnik:
73, Številka:
2
Journal Article
Recenzirano
We examine the form, adoption rates, and economic rationale for various mutual fund investment restrictions. A sample of U.S. domestic equity funds from 1994 to 2000 reveals systematic patterns in ...investment constraints, consistent with an optimal contracting equilibrium in the fund industry. Restrictions are more common when (i) boards contain a higher proportion of inside directors, (ii) the portfolio manager is more experienced, (iii) the fund is managed by a team rather than an individual, and (iv) the fund does not belong to a large organizational complex. Low- and high-constraint funds produce similar risk-adjusted returns, also consistent with an optimal contracting equilibrium.
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