School Of Business Administration: Financial Review

Recent Nobel Prizes to Akerlof, Spence, and Stiglitz motivate this review of basic concepts and empirical evidence on information asymmetry and the choice of debt vs. equity. We first review the literature that holds investment fixed. Then we review capital structure issues related to the adverse investment selection problem of Myers-Majluf. Finally, we discuss the timing hypothesis of capital structure. Empirical studies do not consistently support one theory of capital structure under asymmetry over the others. Thus, the review suggests that additional theoretical contributions are needed to help understand and explain findings in the empirical literature.

Keywords: capital structure, asymmetric information, pecking order hypothesis, timing hypothesis

Sources of Bank Interest Rate Risk

Donald R. Fraser, Jeff Madura, and Robert A. Weigand

Volume 37, No. 3, August 2002, pp. 351-367

We investigate bank stocks’ sensitivity to changes in interest rates and the factors affecting this sensitivity. We focus on whether the exposure of commercial banks to interest rate risk is conditioned on certain balance sheet and income statement ratios. We find a significantly negative relation between bank stock returns and changes in interest rates over the period 1991–1996. We also find that bank characteristics measured from basic financial statement information explain bank stocks’ sensitivity to interest rate changes. These results suggest that bank managers, analysts, and regulators can use this information to assess the relative risk exposure of banks.

Keywords: banks, interest rate risk, financial statements

Determinants of Institutional Responses to Self-Tender Offers

Judith Swisher

Volume 37, No. 3, August 2002, pp. 369-383

I examine how institutional investors respond to self-tender offers for common shares. I find that institutions sell more shares in larger offers and with higher proration factors. Institutions also sell more shares when officer and director holdings are not at risk in the offers. Banks, investment advisors, and other managers respond similarly, selling more shares in larger offers. Although institutions as a group do not respond differently by offer type, insurance companies and investment advisors sell more shares in fixed-price offers. Mutual funds, which differ from other types of institutions, sell more shares for firms with greater increases in leverage.

Keywords: institutional investors, signaling, self-tender offers

Is Off-Board Trading Detrimental to Market Liquidity

Joanne Hamet

Volume 37, No. 3, August 2002, pp. 385-402

Dual trading can have opposite effects: although competition between markets should induce dealers to offer cheaper transactions, market fragmentation could reduce market activity, liquidity, and exchange efficiency. This paper shows that for French stocks traded on the London Stock Exchange’s SEAQ International (SEAQ-I), market activity decreases significantly in the Paris Bourse during UK bank holidays. Thus, SEAQ-I market makers seem to divert a new clientele to the Paris Bourse, which increases both market activity and the breadth of the Bourse’s order book. Also, contrary to the fragmentation hypothesis, dual trading does not seem to increase information asymmetry.

Keywords: dual listing, liquidity, information asymmetry, competition, fragmentation

The Effect of Market Structure on the Incentives to Quote Aggressively: An Empirical Study of Nasdaq Market Makers

Mark Klock, D. Timothy McCormick

Volume 37, No. 3, August 2002, pp. 403-419

We use data on Nasdaq stocks to study arguments that preferencing reduces incentives to quote competitively. We examine a market maker’s volume as a function of various measures of quoting aggressiveness. We find that more aggressive quoting does indeed result in more business. We also examine the relation between volume and quote aggressiveness as a function of the competitiveness. We find that in less (more) competitive markets, increased quote aggressiveness has a smaller (larger) impact on market share. We argue that preferencing arrangements could be more harmful to public investors in markets where competition is weak.

Keywords: quote aggressiveness, order flow, market structure, preferencing, market regulation

Contrarian Investing in a Small Capitalization Market: Evidence from New Zealand

Jim Y.F. Chin, Andrew K. Prevost, and Aron A. Gottesman

Volume 37, No. 3, August 2002, pp. 421-446

This paper investigates the performance of accounting-based contrarian investment strategies in the New Zealand market. The return patterns of these strategies are then related to risk-based and behavioral-based explanations of the contrarian anomaly. Based on our analysis of the risk-return characteristics of the various strategies, we attribute the first year underperformance and second year outperformance of the value portfolios to expectational errors caused by noise trading in the relatively illiquid NZ market. The longer two-year correction process is in contrast to the much larger and more developed US and Japanese markets, where value stock price corrections have been found to occur more rapidly. This provides support for the conjecture that longer horizons are required for value strategies to pay off in imperfectly competitive markets than in competitive markets.

Keywords: portfolio analysis, contrarian investment strategies

An Examination of Conditional Asset Pricing in UK Stock Returns

Jonathan Fletcher

Volume 37, No. 3, August 2002, pp. 447-468

I examine the empirical performance of various specifications of the capital asset pricing model (CAPM) in UK stock returns, using the stochastic discount framework. When the proxy for the market portfolio includes a proxy for labor income growth in addition to the stock market index, the performance of the CAPM improves. The improvement in performance shows in the magnitude and significance of the pricing errors and in the reduced impact of asset characteristics and other factors in the pricing of assets. There is further improvement when I use conditional versions of the models.

Keywords: CAPM, stochastic discount factor

Testing the Random Walk Behavior and Efficiency of the Gulf Stock Markets

Abraham Abraham, Fazal J. Seyyed, and Sulaiman A. Alsakran

Volume 37, No. 3, August 2002, pp. 469-480

Inferences drawn from tests of market efficiency are rendered imprecise in the presence of infrequent trading. As the observed index in thinly traded markets may not represent the true underlying index value, there is a systematic bias toward rejecting the efficient market hypothesis. For the three emerging Gulf markets examined in this paper, correction for infrequent trading significantly alter the results of market efficiency and random walk tests. The Beveridge-Nelson (1981) decomposition of index returns is done to estimate the underlying index.

Keywords: infrequent trading, random walk, market efficiency, emerging markets, Gulf equity markets

The University of Mississippi: School of Business Administration