Abstracts of Volume 41, Number 4, November 2006
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Optimal Incentive Contracts for Loss-Averse Managers:
Stock Options vs. Restricted Stock Grants
Anna Dodonova, Yuri Khoroshilov
Initial Public Offerings: CFO Perceptions
James C. Brau, Patricia A. Ryan,
Irv DeGraw
Dynamic Interactions among the Stock Market, Federal
Funds Rate, Inflation and Economic Activity
Nikiforos T. Laopodis
The Equity Premium: Consistent with GDP Growth and
Portfolio Insurance
Christophe Faugère, Julian Van
Erlach
The Risk-Return Relation in International Stock Markets
Hui Guo
Michael A. Kelly
Optimal Incentive
Contracts for Loss-Averse Managers: Stock Options vs.
Restricted Stock Grants
Anna Dodonova, Yuri
Khoroshilov
This paper provides an explanation
for the widespread use of stock option grants in
executive compensations. It shows that the optimal
incentive contract for loss-averse managers must contain
a substantial portion of stock options even when it
should consist exclusively of stock grants for
“classical” risk-averse managers. The paper also
provides an explanation for the drastic increase in the
risk-adjusted level of CEO compensations over the past
two decades and argues that more option-based
compensation should be used in firms with higher cash
flow volatility and in industries with higher degree of
heterogeneity among firms.
Keywords: Executive
stock options, incentive compensation, incentive
contract, managerial risk aversion, restricted stock,
behavioral finance
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Initial Public Offerings: CFO Perceptions
James C. Brau,
Patricia A. Ryan, Irv DeGraw
We examine four issues pertaining
to IPOs using a survey of 438 CFOs. First, why do firms
go public? Second, is CFO sentiment stationary across
bear and bull markets? Third, what concerns CFOs about
going public? Fourth, do CFO perceptions correlate with
returns? Results support funding for growth and
liquidity as the primary reasons for IPOs. CFO sentiment
is generally stationary in pre- and post-bubble years.
Managers are concerned with the direct costs of going
public, such as underwriting fees, as well as indirect
costs. We find a negative relation between a focus on
immediate growth and long-term abnormal returns.
Keywords: IPOs,
initial public offerings, equity offering, survey, chief
financial officer, CFO, perceptions
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Dynamic Interactions among the Stock Market, Federal Funds
Rate, Inflation and Economic Activity
Nikiforos T.
Laopodis
This paper examines the dynamic
interactions among the equity market, economic activity,
inflation, and monetary policy under three monetary
policy regimes using bivariate and multivariate Vector
Autoregressive cointegrating specifications. The
bivariate results for the real stock returns-inflation
pair weakly support a negative correlation in the 1970s
and 1980s. While the bivariate findings suggest a weak,
negative relationship between real returns and the
federal funds in the 1970s and 1980s, the multivariate
findings strongly support short-term linkages in the
1970s. There appears to be no consistent dynamic
relationship between monetary policy and stock prices in
that the relationship differs across monetary regimes.
Keywords: Monetary
policy, equity market, inflation, economic activity,
VAR, cointegration, Granger causality
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The Equity Premium: Consistent with GDP Growth and Portfolio
Insurance
Christophe Faugère,
Julian Van Erlach
We find that the long-term equity
premium is consistent with both GDP growth and portfolio
insurance. We use a supply-side growth model and
demonstrate that the arithmetic average stock market
return and the returns on corporate assets and debt
depend on GDP per capita growth. The implied equity
premium matches the U.S. historical average over 1926–
2001. Separately, we find that the equity premium tracks
the value of a put option on the S&P 500. Our theory
predicts a smaller equity premium in the future,
assuming the recent regime shifts in dividend policies,
interest rates, and tax rates are permanent.
Keywords: Equity
premium, GDP growth, T-bills, downside risk, and
portfolio insurance
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The Risk-Return Relation in International Stock Markets
Hui Guo
We investigate the risk-return
relation in international stock markets using realized
variance constructed from MSCI (Morgan Stanley Capital
International) daily stock price indices. In contrast
with CAPM, realized variance by itself provides
negligible information about future excess stock market
returns; however, we uncover a positive and significant
risk-return tradeoff in many countries after controlling
for the (U.S.) consumption-wealth ratio. U.S. realized
variance is also significantly related to future
international stock market returns; more importantly, it
always subsumes the information content of its local
counterparts. Our results indicate that stock market
variance is an important determinant of the equity
premium.
Keywords: capital
market integration, stock return predictability,
out-of-sample forecasts
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Michael A. Kelly
We present a faster, more accurate
technique for estimating implied volatility using the
standard partial derivatives of the Black-Scholes
option-pricing formula. Beside Newton-Raphson and slower
approximation methods, this technique is the first to
provide an error tolerance, which is essential for
practical application. All existing non-iterative
approximation methods do not provide error tolerances
and have the potential for large errors.
Keywords: options,
implied volatility
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