We use a unique data set to consider whether a large institution’s (Fidelity Funds) insider trades are informed. Theoretical studies of large informed traders suggest that their information advantage could be greater for buy trades than sell trades, be short- or long-lived, and be exploited by varying the pace of trade execution. Although there is evidence of each of these, Fidelity seems to be informed only for quickly executed buy trades. Other trades outperform a stock market index but not a four-factor return model. This performance profile is consistent with Fidelity’s fees, which depend on performance compared to an index.

Keywords: institutional insider, informed trades, Fidelity, mutual fund, incentive fees

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Hedging, Financing and Investment Decisions

Chen-Miao Lin, Stephen D. Smith

We empirically investigate the interactions among hedging, financing and investment decisions. We argue that the way in which hedging affects a firm’s financing and investing decisions differs for firms with different growth opportunities. We find that high growth firms increase their investment, but not leverage, by hedging. However, we also find that firms with few investment opportunities use derivatives to increase their leverage.

Keywords: Hedging, risk management, capital expenditures, capital structure

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Cash Flows and Discount Rates, Industry and Country Effects and Co-Movement in Stock Returns

John Ammer, Jon Wongswan

We apply the Campbell (1991) decomposition to industry-by-country, national, global industry, and world stock index returns, using 1995-2003 data. World, global industry, and country factors are all important for each of the two key components of stock returns: news about future dividends and news about future discount rates. Furthermore, the world component of future discount rates is more important than the idiosyncratic component, while the reverse is true for news about future dividends. Our results are broadly consistent with co-movement in future discount rates arising from perceptions of common elements of risk in international equity markets.

Keywords: International stock market integration, financial globalization

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The Agency Structure of Loan Syndicates

Pascal François, Franck Missonier-Piera

Leaders of loan syndicates often delegate some administrative tasks to banks known as co-agents. One reason is that co-agents are specialized banks that help split the costs of managing the syndicate. Another reason is that co-agents monitor the leader on behalf of syndicate members to mitigate informational asymmetry problems. Large sample tests on the Dealscan database provide support for both arguments. Evidence of repeated contracting between the same banks explains the moderate magnitude of monitoring effects.

Keywords: Loan syndication; Monitoring; Bank specialization; Co-agents

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Discounting Mean Reverting Cash Flows with the Capital Asset Pricing Model

Carmelo Giaccotto

Discounting cash flows requires an equilibrium model to determine the cost of capital. The CAPM of Sharpe (1964) and the intertemporal asset pricing model of Merton (1973) offer a theoretical justification for discounting at a constant risk adjusted rate. Two problems arise with this application. First, for mean reverting cash-flows the risk adjustment is unknown, and second, if the present value is compounded forward then the distribution of future wealth is likely right skewed. I develop equilibrium discount rates for cash flows whose level or growth rate is mean reverting. Serial correlation also largely eliminates the skewness problem.

Keywords: CAPM, equilibrium cost of capital, capital Budgeting, Gibbs sampling, Monte Carlo Markov chain

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Convertible Securities, Employee Stock Options and the Cost of Equity

Phillip R. Daves, Michael C. Ehrhardt

We provide a method for calculating the cost of equity and the cost of capital in the presence of convertible securities and employee stock options. We demonstrate how this approach can be applied if a company already has issued convertible claims or if it is considering doing so for the first time. We provide several numerical examples illustrating the significance of errors in estimating the cost of capital that can result when (1) employee stock options are ignored or (2) the observable stock price is used as a proxy for the unobservable underlying asset.

Keywords: Convertible bonds, executive stock options, cost of equity, cost of capital, dilution, warrants

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Price Clustering on the Tokyo Stock Exchange

Aslı Aşçıoğlu, Carole Comerton-Forde, Thomas H. McInish

This paper examines price clustering on the Tokyo Stock Exchange. Regardless of tick and lot size, prices ending in zero and five are the most popular. The TSE has no market makers or direct negotiation between traders; therefore, clustering is not explained by collusion or negotiation. Our evidence supports the attraction hypothesis. Clustering also extends to order book depth. There is evidence of strategic trading behavior as traders place orders one price tick better than zero and five to avoid queuing orders at prices ending in these digits. Strategic trading behavior declined and clustering increased when the market became anonymous.

Keywords: Price clustering, depth clustering, limit order market, Tokyo Stock Exchange, anonymity

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A New Variance Ratio Test of Random Walk in Emerging Markets: A Revisit

Osamah M. Al-Khazali, David K. Ding, Chong Soo Pyun

Using Wright’s (2000) nonparametric variance-ratio (VR) test, we revisit the empirical validity of the random walk hypothesis in eight emerging markets in the Middle East and North Africa (MENA). After correcting for measurement biases caused by thin and infrequent trading prevalent in nascent and small stock markets, we cannot reject the random walk hypothesis for the MENA markets. We conclude that Wright’s nonparametric VR test is appropriate for emerging stock markets, and argue that our findings can reconcile previously contradictory results regarding the efficiency of MENA markets.

Keywords: Emerging stock markets, random walk hypothesis, Middle East and North Africa (MENA) stock markets, market efficiency, nonparametric variance ratio tests, thin trading

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