Dan W. French

The weekend effect on the distribution of stock prices: Implications for option pricing

Abstract Evidence of weekend effects on the distribution of security returns suggests that returns are generated by a process operating closer to trading time rather than calendar time. In contrast, accumulation of interest over the weekend follows a calendar-time process. Since both the variance of returns and the interest rate are important parameters of the Black-Scholes option pricing model, this paper suggests that the model be stated to account for this by utilizing a trading-time variance and a calendar-time interest rate. Empirical evidence indicates that this allows the model to better explain market option prices.

Current investor expectations and better betas

-I¶ F ecent debate on the ability of beta to capl2 e ? R 5 ture the riskiness of an asset has evolved in two different directions: 1) the validity of beta in relation to the Capital Asset Pricing Model (CAPM), and 2) the use of beta as a means of foretasting asset returns. The former is a fundamental theoretical issue that we leave for others to deliberate [15]. The latter, however, is an applied problem faced by practitioners who ask: Can investors use beta to estimate future security and portfolio returns?

Does Price Discreteness Affect the Increase in Return Volatility Following Stock Splits

Stock return volatility tends to increase significantly following stock splits. One potential cause of this is the trading of stocks in discrete price intervals called ticks. This study provides a direct test of price discreteness as a determinant of this phenomenon by examining variance increases before and after the 1997 date when the exchanges reduced the tick size from 1/8 to 1/16. Results generally show that the post-split variance increase was unaffected by the reduction in tick size even after controlling for other factors. AMEX stocks proved the exception, with slightly lower variance increases following the tick size reduction. Copyright 2002 by the Eastern Finance Association.

The characteristics of interest rates and stock variances implied in option prices

Abstract Using the Black-Scholes option pricing model, this study simultaneously estimates stock return variances and interest rates implied in market option prices. Results show that the shorter term options exhibit greater implied stock variances than do longer term options. Implied interest rates, however, appear to be constant over the different expirations. Overall, the implied interest rates exhibited higher correlations with Treasury bill rates than with other money market rates, but they were consistently about one-fourth higher than the Treasury bill rates.

Are Short Sellers Informed? Evidence from REITs

This paper uses intraday short sale data to examine whether short sellers of Real Estate Investment Trusts (REITs) are informed. We find strong evidence that short selling predicts future returns of REITs. Heavily shorted REITs significantly underperform lightly shorted REITs by approximately 1% over the following 20 trading days. This predictive relation holds for both small and large trades, but is stronger for large short trades. We also document a positive relation between shorting activity and volatility. Our results are consistent with the view that short sellers of REITs are informed and contribute to market efficiency by impounding information into prices.

NYSE execution costs: A case study of a leading bank

Using trade data obtained from a major bank and a measure of indirect execution costs based on the stock price when orders are placed, we investigate indirect costs and their relation to brokerage commissions. For all trades the mean brokerage commission is 6.5 cents per share, and the mean indirect execution cost is about 3.6 cents per share, or 0.1084% of the transactions amount. Contrary to the prediction of the price pressure hypothesis, indirect execution costs are lower for larger size trades. Further, higher indirect execution costs are not associated with lower brokerage commission.

The measurement of option mispricing

Abstract Different studies have examined the ability of the Black-Scholes option pricing model to estimate accurately market prices of publicly traded options and reached conflicting results. This study examines commonly used ex ante measures of option mispricing, finds that they can produce differing conclusions about option prices, and develops an alternative measure for gauging option mispricing. Empirical analysis of returns to options selected using the various mispricing measures indicates that this new measure is more likely to detect mispricing and identify options that yield excess returns before commissions.

Managerial actions and stock transactions during financial distress: Some empirical evidence

Should the current managers remain in control of the firm during financial distress? We address this issue by examining whether managers who take value-maximizing actions also refrain from abnormal selling of their own shares in the firm. Our empirical results show that managers in the action firms do not engage in abnormal selling even during periods of frequent earnings losses. These managers exhibit higher net purchases than the nonaction managers. Thus, trading behavior of the managers and the actions taken during poor performance both appear to be consistent with stockholder interests.

The Impact of Exchange Listing on Corporate Governance: Evidence from Direct Listings

Direct listing offers a new, but unproven method of going public for industrial firms. We use prior direct listings by public non-listed REITs (PNLRs) as laboratory to explore the impact of exchange membership on the corporate governance resulting from these transactions. To that end, we examine companies with publicly owned, but non-listed shares in a unique setting where the impacts of listing are distinct from the confounding effect of capital raising inherent in a traditional IPO. Our evidence suggests that younger, more profitable PNLRs with better governance and professional management are more likely to directly list. Moreover, we find that internal corporate governance improves beyond the exchange’s requirements upon listing. The data indicates institutional ownership increases following the listing and we confirm these changes are not due capital raising.

Passive Institutional Ownership, R2 Trends, and Price Informativeness

A distinctive trend in the capital markets over the past two decades is the rise in equity ownership of passive financial institutions. We propose that this rise has a negative effect on price informativeness. By not trading around firm-specific news, passive investors reduce the firm-specific component of total volatility and increase stock correlations. Consistent with this hypothesis, we find that the growth in passive institutional ownership is robustly associated with the growth in market model R2s of individual stocks since the early 1990s. Additionally, we find a negative relation between passive ownership and earnings predictability, an informativeness proxy.