Duane Stock

Human Judgment Accuracy, Multidimensional Graphics, And Humans Versus Models

Human judgment accuracy, human information processing, and decision-making aids are topics that have received considerable attention from accounting researchers (see Ashton [1982] and the references cited therein). Generally speaking, the accuracy of human judgment appears to be low (e.g., Ashton [1982, p. 30]), perhaps reflecting the inability of humans optimally to combine multiple sources of information under uncertainty. Three basic options for improving decisions have been outlined by Libby [1981, p. 101]: (1) change the presentation and amount of information, (2) educate the decision maker, and (3) replace the decision maker with a model. The impact of changing the presentation of accounting information on human judgment accuracy has received surprisingly little attention from financial accountants and auditors (see Libby [1981, p. 117]). One option for varying the report format of multiple sources of data is the use of multidimensional graphics in the form of schematic faces (see Chernoff [1973]). Moriarity and Roach [1977] and Huff, Mahajan, and Black [1981] have described the mechanics of constructing multidimensional graphics in the form of faces, and Moriarity [1979] applied such graphics to financial data. While the application of multidimensional graphics in accounting may be fruitful, it is still relatively

Issue size and term-structure segmentation effects on regional yield differentials in the municipal bond market

Abstract This study extends the debate regarding segmentation influences in the market for municipal securities. In particular, it provides empirical evidence that relative security supplies, differential pledging requirements, and differential state personal income taxes produce systematic differences in municipal borrowing costs across states. These influences vary by issue size and term to maturity.

Term structure effects on default risk premia and the relationship of default-risky tax-exempt yields to risk-free taxable yields -- a note

Abstract The behavior of the default risk premium on bonds has caught the attention of many researchers. Some researchers have analyzed how default risk premia may vary with maturity. It has been suggested that default risk premia are independent of maturity; however, recent research by Rodriguez (1988) shows this to not hold for nonpar taxable bonds. This research shows that the shape of the underlying term structure affects default risk premia for even par bonds in a systematic way. Furthermore, the maturity-dependent variation in equilibrium tax rates has a strong impact upon default risk premia behavior where equilibrium tax rates are derived from comparisons of taxable and tax-exempt bonds. The inclusion of the shape of the underlying term structure also has very important implications for the relation between taxexempt yields and taxable yields. The slope and intercept terms of the relation between taxexempt and taxable yields are clearly dependent upon maturity, a fact which has not been recognized before.

Impact of Call Features on Corporate Bond Yields

Financial research has often found that the impact of a call provision on bond required yield is statistically insignificant, despite the fact that fundamental theory maintains that optionality controlled by the issuer should increase the required yield. Theories of why issuers include a call provision suggest a possible explanation in that call provisions may reduce agency costs and provide signaling effects. These agency and signaling effects may serve to reduce the required yield, thus offsetting the conventional optionality effects of the call. This research supports this view—inclusion of a call provision does signal positive prospects.

The Effect of Interest Rates on the Value of Corporate Assets and the Risk Premia of Corporate Debt

A growing number of papers have applied option pricing techniques to the valuation of risky debt. This paper deals directly with how a firms relationship to interest rates affects its debt. A sequential binomial model is used to price the zero-coupon bonds of a firm whose value is related to interest rate changes.The results show that the strength of the relationship between firm value and interest rates (interest-rate risk) can have a significant impact on the value of a firms debt. The model produces its most powerful results when the volatility of firm value is high and the term structure has a steep (negative or positive) slope; there is no impact when the term structure is flat. Our results indicate that empirical studies of yield spreads may have severe shortcomings if the relationship of firm value to interest rate changes is ignored.

An analysis of implied tax rates on long-term taxable and tax-exempt bonds

Abstract We examine the impact of differences in interest rate volatility, the taxation of capital gains and losses, callability, the Tax Reform Act of 1986, corporate and personal tax rates, and the value of the tax-timing option on the quilibrium yield relationship between long-term tax-exempt and taxable bonds. Tax consequences of each of these factors for investors potentially influence the implied tax rate associated with tax-exempt and taxable bonds. Using monthly data from 1957 through 1988 we estimate time series regression equations that relate the ratio of par yields on 20-year and 30-year tax-exempt and Treasury securities to these tax and volatility factors. The empirical results indicate that (1) increased volatility of municipal yields had a strong, positive impact on the equilibrium yield ratio, (2) changes in marginal personal income tax rates negatively affected the yield ratio; and (3) changes in the Treasury yield curve slope negatively influenced the yield ratio. None of these factors affected the yield ratio differently after 1986.

The Sensitivity of Corporate Bond Volatility to Macroeconomic Announcements

We examine volatility of returns for corporate bonds around the days when macroeconomic announcements are made. We find that all corporate investment grade (CIG) bonds earn positive announcement-day excess returns, which increase monotonically with maturity. CIG bond excess returns exhibit strong GARCH effects with highly persistent nonannouncement shocks. Volatility is twice as high on announcement days for CIGs where the announcement effect decreases with maturity. Unlike general (nonannouncement) shocks, announcement-day shocks do not persist and only affect announcement-day conditional variance. Furthermore, the dissipation process for CIGs is different from the one for Treasuries, suggesting that hedging CIGs with Treasuries will not be effective on days immediately after announcement. High yield (HY) bonds behave quite differently around macroeconomic announcements than CIG and Treasuries of corresponding maturity. In addition, we find quite strong evidence of asymmetric volatility for CIG and HY bonds where the asymmetric effect is negative for CIG but positive for HY. These asymmetry results are in contrast to weak asymmetry found for Treasury bonds.

Models of Conditional Variance for Bond Prices

Evidence of predictability of financial time series along with recent advances in modeling time dependent conditional variance clearly call for incorporating such theory into expressions for expected bond price changes and variance of price changes. Thus, we derive new first and second order expressions for conditional variance of price change based on these advances. Among other things, we express conditional variance of price changes as a combination of innovations in simultaneously estimated expected change in yield and conditional variance of yield change. Also, we examine how conditional variance is affected by duration, yield volatility, expected change in yield, and convexity. Portfolio managers can use the results to enhance expected performance analysis. For example, in contrast to many theoretical papers, we find that variance of price changes depends on bond convexity. Bond portfolio managers should thus reassess the role convexity plays in their portfolio choices. That is, they may wish to be compensated for positive convexity in terms of greater expected return or required yield.

The Optimal Redemption Schedule of Serial Municipal Debt: A Dynamic Reconciliation of Revenues, Reinvestment Rates and the Term Structure

The purpose of our research is to developan algorithm that optimally schedules municipaldebt redemptions. It is our hypothesis thatsegmented investor demand, the existing termstructure, the temporal behavior of municipalproject revenues and reinvestment opportunitiesfor interim revenue surpluses are all factorswhich should impact the optimal debt schedulingproblem in a unique and economically meaningfulway. For example, investor preference for shortermaturities and an upward sloping term structureof interest rates should, ceteris paribus,increase the proportion of debt scheduled to berepaid early in the redemption horizon. Ifinvestor demand is limited to a relatively smallgeographic area, such limited demand should bereflected in higher yields. If municipal projectrevenues increase over time then a largerproportion of the debt should be scheduled to beredeemed later. Unfortunately, realisticacknowledgements of the nature of the municipaldebt financing problem create an objectivefunction and a set of constraints which are fartoo complex to yield simple reduced formpresentations of the optimal principalredemptions. Consequently, solutions to theoptimal debt schedule and tests of theconjectures articulated above weresimulated.

A Structural Model for Optimal Selection of Maturity and Timing of Callable Bond Issuance: Help in Incorporating the Impact of Federal Reserve Policy and other Factors

A major shortcoming of previous structural models of bonds is that they ignore how the complex terms of a call feature interact with default to determine term structures at issuance. A term structure of par coupon yields is different and superior to a term structure based upon the option adjusted spread and, furthermore, is the most useful term structure for firms issuing bonds because it is the most accurate measure of cost of debt. We present a par coupon structural model that can be used as an aid in timing bond issues because some of parameters of the model have been proven to exhibit predictability. One can use the model to incorporate the impact of alternative future Federal Reserve policies for short-term interest rates upon the optimal timing and maturity of corporate bond issuance. We report that par coupon term structures can have distinctly different shapes than other simultaneous term structures, such as those derived from option adjusted spreads where the difference depends on default risk, alternative call features, and the interaction of default risk and call features. As one finding among many, we find that call option value (at issuance) declines as credit quality declines.