Martin J. Gruber

Explaining the Rate Spread on Corporate Bonds

The purpose of this article is to explain the spread between spot rates on corporate and government bonds. We find that the spread can be explained in terms of three elements: (1) compensation for expected default of corporate bonds (2) compensation for state taxes since holders of corporate bonds pay state taxes while holders of government bonds do not, and (3) compensation for the additional systematic risk in corporate bond returns relative to government bond returns. The systematic nature of corporate bond return is shown by relating that part of the spread which is not due to expected default or taxes to a set of variables which have been shown to effect risk premiums in stock markets Empirical estimates of the size of each of these three components are provided in the paper. We stress the tax effects because it has been ignored in all previous studies of corporate bonds.

Marginal Stockholder Tax Rates and the Clientele Effect

T HE determination of marginal stockholder tax brackets is an important and unresolved issue in the economic literature. Marginal stockholder tax brackets play an important role in stock valuation models [ 1, 6, 14], in normative investment and dividend policy models [11, 16], and in descriptive capital allocation models [ 7, 8, 10, 12 ]. The purpose of this paper is to present and test a method of determining marginal stockholder tax brackets and to explore the implications of our findings for corporate investment policy, corporate dividend policy, and the assumption of market rationality. In the first section of this paper we expand upon the reasons for studying marginal stockholder tax brackets. In the next section we show how marginal stockholder tax brackets can be inferred from the ex-dividend behavior of common stock. In the third and fourth sections we compute marginal stockholder tax brackets and discuss their implications for capital theory.

The persistence of Risk-adjusted Mutual Fund Performance

The authors examine predictability for stock mutual funds using risk-adjusted returns. They find that past performance is predictive of future risk-adjusted performance. Applying modern portfolio theory techniques to past data improves selection and allows the authors to construct a portfolio of funds that significantly outperforms a rule based on past rank alone. In addition, they can form a combination of actively managed portfolios with the same risk as a portfolio of index funds but with higher mean return. The portfolios selected have small but statistically significant positive risk-adjusted returns during a period where mutual funds in general had negative risk-adjusted returns. Copyright 1996 by University of Chicago Press.

Modern Portfolio Theory, 1950 to Date

Portfolio theory is a well-developed paradigm. There are excellent textbooks on the subject. Of course, we are especially partial to our own

Professionally Managed, Publicly Traded Commodity Funds

Investment in professionally-managed, publicly-traded commodity funds has grown rapidly in recent years. This is the first comprehensive study of the performance of these funds. It is found that randomly selected funds offer neither an attractive alternative to bonds nor a profitable addition to a portfolio of stocks and bonds. Furthermore, past performance of these funds offers very little information about future performance. The findings may be explained by the large transactions costs incurred by these funds and their primary reliance on technical analysis. Copyright 1987 by the University of Chicago.

The Adequacy of Investment Choices Offered By 401K Plans

Defined-contribution plans represent a major organizational form for investors’ retirement savings. Today more than one third of all workers are enrolled in 401K plans. In a 401K plan, participants select assets from a set of choices designated by an employer. For over half of 401K-plan participants, retirement savings represent their sole financial asset. Yet to date there has been no study of the adequacy of the choices offered by 401K plans. This paper analyzes the adequacy and characteristics of the choices offered to 401K-plan participants for over 400 plans. We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%. We find that funds included in the plans are riskier than the general population of funds in the same categories. We study the characteristics of plans that are associated with adequate investment choices, including an analysis of the use of company stock, plan size, and the use of outside consultants. When we examine one category of investment choices, S&P 500 index funds, we find that the index funds chosen by 401K-plan administrators are on average inferior to the S&P 500 index funds selected by the aggregate of all investors.

The Rationality of Asset Allocation Recommendations

The popular finance literature describes the asset allocation decision as one of the most important factors in determining investment performance. This article reviews the implications of modern portfolio theory for the asset allocation decision and then examinesthe recommendations of some leading financial experts to see if they are consistent with theory.

Marginal Stockholder Tax Effects and Ex-Dividend-Day Price Behavior: Evidence From Taxable Versus Nontaxable Closed-End Funds

Almost all research on the movement of stock prices on ex-dividend days has found that prices decline by less than the dividend. Though this is consistent with tax effects, several papers have argued that this phenomenon could be caused by market microstructure effects. In this paper we make use of a natural experiment that provides support for the tax explanations of ex-dividend behavior. Some closed-end funds have taxable, and some have nontaxable, dividend distributions. Both types are subject to taxes on capital gains. The implication of this for ex-dividendday price behavior is very different between these two types of funds if taxes matter. This paper demonstrates that the direction of ex-dividendday price behavior is consistent with a tax explanation and that ex-dividend-day price behavior changes, as theory would suggest, with changes in the tax law.

On the Robustness of the Roll and Ross Arbitrage Pricing Theory

Roll and Ross [6] have written what has quickly become the classic article on testing the Arbitrage Pricing Theory (APT) originally proposed by Ross [8]. They presented methods both for estimating the return generating process and for testing whether particular elements (factors) in the return generating process were priced in equilibrium. They found that more factors are priced than one would expect to be priced if the Capital Asset Pricing Model (CAPM) were held.

COMMON FACTORS IN ACTIVE AND PASSIVE PORTFOLIOS

We are grateful to Micropal for supplying data used in this study.