Nai-fu Chen

ECONOMIC FORCES AND THE STOCK MARKET

This paper tests whether innovations in macroeconomic variables are risks that are rewarded in the stock market. Financial theory suggests that the following macroeconomic variables should systematically affect stock market returns: the spread between long and short interest rates, expected and unexpected inflation, industrial production, and the spread between high- and low-grade bonds. We find that these sources of risk are significantly priced. Furthermore, neither the market portfolio nor aggregate consumption are priced separately. We also find that oil price risk is not separately rewarded in the stock market.

Risk and Return of Value Stocks

The authors find that value stocks are riskier because they are usually firms under distress, have high financial leverages, and face substantial uncertainty in future earnings. These risk characteristics are as powerful as are size and book-to-market in explaining cross-sectional differences in return in Pacific Rim markets. Value stocks offer reliably higher returns in the United States, Japan, Hong Kong, and Malaysia, corresponding to the higher risk, but not in the high-growth markets of Taiwan and Thailand because the spread of risk between small high-book-to-market stocks and big low-book-to-market stocks is small. Copyright 1998 by University of Chicago Press.

A Comparison of Single and Multifactor Portfolio Performance Methodologies

A comparison of single and multifactor portfolio performance methodologies using Value Line and size-ranked portfolios indicates that although both methodologies provide unbiased estimates of portfolio performance, there are systematic differences in the power of the two methodologies. The predictive power of the multifactor methodology is superior for well-diversified portfolios but inferior for less diversified portfolios.

Convertible Bond Underpricing: Renegotiable Covenants, Seasoning, and Convergence

We investigate the long-standing puzzle on the underpricings of convertible bonds. We hypothesize that the observed underpricing is induced by the possibility that a convertible bond might renegotiate on some of its covenants, e.g., an imbedded put option in financial difficulties. Consistent with our hypothesis, we find that the initial underpricing is larger for lower rated bonds. The underpricing worsens if the issuer experiences subsequent financial difficulties. However, conditional on no rating downgrades, our main empirical result shows that convertible bond prices do converge to their theoretical prices within two years. This seasoning period is shorter for higher rated convertible bonds.

An Intertemporal Currency Board

The paper shows that the traditional wisdom of raising interest rates to defend a currency enriches rather than punishes the speculators. Furthermore, using high interest rates as a currency defense tool often produces the opposite effect in times of crisis. A new approach is proposed of using Hong Kong dollar “put” options as an explicit commitment by the government. The put option itself acts like an intertemporal currency board in keeping the linked exchange rate over time. This costly signaling produces a separating equilibrium that distinguishes the strength of the Hong Kong dollar from the other Asian currencies that were under pressure in 1997.

The Hong Kong Currency Board During the 1997–8 Crisis: Problems and Solutions

The note-based Hong Kong currency board was ineffective in dealing with currency speculations at the start of the Asian financial crisis in 1997. The makeshift modification implemented by the Hong Kong Monetary Authority imposed implicit controls on the capital outflow and produced high and volatile interest rates. There are simple solutions. We examine the merits and evidence related to the issuance of currency put options by the monetary authority as a commitment against devaluation. Furthermore, a simple mechanism linking the domestic credit demand to the reserve currency base will induce proper interest-rate dynamics for a currency board to function properly.