Performance of Stoll's Spread Component Estimator: Evidence from Simulations, Time-series and Cross-sectional Data
Raymond Brooks
University of Missouri - Columbia
Jean Masson
University of Ottawa
Abstract
Stoll (1989) introduces an intuitive procedure to estimate the basic components of the bid-ask spread (order-processing cost, inventory cost and adverse-selection cost). He also provides reasonable estimates of the magnitudes of the order-processing, inventory, and adverse-selection costs of making markets for a large cross-section of MASDAQ/NMS stocks. Empirical applications of Stoll's model produce widely different estimates of the bid-ask spread components. We derive the sampling properties of Stoll's estimator of the realized bid-ask spread, i.e., the sum of the order-processing and inventory components. We test Stoll's model in simulations, using the ideal conditions implied by the model. We conclude that noise in serial covariance estimates causes estimates of the realized spread to be severely biased and highly unreliable in short time-series and small cross-sectional samples.
Hedging with International Stock Index Futures: An Intertemporal Error Correction Model
Asim Ghosh
Saint Joseph 's University
Ronnie Clayton
University of Central Florida
Abstract
In this paper we extend the traditional price change hedge ratio estimation method by applying the theory of cointegration to hedging with stock index futures contracts for France (CAC 40), the United Kingdom (FTSE 100), Germany (DAX), and Japan (NIKKEI). Previous studies ignore the last period's equilibrium error and short-run deviations. The findings of this study indicate that the hedge ratios obtained from the error correction method are superior to those obtained from the traditional method as evidenced by the likelihood ratio test and out-of-sample forecasts. Using the procedures developed in this paper, hedgers can control the risk of their portfolios more effectively at a lower cost.
An Empirical Study of a New Class of No-Arbitrage-Based Discrete Models
Ah Boon Sim
University of New South Wales
David C. Thurston
Henderson State University
Abstract
We present empirical tests of the new no-arbitrage-based term structure paradigm in discrete time. We derive and test empirical specifications for deterministic one-factor forward rate volatility models and examine the compatibility of these forward rate volatility functions using term structure dynamics. Our estimation technique uses the generalized method of moments and is based on forward bond price deviations. We do not impose restrictions on the market price of risk, and we incorporate all available term structure information. Our data consist of four sets of pure discount bonds derived from the CRSP bond files and the U.S. Treasury bill quotes.
The Cross-sectional Effects of Option Listing on Firm Stock Return Variances
Bruce D. Niendorf
University of Montana
David R. Patterson
Florida State University
Abstract
We develop a set of hypotheses to explain cross-sectional differences in variance changes associated with option listing. Transactions variance is decomposed into three components: the bid-ask spread, return autocorrelations, and intrinsic variance. Each is investigated separately. We find support for hypotheses that link: (1) changes in dealer transactions costs to changes in the bid-ask spread following option listing; (2) changes in the quantity and quality of information and the value of new information to movements of the return autocorrelation structure toward zero; and (3) changes in trading volume and the clientele that trades the underlying security to changes in intrinsic variance following option listing.
Post-announcement Drifts Associated with Dividend Changes
Gil S. Bates
Morgan State University
Abstract
In this paper I assess the presence of post-announcement drifts associated with dividend changes after controlling for earnings surprises. All quarterly cash dividend changes announced by firms listed on the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) from 1974 through 1989 are examined. The results show that a significant post-announcement drifts associated with dividend changes are present after controlling for earnings surprises. However, the results are not conclusive on whether the market fully incorporates the simple time-series properties of dividends.
Wealth Effects of Enforcement Actions Against Financially Distressed Banks
Peter A. Brous
Seattle University
Keith Leggett
George Mason University
Abstract
We examine the stock price reaction for a sample of commercial banks to the signing of cease-and-desist orders, written agreements, and formal agreements with bank regulators. These agreements restrict financially distressed institutions from certain activities that may be perceived by the capital markets as favorable or unfavorable. Our finding of a significantly negative mean signing-day abnormal return suggests that these enforcement actions are not fully anticipated by the market and that, on average, these enforcement actions are perceived as being unfavorable for bank shareholders. Our cross-sectional analysis suggests that at least part of the problem associated with financially distressed federally insured commercial banks. Although these actions are beneficial to both the federal deposit insurer and ultimately taxpayers, we interpret the cross-sectional findings as implying that regulators are not acting in a timely fashion to restore the financial health of these distressed banks. Even though equity values fall, on average, when banks are faced with an enforcement action, our findings do not support the pre-FIRREA policy not to publicly disclose the signing of enforcement actions because the enforcement action itself is not the source but is merely a reflection of the bank's problems.
Trading of NASDQG Stocks on the Chicago Stock Exchange
Sie Ting Lau
Nanyang Technological University
Michael S. McCorry
University of Sydney
Thomas H. McInish
The University of Memphis
Robert A. Van Ness
Christian Brothers University
Abstract
We use a linear programming model to form two portfolios with approximately equal levels of attributes such as financial leverage. One portfolio comprises stocks that trade exclusively on NASDAQ (CSE/NASDAQ). We find that spreads are lower for the CSE/NASADAQ portfolio, but so is the percentage of quotes at spreads of $0.125. In fact, the lower spreads observed for the CSE/NASDAQ portfolio arise from fewer quotes with spreads of more that $0.25.
Bivariate Binomial Options Pricing with Generalized Interest Rate Processes
Jimmy E. Hilliard
University of Georgia
Adam L. Schwartz
University of Miami
Alan L. Tucker
Pace University
Abstract
We extend existing pricing models and develop a bivariate binomial option pricing technique that accommodates correlated state variables. This technique offers the ability to price American-style options, thereby accommodating early exercise, despite the existence of two correlated underlying state variables. Our technique is computationally efficient and can be further generalized for multiple-state variables, albeit with an accompanying rise in computational expense.