Financial Theory II
Empirical Financial Economics

B40.2332.40, Spring 2000

Course Requirements

Syllabus

Textbook

References

Discussion Board

Sample Programs

There will be two major assignments and a final examination. The major assignment for the course requires students to replicate the major results contained in the following well known study using the latest available data and then update the study:

Fama, E., et al.,1969 The adjustment of stock prices to new information International Economic Review 10, 1-21.

An intensive series of tutorials on this assignment will be offered at a time and place to be determined. The second assignment is in the form of a two page research proposal. This proposal is to follow a very specific format:

Paragraph 3: Detailed and precise description of the data to be used in the study

Paragraph 4: Results you anticipate from this research. This is to be supported by a discussion of theory or of a simple pilot study of the empirical evidence.

Both assignments are due on the date of the final examination, but I will routinely grant incompletes (if requested in advance) for submission of the assignment no later than September 1. No assignments will be accepted later than September 1 and no deferrals will be accepted for any reason.

J. Campbell, A. Lo and A.C. MacKinlay (CLM), 1997, The Econometrics of Financial Markets (Princeton University Press, Princeton NJ).

The purpose of this class is to identify the Efficient Market Hypothesis as a central paradigm of empirical finance. The relationship between this concept and related Random Walk Hypothesis. Introduce the importance of sample design, and how sample selection bias can lead to false inferences in empirical study of the EMH.

We discuss recent advances in the empirical analysis of the Random Walk Hypothesis. Show that these variance ratio tests are essentially tests of the overidentification restrictions implied by this hypothesis, and use this observation to provide a simple introduction and motivation for Hansen's Generalized Method of Moments.

Go through a detailed application of GMM in the context of semistrong tests of the EMH. Show how this relates to the Event Study paradigm. Analysis of the Event Study paradigm in the context of the classic paper by Fama Fisher Jensen and Roll. Are event studies applied data analysis or studies of information equilibria? Discuss the relationship between abnormal performance measures and value of private information measures. Identify the sample selection bias problem as the chief difficulty in FFJR ... and in all event studies where the events are not exogenous but are actions of managers.

A discussion of the empirical issues of event studies. Identify the central role of interpretation in the context of event studies; the choice of statistical methodology is of a second order of importance. Introduce the importance of the Power of the Test as an important criterion in finance applications. Use the Brown Warner experimental design to motivate the Bootstrap procedure.

Discussion of the event study literature subsequent to Brown Warner. Improved statistical methodology adds insight and understanding but limited practical value added. Emphasize the central importance of Acharya's contribution in casting event studies into a more general information economics perspective and providing a practical resolution of the endemic sample selection bias issue.

Review of the empirical asset pricing literature with emphasis on the methodological issues. Are we modelling the cross section variation in expected returns (Gibbons), or the efficiency of the market (Fama and MacBeth)? The Roll critique addresses the power of the latter test. Roll's answer in the context of his interpretation of the Shanken T² metric. Interpreting departures from CAPM.

Discussion of empirical implementation of APT and Multibeta models. The Shanken paradox. Role of principal components.

The Shanken paradox resolved. The McElroy Burmeister paradigm as a framework for the empirical analysis of CAPM, Multibeta and APT models. Time-varying risk premia.

The empirical implications of multiperiod equilibrium asset pricing models. Consumption based asset pricing models and term structure models. Important moment restrictions that arise from this analysis. Relationship to EMH paradigm.

Review a few of the better known anomalies studies, again not with emphasis on their specific content, but rather on experimental design considerations. Here, sample design and appropriate conditioning issues are perhaps more apparent than in other areas.

A careful analysis of the ex-post conditioning issues that arise in performance measurement and other contexts of empirical finance.

Acharya, S., 1988, A generalized econometric model and tests of a signalling hypothesis with two discrete signals Journal of Finance 43(2), 413-429.

Ball, R. and P. Brown, 1968 An empirical evaluation of accounting income numbers Journal of Accounting Research 6, 159-178

Ball, R., S. Kothari and J. Shanken, 1995, Problems in measuring portfolio performance: An application to contrarian investment strategies Journal of Financial Economics 38, 79-107.

Barry, C. and S. Brown, 1984 Differential information and the small firm effect Journal of Financial Economics 13, 283-294

Basu, S., 1977 Investment performance of common stocks in relation to their price-earnings ratios Journal of Finance 32, 663-682

Berk, J. 1995, A Critique of Size-Related Anomalies The Review of Financial Studies 8, 275-286.

Bhattacharya, M., 1983 Transactions data tests of efficiency of the Chicago Board Options Exchange Journal of Financial Economics 12, 161-186

Black, F. and M. Scholes, 1973, The pricing of options and corporate liabilities Journal of Political Economy 81, 637-659

Boudoukh, J., M. Richardson and R. Whitelaw, 1994, A tale of three schools: Insights on autocorrelations of short horizon stock returns Review of Financial Studies 7, 539-573.

Brown, P. et al., 1983 New evidence on the nature of size related anomalies in stock prices Journal of Financial Economics 12, 33-56

Brown, R. and S. Schaefer, 1994 The term structure of real interest rates and the Cox Ingersoll and Ross model Journal of Financial Economics 35, 3-42.

Brown, S. and P. Dybvig, 1986, The empirical implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates Journal of Finance 41(3), 617-632.

Brown, S. and T. Otsuki, 1993, Risk premia in Pacific-Basin capital markets Pacific-Basin Finance Journal 1, 253-261.

Brown, S. and J. Warner, 1980 Measuring security price performance Journal of Financial Economics 8, 205-258

Brown, S. and J. Warner, 1985 Using daily stock returns: The case of event studies Journal of Financial Economics 14, 3-31

Brown, S. and M. Weinstein, 1983 A new approach to testing asset pricing models: The bilinear paradigm Journal of Finance 38 711-743

Brown, S. and M. Weinstein, 1985 Derived factors in event studies Journal of Financial Economics 14, 491-495

Brown, S. 1989 The number of factors in security returns Journal of Finance44, 1247-1262.

Brown, S., W. Goetzmann, R. Ibbotson and S. Ross, 1992, Survivorship Bias in Performance Studies Review of Financial Studies 5, 553-580.

Brown, S., W. Goetzmann and S. Ross, 1995, Survival Journal of Finance 50, 853-873.

Burnside, C. 1994, Hansen-Jagannathan Bounds as Classical Tests of Asset-Pricing Models Journal of Business and Economic Statistics 12, 57-79.

Chen, N-F., 1983 Some empirical tests of the arbitrage pricing theory Journal of Finance 38, 1393-1414

Chen, N-F., R. Roll and S. Ross, 1986 Economic forces and the stock market Journal of Business 59 383-403

Connor, G. and R. Korajczyk, 1988, Risk and return in an equilibrium APT: Application of a new test methodology Journal of Financial Economics 21, 213-254.

Cowles, A., 1933 Can stock market forecasters forecast? Econometrica 1 309-325

Dybvig, P., and S. Ross, 1985, Yes, the APT is testable Journal of Finance 40, 1173-1188.

Elton, E., M. Gruber, S. Das and M. Hlavka, 1993, Efficiency with costly information: A reinterpretation of evidence from managed portfolios Review of Financial Studies 6, 1-22

Fama, E., 1984a The information in the term structure Journal of Financial Economics 13, 509-528

Fama, E., et al.,1969 The adjustment of stock prices to new information International Economic Review 10, 1-21.

Fama, E., 1984b Term premiums in bond returns Journal of Financial Economics 13, 529-546

Fama, E., 1965 The behavior of stock market prices Journal of Business 38, 34-105

Fama, E. and J. MacBeth, 1973 Risk, return and equilibrium: Empirical tests Journal of Political Economy 71 607-636

Fama, E. and K. French, 1992, The cross-section of expected stock returns Journal of Finance 47, 427-466.

Franks, J., R. Harris and S. Titman, 1991, The postmerger share-price performance of acquiring firms Journal of Financial Economics 29, 81-96.

Ferson, W. and M. Gibbons, 1985, Testing asset pricing models with changing expectations and an unobservable market portfolio Journal of Financial Economics 14 217-236.

French, K., A comparison of futures and forward prices Journal of Financial Economics 12, 311-342.

French, K. and R. Roll, 1986 Stock return variances: The arrival of information and the reaction of traders Journal of Financial Economics 17, 5-26

Gallant, R., P. Rossi and G. Tauchen, 1992, Stock prices and volume Review of Financial Studies 5, 199-242

Gibbons, M., and K. Ramaswamy, 1993, A test of the Cox, Ingersoll and Ross model of the term structure Review of Financial Studies 6, 619-658

Gibbons, M., 1982 Multivariate tests of financial models: a new approach Journal of Financial Economics 10 3-27

Galai, D., 1977 Tests of maret efficiency of the Chicago Board Options Exchange Journal of Business 50 167-197

Guedes, J. and R. Thompson, 1995, Tests of a signalling hypothesis: The choice between fixed- and adjustable-rate debt The Review of Financial Studies 8, 605-636.

Hansen, L.P. and K.J. Singleton, 1982b, Generalized instrumental variables estimation of nonlinear rational expectations models Econometrica 50(5), 1269-1286.

Hansen, L.P. and R.J. Hodrick, 1983, Risk averse speculation in the forward foreign exchange market: An economic analysis of linear models, in: J.A. Frenkel, ed., Exchange Rates and International Macroeconomics (University of Chicago Press, Chicago IL) 113-152.

Hansen, L. and R. Jagannathan, 1991, Implications of security market data for models of dynamic economies Journal of Political Economy 99, 225-262.

Hansen, L.P. and K. Singleton, 1983, Stochastic consumption, risk aversion, and the temporal behavior of asset returns Journal of Political Economy 91(2), 249-265.

Hansen, L.P. and K.J. Singleton, 1982a, Large sample properties of generalized method of moments estimators Econometrica 50(4), 1029-1054.

Hansen, L., J. Heaton and E. Luttmer, 1995, Econometric Evaluation of Asset Pricing Models The Review of Financial Studies 8, 237-274.

Harvey, C., Predictable risk and returns in emerging markets The Review of Financial Studies 8, 773-816.

He, J., L. Ng and C. Zhang, 1996 Asset pricing specification and performance evaluation Working paper, City University of Hong Kong.

Jensen, M. and R. Ruback, 1983 The market for corporate control Journal of Financial Economics 11, 5-50

Klemkosky, R. and B. Resnick, 1979, Put-call parity and market efficiency Journal of Finance 34, 1141-1155.

Lehmann, B. and D. Modest, 1988, The empirical foundations of the arbitrage pricing theory Journal of Financial Economics 21, 213-254

Litzenberger, R. and K. Ramaswamy, 1979 The effect of personal taxes and dividends on capital asset prices: Theory and empirical evidence Journal of Financial Economics 7, 163-196

Lo, A. and A.C. MacKinley, 1988, Stock market prices do not follow random walks: Evidence from a simple specification test Review of Financial Studies 1(1), 41-66.

Lo, A. and C. MacKinlay, 1990, Data-snooping biases in tests of financial asset pricing models Review of Financial Studies 431-468.

MacBeth, J. and L. Merville, 1979, An empirical examination of the Black-Scholes call option pricing model Journal of Finance 34, 1173-1186.

MacKinlay, C., 1995 Multifactor models do not explain deviations from the CAPM Journal of Financial Economics 38, 3-28.

Malkiel, B., 1977 The valuation of closed end investment company shares Journal of Finance 32, 847-859

Mandelkar, G., 1974 Risk and return: The case of merging firms Journal of Financial Economics 1, 303-335

Manaster, S. and R. Rendleman, 1982, Option prices as predictors of equilibrium stock prices Journal of Finance 37, 1043-1058.

McElroy, M., and E. Burmeister, 1988, Arbitrage pricing theory as a restricted nonlinear regression model Journal of Business and Economic Statistics 6(1), 29-42.

Ohlson, J. and S. Penman, 1985 Volatility increases subsequent to stock splits: An empirical aberration Journal of Financial Economics 14, 251-266

Ohlson, J. and J. Patell, 1979 Residual (API) analysis and the private value of information Journal of Accounting Research 17,504-549

Patell, J. and M. Wolfson, 1984 The intraday speed of adjustment of stock prices to earnings and dividend announcements Journal of Financial Economics 13, 223-252

Reinganum, M., 1983 The anomalous stock market behavior of small firms in January Journal of Financial Economics 12, 89-104

Reinganum, M., 1981 Misspecification of capital asset pricing: Empirical anomalies Journal of Financial Economics 9, 19-46

Richardson, M. and T. Smith, 1991, Tests of financial models in the presence of overlapping observations, Review of Financial Studies 4, 227-254.

Roll, R., and S. Ross, 1980 An empirical investigation of the arbitrage pricing theory Journal of Finance 35, 1073-1103

Roll, R., 1977 A critique of the asset pricing theory's tests Journal of Financial Economics 4 129-176

Roll, R., 1985 A note on the geometry of Shanken's CSR T² test for mean/variance efficiency Journal of Financial Economics 14, 349-358

Ross, S., 1987, Regression to the max (Unpublished working paper, Yale University)

Schipper, K., and R. Thompson, 1983, The impact of merger related regulations on the shareholders of acquiring firms Journal of Accounting Research 21, 184-221

Shanken, J., 1982 The arbitrage pricing theory: Is it testable Journal of Finance 37, 1129-1140

Shanken, J., 1985a Multi-beta CAPM or equilibrium APT?: A reply Journal of Finance 40, 1189-1196

Shanken, J., 1982, The arbitrage pricing theory: Is it testable? Journal of Finance 37, 1129-1140.

Shanken, J., 1985b Multivariate tests of the zero-beta CAPM Journal of Financial Economics 14, 327-348

Shanken, J., 1987, Multivariate proxies and asset pricing relations: Living with the Roll critique Journal of Financial Economics 18, 91-110.

Shanken, J., 1992, On the estimation of beta pricing models Review of Financial Studies 5, 1-34.

Thompson, R., 1985, Conditioning the return-generating process on firm specific events: A discussion of event study methods Journal of Financial and Quantitative Analysis 21, 184-221.

Zhou, G., 1994 Analytical GMM tests: Asset pricing with time varying risk premiums Review of Financial Studies 7, 687-709.


		*Financial Theory II* *Empirical Financial Economics* *B40.2332.40, Spring 2000*

			Course Requirements

			Syllabus

			Textbook

			References

			Discussion Board

			Sample Programs