This study empirically tests contingent claims pricing models for American currency spot and futures options. Numerical analysis indicates that the difference in the model prices of spot and futures put (call) options (with the same exercise price and maturity) is, for a premium (discount) currency, positive and an increasing function of (a) the absolute difference in the prices of the underlying spot and futures contracts and (b) the maturity of the options. Tests on British pound, Deutsche mark, and Swiss franc options indicate many violations of the ordinal pricing relationships noted above. Additional tests indicate that option prices are inconsistent with functional relationship (b) above. Most of the observed violations are sufficiently large to provide arbitrage profits net of transaction costs, assuming interest rates are constant and the Interest Rate Parity theorem holds continuously. Alternatively, both the violations and the inconsistent functional relationship may be due to violation of the assumption of constant interest rates.

This paper explores implications of differential personal taxation for corporate investment and dividend decisions. The personal tax advantage of dividend deferral causes shareholders to generally prefer greater investment in real assets under internal as opposed to external financing. Furthermore, dividend deferral is shown to be costly at the corporate level, causing shareholders in different tax brackets at times to disagree over optimal investment and dividend policies under internal financing. The profitability of internally-financed security investment is shown to depend on a security's tax status and shareholders' tax brackets. However, externally-financed security purchases are unprofitable from a tax standpoint.

Among the elements of value reflected in the prices of corporate securities are the taxtiming options associated with the opportunities for investors to tax manage their portfolios by deferring gains and taking losses. We show that the aggregate value of these taxtiming options for the securityholders of a firm will be enhanced when the firm has multiple classes of tradeable securities outstanding. For that reason, the inclusion of debt as well as equity in a firm's capital structure should raise the total market value of the firm. We further show that, under most likely circumstances, there will be an interior optimal degree of leverage that will maximize tax-timing option values.

The federal funds rate arguably is the most important interest rate in the U.S. capital market because it plays a central role in monetary policy and the term structure. This paper examines the micromechanics of the funds market. We show that in a continuous market with asynchronous trading, regulatory constraints and accounting conventions that focus agents' attention on discrete time instants have important implications for the dynamics of trading activity and realized market prices. We also exhibit a model of the market that explains observed regularities in the intertemporal behavior of the funds rate.

This paper examines the intertemporal behavior of the short-term rate of interest in a mean-reverting model (Vasicek's elastic random walk model). Using the Goldfeld-Quandt switching regressions technique, we show that the mean-reverting model switched regimes three times over the sample period (March 1959 to December 1985) and that two of these switches coincide with the 1979 and 1982 changes in Federal Reserve monetary policy on interest rates. Parameter estimates prove to be unstable over the sample period. There is evidence of slow mean reversion over the entire sample period; yet significant mean-reversion emerges only in the 1979n1982 regime.

Previous investigators have shown that the Sharpe measure of the performance of a managed portfolio may be flawed when the portfolio manager has market timing ability. Herein we develop the exact conditions under which the Sharpe measure will completely and correctly order market timers according to ability. The derived conditions are necessary, sufficient, and observable. We compare these derived conditions to empirical estimates of actual market conditions and find that, under typical market conditions, the practice of using quarterly portfolio return data will frequently result in a failure of the Sharpe measure to order timers according to ability. We show, however, that such failures can be greatly reduced by more frequent sampling of managed portfolio returns.

This paper presents a test of the theory of rational option exercise. Exercise data from the market for options on Treasury bond futures are used to test the model of rational early exercise developed by Barone-Adesi and Whaley (1987) (BAW). The results show that the BAW model underestimates the futures price that will trigger exercise for calls and overestimates this price for puts. The exercise bias is observed to change across option maturities and the direction of the bias is consistent with the direction of the model-pricing bias observed by Whaley (1986).

This paper analyzes the correspondence between arbitrage sector pricing efficiency and the short-term hedging costs and effectiveness of futures contracts. Reversals of initial contract mispricings by arbitrage sector trading leads to an important mispricing return component in the total return to hedge portfolios. The existence of the mispricing return has implications for initial hedge ratio selection, hedging effectiveness, and expected hedge return. The analysis is used to interpret the hedge ratio guidance and performance of short-term hedges between the Standard and Poor's 500 stock index futures contract and the underlying S&P 500 cash stock index portfolio over the 1982–1986 period.

In a perfectly efficient market, after adjusting for drift, futures prices would follow a martingale model. The martingale property implies that the changes in futures prices should be serially uncorrelated. This study finds that the price changes of the S&P 500 futures contracts during 1983 and 1984 have negative serial correlation and are better described by a random walk model with reflecting barriers or by a random walk model with reflecting barriers and mean reversion.

Mikkelson, W., and M. Partch. “Withdrawn Security Offerings,” Journal of Financial and Quantitative Analysis, 23 (June 1988), 119-133.