Article Abstract:
In a recent article, Black (1) introduces a type of trading that he terms noise trading. He asserts that noise trading, which he defines as trading on noise as if it were information, must be a significant factor in securities markets. However, he does not provide an explanation of why any investors would rationally want to engage in noise trading. The goal of this paper is to provide such an explanation for one type of investor, managers of investment funds. As shown here, the incentive for a manager to engage in noise trading arises because of the positive signal that the level of the manager's trading provides about his or her ability to collect private information concerning current and potential investments. If the manager's compensation is directly related to investors' perceptions of his or her ability, the manager will then trade more frequently than is justified on the basis of his or her private information. In addition to providing this explanation for noise trading, the results of this analysis may also be useful for further empirical exploration of the relation between investment fund portfolio turnover and subsequent performance. (Reprinted by permission of the publisher.)
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Article Abstract:
This article develops ways to endogenize the borrowing constraints used in a class of computable incomplete markets models. We allow the constraints to depend on an investor's characteristics such as time preference, risk aversion, and income streams. The proposed constraint can be interpreted as a borrowing limit within which an investor has no incentive to default. Using a numerical algorithm, we find that for an array of structural parameters, the endogenous borrowing constraints can be much less stringent than the ad hoc borrowing constraints adopted by the existing studies. (Reprinted by permission of the publisher.)
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Article Abstract:
Both short-term financing and the issuance of callable bonds can be used by a corporation to finance itself while indicating its brighter economic prospects in the future. However, the short-term financing is associated with weakened risk-sharing on capital markets, according to this study. Equity issuances generate better risk-sharing. The analysis seeks to explain the highly infrequent occurrence of long-term, non-callable bonds issued to finance corporations or support corporate capital structures.
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