A generalized econometric model and tests of a signalling hypothesis with two discrete signals

Article Abstract:

To test the major prediction of a signalling hypothesis - that the market price is monotonic in the signal - the price response to the signal must be measured. Since a signal is an outcome of a rational decision rule of the signaller, the market can infer the true type of the signaller from the signal. This necessitates estimation of the price response to the signal, conditional on the rational decision rule. Thus, the empirical models (e.g., event studies in corporate finance) that estimate the market price responses to signals without conditioning on the rational decision rules are misspecified if viewed as tests of the prediction of a signalling hypothesis. This paper builds a generalized econometric model with two possible discrete signals, derives the rational decision rules, presents a simple estimator of the price response to a signal, and illustrates its use in testing a recently expounded hypothesis that firms signal their true value by forcing or not forcing an outstanding convertible bond. (Reprinted by permission of the publisher.)

Models, Econometrics

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Financial investment opportunities and the macroeconomy

Article Abstract:

This paper studies the relation between changes in financial investment opportunities and changes in the macroeconomy. States variables such as the lagged production growth rate, the default premium, the short-term interest rate and the market dividend-price ratio are shown to be indicators of recent and future economic growth. Further, the market excess return is negatively correlated with recent economic growth and positively correlated with expected future economic growth. These results offer straightforward interpretations of recent evidence of the forecasts of the market excess return by state variable via their forecasts on the macroeconomy. (Reprinted by permission of the publisher.)

Research, Investments, Economic research, Economic indicators, Macroeconomics

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