Fundamental Investment Analysis

A liquidity trader wishes to trade a ?xed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases. In the presence of transaction fees, numerical simulations suggest that traders want to trade more frequently when price volatility goes up or liquidity declines.

In this chapter, I'll lay out the principal facts and controversies surrounding international flows of capital and their attendant risks. I'll review the perspectives of economic historians and economists on the implications of capital mobility, both during the first wave of globalization (prior to World War I) and during the recent wave (since 1980). I'll emphasize changes over time - especially political changes - that have weakened the case for unfettered capital mobility and have made capital flows more controversial among economists today than in the past.

A fictional example illustrates how interdependencies among products in the production process, and the costs associated with those interdependencies, challenge the ability of cost accounting systems to generate decision-useful product cost information. The cost interdependency in the current example is a production-line change-over cost that is incurred to retool a machine whenever the production process changes from one product to another.

We develop an equilibrium model to understand how the efficiency of capital allocation depends on outside investor protection and the external financing needs of firms. We show that when capital allocation is constrained by poor investor protection, an increase in firms' external financing needs may improve allocative efficiency by fostering the reallocation of capital from low to high productivity projects. We also find novel empirical support for this prediction.

In this paper, we analyze the optimal policy for a risk averse agent who wants to sell a large block of shares of a risky security in the presence of price impact and transactions costs. Our framework reduces to the standard Merton portfolio problem in the absence of any market frictions. Optimal liquidation results in revenue distributions which are substantially different from those generated by a naive strategy. The main tradeoff involves choosing between revenue distributions which have high means versus those which have low variances.

We investigate the ability of a tax-based fundamental –the ratio of tax-to-book income– to predict earnings growth and stock returns and to explain the earnings-price ratio. This tax fundamental reflects both temporary and permanent book-tax differences as well as tax accruals, such as changes in the tax valuation allowance. We find that the tax-to-book income ratio predicts subsequent five-year earnings changes, both before and after the implementation of Statement of Financial Accounting Standards (SFAS) No. 109 in 1993. For the pre-SFAS No.

Participants in 401(k) retirement plans violate the basic principle of diversification by investing significant fractions of their savings in their employers' equity. This paper characterizes investors' active changes to their company stock investment over time by analyzing new inflows and transfers. The average investor seems to base active changes on salient information, paying attention to past returns, volatility, and business performance.

In asset pricing models, the uncertainty surrounding firm fundamentals plays a central role, driving expected returns, volatility, and valuation ratios. In this paper, we extract estimates of the uncertainty embedded in earnings announcements using option prices. To do this, we take seriously the fact that the timing of earnings announcements, although not the response of equity prices, is known in advance. We develop a no-arbitrage option pricing model incorporating jumps on earnings announcement dates.