Irrelevance Hypothesis Research Articles

Bayesian Flexible Local Projections

Abstract We develop a methodology to estimate impulse response functions via Bayesian techniques with the goal of providing a bridge between a linear vector autoregressive specification and a high-order polynomial local projection, namely flexible local projection. We label this methodology Bayesian Flexible Local Projection (BFLP). We assess the properties of BFLP in a Monte Carlo framework considering both linear and non-linear models as data generating processes. We also empirically illustrate how BFLP can be used with standard identification strategies. In particular, we show how to use external instruments to identify the effects of the monetary policy shock in the United States. Furthermore, exploiting the time-varying nature of the impulse response functions based on BFLP, we assess the zero lower bound irrelevance hypothesis and find no strong evidence that monetary policy was less effective in influencing output and inflation during the recent ZLB period.

Testing the Effectiveness of Unconventional Monetary Policy in Japan and the United States

The effective lower bound (ELB) on a short term interest rate may not constrain a central bank's capacity to achieve its objectives if unconventional monetary policy (UMP) is powerful enough. We formalize this 'irrelevance hypothesis' using a dynamic stochastic general equilibrium model with UMP and test it empirically for the United States and Japan using a structural vector autoregressive model that includes variables subject to occasionally binding constraints. The hypothesis is strongly rejected for both countries. However, a comparison of the impulse responses to a monetary policy shock across regimes shows that UMP has had strong delayed effects in each country.

Canada: The Inflation Irrelevance Proposition

The underlying thesis is that inflation does not impact in a significant way stock returns. A stronger thesis is that both domestic and foreign inflation rates are neutral to stock returns. This joint hypothesis is tested for Canada, using 5 theoretical models that describe the determinants of Canadian stock returns. These models range from the most stripped one to the least constrained. All 5 models produce evidence of the strong inflation irrelevance hypothesis for the two key variables, Canadian and foreign (US) inflation rates. Naturally, the largest theoretical model is to be selected for inference purposes. This model includes 12 explanatory variables: 2 inflation rates, 2 proxies for earnings, 2 local duration effects, 2 foreign (US) duration effects, the Canadian/US dollar foreign exchange rate, the price of oil, and two categorical variables that pick up the effect of foreign (US) stock markets. The results show that the model provides sign and size effects in conformity with expectations from the theoretical macroeconomic interrelationships. Hence, the paper, besides documenting inflation neutrality, models in a meaningful manner the determinants of the stock market. All in all the empirical results are largely supportive.

Global Demand Spillovers Near the Zero Lower Bound

This paper revisits the Zero Lower Bound (ZLB) irrelevance hypothesis from a multi-country perspective, investigating country-specific adjustment to external world shocks across a panel of 17 advanced economies from 1979 to 2019. To quantify world shocks, a broad set of real commodity prices are used to proxy global demand pressures. I then document a robust threshold in policy rates lying between 2.5% and 3.5%, below which global demand spillovers to domestic financial markets and economic activity rise substantially. These magnified spillovers near the ZLB persist after controlling for the post-2008 period, economic boom-bust cycles, secular time trends, and commodity exporters. Estimates from a threshold-augmented VAR further show that global demand shocks near the ZLB induce magnified financial and real adjustment along with rising real interest rates. Meanwhile, the economic expansion associated with a 1 percentage point drop in idiosyncratic long-term bond yield innovations offsets completely the average impact of global demand spillovers near the ZLB. This suggests that magnification near the ZLB is relevant, yet potentially countered by endogenous unconventional monetary policies targeting long-term yields over the same period.

Global systemically important banks regulation: Blessing or curse?

Do market participants believe that recent regulations will curb moral hazard at global systemically important banks (G-SIBs)? We analyze market returns to three events: the 2011 designation of certain banks as G-SIBs, the November 2014 identification of banks subject to additional capital surcharges, and the November 2015 announcement of Total Loss Absorption Capacity (TLAC) requirements. We find that reaction to the “designation event” fits the profit-based-reaction hypothesis, reaction to the “additional capital surcharges event” fits the regulatory burden hypothesis, and reaction to the “TLAC event” fits the irrelevance hypothesis. Weaker banks benefited more from being designated as G-SIBs, while EU banks suffered more from the additional capital surcharges.

On the Empirical (Ir)Relevance of the Zero Lower Bound Constraint

We evaluate the hypothesis that the zero lower bound (ZLB) constraint was, in practice, irrelevant during the recent ZLB episode experienced by the U.S. economy (2009Q1-2015Q4). We focus on two dimensions of economic performance that were ex-ante likely to have been affected by a binding ZLB: (i) the volatility of macro variables and (ii) the economy’s response to shocks. Using a variety of empirical methods, we find little evidence against the irrelevance hypothesis, with our estimates suggesting that the responses of output, inflation and the long-term interest rate were hardly affected by the binding ZLB constraint. We show how a shadow interest rate rule (which we take as a proxy for forward guidance) can reconcile our empirical findings with the predictions of a simple New Keynesian model with a ZLB constraint.

Abstracts

Abstracts

Stock Price Reactions on NASDAQ Stock Exchange for Special Dividend Announcements

Announcing dividend pay-out policy by a company will signals market firm’s future prospects and changes its stock prices according to dividend signalling theory. By analysis the effect of special dividend announcements for 5 companies listed in NASDAQ for the period of 2014-2018, this study investigates the stock price reactions to special dividend announcement for 40 days around the event and challenges dividend signalling theory. The empirical results calculated both in discrete and logarithmic forms. Only few disordered significant abnormal returns and average abnormal returns occurred according to the t-test. The results show that shareholders do not gain value from announcement of special dividend in NASDAQ stock exchange market. That Results indicated from adjusted market model in this research do not support dividend-signalling theory Hence do not confirm that the announcement of dividend has significant effect on price of shares. In general the results consistent with the Miller and Modigliani (1961) dividend irrelevance hypothesis.

When too much of a novel thing may be what's "bad": commentary on Fisher, Godwin, and Seltman (2014).

When too much of a novel thing may be what's "bad": commentary on Fisher, Godwin, and Seltman (2014).

Does the Capital Structure Really Matter? A Study from the United Kingdom

Among other things, the study employs time series and cross-sectional regressions to shed some intuitive light on the relevance of the Modigliani and Miller (1958) irrelevance hypothesis. Based on the principal objective of the study, I attempt to empirically examine the relationships between explanatory variables: capital structure (gearing ratio), debt tax shields, non-debt tax shields, asset structure and bankruptcy probability and the dependent variable: firm value. Based on the analysis of a set of ten UK industries, my findings are not compatible with the Modigliani and Miller (1958) propositions. The evidence is highly consistent with the Modigliani and Miller (1963) theoretical predictions about tax benefits. Therefore, capital structure really matters if firms judiciously use corporate debt. The study also sheds some insightful light on the inter-industry capital structure differences. Using a one-way ANOVA test, I find that various industries, subject to various nature of business, have developed characteristically different capital structures. Another persuasive and interesting findings that I have uncovered through this study are that, costs of debt are similar across a set of industries studied regardless of the capital structure.

A Note on Corporate Capital Structure Theories

Financial theory revolves around rational participants who want to maximize their utility or wealth for a given level of risk. This maximization, in the first place, calls for the optimality of available resources, making capital financing decisions critical for corporations. Any discussion on optimal capital structure leads back to Modigliani and Miller’s classical capital structure irrelevance hypothesis (1958), according to which, in an efficient market, the value of the firm is unaffected by its choice of capital structure in the absence of taxes, bankruptcy costs, and asymmetric information. This irrelevance makes the firm’s managers indifferent to opting for debt or equity in the firm’s capital structure.

Understanding Stock Price Volatility: The Role of Earnings

In an efficient capital market, asset prices vary when investors change their expectations about cash flows, discount rates, or both. Using dividends to measure cash flows, previous research shows that the aggregate dividend-price ratio varies due to changes in expected discount rates (returns) rather than expected cash flows. In contrast, using accounting earnings instead of dividends as a measure of cash flows, this paper shows that as much as 70% of the variation in the dividend-price ratio can be explained by changes in expected earnings. Moreover, the paper documents a significant negative correlation between expected returns and expected earnings, suggesting that variations in a common factor to both may generate significant price volatility. The results are consistent with the dividend-policy irrelevance hypothesis.

Understanding Stock Price Volatility: The Role of Earnings

In an efficient capital market, asset prices vary when investors change their expectations about cash flows, discount rates, or both. Using dividends to measure cash flows, previous research shows that the aggregate dividend-price ratio varies due to changes in expected discount rates (returns) rather than expected cash flows. In contrast, using accounting earnings instead of dividends as a measure of cash flows, this paper shows that as much as 70% of the variation in the dividend-price ratio can be explained by changes in expected earnings. Moreover, the paper documents a significant negative correlation between expected returns and expected earnings, suggesting that variations in a common factor to both may generate significant price volatility. The results are consistent with the dividend-policy irrelevance hypothesis.

Why are firms with entrenched managers more likely to pay dividends?

Purpose – The purpose of this paper is to examine the relation between managerial entrenchment and dividend policy for a large number of US industrial firms and examine the relative importance of three competing explanations behind the empirical association between managerial entrenchment and dividend policy, namely, the entrenchment irrelevance hypothesis, the dividend signaling hypothesis, and the optimal entrenchment hypothesis.Design/methodology/approach – Utilizing all firms in the Investor Responsibility Research Center database, Compustat and center for research in security prices (CRSP), this paper investigates firm's propensity to pay dividends based on various logit and Tobit regressions as a function of managerial entrenchment measured by Gompers et al. G index after controlling for known determinants of firms' dividend decisions during the period from 1990 to 2003.Findings – Results show that firms with entrenched managers are more likely to pay dividends. Their high propensity to pay persists...

What Determines the Aggregate Dividend-Price Ratio? Earnings Versus Dividends

In an efficient market, prices should vary only if investors change their expectations about cash flows, discount factors, or both. Prior research showed that dividend yield varies mostly due to variation in expected returns, and contains little information about cash flow. This literature concentrates on dividend growth variation as cash flow information. However, according to Miller and Modigliani (1961) with no taxes, given earnings, dividends are strictly a financing decision and should not affect prices. Consistent with the dividend-policy irrelevance hypothesis, this paper shows that variation in expected profitability growth explains as much as 70% of the variation in the dividend yield. Thus, the dividend yield contains information about cash flows in terms of earnings, not dividends. In addition, this paper finds evidence consistent with a permanent shift in the dividend yield in the 90s. Controlling for this permanent shift, the results indicate that the dividend yield has not lost its ability to predict returns.

Asymmetries in the Use of Verbal Irony

Three experiments assessed four variables that may affect verbal irony processing: people’s expectations of events, event outcome, evaluations of outcome, and shared common ground. Reading times and rating tasks were used to quantify the interaction of these factors. The failed expectation hypothesis predicts an interaction of expectation, outcome, and evaluation. In contrast, the expectation irrelevance hypothesis states that expectation does not matter—only interactions between outcome and evaluation should result. The results provide support for the expectation irrelevance hypothesis. There were also consistent common ground effects: Statements directed at high common ground targets were read more quickly and rated as more ironic than statements directed at low common ground targets. These studies also provide online evidence of the asymmetry of affect (positive evaluations of negative outcomes are more ironic than negative evaluations of positive outcomes). Together, these experiments further elucidate the complex pragmatic factors that govern verbal irony comprehension.

An Empirical Examination of the Pricing of Seasoned Equity Offerings: A Test of the Signaling Hypothesis

This paper tests the predictions made by Signaling Theory against the competing Price–Irrelevance Hypothesis (Eckbo and Masulis, 1992). Signaling Theory suggests that the issue price of a security provides a signal of quality of the issuing firm. In contrast, the Price–Irrelevance Hypothesis suggests that equity pricing does not possess information content. This paper investigates the pricing of seasoned equity offerings by examining the role of firm quality and relative firm valuation on issue price discounts. Additionally, this paper investigates the relationship between the issue price discount and the market reaction at the issuance of seasoned equity offerings. The results indicate that firm quality does not have a significant impact on the degree of price discounting by the issuing firm. Relative firm market valuation does appear to be a determinant of the magnitude of discounting in setting the issue price. This paper also provides evidence that seasoned equity offerings firms that provide a lower issue-price discount experience a lower stock-price decline following the issuance as compared to firms offering a higher price discount.

Equity rights issues: Signalling vs issue price irrelevance hypothesis

AbstractThis study examines the relationship between common stock returns and the subscription price level of equity right offerings in Greece during the period 1981–90. the findings show that the associated stock returns are independent of the issue price. This evidence does not support the view that the issue price serves as a signal of the stock's true value.

Bankruptcy Risk and Optimal Capital Structure

ABSTRACTThis study finds shortcomings in empirical tests of the capital structure irrelevance hypothesis. The alternative hypothesis is that firms choose value maximizing mixes of debt and equity on account of bankruptcy costs and the tax deductibility of interest payments. Based upon the cross‐sectional implications of the tax shelter‐bankruptcy cost hypothesis, an alternative test of the irrelevance hypothesis is performed. The test examines the relationship between failure rates and leverage ratios for 36 lines of business. The results are inconsistent with the irrelevance hypothesis.

Dividend Policy and Capital Market Theory

THE reaction of investors to the dividend policy of the firm has received considerable attention during the last two decades. During this period two principal schools of thought emerged. The first, led by Myron Gordon (1959, 1962), suggested that dividend policy is relevant to security valuation; the second, led by Modigliani and Miller (1961), suggested that it is not. Although the lines between these two positions were drawn more than ten years ago, the issue concerning dividend relevance remains unresolved today.' The reason for the long duration of the controversy is the lack of unambiguous empirical evidence which strongly supports either of the two schools.2 During the last decade the research on capital markets conducted by Sharpe (1964), Lintner (1965), and Mossin (1966) brought to the field of finance the Capital Asset Pricing Model (hereafter, CAPM). This valuation model has provided the basis for a significant number of empirical studies ranging from the value of added disclosure requirements to the benefits of corporate mergers.3 Although it is customary in these studies to state the assumptions under which the CAPM was developed, the use of the model itself assumes implicitly that the degree to which the assumptions abstract from reality does not impair the model's usefulness as a testing device. One of the inherent assumptions in the use of CAPM concerns dividend policy. In this regard, using the CAPM implicitly assumes the irrelevance hypothesis indicating a strong tendency among scholars to accept the irrelevance position. The argument for this position initially spelled out by Modigliani and Miller (1958) is demonstrated through an analysis of (1) the rationality of the behavior of stockholders, and (2) market forces. It suggests that, as long as a firm's investment decisions are known, the capital market will evaluate the firm's shares according to its potential profitability. If certain shareholders prefer more cash income than dividends paid, they can obtain such by liquidating part of their stock holdings. Doing this, these investors would realize the same return as those who maintain their original stock holdings regardless of the firm's dividend policy.4 Contrary to this, the relevance school suggests that a payment of cash dividends by the firm to its shareholders has a significant impact on the valuation of its securities.5 The arguments set forth in support of this position vary from the informational content of dividends to the clientele effect and return prospects on retained earnings.6 The purpose of this paper is to present the results of a theoretical and empirical investigation of the dividend issue and to examine the implications of the findings in light of recent developments in capital market theory. The results of this study indicate, contrary to other recent studies,7 that investors do in fact have a net preference for dividends and, consequently, the practical use of the capital asset pricing model, which implicitly assumes investor indifference between returns in the form